Self-regulatory organisations (SROs) are defined as organisations of intermediaries which represent a particular segment of the securities market, and which act as a first level regulator regulating the members of that segment. In 2013, the Securities and Exchange Board of India (Sebi) initiated the process of selection of SRO for mutual fund distributors (MFDs), but the in-principle approval given to one of the entities was challenged. On being allowed to start the process afresh by the Supreme Court, Sebi sought leave from the apex court to make necessary amendments to the Self-Regulatory Organisations Regulations, 2004 (SRO Regulations), which was granted. Pursuant to this, on April 1, 2019, Sebi issued a Consultation Paper seeking comments from the public on the proposal to amend the SRO regulations.
Recognising the importance of SROs, Sebi proposes to recognise SROs based on a nomination process, instead of inviting applications. A nomination committee headed by a retired judge is proposed to be constituted to consider and give its recommendations to Sebi regarding the suitability of an organisation or entity to be recognised as an SRO. We believe that the nomination committee should ensure that the entity being nominated is promoted by appropriate people. For example, for SROs for MFDs and investment advisers (IAs), the nomination committee should ensure that the SRO is promoted by the market participants themselves. Allowing asset management companies (AMCs) to shoulder this responsibility, as discussed in the Consultation Paper, will not lead to the creation of an SRO in the truest sense. Giving the power to someone who is not ‘self’ would do violence to the language and the meaning of creating an SRO. Further, any entity created by AMCs would be in an adversarial position to the interests of the MFDs and IAs. Therefore, giving supervisory power to such an entity would be inappropriate and lead to a dysfunctional SRO.It is proposed in the Consultation Paper that the governing board of the SRO shall consist of elected representatives of members of SRO,
Sebi-nominated public interest directors and shareholder directors. With respect to SROs of MFDs and IAs, it is proposed that the governing board shall comprise not more than 25 percent shareholder directors, not more than 25 percent elected representatives and not less than 50 percent PIDs. We believe that the number of shareholder directors should be reduced. As an SRO is to be formed by the members themselves, they are adequately represented by the elected representatives. Any additional representation from promoter entities on the board should be restricted. This will ensure an appropriate balance between independent members and expertise on the board of an SRO. Further, it is proposed that the recognition granted to an SRO would be on a permanent basis, an increase from the five-year recognition provided in the SRO regulations currently.
On the question of whether there should be a single or different SROs for different classes of regulatees, especially regarding IAs and MFDs, we believe that there should be separate SROs. IAs do not restrict their advice to mutual fund products. They offer a wide range of services. Therefore, clubbing them with MFDs for the purposes of SRO may not be appropriate. At a future date, when a master SRO like Financial Industry Regulatory Authority (Finra) is created, the two can be subsumed within that. While SROs currently do not have the authority to levy monetary penalties, we believe that when a Finra-type entity is established, power to levy monetary penalties may also be granted to that master SRO. This will assist the master SRO to effectively exercise its mandate.
Further, ‘policy making’ should be added to the role of an SRO. SROs should be structured in line with international SROs, where SROs have the mandate and power to formulate policies for the industry.
Lastly, on the question of net worth, we opine that the net worth requirement should be completely removed. An SRO should be a body of competent professionals. A net worth of Rs 1 crore, as proposed in the Consultation Paper, is not conducive for the set up and functioning of an SRO. The operational costs can be compensated by the membership fees received from the market participants.
To conclude, the focus on introducing SROs for MFDs and IAs is a welcome development. But the real challenges will be witnessed only when these SROs actually start exercising their mandate. As is said, everything is subject to the test of time.
Sandeep Parekh is the managing partner and Raghuvamsi Meka is an associate at Finsec Law Advisors.