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In a classic example of regulatory turf war, market watchdog Securities and Exchange Board of India (SEBI), in a recent letter to the banking regulator Reserve Bank of India (RBI), has expressed its displeasure over RBI’s intervention in trading of HDFC’s shares.
Trading gone wrong
As a preface, the FDI Policy sets the bar at 74% for foreign investment in private sector banks. As per RBI rules, RBI puts stocks which cross 72% threshold on its watchlist and opens up free trading as and when the shareholding falls below 72%.
On 16th of February, conversion of some ESOPs in HDFC Bank brought down foreign investors’ limit below 72%, for a stock which is typically utilised to its fullest 74%, prompting RBI to open window for fresh purchases,
“The Reserve Bank of India has today notified that the aggregate foreign shareholding through American Depository Receipts (ADR)/Global Depository Receipts (GDR)/ Foreign institutional Investors (FIIs)/Foreign Portfolio Investors (FPIs)/ Foreign Direct Investment (FDI)/Non-Resident Indians (NRIs)/ Persons of Indian Origin (PIOs) in M/s HDFC Bank Ltd. have gone below the prescribed limit stipulated under the extant FDI Policy. Hence the restrictions placed on the purchase of shares of the above company are withdrawn with immediate effect.”
With limited leg-room and huge demand for this stock from overseas investors, the 74% limit was breached within moments after the stock was opened for trade on 17th February. The value of HDFC Bank shares rose by approximately 8-9% owing to increased foreign investor demand. The RBI thereafter issued another (delayed) notification restoring the 74% ceiling on the stock,
“The Reserve Bank of India has today notified that the foreign shareholding by American Depository Receipts (ADR)/Global Depository Receipts (GDR)/ Foreign institutional Investors (FIIs)/Foreign Portfolio Investors (FPIs)/ Foreign Direct Investment (FDI)/Non-Resident Indians (NRIs)/ Persons of Indian Origin (PIOs) in M/s HDFC Bank Ltd has crossed the overall limit of 74% of its paid-up capital. Therefore, no further purchases of shares of this company would be allowed through stock exchanges in India on behalf of Foreign institutional Investors (FIIs)/Foreign Portfolio Investors (FPIs)/ Non-Resident Indians (NRIs)/ Persons of Indian Origin (PIOs).”
This direction which was given at 1.39 pm also directed brokers who had punched in trades for foreign clients after 1.39 pm to take the trades on their books. The time difference between RBI ordering stopping of FPI investments and actual operationalisation of the direction had resulted in huge investments. This has resulted in confusion over execution of trade by some FPIs at that time, a confusion that accounts for an estimated Rs. 6000-7000 crores. The fate of these investments is uncertain – whether they’ll be annulled or made proprietary trades of brokers.
Sandeep Parekh, Partner at Finsec Law says,
“RBI’s interference in this manner, i.e., trying to restore ceiling during market hours, is unprecedented. The incident has thrown several issues that require immediate attention between various parties, including the finance ministry, sectoral regulators, stock exchanges and depositories. RBI’s unilateral measures on noticing a breach has created considerable confusion.”
Aggrieved with RBI’s intervention in what is SEBI’s business, SEBI has written a letter to the RBI expressing its displeasure for intervening during market hours.
What was the exact reason for this?
Tejesh Chitlangi, Partner at IC Legal explains,
“There are two key reasons as to why SEBI has written to the RBI. First, RBI did not consult or inform SEBI before issuing the (1.39 pm) notification, though FPIs also fall within SEBI’s jurisdiction. Second, such a move during market hours could have adversely impacted the market functioning. With a stock as liquid and sensitive as HDFC Bank, an adverse impact on the price could have hurted retail investors.”
While there it may be said there is no doubt that RBI had overstepped its jurisdiction, at the time it was left with no option but to do so.
However, moving forward, what is required a unified financial framework which eliminates the question of turf transgression or unregulated no-man’s land in financial markets.
Another suggestion made by legal experts is that joint monitoring for FPIs limits in stocks during trading hours with any conflict being tackled by a third party, such as the Financial Sector Development Council. According to Tejesh Chitlangi,
“It’s fairly simple, there should be an integration of IT platforms between custodians, depositories and stock exchanges so that any orders punched by FPIs beyond regulatory threshold are automatically rejected by the system.”