[By Hemang Arora & Ayush Pratap Singh]
The authors are students of Gujarat National Law University.
Abstract
On 21 July, 2022, SEBI issued a consultation paper proposing to bring online bond trading platforms under its regulatory purview. The SEBI raised concerns in the paper regarding the lack of regulation surrounding these online bond trading platforms and therefore provided recommendations to address the same. SEBI thus recommended mandatory registration requirements, eligibility requirements etc., in order to address these concerns. This has come at a time when India is going through an evolution in its technological advancement, if we specifically talk about the securities market. This is evidenced by an approximate increase of six million retail investors within the Indian economy. The need for this regulation has arisen due to the sharp rise in retail investors in the country and the increasing knowledge of the common man in the field of securities.
Online bond trading platforms usually provide an electronic interface to users on which buying and selling transactions are routed through a recognised exchange.
Even though these bond platforms attract a variety of investors, especially non-institutional investors, the problem is that they are not subject to any regulatory oversight, meaning that the platform providers are not registered with any regulatory agency.
Analysis of SEBI’s Proposed Framework
Increase in the Number of Online Bond Trading Platforms
In the consultation paper, SEBI has noted an increase in the number of online bond trading platforms in India due to low-interest rates on Fixed Deposits and the appeal of such platforms to non-institutional investors
Issues Surrounding Online Bond Trading Platforms
SEBI has noted the increase in the number of investors on online bond trading platforms to be a positive sign but has also raised concerns that need to be addressed. The SEBI has provided a list of issues to be discussed.
- Lack of regulatory framework: SEBI has raised concerns about the lack of a regulatory framework governing online bond trading platforms and the lack of recourse for investors in the event of issues with transactions.
- No discernibility factor between listed and unlisted securities: Listed and unlisted securities are currently offered together on the same webpage, making it difficult for new investors to distinguish between them.
- No definite standard of KYC norms: SEBI observed that most of these platforms do not align and comply with the Prevention of Money Laundering Act, 2002 guidelines or SEBI KYC requirements.
- Improper and ambiguous redressal mechanisms: SEBI has emphasised the need for a framework for addressing investor grievances and providing an arbitration mechanism for dispute resolution on online bond trading platforms, similar to the Investor Services Cell on regulated platforms.
- Issues relating to conflict of interest, and mis-selling: SEBI has raised concerns about the potential for mis-selling of lower-rated securities as high-yield securities on online bond trading platforms, and the need for increased regulation if the platform has cross-holdings or management linkages with issuers.
- Deemed Public Issue (“DPI”): SEBI has raised concerns about the potential for the down selling of debt securities on private placement by online bond trading platforms to constitute a DPI. In some cases, the entire issue was reportedly down sold to over 200 investors within 15 days of allotment, according to SEBI data. SEBI has noted that the sale of securities on a private placement basis by online bond platforms to over 200 investors will violate Section 25(2)(a) of the Companies Act, 2013.
- Reporting of Trades: The current regulatory framework requires debt securities trading to be reported and settled through clearing corporations of exchanges. It is essential that online bond platforms be brought under this regulatory framework to ensure compliance with these provisions
- Issues relating to clearing and settlement: SEBI has observed procedural inconsistencies, including the bypassing of the role of stock exchanges and clearing corporations, in the processes followed by online bond platforms. In some cases, the platforms directly accepted funds from clients and processed security settlements through off-market mode, especially for unlisted bonds or transactions below Rs. 2 Lakhs.
Recommendations by SEBI
- Mandatory registration requirements: SEBI has proposed mandatory registration of online bond platforms as stock brokers with SEBI or by SEBI registered brokers to give investors confidence and ensure the application of stock broker regulations for investor protection.
- Eligibility requirements: According to the proposal by SEBI, the debt securities to be offered on the platform shall only be listed in nature.
- Addressing the concerns relating to DPI: To address the issue of DPI, SEBI has proposed that listed securities offered on online bond platforms be locked in for six months from the date of allotment by the issuer.
