The Tribune, Chandigarh, India

PERSPECTIVE

'The biggest challenge for SEBI: Not enough Indians trust capital markets'
K. N. Vaidyanathan, Executive Director, Securities and Exchange Board of India, allayed investors' fears at The Tribune Talk organised on April 9 at Chandigarh. Excerpts from the address:

K. N. Vaidyanathan — Photo: Manoj Mahajan WHY is SEBI (Securities and Exchange Board of India) becoming a little more important? The first 15 years of SEBI (which was set up in 1992), I would say were consumed around secondary markets. Our country would, therefore, possibly be amongst the most advanced secondary markets in the world. A testimony of that is that in the 2008 crisis when countries like the US and the UK went through settlement problems, India was one of the countries that did not have any equity settlement problems. Yes, the market prices fell. We fell about 55 per cent from the top. But if you had sold shares, you got money; if you bought shares, you got shares. The entire settlement of the exchange worked because of the margining system that SEBI had regulated. And that protected investors' interests.

But in that process of focus on secondary market, two important components did not get much attention. One was primary markets and the other mutual funds. In my view, during the last three-four years of SEBI, I call it SEBI Version 2.0, which is a lot more focussed on the investors' protection. It is a lot more direct on investors' protection.

In the past when SEBI caught somebody for any malpractice, the common thing would be to levy a penalty on that person. And that penalty depended on the case. It would either go into something called investors' protection fund of SEBI or it would go to the Consolidated Fund of India. Neither of the two truly addresses the main point of the shareholder. If I have been jigged, what is the joy in getting the broker to pay that goes to the investors' protection fund or getting the company to pay to the investors' protection fund. It is me who has been affected.

For the first time consider what SEBI 1.0 did in the case relating to IPOs. This was about a bunch of people in Gujarat who had manipulated the allotment process to get more favours to them. As a first part of the exercise, SEBI found that the unlawful gain these people made was Rs 28 crore. So, as a first punishment these people were debarred from the market and fined and those Rs 28 crore was taken over. In SEBI 1.0 that would have been the end of the story.

In SEBI 2.0 what it did was to actually identify who were the people who would have otherwise got allotment. The Finance Minister actually chaired the function and SEBI returned these Rs 28 crore to about 10 lakh people. We have now established a track record of not only identifying manipulations, not only identifying the extent of unlawful gain; we have gone a step ahead to identify those who otherwise would have gained it. That to me is a major point of SEBI 2.0 because investors' protection otherwise is good lip-service. If you are not there to do what the investor wants you to do for them, then the investors' protection is just a slogan. It is not DNA. That is SEBI 2.0.

Another major initiative SEBI took is towards mutual funds. One of the self-serving myths promoted by brokers and distributors is that financial products are sold, not bought, which essentially means they believe that the actual customer or investor is a mediator. If they are suitably incentivised they can go and sell any product. The truth is far from it. The truth is because of all such practices capital markets have never gained the trust of Indian public. If you look at it, the penetration of bank deposits among Indian households is of the order of 55 to 60 per cent; the penetration of insurance in Indian household is about 20-25 per cent; the penetration of capital markets in Indian households is about 10 to 15 per cent.

I think the truth is out there. Not enough people trust and feel comfortable with capital markets. That to me is the biggest challenge for SEBI. And the biggest challenge manifests in two parts. One, how do we address mis-selling and how do we address mis-buying. In mutual funds what was happening was that there was an animal called distributor who was incentivised very differently to the investors. There was a component of mutual fund called entry load. Entry load was the amount of money that was deducted from your investment and paid to the distributor. It was a bad practice.

We are not saying that the distributor should not make money. We just wanted to bring transparency to this. So what did SEBI do? After new consultative process -- speaking to the industry, speaking to the non-industry people -- we believed that this was a very bad practice, so we abolished it. Again, it is important to remember in SEBI 1.0 it would have been acceptable to say - let us have variable load; let the customer sign on the application; let each person determine what it is. None of this would have addressed the issue of investors' protection as fairly and as squarely as the issue abolishing the entry load.

The entire mutual fund industry believed that SEBI was set to kill the industry. The mutual fund industry believed that this move of abolishing the entry load will, therefore, make distribution of mutual funds difficult in this country and, therefore, will do the biggest disservice to the industry. Unfortunately, for a few months thereafter, the industry found a net outflow from the mutual fund. It was extremely convenient for the industry to argue: See, I told you; people are leaving this industry.

