Regulation 2023

Regulations of Securities Industry
Major Bubbles and Crashes
• Tulip mania (17th Century)

• South Sea bubble (18th Century): “I can calculate the movement of stars but not the madness of men”
• Great Stock Market Crash (Black Tuesday, 1929)
• Latin American Default (1980s)
• Black Monday (1987)
• East Asian Crisis (1997)

• LTCM collapse (1997-98)
• Dot com boom and bust (2000)
• The Great Financial Crisis (2008)

• European Crisis
Discussion on Great Financial Crisis
Learnings from Great Financial Crisis
• Misaligned Incentives create unstable outcomes
• Debt with derivatives is a lethal combination.
• Market participants are intertwined.
• Proprietary trading increases the probability of failure
• Unlisted derivatives hide the systemic risk
• Market players take advantage of regulatory gap.

Mixing debt with derivatives
Share of a company are trading at Rs.100 and you have an

investment amount of Rs.1000. You can do the following:
• Buy 10 shares
• Borrow Rs.1000 more and then invest the total
• Borrow Rs.1000 more and enter into stock futures contract. The
futures price is trading at Rs.100 and you need to deposit a
margin of 5% for the trade.
If the next day the share price and futures price appreciates to
Rs.101, then compute the return earned. Assume the interest to be
paid for a day’s borrowing is negligible.
• Case1: Return=1%
• Case 2: Debt would enable to buy 20 shares. The net return would be 2%.
• Case 3: If the margin is 5%, then using a sum of Rs.2000 we can a stock
futures contract with a lot size of 400 shares (amounting to Rs.40,000). The
total return in this case would be 40%.
India
• Harshad Mehta Scam
• MS Shoes and IPO Scam
• Dot com boom and bust
• Ketan Parekh Scam
• The Great Financial Crisis
• NBFC Crisis
1. What role Investment Banks have in an economy?
2. What is the reason behind regulating Investment Banks?

Regulations (Mainly USA Focused)
• The Securities Act of 1933

• Glass-Steagall Act 1933
• Securities Exchange Act of 1934
• Gramm-Leach-Bliley Act 1999
• Sarbanes-Oxley Act
• Regulation Analyst certification
• Dodd-Frank Act-2010
• MIFID-II (Europe)
The Securities Act of 1933
1. To bring stability to capital markets and

2. Stop manipulative and deceptive practices in the sale or
distribution of securities.
The Act dealt with the following major sections:
• Registration Statement
• The Investment Prospectus
• Due Diligence
• New Liabilities
The Glass-Steagall Act
1. Separated Commercial and Investment Banking functions
2. Creation of federal deposit Insurance corporation which insured

the deposits of investors in case of default by Bank
3. Led to spinning-off of the commercial banking business from

Investment banking business.
4. Commercial banks could earn no more than 10% of their total

income from securities transactions.
Securities Exchange Act of 1934
• A supplement to the securities Act of 1933

• Dealt with supervision of new security offerings
• Creation of SEC
• Regulates exchanges and secondary market transactions
• Reporting and disclosure requirements
The Gramm-Leach-Bliley Act
• Overturned the mandatory separation between commercial banks

and Investment Banks.
• Provides more stable business model irrespective of economic

environment.
• European banks not under the ambit of the Act, thus providing
competition to the US Banks.
• Before this act the limit for revenue had been relaxed to 25% from
10%.
Sarbanes-Oxley Act
• Required SEC to adopt rules to minimize the risk of Investment

bankers influencing equity analyst research reports by separating
stock analysis from underwriting activities.
• Analyst who provided a negative report of a company were

protected from retaliation by underwriters.
Regulation Analyst Certification
Requires the analyst to:
• Certify that the views expressed in the research report accurately

reflect the research analyst’s personal views about the security,
• Certify that either no part of analyst’s compensation will be

directly or indirectly related to the specific recommendation or
views in the report or specify the part of compensation that is
directly or indirectly related to the analyst compensation
Dodd-Frank Act
• Creation of Financial Stability and Oversight Council: Identify regulatory
gaps and provide early warning system for systemic risks.
• Creation of Consumer Financial Protection Bureau: Rule-writing power
governing banks and non-banks offering financial products to consumers.
• Securitization: Firms engaging in securitization should retain at least 5% of
the value of debt product so created.
• Regulation of OTC: Code of conduct for registered swap dealers. Prescribes
public access to swap transactions.
• Funeral plans: large financial companies to submit plans regarding how
they would shut down if they fail in future. Enables preemptive liquidation.
• Proprietary trading not allowed.
• Ratings Agencies: Ratings agencies to be accountable.
• Registration of Hedge Funds and PE with SEC
Key Reforms
• Higher Capital requirements

• Large banks which are systemically important must hold an
extra 2.5% of equity over and above the mandatory limit
• Ban on Proprietary trading
• Separate Investment Banking from retail bank
• Foreign banks to establish local holding companies for all their
subsidiaries.
• Standardization of derivatives that are offered and push them
into clearing houses and exchanges
• Capping on the bonus
Impact of new regulation on Investment Banking
1. Increase Transparency: In providing investment advice

