Concerns about recent developments on SEBI's regulation-making on market rumours and insider trading

by Bhavin Patel and Renuka Sane.

Insider trading is one of the areas of financial regulation where the order of complexity required of state capability is relatively high, and the gains to society from successful implementation are relatively low. The Indian environment on SEBI enforcement against insider trading has accumulated many difficulties. In recent months, we have seen the next step forward in SEBI's journey, with a novel legal idea around rumours swirling in the market. In this article, we summarise the recent developments, and show two substantive problems with the direction taken by SEBI. These substantive problems are ultimately grounded in failures of process. There are signs that the process adopted in recent months for these developments on rumours, has more deficiencies than usual.

Recent developments on how SEBI thinks about rumours

Over the past year, SEBI has been concerned about the impact of market rumours on security prices. It proposed that certain listed entities be required to verify "market rumours" related to their firm. Amendments to this effect (the June 2023 Amendments) were made in the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (the LODR Regulations), though the amendments are yet to be enforced. On December 28, 2023, it published a Consultation Paper on Amendments to SEBI Regulations with Respect to Verification of Market Rumour (the Current Consultation Paper) suggesting that listed entities should verify market rumours only if they are material. 'Materiality' meant that such rumours should lead to price movement in the security. It also proposed that if a listed entity classifies certain information as Unpublished Price Sensitive Information (UPSI) but does not verify a market rumour related to such information, it should continue to be treated as UPSI under the SEBI (Prohibition of Insider Trading) Regulations, 2015, (the PIT Regulations). In its Board Meeting held on March 15, 2024, SEBI approved this proposal, confirming that if a rumour related to UPSI is not verified, it will continue to be treated as UPSI. In other words, if a speculative story appears in the public domain, pertaining to UPSI about a firm, it will still be treated as UPSI until the listed entity verifies the story.

These steps contain difficulties that are generic to the working of SEBI. Firms are already mandated to release certain information (through listing obligations), and not release some (through prohibition on insider trading). SEBI's proposals on verification of market rumours have not yet explained the market failure proposed to be solved and how the selected intervention is the least costly way of doing so. In this particular case, the legal effects of the new law can be particularly damaging. The decision in the March 15 Board meeting, to continue to treat Generally Available Information (verified or not) as Unpublished Price Sensitive Information (till the company verifies it), goes against the grain of how price discovery works in the public market. A greater process discipline will help improve the thinking, and the democratic legitimacy, of insider trading regulation.

Substantive problem #1: The impact on the OTC market

Consider the following illustration:

• Assume a listed entity classifies "defaulting on a large supplier contract" as UPSI.

• Since the information is classified as UPSI, insiders would be prohibited from trading based on such information under the PIT Regulations. Note that the definition of insider under R. 2(1)(g) of the PIT Regulations includes persons with access to UPSI. This implies that if a retail investor, with no connection to the firm, has access to this information, the retail investor is also classified as an insider. This speaks to the over-inclusiveness of the term 'insider' under prevailing securities laws.

• Assume that a newspaper carries a story about a "rumour about the default". Since this is now reported in the media, it will be accessible to the general public. The listed entity chooses not to verify the information since it does not trigger the materiality threshold under R. 30 of the LODR Regulations (for example, it might not cause a price movement or may only cause a price movement lower than the limits specified in the threshold).

• Under the current proposal, an unverified event or information reported in the media would not be considered 'generally available information' under the PIT Regulations. It would continue to be UPSI. The definition of insider regarding UPSI would extend to the general public. As a result, the PIT Regulations would generalise the prohibition on trading based on such information, even though it has been reported in the media, because the listed entity chose not to verify it. This may effectively hinder the price discovery process, a core function of securities markets.

Further, the explanation to R. 4(1) of the PIT Regulations states that if a person possesses UPSI, their trades would be presumed to have been motivated "by the knowledge and awareness of such information". The proviso to this explanation states that an insider can prove their 'innocence' if: (i) the transaction is an off-market inter-se transfer between insiders who were in possession of the same unpublished price sensitive information without being in breach of R. 3 and both parties had made a conscious and informed trade decision, (ii)the transaction was carried out through the block deal window mechanism between persons who were in possession of the unpublished price sensitive information without being in breach of R. 3 and both parties had made a conscious and informed trade decision.

As a result, under proviso (i) two people who read the same unverified story in the media are consequently insiders and who have made a 'conscious and informed trade decision' can trade in the listed entity's securities if such trade is off-market; and under proviso (ii) a block deal trade is also allowed under similar circumstances.