The sad truth for the industry is no such thing has happened. People were leaving because they had come in at the top of the market in 2007 and in 2010 when they saw the market recovered and they got their cost back, they walked off. As the market corrected in 2010, a lot of people came in. Now, for the last four-months, the markets have corrected and become reasonable, we set a net inflow into the mutual funds. We have seen record sales of mutual funds. I am not here to say that the distributors are not important for the industry. But I am saying that it is important to set up economic incentives that will help longer term growth of the industry.

One was entry load; the second was new fund offerings. Every fund would compete with each other to keep launching new products but frankly the best story of India is India. If I am a money manager, I should take your money and say I will invest in India growth story. So If I look abroad, all big fund managers run single fund XYZ India fund. For example, the largest India fund is HSBC India fund and the fund manager is based in Singapore and they get retail subscription to it. That fund today is 8½ billion dollars. The JF India fund is a single fund which is two and half three billion dollars.

So the beauty of the India story is to raise money to say I will invest in India and I will identify the great stocks to invest in India but because of the vested interest of distributors and because they could earn not 2 per cent but 5 per cent commission if it was a new fund, all the fund houses kept launching new products and these new products have very creative means.

So after abolishing entry load we said enough of new products. There has to be such a compelling case to launch a new product and not only launch a new product, please go back and consolidating your existing products. Mutual funds are not designed to act as a custom solution for small groups of people. They are designed as mass products because that's the most efficient ways to challenge retail selling into capital markets. So we have been driving the industry to consolidate.

Since we abolished the entry load, that is, in August 2009 to March 2011, in about 20 months period, savings to the investors on account of the abolishing the entry tax have been
Rs 2,500 crore. I do not think any fiscal measure in India has ever been of that size. This amount has come out of distributors and has gone to the investors; yes, I agree that some distributors may have been affected, but they are few. The number of people affected by this are in minority and the people who have benefited are in millions and in majority.

The second is to reduce risk in the system. This is an industry which sold the riskiest product to the retail market and the least risky product to the institutional market or the corporate market. Somewhere there is a disconnect. So you would sell a 11-stock equity fund to retail customers and you would sell low risk in a government bond or corporate bond investing to banks and corporate institutions. I think somebody got his breakfast wrong. You should be offering the low-risk products to the mass retail audience because, believe me, if you tested over one, two or three years, if you have been investing in a low-risk debt products of mutual funds you would have earned at least 2.5 per cent more than bank deposits. But this product has very little, in fact close to zero retail participation, and it's the biggest segment of the mutual fund industry.

Of the Rs 6,26,000 crore invested in mutual funds, 40 per cent is retail, 60 per cent is institutional or corporate or banks, however, you call it. And the low risk is there. Going back to that example, we have a mutual fund which launched a 11 stocks equity fund. For example, if you are getting 11 stocks, the highest risk that you can take, of course, is the single stock but if you are betting into a fund and are buying a fund of 11 stocks, it's the highest risk that you can take. This fund was launched at the top of the market in 2008 and they have collected Rs 660 crore. The net asset value of the fund today is three rupees. There is a loss of 70 per cent. The retail investors' loss is 70 per cent. And in this fund the distributors of the fund were nowhere to be seen when I asked what was the promise you made to the investors.

The third initiative is to enhance services. As I said because the industry was a lot more distributor focussed, it is not too enough for investors. But in the mutual fund industry we are still in the 15-year-old technology. So you will have a folio in UTI equity fund within the same fund you will have a different folio. So if I get investor from the mutual fund I should get one single view of my position and that should tell me if I am getting or losing money but I should get it in one place.

Our orientation is get the industry to focus more on the investor so that he finds it easy to transact, cheaper to transact, less risky to transact and more convenient to transact. That's what we are trying to do at SEBI. So what it means to you the investor or the potential investor, I can put my hand on my heart and say that the Indian Mutual Fund is the cheapest regulated investment product not just in India but in a number of markets.

The money put aside for banking every year is Rs 4 lakh crore. The money put aside for insurance every year is Rs 1.5 lakh crore. But mutual funds in the best of years got Rs 25,000 to 30,000 crore. So the headroom for growth is phenomenal and now I think that we have created an environment which should give more comfort to investors.

