Non-cooperation with the regulator led to ban on UBS
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What SEBI seeks to indicate is that FIIs are not above the country's regulatory system
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The investigation by sebi was aimed at finding out whether the market collapse was driven by vested interests.
ANXIOUS MOMENTS: Dealers surprised over the unexpected sharp fall in stock prices early on May 17, 2004, as Sensex fell by 15 per cent within few minutes and trading was suspended twice during the day.
THE DECISION by the Securities and Exchange Board of India (SEBI) to ban Swiss investment firm UBS Securities from issuing participatory notes and other offshore derivative instruments for one year is expected to have far-reaching implications in the regulation of the country's capital markets. The signal the decision sends is straightforward: foreign institutional investors (FIIs), for so long the darlings of the bourses, will not be treated with kid gloves any more by the market regulator. The thrust of SEBI's investigation was to pin down the manipulators who perpetrated the unprecedented market tumble of May 17, 2004, when the Sensex, the Bombay Stock Exchange's 30-share sensitive index, crashed by 842.37 points, the biggest intra-day crash in its 129-year history, and the Nifty, the National Stock Exchange's index, shed 193.65 points.
This happened in the immediate aftermath of the general elections that brought in the UPA government at the Centre.
To place the developments in perspective, UBS Securities has not been branded as one of the manipulators SEBI was going after; rather, it has been rapped on the knuckles for not cooperating with the regulator's investigation. "This is a well-reasoned and well-written order, a change from the past," said C. Achuthan, the former presiding officer of the Securities Appellate Tribunal, who declined to comment on the details of the order on the ground that the time to appeal against it has not passed.
The SEBI investigation was aimed at finding out whether the market collapse was driven by vested interests or whether it was a spontaneous response to the mood of the day. It appears from the order that there is no clear conclusion on the issue, but SEBI could not have been helped by the stonewalling tactics UBS adopted to avoid furnishing crucial details. What SEBI has clearly done, though, is indicate that FIIs are not above the country's regulatory system.
Misuse of PN route
There is a bit of history behind the recent rise and fall of the stock markets — and a strong connection to participatory notes (PNs), a derivative instrument issued by FIIs to foreign market players who do not wish to reveal their identities, or are not registered with the Indian regulator and are, therefore, barred from getting into the Indian market.
Regulatory authorities found, in early 2004, that a whopping Rs. 24,000 crores had entered the market through the PN route. This accounted for 25 per cent of the total FII investment (Rs. 90,000 crores) at the time. The fur started flying when the Reserve Bank of India indicated that there was a possible outflow of illegal money from the country, and that this was being pumped back into Indian stock markets through PNs.
The PNs are alleged to have come back by way of Mauritius, a route well known for money laundering. A similar phenomenon was noted during the stock market boom of 2000. Investigations into the Ketan Parekh-led scam of 2001 revealed that around $2 billion had been brought in or taken out of the country through overseas corporate bodies registered in Mauritius. The ultimate beneficiaries of these capital flows were resident Indians.
The uncovering of the journey the Rs. 24,000 crores had taken jolted SEBI. It responded, initially, by stating it would ban all investments made through PNs. The market reacted by beginning to fall. SEBI, in a volte-face, legitimised the PN investments it had just deplored. The then BJP government approved, and it had good reasons too: keeping the market buoyant was crucial to its `India shining' agenda. In this context, the observations made by the Joint Parliamentary Committee (JPC) on the market scam of 2001 are enlightening. It stated: "SEBI has expressed suspicion that some Indian promoters have purchased shares of their own companies through PNs issued through the sub-accounts of FIIs. This mechanism enables the holders to hide their identities and enables them to transact in the Indian capital market. The Committee notes that SEBI has since directed FIIs to report about the details of the PNs as and when issued by them. The Committee suggests that failure on the part of FIIs to report issue of PNs should be viewed seriously and should entail stringent punitive action. It should also be ensured that this instrument is not misused in any way to manipulate the Indian securities market."
In the case of UBS, the regulator concluded: "On a conspectus of the material particulars and the material developments in the case, the inexorable conclusion would be that UBS has totally failed to discharge its obligations to regulatory requirements, with a design to withhold critical information for stultifying the investigations. No matter what happens to information, the material point is that UBS has not complied with Regulations 15A, 20 and 20A of FII Regulations, and Clause 1,2,5 and 6 of code of conduct applicable to FIIs... "It is evident that UBS has failed to maintain high standards of integrity, fairness and professionalism in all dealings in Indian securities market with the regulatory authority. It has failed to exercise due diligence in dealing with its clients and with the regulator... UBS has made untrue statements and suppressed material facts in the documents, reports and information furnished to SEBI, while seeking to wriggle out of the regulatory requirements imposed on it."
SEBI contends that not only did UBS fail to furnish all the information it had, but even provided misleading information. This is a damning verdict on the conduct of a market player of the size and standing of UBS Securities. Plainly put, this was no innocent lapse by the investor. The RBI's warning of slush money entering Indian markets, made in January 2005, bears repetition in this context. RBI Governor Y.V. Reddy noted: "The magnitudes of FDI [foreign direct investment] and FII flows are tending to be large and volatility has perhaps increased. The impact of such flows on the stock markets is discernible, but perhaps less evident at this juncture in corporate ownership and control.......There is scope for enhancing the quality of flows through a review of policies relating to eligibility for registration as FIIs, and an assessment of the risks involved in flows through hedge funds, participatory notes, sub-accounts, etc. Strict adherence to the `know your investor' principle, especially in regard to flows from tax havens, including beneficial ownership, would enhance quality."
If UBS was betting it could get away with obfuscation and obstruction, it knows better now — perhaps.
Oommen A. Ninan
in Mumbai
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