The effect would be that regular trades on the floor of the exchange based on unverified media reports would be prohibited. However, off-market transactions or block deals conducted based on such information would not count as 'insider trading', creating a problem of arbitrary discrimination. This also drastically reduces the pool of investors able to trade, which may possibly lead to a liquidity collapse.

Substantive problem #2: Contradictions with existing regulations

The proposals contradict a literal interpretation of UPSI as set out in the PIT Regulations since they suggest that information which is neither unpublished (since it has been published in the media) nor price-sensitive (since it does not affect the price of securities and therefore falls outside the scope of the materiality threshold verification requirements under R. 30 of the LODR Regulations) would still be considered UPSI. This would suggest a need to amend the definition of UPSI under the PIT Regulations and, potentially, the provisos to the explanation to R. 4(1) and the definition of insider under R. 2(1)(g). The proposals in the Current Consultation Paper also necessitate changes to determining materiality under R. 30(4) of the LODR Regulations. This is because the proposed definition of materiality is not a part of the June 2023 Amendments. The materiality thresholds proposed impact which market rumours listed entities need to verify.

Difficulties with the process

Assuming that SEBI has considered the potential impact on liquidity and does not regard it as problematic, we are still faced with the problem of how these proposals may be implemented. The current proposal may require changes in other substantive regulations. If they are indeed to be implemented, they should be done through amendments to the PIT and LODR Regulations. Board minutes, Circulars, or Guidelines should not suffice to effectuate substantive changes. Under Section 30 of the Securities and Exchange Board of India Act, 1992 (the SEBI Act), changes to regulations must be laid "as soon as may be after it is made, before each House of Parliament, while it is in session, for a total period of thirty days." This allows for Parliamentary oversight of the regulator's exercise of powers of subordinate legislation and prevents the use of such powers beyond permitted limits. The June 2023 Amendments are scheduled to take effect from June 1, 2024, there is little time left for listed entities to prepare, and such amendments should be published soon. The process under S. 30 of the SEBI Act was followed in the case of the June 2023 Amendments, and the Amendments were laid before Parliament on August 11, 2023. There is no reason this process should be side-stepped now. SEBI should come out with a precise legal instrument, and the amendments to the PIT and LODR Regulations, to implement its proposal.

Ideally, the regulator should, in addition to inviting and analysing public comments, identify the problem or market failure these seek to address, the principles governing the proposals, the outcome the regulator aims to achieve through such changes, and an analysis of their costs and benefits as recommended by the Financial Sector Legislative Reforms Commission (FSLRC) in its Handbook on adoption of governance enhancing and non-legislative elements of the draft Indian Financial Code of December 26, 2013. The Financial Stability and Development Council had also approved the implementation of the FSLRC's recommendations in its meeting in October 2013. If this process had been followed, the failures in substantive thinking described earlier would have been avoided.

The authors are researchers at TrustBridge. We thank Amol Kulkarni and Madhav Goel for useful comments.

Assessing regulatory capability in Tamil Nadu electricity regulation: Evidence from appeals

by Bhavin Patel and Renuka Sane.

The Indian journey to decarbonisation faces the roadblocks of electricity policy. One of the critical impediments faced is that of state capability in electricity regulation. There is a new body of knowledge in India, in regulatory theory, that can usefully be brought to bear on the problem of improving electricity regulation. One element of this field is the question of assessing the state of regulatory capability. At any point in time, how would we judge the extent to which electricity regulation in a certain state is working well?

Electricity is regulated by the Central and State Electricity Regulatory Commissions (ERCs), which perform legislative, executive, and quasi-judicial functions. The concentration of power and the lack of democratic accountability in the new administrative state raise concerns about their functioning in modern economies. In India, the ERCs have quasi-judicial powers that are even broader than those of other regulators such as the SEBI. With one electricity regulator -- the TNERC -- in focus, we took up the research strategy of assessing regulatory capability through the analysis of regulatory orders that go to appeal. A key metric of the quality of orders the regulator passes is how well its orders fare at an appellate forum. If the regulator succeeds in defending its decisions, it signifies that the orders are well-reasoned and have followed the procedures required by the applicable law (whatever they be).