As a regulator whether we are physically there or not, we have to feel your presence and that is achieved by a combination of things. And I call that combination reduce the cost of compliance, increase the cost of non-compliance. I am willing to reduce the cost of compliance if there is an increase in the cost of non-compliance. Unlike the past when if you did something funny and you were caught, you could get away with a Rs 2-10 lakh fine. So recently, SEBI passed an order against a large industrial house where the penalty amount was Rs 50 crore. That Rs 50 crore sent the message and I called it the cost of non-compliance. So we have to significantly raise the bucks. Across society people will get fear only if they know that if I get caught it is going to be a serious damage to me whether it's a businessmen or a public citizen. The respect for the law happens when the cost of non-compliance is known to be high.

But the challenge remains on investors' awareness. How do we popularise this? In India, given our natural distrust, as much as all the smart guys in suits and ties tell me that financial products are sold and are not bought, but the actual Indian real investor is far more discerning than he appears to be. He simply stays away from that market. I think the real message to send out is there is no short-cut in making money.

As a regulator, my task is not to encourage investment in mutual funds only, but my advice to all of you is that if you have some barrier in regard to investment in mutual funds, that barrier should be removed. And if Indians want to take risk, mutual funds offer a better option to direct investment.

OPED

Democratising Arab world
Guard against premature triumphalism
by Ash Narain Roy

Democracy grows differently on different soils. There is no universal model for democracy. If modern democracy travelled to the Arab world with a puzzling slow speed, there are reasons for it. When the Arab world bucked the global advance of democracy following the collapse of Marxism in the 1990s, it too had reasons. Today, when democracy seems to have arrived in some parts of the Arab world, long mired in undemocratic and authoritarian past, there is need to guard against premature triumphalism.

The drums of democratic change are, of course, beating. But a democratic Arab world by Western liberal standards may be long in coming, or may perhaps never come. The optimism about democratic future is mixed with fears.

The post-Cold War period saw Communist -era autocracies collapse like snowmen in a spring shower. In fact, three out of five states throughout the world embraced democracy. Every part of the globe became host to a significant democratic presence, with a single exception — the Arab world. Was this exceptionalism because of the historic baggage or colonial experience or simply because of culture and religion?

Various explanations are on offer. Some explain it in terms of a clash of civilisations. Others say democracy and Islam are like oil and water; they just do not mix. To say that Muslim culture is incompatible with democracy is too paternalistic a view that needs to be dismissed.

Edward Said, the iconic author of Orientalism offers the following explanation: “The absence of democracy is partially the result of alliances made between Western powers on one hand and minority ruling regimes or parties on the other.” Larry Diamond, author of The Spirit of Democracy says, “there is an Arab rather than a ‘Muslim’ democracy gap.”

Arabs argue that the absence of democracy is the result of an artificial territorial division of the Middle East by Europe’s First World War victors which created disparate societies with inevitable internal conflicts and allowed foreign-backed autocrats to rule. Massive amounts of foreign aid cemented that bargain.

It is, of course, easy to blame the foreign powers — from the Mongols to the Ottoman Empire, European colonialists, the United States and Israel — for the democratic deficit in the region. What about the people living at ease with “controlled democratisation”, the power structure that was centred around what was labeled as dimuqratita-al-khubz (democracy of bread)? Under this model, there existed a social contract in which the ruling dispensation provided social and economic welfare in return for political loyalty. Mubarak, Assad, Gaddafi, Saddam, they all practiced that model.

The region’s oil and gas helped to lubricate the bank accounts of dictators, got them the security forces to do the dirty job and emboldened them to buy off political dissent. The Arab ruling elite also used lack of progress in resolving the Palestinian issue as a cover to stall democracy demands.

The ouster of dictators is no guarantee of democracy taking roots in the desert of Arabia. Democracy is a tender plant that needs to be nursed. As Ron Chapman, a popular Dallas radio personality, says, “You cannot plant pineapples in the Arctic. Likewise, you cannot assume democracy will flourish in a region that has no history of representative government, individual freedoms, or human rights”.

The American Revolution took 25 years to run its full cycle. After 11 years of riots and tension, Americans finally drafted the Declaration of Independence. The Russian revolution started in 1917 with the overthrow of Czar Nicholas. It too began with a call for freedom. Unfortunately, that was soon followed by the Bolshevik revolution. It took 73 years for that revolution to run its course. And with what result? True democracy still eludes the Russian people.

