Innovation in the Japanese Financial Services Industry, Part 2: Panel Discussion

Celent hosted Innovation & Insight Day Tokyo on June 5. Following the event presentation titled "Digital Financial Services and New Innovation Initiatives," which focused on Celent's innovation survey results, a panel discussion was held.

This is the second in a two-part report providing an overview of event proceedings.

 

Five leading experts in Japan's financial industry joined the event as panelists. Celent would like to offer a heartfelt thank-you to these individuals for taking part despite the pressure and the presence of competition and many disclaimers. The panelists’ wealth of experience and sheer passion for innovation was palpable and the content thought provoking. Above all, the impassioned and experience-informed comments of panelists displayed the confidence of Japan's financial industry. Below are some of the more salient comments that demonstrate the spirit and mindset of innovators in Japan.

What motivates your firm to innovate?

  • "Responding to customer expectations."
  • "A backdrop of growing user needs and the proliferation of technology and the environment to meet these needs."
  • "Our objective is to remove all inconvenience from the customer experience."
  • "We aspire to offer financial services that achieve exactly what people feel they need and consumers think they want."
  • "Innovation is the lifeblood and fate of a corporation."

 

What drives innovation at your firm?

  • "Aligning innovation objectives and technology employed."
  • "Integrating technology and compliance is important."
  • "Amplifying the motivation and drive of each employee to take action."
  • "Reflecting the intentions of management."
  • “Resisting the temptation to seek short-term growth.”
  • "Supporting management philosophies that bet on uniqueness."

 

The threat and opportunity of disruptive innovation

During the proceedings there were questions and opinions from participants exchanged with the moderator:

  • "There is no special opportunity for innovation. It is important to reflect innovation in daily management. That is something that we have done since we started our business and something that we will continue to do. Innovation is simply naturally part of what we do.”
  • "We do not see disruptive innovation as a threat. Rather, for the development of the industry as a whole, the kind of shakeout such innovation entails is necessary. We will undergo challenges and survive—and look to take on more such challenges.”

 

Celent concluded the event with the below message.

Managers: Have faith and confidence in innovation

The importance of leadership and management responsibility in innovation is self-evident. At the same time, innovation is a mid-to-long-term journey—more a marathon, than a sprint. Failure is sometimes to be allowed. In addition, it is not uncommon to destroy a corporate culture that has been fostered over many years. An intense commitment to innovation on the part of management itself is required. Technological drivers continue to advance and case studies of successes only increase. Mangers: Be confident.

 

Distinguish between disruptive innovation and kaizen (improvement), and the need to tackle the former

The greatest factors hampering the progress of disruptive innovation are not to be found outside a company but within it. Especially within large corporations, where tendencies such as the below are seen; conversely, these tends to derail innovation. These tendencies include the following.

  • Compared with start-ups and small or medium enterprises, large firms boast a wealth of capital and business resources.
  • In particular, these resources include human resources and technology, which can be channeled to R&D.
  • These companies often have business operations that require 360-degree management and much competition
  • Such firms are often home to isolated “black sheep” employees that seek to innovate.

If you neglect innovation, cannibalization can be expected to take place not only in your core business areas but in new businesses as well. To keep innovators from being ostracized as black sheep, it is important to clearly distinguish between the accumulation of kaizen (improvement) on a daily basis in core operations and disruptive innovation, and, in particular, it is important to direct management and initiative toward the latter.

 

Initiatives and leadership that are not negative contribute to positive value standards

Of course, trusting in your management resources, in particular in your personnel and technology, and putting effort into your business battles over “invisible continents,” “immeasurable risk” and “non-consuming consumers” is important. However, in such challenges when results do not appear with time, then you should not underestimate the power of disruptive innovation. Furthermore, it is key “to always be positive.” Leadership and initiatives that acknowledge and embrace diversity and difference and that do not deny any possibility are needed.

 

Today no industry or industrial structure is immune to change and, like plate tectonics, the ground around us is always shifting. Digital technology is doing more than changing products, services, consumer experiences, and expectations; it is also radically changing value chains and business models.