In a recent paper, Performance at the Appellate Tribunal as an indicator of regulatory capacity: The case of TNERC at APTEL, we study the overturn rate of the orders of the Tamil Nadu Electricity Regulatory Commission (TNERC) at the Appellate Tribunal for Electricity (APTEL) between 2013 and 2023.

We find that TNERC failed to hold its ground in 52% of appeals. Of these, about half were remanded back to the TNERC, suggesting that it did not do an adequate job of bringing the evidence necessary to decide a matter, despite being conferred the powers of a Civil Court for such purposes under Section 94 of the Electricity Act, 2003. Further, the TNERC lost 86% of matters that involved issues related to how it uses its regulatory powers.

These results raise concerns about the exercise of quasi-judicial authority by the TNERC. There is considerable knowledge in the field of regulation in India, on how such deficiencies can be addressed. If policy makers were to take up such strategies, it would help improve private sector confidence for electricity investment in Tamil Nadu.

Our work is limited to orders that were appealed. There is a selection bias, in that regulated persons make rational choices when deciding to appeal. In the extreme, it is possible to argue that all sound orders are not appealed, and only defective orders are appealed, so the defect rate is just the appeal rate (which is about 8% with appeals to APTEL that we measure, and some appeals that go to the High Court under writ jurisdiction which we do not measure). We suspect the defect rate is higher. Considerations in appealing include issues such as errors in the regulatory order which create a high chance of winning, the expense in appealing, the rupee value at stake multiplied by the probability of winning, and the non-rule-of-law pressures from TNEB in favour of not appealing. The appealed orders, that are studied by us, offer valuable insights into the limitations of state capability in regulation in TN electricity. Such measurement should motivate regulatory reform, and it should be used in measuring the extent of progress in regulatory reform.

Our approach can be usefully applied in analysing and improving electricity regulation in other states. To assist this process, we have also released a detailed Manual For Reviewing Regulatory Orders: Orders of the Tamil Nadu Electricity Regulatory Commission at the Appellate Tribunal for Electricity. This will enable replication of our results for Tamil Nadu, and porting these methods to other states.

The authors are researchers at TrustBridge.

Announcements

Janaagraha is hiring: Head - Municipal Finance

We at Janaagraha seek an exceptional individual to lead our municipal finance mission to the next level of impact. We aim to increase municipal revenues, ensure transparency in spending, and improve accountability for citizen outputs and outcomes. Transforming public finance in cities is quintessential to human development in India. Over the last four years, we have achieved remarkable milestones in the pursuit of our municipal finance mission, including:

• Public disclosure of audited annual accounts of over 4,200 municipalities in a comparable format on www.cityfinance.in
• Catalyzing property tax reforms in 20 states resulting in a 50% growth in pan-India property tax collections since 2017-18
• Digital grant management of USD 15 billion of XV FC grants on www.cityfinance.in

More importantly, we have put together an exemplary, majority-women team. We are looking for a senior leader with a proven track record in systems practice to join our team and take our municipal finance program to new heights of systems change.

Key Responsibilities

• Deliver on government and donor engagements.
• Engage closely with senior leaders in government and the market ecosystem to both advocate for systemic reforms in municipal finance and to inform Janaagraha's strategy for the same.
• Continuously strive to transform municipal finance in India at scale and with speed and agility, through a whole of systems approach.
• Lead planning and development of Janaagraha's Municipal Finance programme.
• Engage with the urban governance and municipal finance ecosystem.

Qualifications and Experience

• Master's degree or equivalent in business administration, finance, public finance, public administration, public policy or other directly relevant fields OR a Membership of a Professional Institute such as the Institute of Chartered Accountants of India.
• 15+ years of experience in government advisory, public finance, business management/consulting or senior leadership roles in finance.
• Candidates with direct government experience in any civil services are particularly welcome.

Location: Bengaluru/Delhi

Interested candidates can send in their CV to work@janaagraha.org

You can learn more about the role here.

Janaagraha's culture codes can be seen here.

About Janaagraha

Janaagraha is a Bengaluru-based not-for-profit institution working to transform the quality of life in India's cities and towns. It defines quality of life as comprising quality of infrastructure and services, and quality of citizenship. To achieve its mission, Janaagraha works with councillors and citizens to catalyse active citizenship in city neighbourhoods, and with governments to institute reforms to city-systems. Janaagraha has worked extensively on urban policy and governance reforms for over two decades including on JnNURM, and with the XIII, XIV and XV Finance Commissions, Second Administrative Reforms Commission, Comptroller and Auditor General of India, NITI Aayog/Planning Commission, Ministry of Housing and Urban Affairs (MoHUA), as well as the state governments of Odisha, Uttar Pradesh, Tamil Nadu, Rajasthan, and Assam.