It would be unrealistic, therefore, to expect democracy to suddenly spring from the desert sands of the Arabia. The Arab world will do well to learn the lessons from the various colour revolutions. The Arab spring has been likened to the Eastern European revolution of 1989. Even though the comparison is perhaps not too apt, the lessons from that experience, particularly from colour revolutions are very significant.

The 1989 revolution was a multiple revolution — which led to an implosion of a system (the command economy), the fall of an empire (the Warsaw pact), the withering of a state (the Soviet Union) and the collapse of a global ideology (Soviet communism).

The colour revolutions that followed in countries like Serbia (2000), Georgia (2003), Ukraine (2004) and Kyrgyzstan (2005) provide important lessons. Though each national experience was distinct, there were also some common features. The colour revolutions followed fraudulent elections by semi-autocratic regimes.

Though popular mobilisation was the driving force, the colour revolutions were also led by individuals who had already occupied high political positions. For example, Mikhail Saakashvili had been Georgia’s Justice Minister during Eduard Shevardnadze’s period as President before becoming the “rose revolution’s figurehead; Viktor Yushchenko had been Ukraine’s Prime Minister before the “orange revolution”. So was Kurmanbek Bakiyev in Kyrgyzstan.

However, the differences between the colour revolutions and the Arab uprising may be more instructive. In Georgia and Ukraine, people rebelled against political remnants of the Soviet era. The anger was against the old rulers unable to reform the political system and modernise the economy.

Georgia and Ukraine looked upon the former Soviet republics of Estonia, Latvia or Lithuania as a model, while they had barely begun a “transition” to western-style democracy and market economy. A peaceful revolution was a way to announce their detachment from the older generations for failing to be “modern” and “western”.

By contrast, the sheer hopelessness of the people especially youth against the tyrant rulers helped to drive the Arab movement. The social media too played a role in galvanising various groups. The west encouraged, supported, even financed the popular revolt in Serbia, Georgia and Ukraine. In the case of the Arab rebellion the West was nowhere on the scene. In fact, the West will be too nervous if these movements threaten the oil Sheikhdoms, particularly Saudi Arabia, for fear of disastrous consequences for its own economy.

The Arab democrats will also do well to learn from the outcome of the colour revolutions. The overthrow of an old dictator does not lead to a change in the system. In Ukraine, the post-orange revolution president Viktor Yushchenko failed to bring much change beyond holding free elections. Soon his rival Viktor Yanukovich captured power. In Georgia, Mikheil Saakashvili established a centralised government where Parliament was under the complete control of the ruling party, and the media had even less freedom after the change. In other words, the end result of the rose revolution in Georgia strongly resembles the starting point of Arab revolt.

The Arab revolution has started to lose momentum. While Gaddafi is proving to be a hard nut to crack, the US is not keen to destabilise the Assad regime in Syria. The Egyptians are now realising that the military is either unwilling or incapable of ushering in an era of true democratic reform.

The writer is Director, Institute of Social Sciences, New Delhi

Profile
A cardiologist and an activist
by Harihar Swarup

AN eminent cardiologist, Dr K. Srinath Reddy, has the distinction of keeping two Prime Ministers fit and healthy — P V Narasimha Rao and Dr Manmohan Singh. Dr Reddy is the President of the Public Health Foundation of India and till recently headed the Department of Cardiology, All India Institute of Medical Sciences. A world leader in preventive cardiology, Dr Reddy has provided an outstanding leadership in tobacco control.

Dr Reddy believes in keeping a low profile and he preferred to be in background till Dr Singh fell ill. As the head of the Prime Minister's health panel, he was thrust into the limelight. He has been quoted as saying the “PM’s physician should always be available but never visible”. The Prime Minister's Office, however, decided to change that when it was decided that Dr Reddy would be the single point of contact for media briefings during the PM's stay in hospital.

Dr Reddy came under criticism for advising the Prime Minister to go in for surgery. Many thought it would have been better if Dr Singh had opted for angioplasty. After the decision was taken Dr Reddy informed the PM’s family and the PM about various options and the best course of treatment. Dr Singh just took five minutes to say “on the balance of possibilities, let’s go for surgery”.

Dr Reddy has been quoted as saying “PM’s recovery is the fastest that I have seen in my career. He has tremendous will power. He kept on saying that he has to get back to work as soon as possible”. Dr Reddy became a hero for having taken all the right medical decisions.