- Channelising transactions:
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- Exchange Platform-Debt Segment- SEBI has recommended routing transactions on online bond platforms through the trading platform of the debt segment of exchanges to reduce settlement risks and guarantee settlement on a T+2 basis.
- Request for quote platform (RFQ)- SEBI has also recommended using the RFQ platform of the Stock Exchange, where transactions will be settled and cleared on a Delivery Versus Payment (DVP-1) basis, as an alternative to the previously mentioned option
- SEBI has proposed that online bond platforms use Exchange platforms’ APIs to quickly integrate with Exchange systems. This proposal is similar to the trading mechanism used for equities transactions, in which stock brokers create their own front-end for clients to place orders, and the transactions are carried out on the trading platforms of the Exchange. This would allow the platforms to preserve their current web interface and display a list of available debt securities, ratings, risk information, and other details on their website.
Opinion of the authors on the Regulatory Framework
According to the authors, the benefits of the regulatory framework would be manyfold. For instance, the implementation of standard KYC norms and the applicability of a code of conduct applicable to stock brokers will ensure fairness. Further, the overall regulatory inspection and oversight shall bring investor confidence in the process.
If we talk about the routing of transactions, it would also bring about positive changes such as a robust management framework and surveillance mechanisms, fair and transparent pricing, guaranteed settlement etc.
While there are benefits to the framework proposed by SEBI, some of the recommendations are classic examples of a double-edged sword that need to be addressed:
SEBI has recommended that only listed debt securities would be eligible to be subscribed through the bond platforms. While this helps ease concerns relating to DPI in that currently, private placement of bonds has a limit of two-hundred investors. It has been noted that offering unlisted bonds on the bond platforms has automatically resulted in a DPI, as several bonds were sold to more than two-hundred investors. Thus in order to address this concern, SEBI made this recommendation. However, suppose we look at the other side of this recommendation. In that case, such a ban on unlisted securities could hinder the market’s growth as settlement of trades would potentially have to be done through routes that are not common practice these days.
Another recommendation/argument of SEBI that is a double-edged sword is when SEBI argues that online bond trading platforms lack a regulatory framework. It is pertinent to note that SEBI fails to make any mention of the SEBI (Merchant Banker) Regulations 1992, SEBI (Investment Advisers) Regulations 2013 and the SEBI (Research Analysts) Regulations 2014. This point holds huge significance since these regulations also provide requirements such as mandatory registration, and hence therein lies the possibility that online bond trading platforms come under the regulatory purview of the above-mentioned regulations. Taking this argument further, one of the recommendations given by SEBI in the consultation paper includes the mandatory requirement for bond platforms to register as stock brokers. This, according to SEBI, would bring about benefits such as an increase in investor confidence, the presence of a robust framework and other benefits, as discussed in the previous paragraphs of this section.
However, implementing such a recommendation could lead to issues of interpretation and applicability of the law. One of the issues could be that the regulations mentioned above would cease to apply to these platforms. This would actually remove the regulatory framework in place and would defeat the whole purpose of this alternative framework by SEBI.
Lastly, SEBI also has to be careful of not over regulating this bond platform market. Overregulation is something SEBI has previously been accused of. For instance, in the DLF case, the Securities Appellate Tribunal (“SAT”) came down heavily on SEBI and termed their activities as overregulation. DLF had filed an appeal for interim relief to SAT following the ban imposed on them by SEBI on accessing the capital market. One of the members of the bench of SAT remarked that, “You pass 10 such orders and the whole economy will crash. Is this regulation or abolition?… They (Sebi) are going more towards abolition mode than regulation…and it is clearly over-regulation. What do you get, what pleasure, out of such orders? You cannot recognise the effect of such orders. They are not to be called word-class regulators,”
Thus over-regulation is another example of how the implementation of these recommendations by SEBI could prove to be counter-productive.