Until now, Japan’s financial industry has developed by virtue of outstanding leadership and the agile introduction of technology. Celent would like to emphasize anew the importance of innovation to Japan’s financial industry, buttressed as it is by people and technology. The results of Celent’s recent innovation survey hinted at further reform to come in Japan’s financial industry. When it comes to innovation, now is an opportune time for commitments from top management and fresh initiatives from technology vendors.

Undertaking this innovation conference was a major challenge for Celent Tokyo. However, any undue anxiety completely vanished amidst the enthusiasm of survey and event participants. The Japanese financial industry is extremely positive and enthusiastic when it comes to innovation. Celent would like to express its deep gratitude to the professionals in the financial industry who took time to participate in this event in various capacities, and we hope that it will prove in some way useful to your continued success.

 

Fig. 2 Structures to Support Innovation: Financial Services Institution / Vendor Comparison

FIG2_20140703

Source: Celent Innovation Survey 2013/2014

Innovation in the Japanese Financial Services Industry, Part 1: Two Gaps

On June 5, nearly 120 individuals from Japan's financial sector and the financial technology sector gathered to participate in our Innovation & Insight Day Tokyo 2014. This is the first of a two-part recap providing an event overview and recounting event highlights.

The first keynote address compared the May 2014 Japan Financial Industry Innovation Survey with a similar global Celent survey conducted last October. This comparison pointed to two existing gaps.

 

Gap Number One: A Leadership Gap

1. Perception of the importance of innovation

"The next few years innovation will be extremely important. Customer expectations are changing very rapidly and it is crucial to act so as not to fall behind." The ratio of respondents who agreed with this statement was similar in Japan and globally as shown below.

  • Global: 79%, Japan: 81%

—Conclusion: There can be no doubting the importance of innovation.

 

2. Leadership and innovation initiatives

"Our firm has an individual in charge of innovation (a chief innovation officer)."

  • Global: 11%, Japan: 7%

"We have an organization in charge of innovation (center of excellence)."

  • Global: 27%, Japan: 7%

"Innovation-related leadership relies on proponents at the CEO level."

  • Global: 62%, Japan: 85%

—Conclusion: There was a clear lack of leadership among top management when it comes to innovation initiatives.

 

3. Three significant impediments

Global: 1) Daily work operation routines, 2) Internal habits and practices, 3) Inadequate support system.

Japan: 1) Internal habits and practices, 2) Lack of senior management support, 3) Daily work operation routines.

—Conclusion: Both globally and in Japan, in contrast to the high levels of awareness of the importance of innovation, at financial institutions there was a distinct lack of leadership.

 

Gap Number Two: Gap Between Financial Institutions and Vendors

The Japan survey asked both financial institutions and financial solution vendors about innovation-related initiatives. Responses indicated another gap here between financial institutions and these vendors.

1. Years promoting innovation

There was no significant difference between financial institutions and vendors, with both recording similar figures:

  • Three years or less: 54%, Five years or more: 30%

—Conclusion: Financial institutions seem to interpret the fact that technology-supplying vendors possess approximately the same level of experience as themselves as meaning that innovative initiatives cannot benefit from sufficient experience.

 

2. Organizational and structural

"A chief innovation officer has been appointed"

  • Vendors: 24%, Financial institutions: 7%

“Have established a center of excellence”

  • Vendors: 14%, Financial institutions: 7%

"CEO-level proponents of innovation are relied upon for leadership"

  • Vendors: 67%, Financial institutions: 85%

—Conclusion: With a slightly lower degree of reliance on upper level management for innovation leadership, vendors are slightly superior.

 

3. Departments that lead innovation

Financial institutions:

  • Business departments lead: 30%, IT departments lead: 11%

Vendor innovation proposals:

  • Directed to business departments: 14%, Directed to IT departments: 17%

Undertaking initiatives in both business and IT areas:

  • Financial institutions: 59%, Vendors: 69%

—Conclusion: There is a visible gap between financial institution innovation IT initiatives and vendor business sector initiatives.

 

4. Digital financial services initiatives

There was also a visible gap when it came to the priority level of digital financial services (innovative financial services that harness digital technology) as advocated by Celent.

  • Financial institution priority areas: Process improvements, transaction feature enhancements, product and service customization
  • Vendor initiative areas: Three sectors were overwhelmingly dominant: big data, mobile two-way communication, omnichannel

—Conclusion: Survey results indicated a general tendency for financial institutions to be more conservative and vendor proposals to be more aggressive.

