PR No. 93/2012

The second meeting of the International Advisory Board (IAB) of the Securities and Exchange Board of India (SEBI) was held on November 3-4, 2012 in Mumbai. Major issues discussed during the meeting are:

i. High Frequency Trading (HFT) & Algo Trading

The IAB discussed the recent flash crash episodes witnessed globally and in India. The pros and cons of HFT / Algo trading on capital formation, efficiency of secondary markets and fairness to market participants were intensely deliberated. It was acknowledged that nearly all financial markets across the globe have these issues and the International Organization of Securities Commissions (IOSCO) has been actively discussing ways in which regulators and exchanges should modify market structures to tackle the challenges posed by HFT.

The discussion covered a gamut of issues such as the effects of HFT on volatility and liquidity in markets, ability of HFT strategies to influence or manipulate markets, trade annulment policies and the need for pauses to respond to sudden movement in prices in order to reduce uncertainty.

The most critical point that emerged was the need for regulator and exchanges to keep up with the developments and maintain the trust of participants by ensuring orderliness in markets.

The heads of NSE, BSE, MCX-SX and USE also participated in this discussion.

ii. Regulation of Collective Investment Schemes

The IAB extensively discussed the issue relating to regulatory gap in respect of various unregulated collective investment schemes and money circulation schemes in India. The IAB members also brought to the table a global perspective to the issue by sharing their experiences from other jurisdictions.

It was pointed out that the regulation of such schemes is not the primary objective of a securities market regulator and would require substantial resources. It was also underlined that such schemes are often localized and there is a criminal enforcement angle attached to the regulation of such schemes. It was, therefore, suggested that State Government participation is very important for the success of any regulatory framework for the same. Further, the need for an independent and separate regulator with sufficient resources was underlined.

iii. Capital Adequacy Norms

The need for reviewing the capital adequacy norms for market intermediaries to meet the unknown and non-market risks faced by intermediaries was acknowledged. It was stressed that capital adequacy requirements for intermediaries should be linked to the risks in terms of exposure faced by them or the volumes of turnover or number of clients serviced by them, use of algo etc. It was further stated that there is a need to link the capital adequacy requirement with the extent of proprietary trading undertaken by a trading member. It was, however, felt that a balance has to be struck between the need for capital adequacy for dealing with the unknowns and the need to keep the regulatory cost within reasonable limits. On a related point, it was suggested that risk management at the Central Counter Party should factor in the practices of trading members while adjusting its norms and level of deposits.

iv. Regulation of Research Analysts

The role played by various entities as research analysts in India and the extant regulations governing them were deliberated upon. The international practices in this regard were also discussed. A view emerged that the analysts providing services for a fee should be regulated under the proposed Investment Advisor Regulations of SEBI. As far as other analysts are concerned, it was suggested that, to begin with, a separate code or set of guidelines may be prescribed.

v. Role of Mutual Funds in Management of Pension Money

Given the lower penetration of pension subscriptions in India, it was suggested that more private sector instruments with proper incentives and safeguards are essential for the growth of pension industry. Citing the role played by mutual funds in pension sector globally, it was emphasized that the question on the role of mutual funds in management of pension money in India is not "if" but "how".

The deliberations identified issues like need for uniform tax treatment of retirement related investments irrespective of the investment routes and the need for a significant boost to the development of annuity industry in India.

It was acknowledged that the AMC industry under SEBI regulations has evolved over time and, therefore, SEBI and AMC industry in India should have an active partnering role to play in the development and penetration of pension industry in India. The need to have an appropriate cost structure for handling retirement related investment was also pointed out.

SEBI constituted the IAB in September, 2011. The role of the IAB is to guide SEBI and, in doing so, bring in the global experiences and emerging developments and challenges. The IAB meets twice in a year. The first meeting of the IAB was held on January 27, 2012.

The current Members of the IAB, in addition to the Chairman, SEBI are Prof. Viral Acharya, Ms. Jane Diplock, Prof. Mark Maletz, Prof. Maureen O’Hara, Prof. Arvind Panagariya and Dr. Andrew Sheng (arranged alphabetically by the surnames).

Prof. Acharya is the C.V. Starr Professor of Economics in the Department of Finance at New York University Stern School of Business and a Member of Advisory Scientific Committeeof European Systemic Risk Board. Ms. Diplock is presently an Independent Director of Singapore Exchange Limited, Australian Financial Services Group Pty Limited, International Integrated Reporting Committee Board and Member of Public Interest Oversight Board (PIOB). She is also the former Chairman of both the Executive Committee of IOSCO and of the New Zealand Securities Commission.

Prof. Maletz is a Senior Fellow at Harvard Business School and an internationally recognized thought leader in the areas of leadership development and organization transformation.

Prof. O’Hara, the Robert W. Purcell Professor of Finance at the Johnson Graduate School of Management, Cornell University, is the Chairman of the Economic Advisory Board of the FINRA and a Member of the CFTC-SEC Task Force investigating the ‘flash crash’.

Prof. Panagariya is the Jagdish Bhagwati Professor of Indian Political Economy at Columbia University and the former Chief Economist of the Asian Development Bank. Dr. Sheng, the former Chairman of the Securities and Futures Commission of Hong Kong, is presently the Chief Advisor to the China Banking Regulatory Commission and a Board Member of the Qatar Financial Centre Regulatory Authority.

Mr. Prashant Saran, Mr. Rajeev Kumar Agarwal, Whole Time Members of SEBI and all the Executive Directors of SEBI participated in the two day deliberations.

Mumbai

November 05, 2012

High frequency trading regulation urged to strengthen market structure, surveillance and safeguards against volatility and manipulation. The IAB recommended updated market structures and surveillance for High Frequency Trading to address volatility, liquidity impact and manipulation risks; risk sensitive capital adequacy for intermediaries tied to exposures, turnover, proprietary trading and algo use; State involvement or an independent regulator for localized collective investment and money circulation schemes; regulation of fee based analysts under Investment Advisor rules and separate guidance for others; and active use of mutual funds, tax harmonization and cost structures to deepen pension fund management.