The Public Health Foundation of India was conceptualised as a response to growing concern over emerging public health challenges in India. Having a corpus of Rs 230 crore, it is currently engaged in building critical research and institutional infrastructure in health.

Dr Reddy has also been involved in several major international and national research studies, including an INTERSALT global study of blood pressure and electrolytes, an INTERHEART global study on risk factors of myocardial infarction, national collaborative studies on epidemiology of coronary heart disease and community control rheumatic heart disease.

Widely regarded as a leader of preventive cardiology at the national and international levels, Dr Reddy has been a researcher, teacher, policy enabler, advocate and activist who has worked to promote cardiovascular health, tobacco control, chronic disease prevention and healthy living. He established school-based health promotion and youth-led health, advocacy programme through HRIDAY, with the active engagement of school and college students across India.

Not many know that Dr Reddy is a man of literary talent, a rare facet in a medical man’s personality. He has won literary awards, including the ECAAR Global Peace Essay contest ( adjudged by 11 Nobel laureates in 1992) and The Times of India essay contest on human rights. He was a prize-winning debater and quizzer at the university level. He was awarded Padma Bhushan in 2005.

On Record
Curbing corruption not easy, says Santosh Hegde
by Shubhadeep Choudhury

Santosh Hegde, Lokayukta of Karnataka and a former Supreme Court Judge, was among those who had drafted the original Jan Lokpal Bill along with others such as Anna Hazare, Kiran Bedi and Prashant Bhushan. Hegde has now been inducted as a member in the committee set up by the Union Government for re-drafting the Lokpal Bill.

In an interview with The Tribune in Bangalore, Hegde shared some of his concerns about corruption and the role of the Lokpal as envisaged by him.

Excerpts:

Q: You have been the Lokayukta of Karnataka for more than four and half years. Your tenure is coming to an end in July. Do you think you have been able to contain corruption in the state?

A: Containing corruption is not an easy job. Over the years, corruption has increased considerably. Tackling corruption will take its own time. There is no institution to act as a watchdog against corruption at the all India level. The Lokpal is supposed to fill up that vacuum. Even if we can bring corruption to the level it existed in the fifties or sixties, it will be a wonderful achievement.

Q: You did not mention your own achievement as the Lokayukta in eradicating corruption?

A: We have not been able to eradicate corruption. But through our actions we have been able to create awareness among the people on the issue of corruption and on the importance of their cooperation to fight it. The police is not able to stop all the crimes. Does it mean that we should close the police department? The elected governments are not able to meet all the aspirations of people. Should we stop electing governments because of that?

Q: There is a Central Vigilance Commissioner (CVC), besides the Prevention of Corruption Act to root out corruption. Is it necessary to have a Lokpal to act as a watchdog against corruption?

A: In 1966, when the Administrative Reforms Commission (ARC) prescribed the introduction of the Lokpal, the office of the CVC, the Anti-Corruption Bureau, etc, were already in existence. Still, the ARC recommended the introduction of the Lokpal and asked that all other anti-corruption outfits should be merged with it. If the office of Lokpal was set up as far back as 1966, all those scams now appearing in the media regularly would not have taken place.

Q: There is also a criticism that the agitation launched by Anna Hazare for a Lokpal with sweeping powers was extra-constitutional. Ideally, the move should have come from within Parliament.

A: There is nothing extra-constitutional about it. What can the civil society do if the parliamentarians sit over the ARC’s recommendation for more than 40 years? Since government functionaries would have faced the music if the Act had come into existence, the MPs did nothing for its implementation. It is the failure of parliamentarians that has forced the civil society to take up the cause. Bills are now passed in Parliament without any discussion. Many MPs do not even attend the session. People are generally quite fed up with parliamentarians.

Q: Is the Jan Lokpal Bill drafted by you and others is more stringent than the Lokpal Bill drafted by the government?

A: Yes. For instance, the government Bill did not include bureaucrats in its ambit. This loophole has been plugged in the new Bill.

Q: Besides corruption, public grievances have also been included in the purview of the proposed Jan Lokpal Bill. Some critics say that the Jan Lokpal should focus only on corruption. What is your take on it?

A: I fully support the inclusion of public grievances also in the ambit of the proposed Bill. Maladministration is often an act of corruption. For instance, all those pensions under the social welfare schemes are often given only to people close to the government. Other deserving candidates are left out. Similarly, some areas get good funding for development schemes while others do not get. It is essential that these discrepancies also are dealt with by the Lokpal.