 

What exactly is this gap and what does it signify? This gap is between the proposals of vendors that feature the newest or hottest technology and the initiatives of financial institutions, which have yet to recognize the advantages of or are still evaluating such technology or technological initiatives. At the very least, currently it is easy to see that, unfortunately, vendors and financial institutions are not yet on the same page when in comes to what they are looking for in initiatives. Moreover, it could be that even if new technology is applied incrementally (to drive improvement) it could also prove to be a driver of disruptive innovation.

In addition to responses that can be numerically tabulated and analyzed, the survey also allowed participants to articulate freely their own invaluable opinions. A more detailed analysis of this survey and examination of innovation in the financial industry in Japan will be available in the upcoming Celent report "Innovation in the Japanese Financial Services Industry: The Gap between Management and Initiatives." Please be on the lookout for it.

 

Fig. 1 Comparison with Other Industries: Global / Japan Comparison

Compared with other industries, financial services firms (e.g., banks, insurers, asset managers) innovate…

FIG1_20140703

Source: Celent Innovation Survey 2013/2014

 

日本の金融機関におけるイノベーション②:パネルディスカッションから

セレントは、去る6月5日、「イノベーション&インサイト・デー 東京 2014」を開催した。「デジタル金融サービスと新たなイノベーションの取り組み」と題した本イベントでは、セレントによるイノベーションサーベイの報告に引き続き、パネルディスカッションを実施した。
本稿は、本イベント報告の第2回である。

 

当日は、日本の金融業界を代表する5人のパネリストにご登壇頂いた。競合とディスクレーマーの強い圧力の中でのご登壇に、セレントは深く感謝申し上げたい。そして何より、パネリストのイノベーションへの情熱と経験、示唆に富む発言内容には、日本の金融業界の自信が感じられた。以下、発言者は特定せず、日本のイノベーターの「心意気」をまとめる。

 

イノベーションの動機

  • 「顧客の期待に応えるために」
  • 「ユーザニーズの高まりと、それを実現する環境や技術の普及を背景として」
  • 「顧客経験の不都合をなくすことを目的に」
  • 「人の気持ち、生活者の想いを実現する金融サービスの提供を目指して」
  • 「イノベーションとは、企業の宿命である」

 

イノベーションのドライバー

  • 「イノベーションの目的と採用する技術とのアライン(整合)」
  • 「テクノロジーとコンプライアンスの摺合せが重要」
  • 「従業員ひとりひとりの取り組み姿勢(やる気)が加速」
  • 「あくまでマネージメントの意思を反映」
  • 「爆発的な成長への誘惑を絶ち」
  • 「ユニークさに賭ける経営哲学が支える」

 

破壊的イノベーションの脅威と機会
会場からの質問、モデレータ―からの問いかけに答えて、

  • 「イノベーションの機会に、特別なものは無い。日々のマネージメントにイノベーションを反映することが重要、創業以来そうしてきたし、これからも続ける。イノベーションは自然体」
  • 「破壊的なイノベーションに、脅威は感じない。むしろ、業界全体の発展のためには、そうした荒波が必要。そうしたチャレンジは受けて立つし、そのようなチャレンジを続けてゆきたい」

 

最後に、セレントからは以下のメッセージで締めくくった。
経営者は、イノベーションに自信を
イノベーションにおける経営者の責任とリーダーシップの重要性は自明である。一方で、イノベーションは中長期にわたる旅で、時には失敗も許容する必要がある。また、長年かけて培った自らの企業文化すら打ち壊すことも稀ではない。経営者自身のイノベーションへの強烈なコミットメントを要求される。ドライバーとなるテクノロジーは日進月歩だが、確実に成功事例は増えている。経営者には、自信を持って欲しい。

 

破壊的なイノベーションと「改善(カイゼン)」を区分して、前者に取り組む必要性
破壊的なイノベーションが進展しない最大の理由は企業の外ではなく、内に存在する。特に、大企業には以下の性向が見られるが、これらはむしろ破壊的なイノベーションを回避させる。すなわち;