Announcements

IIHS Urban Fellows Programme

The Indian Institute for Human Settlements (IIHS) invites applications for the ninth batch of the Urban Fellows Programme (UFP). The UFP is a nine-month, full-time, residential, interdisciplinary programme based at the IIHS Bengaluru City Campus.

The UFP is a unique space that combines classroom teaching, site-based applied learning, live projects and external internships to introduce learners to diverse forms of urban practice. Its interdisciplinary framework encourages learners from different disciplines, and practices diversity across multiple facets. Alumni of the UFP work in a wide range of sectors and organisations, driving urban transformation across India.

The UFP will run from August 2024 to May 2025 and recent graduates and young professionals from varied educational backgrounds or practice domains are eligible to apply. The UFP is committed to providing scholarships to all deserving candidates through a needs-blind process.

This video gives an overview of the UFP and this video explains how the UFP is unique.

Admissions close on 15 April 2024. For queries, you can write to ufp.info@iihs.ac.in or contact +91 99012 55788, 96064 84336 (10:00 am to 6:00 pm India Time, seven days a week).

For more information, please visit the UFP website.

Rethinking innovation policy in India: amplifying spillovers through contracting-out

by R. A. Mashelkar, Ajay Shah, Susan Thomas.

Independent India valued science and rationalism at an early stage of social and economic development. The objectives of building the scientific temper and harnessing the power of science and technology were clearly articulated, for example, in the 1958 Science Policy Resolution. These objectives pertain to improvements in the people, in the society. 

The practical aspects of government expenditures on innovation, and the construction of organisations doing frontiers work, emphasised government organisations. The government used taxpayer resources, built science organisations, hired scientists as civil servants, and developed capabilities within these organisations

In a new paper, Rethinking innovation policy in India: amplifying spillovers through contracting-out, we reopen the objectives of innovation policy in India, applying modern knowledge of public economics and public administration to obtain fresh insights.

We start at the foundations of innovation policy, with new clarity on the questions of why (what motivates state intervention in innovation?), what (in what areas should government intervention into innovation take place in India?), how (what mechanisms should be used when spending public money?) and how much (at what point do the incremental gains to society equal the incremental costs).

The market failure that motivates this field is the problem of spillovers, where the full gains from innovative activity by one person are not captured by her, leading to systematic under-investment into innovation by her. There is a case for public expenditure, where taxpayer resources are spent on innovation, but the expenditure needs to be done in a way that induces spillovers into the society.

We undertake four detailed case studies: the US National Aeronautics and Space Administration (NASA), the US National Institutes of Health (NIH), innovation policy in French defence procurement and CSIR's New Millennium Indian Technology Leadership Initiative (NMITLI). In each case, we understand how tradeoffs are made between `make' and `buy'. Make involves building state organisations, scientists as civil servants. Buy involves contracting-out innovative activities into the society, to private firms and particularly to high-spillover sites of universities and research organisations (whether public or private).

While doing more contracting-out is appealing from the first principles of innovation policy -- the purpose is to obtain greater capabilities in the society, not in the state -- there are many difficulties in implementation. We suggest the strategy for implementation which involves (a) Changes to the GFR; (b) Changes to the founding documents of government innovation organisations; (c) Changes to procurement rules and internal process manuals; (d) Resource planning for a gentle reform trajectory; and (e) a sketch of the required project planning.

Many elements of innovation policy in India have been moving in a similar direction. Three recent initiatives should be pointed out. The Union Interim Budget of 2024-25 envisages a Rs.1 trillion fund that would be channeled to research and innovation in the private sector. The `National Research Foundation' has been setup with a law that came to force on 5 February 2024. The K. Vijay Raghavan Committee report, submitted in early January 2024, has important ideas on improving the working of DRDO. There is a harmony between the philosophy of these three moves, and the ideas of this paper. Conversely, the detailed work of this paper can be useful in translating these initiatives from concept to implementation.

R. A. Mashelkar, FRS, was Director General of CSIR. Ajay Shah and Susan Thomas are co-founders of XKDR Forum.

Author: Charmi Mehta

Charmi Mehta is a Researcher at XKDR Forum, Mumbai.

