Are markets developed by regulators, or crooked geniuses like Mike Milken & Harshad Mehta?

Are markets developed by regulators, or crooked geniuses like Mike Milken & Harshad Mehta?

MC Govardhana Rangan

26 March 2015

The Economic Times

Who is the hero of the ongoing World Cup tournament? Brenden McCullum, or the International Cricket Council? Did Sachin Tendulkars and Kapil Devs make cricket a popular sport in India, or the Board of Control For Cricket in India?

If people ‘play’ in financial markets, what is true for cricket could be true for equities and bond markets as well. Historically, the Reserve Bank of India (RBI) has been ruling the government securities market. Now, the plan is to shift it to the Securities & Exchange Board of India (Sebi) and equip an ‘independent’ debt management agency to take over the role of RBI as the government’s investment banker.Does just shifting regulation to Sebi ensure bond markets will grow? “Not if Sebi too aids and abets the repression,’’ says Jahangir Aziz, who authored the Report of the Internal Working Group on Debt Management in 2008. “The bond market regulator’s job presumably is to create an efficient, deep, and safe bond market.’’

What is the objective behind these moves?

1.) Avoid conflict of interest

2.) End financial repression

3.) Develop the bond market

Where is the conflict? Imagine ABC company hiring XYZ bank to manage its share sales; frame rules for the sales, price the shares, allot them, trade in them; be its custodian and transfer agent. It is a perfect recipe for abuse, even if is for the government. The abuse of power by profligate governments led to legislation in developed nations moving toward independent debt management offices. India wants to tread the same path.

Although the tendency to use RBI as a tool to favour government borrowing has slowed down since the 1991 liberalisation, yields were kept moderate till recently when it kept buying bonds from the market despite its strong anti-inflationary rhetoric. So, an independent regulator and independent debt managers are welcome, at least theoretically.

“The evidence over the past 30 years both in India and abroad clearly favours an independent Public Debt Management Agency (PDMA),” says Aziz, who is now chief economist, Asia, at JPMorgan. “The idea of a shareholding company (for PDMA) still remains valid.’’

An independent PDMA is as good as the independence it gets. What if, as many suggest, the RBI and PDMA ‘co-ordinate’ for smooth sailing of borrowing and their actions do not send conflicting signals to the market?

If the idea of creating two independent bodies is to end abuse of power, is not ‘co-ordination’ a kind of legalised market manipulation defeating the very purpose of separation?

The effectiveness of independent institutions will largely depend on the nature and calibre of those in government rather than in the institutions themselves. If the government is imprudent and abusive, no independent institution can be effective.

“A public debt management agency as a professional organisation, independent of the (central) bank, independent of the government, is something that is desirable,” says RBI governor Raghuram Rajan.

Can the second objective of financial repression be ended just by taking debt management away from RBI?

If the 21.5% banking industry’s mandatory Statutory Liquidity Ratio — the proportion of deposits to be kept in the form of government bonds — is financial repression, so is the 50% mandated for the insurance industry.

While the objective of ending financial repression is noble, it will be more credible if the insurance industry is also exempted from such an onerous obligation, which is kept in the name of providing safety to policy holders.

“Internationally, government bond holdings are not mandatory,’’ says Abhijit Gulanikar, chief investment officer at SBI Life Insurance. “Investments are based on the asset-liability management perspective, risk and liquidity management perspective.’’

If the insurance industry continues to bear the burden of investing half its premium in government bonds, but the banks’ SLR is reduced, then it will be a half-hearted job of reducing financial repression.

Another objective is the development of bond markets. One generation of financial services executives has exited the workforce just listening to debates on the subject. “We keep talking of issues that are in the way of its progress and the solutions that could address them,” says R Gandhi, deputy governor at RBI. “Yet, there has been limited movement in this area despite several attempts and there is some kind of gravity keeping us down.”

The government bond market is just 49% of gross domestic product, compared with 62 for Malaysia, and 59% for Thailand. When it comes to the corporate bond market, it is even worse at just 5% of GDP, compared with 43% for Malaysia and 78% for South Korea.

Part of the blame lies at RBI’s doorstep. It restricted G-sec trading after the Harshad Mehta scandal broke out in 1992. Despite public statements on deepening the bond market, not much was done on the ground.

Although both the Securities and Exchange Board of India and the RBI disliked the broking community for their role in the 1992 scandal, Sebi managed to move ahead unlike the RBI.

Can life become better with Sebi regulating the G-sec market? Doubts remain.

“Sebi has been regulating the corporate bond market for a while now,’’ says A Prasanna, economist at ICICI Securities Primary Dealership. “Bond markets internationally are institution-driven. It will remain the same here as well. To expect the debt market to become like equities is unrealistic.’’

An example of a vibrant bond market is the US. Did SEC or the Federal Reserve make it so? Or, to use the cricket analogy again, did individuals like Tendulkar make the game popular?

The answer may lie in Mike Milken, the junk bond king who shook up the existing set-up and made it possible for even lowerrated companies to raise funds from the market.

The success might have driven Milken to criminal behaviour such as insider trading, or price manipulation just like Harshad Mehta did with Indian stocks. But it is hard to deny their role in making these markets popular.

“Milken had been dangerous, but he had also been one of the most imaginative, visionary financiers of our time,’’ writes Connie Bruck in Predators’ Ball. “He could probably have had nearly as much impact as he had had upon the corporate restructuring of this country (the merits of which will long be debated) without ever violating the law. With Milken, creation had come first and his alleged lawbreaking, later. In that lies an element of tragedy.”

For bond markets to take wing, India probably needs a law-abiding Milken or Mehta.


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