  • 中小企業やスタートアップと比較して、圧倒的に潤沢な資金
  • R&Dに投入できる十分な経営資源(特に、人と技術)
  • (360度のマネージメントが必要な)多様な事業部門と多くの競合
  • 孤立する「ブラックシープ(黒い羊)」

イノベーションを放置すれば、カニバリゼーション(共食い)は、自社のコア業務領域ばかりでなく、あらゆるニュービジネスにおいて発生してしまうであろう。イノベーターを嫌われ者の黒い羊として追放させないために、コア業務における日々のカイゼン(改善)の積み上げと、破壊的なイノベーションを峻別し、後者にこそ、マネージメントとイニシアチブを向けることが重要である。

 

「否定しない」リーダーシップとイニシアチブ
自社の経営資源、特に人材と技術力を信じ、「見えない大陸」や「測れないリスク」、「無消費な消費者」との戦いに傾注することが大切だ。遅々として成果が表れないこうした挑戦における、破壊的なイノベーションの威力を軽視してはならない。そして、常に「肯定的であること」。多様性や異質であること是認し、あらゆる可能性を否定しないリーダーシップとイニシアチブが待望される。

 

今日、産業構造が変わらない業界などどこにもなく、その地殻変動は随所で進展している。デジタルテクノロジーは、商品やサービス、顧客のエクスペリエンスや期待を変化させるだけでなく、価値連鎖やビジネスモデルそのものも、激変させている。

日本の金融業界は、これまでも、卓越したリーダーシップと俊敏な技術導入で発展して来た。人とテクノロジーが支える日本の金融業界、そこでのイノベーションの重要性をセレントは再度強調したい。2つのイノベーションサーベイの結果は、日本の金融業界に一層の変革を促す示唆を与えた。今こそ、イノベーションに関して、トップマネージメントのコミットメントと、テクノロジーベンダーのイニチアチブが期待される。

本イノベーションイベントは、セレント東京にとって、大きな挑戦だったが、サーベイとカンファレンスへの参加者の熱気は、そうした杞憂を一掃した。日本の金融業界は、イノベーションに対して極めて積極的かつ熱心である。セレントは、様々な形で本イベントにご参加下さった、金融業界のプロフェッショナルの皆様に深く感謝し、日本の金融機関におけるイノベーションの成功を熱望する。

 

図 2. イノベーションを支援する組織(金融機関・ベンダー比較)

Innovation survey2

出典: セレント「イノベーションサーベイ」2013/2014

日本の金融機関におけるイノベーション①:2つのギャップ

6月5日、日本の金融業界と金融テクノロジー業界から約120名のご参加を頂き、「イノベーション&インサイト・デー 東京 2014」を開催した。本稿では、本イベントの要諦を2回に分けて報告する。

まず、基調講演において、先月実施した「日本の金融業界におけるイノベーションサーベイ」と、昨年10月にグローバルに実施した調査結果を比較し、そこからの示唆として2つのギャップを報告した。

 

その1:リーダーシップ・ギャップ
1. 重要性認識
「これから数年間、イノベーションは非常に重要。顧客期待は急速に変化しており、遅れないように対応する必要がある」との回答の割合は以下の通りであった。

  • グローバル:79%、日本:81%

・・・・イノベーションの重要性に疑う余地はない。

 

2. イノベーションに取り組むリーダーシップ
「イノベーションの責任者(チーフ・イノベーション・オフィサー)がいる」

  • グローバル:11%、日本:7%

「イノベーションの専門組織(イノベーション・CoE)がいる」

  • グローバル:27% 日本:7%

「イノベーションに関するリーダーシップはCEOレベルの推進者に頼る」

  • グローバル:62%、日本:85%

・・・・イノベーションに対する取り組みについて、トップマネージメントのリーダーシップ不足は明らかであった。

 

3. 3大阻害要因

  • グローバル:①日常業務のルーチン②社内慣習③サポート体制の不備
  • 日本:①社内慣習②経営幹部のサポート不足③日常業務のルーチン

・・・・グローバルにも日本でも、金融機関におけるイノベーションは、その重要性の認識に反して、リーダーシップ不足は鮮明であった。

 

その2:金融機関とベンダー間のギャップ
日本サーベイでは、イノベーションに関するイニシアチブを、金融機関と金融ソリューションベンダーの両セグメントに尋ねたが、両者の間にはもう一つのギャップが垣間見られた。
1. イノベーション推進の経験年数