On this blog:

• The electricity chokepoint in Tamil Nadu public finance, 26 February 2024.
• Offshore wind in Tamil Nadu: from potential to reality, 13 January 2024.
• The difficulties of asset monetisation in the transmission sector, 9 January 2024.
• Identifying roadblocks in highway contracting: lessons from NHAI litigation, 13 July 2022.
• How competitive is bidding in infrastructure public procurement? A study of road and water projects in five Indian states, 29 March 2022.
• Lessons from the COVID-19 vaccine procurement of 2021, 15 November 2021.

The electricity chokepoint in Tamil Nadu public finance

Charmi Mehta, Radhika Pandey, Renuka Sane and Ajay Shah

Each state in India can be visualised as an entity in itself. Vast magnitudes of finance will be needed to put the states on an energy transition pathway. While this pathway will be different for every state, the electricity sector is likely to be the recipient of much of these funds. The investibility of the electricity sector is thus an important field of study.

Many states in India face fiscal distress and many states in India have difficulties in the electricity system. In a new paper, 'The electricity chokepoint in Tamil Nadu public finance', we bring the two streams of knowledge together for the state of Tamil Nadu, and offer fresh insights for fiscal policy and for electricity policy.

The formal toolkit of a `debt sustainability analysis' (DSA) is brought to the standard Tamil Nadu fiscal data. This involves a first stage of comparing a group of fiscal indicators against normative benchmarks, and a second stage of forecasting the debt/GSDP ratio and the interest payments to revenue receipts ratio (IP/RR ratio) for five years; till FY 2028. These results, which we term the `baseline DSA' translate the mainstream intuition towards Tamil Nadu's fiscal difficulties into tangible numbers and forecasts.

A consolidated financial picture is drawn by integrating the two electricity sector utilities -- TANGEDCO and TANTRANSCO -- fused into the Government of Tamil Nadu debt stock. This yields a modified DSA that we term a `Corrected DSA'. This is done to acknowledge the implicit guarantee that state governments hold towards the debt of state-owned entities. This modified picture is thus a truer depiction of the fiscal problems of the state.

The fact that large debt servicing expenditures were successfully achieved for the last decade has helped create a confidence that the fiscal strategy of Tamil Nadu is deplorable but feasible. Of essence in the fiscal outlook of every highly indebted entity is the problem of sustainability. There are three concerns:

1. Sustained large scale borrowing, from the financial system, may potentially face difficulties through the risk appetite of lenders, changes in regulations, systemic crises in the financial system, etc.
2. The most important assumptions that shape the results of this paper are the nominal interest rate ($r$), estimated at 7%, and nominal GSDP growth rate ($g$), estimated at 9%. This has a $r-g$ of -2: it is a very positive environment from the viewpoint of fundamental fiscal dynamics. In the future, if $r-g$ becomes less benign, the debt dynamics could change significantly.
3. The conventional notion of fiscal stress is phrased in terms of bond default. In India, fiscal distress is known to manifest itself as unplanned budget cuts (that disrupt the working of the government), defaults on payments to private firms, and even the deferrals salaries or pensions. We look back upon three instances when state governments faced high fiscal stress in 2001, and find that the present projections for Tamil Nadu for FY 2028 are partially similar to these values.

The fiscal knowledge of this paper has implications for electricity policy. The electricity system requires two large blocks of investment. A big block of capital is required to rebuild the grid for the post-carbon world. And, a big block of capital is required for the investment in renewables and storage that are required to sustain economic growth in the post-carbon world. Of particular importance is the economic upside from exploiting that remarkable natural resource which is found off the coast of Tamil Nadu in the form of offshore wind generation. These investments will not arise in the environment of chronic fiscal stress in the electricity system.

The electricity knowledge of this paper has implications for fiscal policy. Through simulations where electricity subsidies remain constant or they are completely eliminated, we find that the electricity system is material in solving the fiscal problem. Thus, we extract the electricity subsidy problem from the sector, and place upfront its impact on the public finance parameters and the development trajectory of the state. A complete electricity sector reform versus business-as-usual translates into an FY 2028 outcome for the debt/GSDP ratio of 32.47% vs. 43.53%, and an IP/RR ratio outcome of 19.71% vs. 26.12%. These are large differences. They encourage us to prioritise electricity sector reform as a part of the medium-term fiscal strategy.

Charmi Mehta and Ajay Shah are researchers at XKDR Forum. Radhika Pandey is a researcher at NIPFP. Renuka Sane is a researcher at Trustbridge.