  • 金融機関とベンダーの間で大きな差異はなく、両者とも、
  • 3年未満:54%、 5年以上:3割強

・・・・金融機関からすると、テクノロジーを供給するベンダーのイノベーションに関する経験は同程度、そのイニシアチブが十分に享受出来る状態では無いとみなされる。

 

2. 組織・体制
「チーフ・イノベーション・オフィサーを任命済み」

  • ベンダー:24%、金融機関:7%

「イノベーション・CoEを任命済み」

  • ベンダー:14%、金融機関:7%

「リーダーシップをCEOレベルの推進者に頼る」

  • ベンダー:67%、金融機関:85%

・・・・ベンダーに一日の長が見られた。

 

3. イノベーションを主導する部門

  • 金融機関:ビジネス部門が主導:30%、IT部門が主導:11%
  • ベンダーのイノベーション提案:ビジネス部門向けは14%、IT部門向け:17%
  • ビジネス・IT両部門での取り組み:金融機関:59%、ベンダー:69%

・・・・・金融機関のイノベーションにおけるIT部門のイニシアチブと、ベンダーのビジネス部門に対するイニシアチブに関して、ギャップが垣間見られた。

 

4. 「デジタル金融サービス」への取り組み
セレントが提唱する、「デジタル金融サービス」(デジタル技術を活用した、革新的な金融サービスの提供)への取り組み状況においても、金融機関とベンダーの優先順位に明らかにギャップが見られた。

  • 金融機関の優先分野:「プロセス改善」、「取引機能拡張」、「商品・サービスのカストマイズ」
  • ベンダーの取り組み分野:群を抜いて「ビックデータ」、「モバイルと双方向通信」、「オムニチャネル」

・・・・金融機関は総じてコンサバティブ、一方、ベンダーはアグレッシブな提案姿勢が浮かび上がった。

 

このギャップは何を意味するのか?新しい(若しくは、流行の)テクノロジーを積極的に提案するベンダーと、その有効性を見出せない(若しくは、評価中の)金融機関の取り組みギャップであろうか?少なくとも、現時点では両者のイニシアチブがきっちりとシンクロしていないことは、残念ながら、容易に想定されよう。また、新たなテクノロジーが、インクリメンタルな(カイゼン的な)イノベーションには適用されても、ディスラプティブな(破壊的な)イノベーションのドライバーとなれているか?
サーベイでは、これら数値で分析出来る項目に加え、自由回答における参加者の貴重な「つぶやき」を記録した。それらの詳細と分析は、近刊のセレントレポート「日本の金融機関におけるイノベーション:マネージメントとイニシアチブのギャップ」をご参照願いたい。

http://www.celent.com/ja/reports/32573

 

図 1. 他業界と比較した、金融機関のイノベーションの進捗レベル認識(グローバル比較)

Innovation survey1

出典:セレント「イノベーションサーベイ」2013/2014

 

The State of the Indian Capital Market

There are fundamental problems in the Indian capital market structure, such as lack of liquidity and limited depth and breadth. Many listed securities on stock exchanges are not traded; among the traded securities, not many are traded actively. The market is highly concentrated; a few companies dominate trading at the exchanges. This clearly narrows the breadth of the market, giving rise to liquidity problems for many stocks. Geographic breadth is another problem for Indian markets. Around 80% to 90% of total cash trading and 70% to 80% of mutual fund ownership come from the top 10 cities, with the top two cities (Mumbai and Delhi) accounting for about 60% in each segment.. These shortcomings can be addressed by technology development, better regulations, and focus on financial inclusion. India’s capital market regulator, Securities and Exchange Board of India (SEBI), has been addressing many of these issues. Although the equity market in India is relatively well developed, the debt market is lagging by some distance. The debt market is dominated by government securities. The corporate bond market is very small for a number of reasons, including lack of market infrastructure and adequate regulatory framework, low liquidity, lack of investor interest, etc. Efforts are being made to develop the corporate bond market. Some of the measures include increasing the limit for foreign participation, reducing issuance and transaction costs for corporate bonds, applying similar mark to market accounting requirements for loan and corporate bonds to discourage banks from relying heavily on loans, and setting up a basic framework of credit default swaps on corporate bonds in the country. Some positive results have been observed in recent years, but debt market development will require long-term efforts and commitment. By contrast, India has a healthy exchange-traded derivatives market. India started off with trading in derivatives in the early 2000s, initially allowing trading in index futures (2000) and index options (2001). Options and futures on stocks were allowed in 2001. Since then the product universe has expanded, as has the investor base, resulting in higher volumes and a robust trading platform with sound risk management practices. Index futures and options and stocks futures dominate derivative contracts traded at Indian exchanges. The investor segment is broadly classified into retail and institutional segments. The retail segment brings in the volume, but its trades are essentially low value. A key concern has been this segment’s drop in participation in the secondary market and also in IPOs. This decline began with the crisis in 2008, but the lackluster performance of most IPOs has contributed to what has become an alarming drop. Foreign institutional investors (FIIs) have been a dominant contributor to Indian markets. Since economic reforms started in 1991, India has focused on attracting foreign investment flows by relaxing eligibility conditions for FIIs, relaxing investment limits, and expanding investment instruments. The intermediaries in the market include the exchanges and brokerages. India has 22 stock exchanges registered with SEBI, with over 8,000 registered brokers and over 60,000 registered subbrokers. However, most of the trading takes place at the two major pan-Indian exchanges, National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE). NSE is the largest exchange in the country, with around 70% of the equity volumes, while BSE is the second largest. A lot of revamp is happening within exchanges as they turn more competitive to gain market share. Brokers, both domestic and international, are competing in a highly fragmented market. The next wave of growth will probably arise out of technological capabilities, and hence brokerages are trying to outdo each other by providing advanced trading tools like Direct Market Access (DMA) support and algorithmic trading solutions. India has been an early adopter of the various technological changes occurring in the capital markets. With electronic trading picking up along with the adoption of the internet, booming retail equity business evolved in the last 10 years. Surprisingly, due to the market boom and IPO bonanza, retail adoption of technology initially outgrew technology adoption on the institutional side, where voice brokers still played a large part. As foreign participation in the Indian markets picked up, it brought in a rigor and technological requirement essential for international competition leading to adoption of the latest technologies by domestic market participants. A key reason for the success of the Indian capital markets has been the efficiency of SEBI, the capital market regulator. Four regulators control the participants in the securities market. There have been turf wars, and the future might see a super-regulator. India has a good regulatory environment regulating the capital markets, which shielded the economy, to some extent, from larger negative impacts of the global financial crisis and helped it regain its mark quickly afterwards. The regulator has been cautious in expanding the market, and transparency and investor protection have always been high on its agenda. This has sometimes created conflicts with industries as well as among regulators, but it has taken the markets along the right path of development.

IPO Pricing Issues in India

One of the most important issues in floating an IPO is the pricing aspect. Different forces, often in conflict with each other, are at play here. Issuers would ideally like to maximize the proceeds from the process. Investors would want the offer to be under priced at best and to be (near) correctly valued at worst. Underwriter gets a portion of capital raised as fee, and they would want to maximize their income. But if an IPO is overpriced, there may not be sufficient demand from the market and as a result the issuer may not be able to sell all the shares it had planned. The reputation of the underwriter is also at stake here. It has been observed from empirical data that historically IPOs have been under priced. However, the trend regarding pricing of IPOs seen in India over the last one year has followed an opposite pattern. It has been observed, 70% of the 55 firms that went for IPO during the period April, 2010 to March, 2011, are trading below their offer price. Moreover, 70% of the same 55 firms traded at premium on their listing days, but price fell on subsequent trading days. This implies only very short term investors have actually benefited from these offerings. This is even more surprising when one considers IPO performance in conjunction with overall market performance. In August 2009 BSE created an IPO index that tracks the value of companies for two years after IPO starting from the third day of trading. The graph shows the movement of this BSE IPO index along with that of the SENSEX. It is noteworthy, while the two moved in tandem initially, they have diverged from each other since September, 2010. Thus while the SENSEX gained over 10% during April 2010 to March 2011, BSE IPO index fell over 15% during the same period. This implies overall market condition is not to be blamed for the poor performance of the newly listed firms. This does not augur well for the markets. Retail investors, most of whom invest with medium to long term objectives and are not very sophisticated or well informed, suffered heavy losses and may lose interest in the IPO segment. The pricing of IPOs has come under scrutiny from a number of market participants and the capital market regulator, Securities and Exchange Board of India (SEBI), has taken note of the situation. In the past SEBI had expressed its displeasure regarding overpricing of IPOs and asked the underwriting banks to be more prudent regarding IPO pricing. Recently SEBI proposed that underwriting banks must disclose to investors the performance and track records of their earlier issues in their prospectus and on website. The regulator is also concerned about hyping of public issues through misleading advertisements and media reports and could propose strict penalty if underwriters are found to be involved in such activities. Moreover, SEBI has expressed its displeasure over investment banks, vying among each other to bag deals, quoting very low fees from issuers, thereby promoting issuer interest above investor interest.

Equities Trading at Indian Exchanges: Competition Can Wait

MCX-SX, which offers trading in currency futures, had requested to the Securities and Exchange Board of India (SEBI), the capital market regulator, for approval to launch trading in equities, equity derivatives, interest rate futures and other instruments. It was thought that this move would add a new dimension to India’s exchange landscape which is dominated by the two main exchanges, the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE). The recently started United Stock Exchange, which commenced its operations in the currency futures segment on 20th September, 2010, recorded on its very first day a turnover more than that of the combined turnover at NSE and MCX, the country’s existing currency trading exchanges. It was anticipated equities trading at MCX, if approved, would also throw up similar competition to the country’s two existing exchanges. In September 2008, MCX-SX was conditionally recognized as stock exchange trading in currency futures by SEBI for a year; recognition was extended in August 2009 for one more year to give MCX more time to comply with requirements. In April, 2010 MCX-SX sought permission seeking approval for trading in segments permitted to BSE and NSE. In July, 2010, MCX-SX filed petition before the Bombay High Court seeking intervention over the delay in approving its application by SEBI; in August 2010, the Bombay High Court asked SEBI to take a final decision on the matter by September 30. On 23rd September, 2010, SEBI rejected the application stating it ‘was not satisfied that it would be in the interest of trade and also in public interest to allow the application’. SEBI’s rejection, as mentioned in its order, was based on a number of issues. Under MIMPS (Manner of Increasing and Maintaining Public Shareholding in Recognized Stock Exchanges Regulations), no person resident in India shall at anytime, directly or indirectly, either individually or together with persons acting in concert, hold more than five per cent of the equity share capital in a recognized stock exchange. A select class of financial institutions, however, can own up to a maximum of 15% each.
  • MCX-SX is promoted by Multi-Commodity Exchange of India Ltd (MCX) and Financial Technologies India Ltd (FTIL). When MCX-SX was formed, its promoters MCX and FTIL owned 51% and 49%, respectively, which, after divestment, came down to 37% and 33.9%. The promoters in April, 2010 undertook a further financial restructuring to comply with regulations, by reducing their respective shares to 5% each. However, it also issued warrants to MCX and FTIL, which allows the promoters to gradually sell the warrants under favorable market conditions. Under this arrangement, according to SEBI, MCX and FTIL have together now a holding of 71.90% in the shares and warrants issued by the company.
SEBI listed ‘excessive concentration of economic interest in the stock exchange in the hands of the two promoters’ and ‘not being fully compliant with shareholding regulations‘ as reasons for rejection.
  • MCX-SX had submitted that the two promoters did not share a common management, but it (SEBI) found the two entities are operating under a common management. According to SEBI, therefore the share holding of FTIL together with that of MCX (5% each) exceeds the permissible limit of 5% limit of ownership in a stock exchange.
  • SEBI stated that ‘the promoters of MCX-SX and their associates had arrangements with three shareholders of MCX-SX where sale of shares between the parties were based on offers to buy back the shares at or within specified time in the future’. It found such arrangements illegal.
  • In its order SEBI said ‘MCX-SX has been dishonest in its disclosures to SEBI on material information and has failed to fulfil its disclosure and fiduciary responsibilities’ and also it ‘has failed to adhere to fair and reasonable standards of honesty that should be expected of a Stock Exchange’.
MCX-SX may appeal to the Securities Appellate Tribunal (SAT) against the decision, or go for a writ petition in the high court.

Front-running needs to be eradicated

‘Front-running’, the practice of traders or brokers benefiting from stock market transactions by leaking information of the trades to some of the other market participants in advance, has long been suspected in the Indian stock markets. I have had discussions with the domestic buy side in which they have taken me through the various stages of an equity transaction and pointed out the pre-trade, trade and post-trade stages in which there can be leakage of information that can be profited from. What is worse, the players who suffer from the practice just shrug their shoulders and describe it as something they can do little about. Similarly, when I have spoken of Indian brokerages that have become more capable technologically being used by foreign buy side firms, the same issue has turned up. The latter is wary of the possibility of insider trading or front-running damaging their profitability. Against this back drop, the ban on a trader of HDFC Mutual Fund by the capital market regulator, SEBI, on the basis of 38 instances of wrong doing over 24 trading days between April and July 2007 when the three investors colluding with the trader bought or sold shares before HDFC AMC’s trades were executed, is a welcome development. While it could be merely an initial move in cleansing the markets of an undesirable practice, it shows the capability and the willingness of the regulator to punish participants that undertake front-running. For the traders or brokerages that engage in such actions, it is crucial to understand the damage they are doing to the reputation of their firms and indeed the market as a whole by engaging in such practices. Firms that are very well capable of competing on an equal footing in the markets are being handicapped by the existence and indeed the mere talk of front-running. Such unfair practices are self-defeating and needed to be weeded out. The regulator is to be complimented on taking such an action and we hope that future transgressions would be similarly caught and punished. Furthermore, both buy side and sell side firms need to ensure that they have sufficient checks and balances in place to help the regulator eradicate the practice. Similarly, whistle-blowing needs to be encouraged, not just by individuals, but also firms that believe that their brokers or traders have let them down.

SEBI succeeds in curbing ULIP threat to Mutual Funds

The Securities and Exchange Board of India (SEBI), India’s capital market regulator has succeeded in achieving its underlying objective in the recent row with the insurance regulator, Insurance Regulatory and Development Authority (IRDA). The removal of the front-load commissions for mutual funds by SEBI in mid-2009 had led to an environment in which the mutual funds were at a disadvantage against the insurance companies’ unit linked insurance plans (ULIPs), which had a large investment component. For ULIPs, the commissions for the agents continued to be high, at times more than 40% for the initial installments. As a result, there was mis-selling (over-selling and resorting to unfair practices) on part of the insurance agents. By raising the issue of its role in the regulation of the investment component of the ULIPs, SEBI ensured that the IRDA was forced to take action to prevent SEBI from encroaching into its domain of insurance regulation. In the end, IRDA had to increase the insurance component of ULIPs and also to create disincentives for people who were investing in ULIPs for a period of less than five years. Also, the commission structure of ULIPs had to become more transparent to prevent mis-selling. The two main beneficiaries of this action have been the mutual funds that have regained their pre-eminence as a tool for investment, and the consumers who are enjoying more transparency in ULIPs than earlier, albeit at the cost of fewer choices, as the ULIPs are no longer directly competing with mutual funds. There are some important issues that have been raised by this entire episode. The main one is that there needs to be a redressal mechanism through which the regulators can solve problems with each other. The ULIP episode has been a highly long-drawn public affair that caused a lot of confusion for the investors and companies alike. The insurance companies’ revenues due to ULIPs will also suffer as there would be less investment in them now. Furthermore, the episode does not reflect well on the reputations of the regulators or the Ministry of Finance. There were contradictory signals coming from the ministry as the Finance Minister referred the matter to the courts, but the his Minister for State supported the IRDA’s case in a written reply to the Upper House. The early stage of development of financial regulation in India means that there will be more turf wars. The government is possibly trying to create the infrastructure for their quick resolution through the creation of the Financial Stability and Development Council (FSDC). Whether it is through the FSDC or some other means, it is important to lay down clear guidelines to be followed. Otherwise the Indian financial markets would more and more resemble the Wild West, entertaining for sure, but too chaotic to make sense of. This issue has been dealt with in greater detail in a recent Celent report: Capital Market Regulation in India: Turf Wars Inevitable?