2. Reduce risk arising from opaque markets: shift of OTC
derivatives or products to central counter parties
3. Increasing capital requirements: imposition of incremental risk
charge, securitization charge, measures for proprietary trading
4. Reducing leverage:
5. Asset holding: compulsory for banks to increase their holding of
high quality, liquid assets. This would impact the profitability
6. High funding cost on account of regulatory requirement to
reduce the maturity mismatch by increasing long term funding
7. Counter party credit risk charge: based on maturity of product
and creditworthiness of counterparties.
The above reduces revenue streams and increases operating costs

leading to decreasing ROE
Regulators in India
• Ministry of Corporate Affairs

• Department of Economic Affairs (Under Ministry of Finance)
• SEBI
• RBI
• Stock Exchange (not a regulatory authority but works along with
them)
Indian Regulation Characteristics…
• The term “Investment Banking” is not explicitly used in any

regulation in India.
• Indian regulatory regime does not allow all Investment Banking

functions to be performed under one legal entity. Why?
• To prevent excessive exposure to business risk under one
entity
• To prescribe and monitor capital adequacy as well as risk
mitigation mechanisms.
• Indian Investment Banks follow a conglomerate structure by

keeping their business segments in different corporate entities to
meet regulatory norms.
…Indian Regulation Characteristics
• Merchant Banking business has to be in a separate company as it
requires a separate license from SEBI.
• Merchant Bankers prohibited from undertaking any business

other than that in securities markets.
• Asset management business in the form of a mutual fund

requires a three-tier structure.
• Equity research is independent of merchant banking business.
• Securities business (i.e. stock broking) has to be separated into a

different company as it requires stock exchange membership
apart from SEBI registrations.
Regulatory Framework
• Merchant banking activity under SEBI(Merchant Banking
regulations 1992).
• Underwriting activity regulated under SEBI (underwriters
regulations 1993)
• Stock Broking and other secondary market operations under:
• Stock exchange bylaws,
• SEBI (Stock Brokers and Sub Brokers rules 1992),
• SEBI (Prohibition of Insider Trading regulations 1992)
• Asset Management under SEBI (Mutual Fund regulations 1996)
• Alternate Investment Funds regulation 2012
• AIF-I, AIF-II and AIF-III
Domestic Systemically Important Banks (D-SIB)
• The D-SIB Framework specifies a two-step process of identification of D-SIBs. In
the first step, the sample of banks to be assessed for systemic importance has
to be decided.
• The selection of banks in the sample for computation of Systemic Important

Scores (SIS) is based on analysis of their size as a percentage of annual GDP.
• Based on the methodology provided in the D-SIB Framework and data

collected from banks as on March 31, 2019, the banks identified as D-SIBs and
associated bucket structure are as under:
Additional Common Additional Common
Equity Tier 1 Equity Tier 1
requirement as a requirement applicable
et Banks
percentage of Risk from April 1, 2019 (as
Weighted Assets (RWAs) per phase-in
for FY 2018-19 arrangement)
5 - 0.75% 1%
4 - 0.60% 0.80%
3 State Bank of India 0.45% 0.60%
2 - 0.30% 0.40%
1 ICICI Bank, HDFC Bank 0.15% 0.20%

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Regulations of Securities Industry

Major Bubbles and Crashes

• Tulip mania (17th Century)

• Latin American Default (1980s)

• Black Monday (1987)

• East Asian Crisis (1997)

• Dot com boom and bust (2000)

• The Great Financial Crisis (2008)

• Misaligned Incentives create unstable outcomes

• Debt with derivatives is a lethal combination.

• Market participants are intertwined.

• Proprietary trading increases the probability of failure

• Unlisted derivatives hide the systemic risk

• Market players take advantage of regulatory gap.

Share of a company are trading at Rs.100 and you have an

• Borrow Rs.1000 more and then invest the total

• Harshad Mehta Scam

• MS Shoes and IPO Scam

• Dot com boom and bust

• Ketan Parekh Scam

• The Great Financial Crisis

2. What is the reason behind regulating Investment Banks?

• The Securities Act of 1933

1. To bring stability to capital markets and

The Act dealt with the following major sections:

1. Separated Commercial and Investment Banking functions

2. Creation of federal deposit Insurance corporation which insured

3. Led to spinning-off of the commercial banking business from

4. Commercial banks could earn no more than 10% of their total

• A supplement to the securities Act of 1933

• Overturned the mandatory separation between commercial banks

• Provides more stable business model irrespective of economic

• Required SEC to adopt rules to minimize the risk of Investment

• Analyst who provided a negative report of a company were

Requires the analyst to:

• Certify that the views expressed in the research report accurately

• Certify that either no part of analyst’s compensation will be

• Higher Capital requirements

1. Increase Transparency: In providing investment advice

The above reduces revenue streams and increases operating costs

• Ministry of Corporate Affairs

• The term “Investment Banking” is not explicitly used in any

• Indian regulatory regime does not allow all Investment Banking

• Indian Investment Banks follow a conglomerate structure by

• Merchant Bankers prohibited from undertaking any business

• Asset management business in the form of a mutual fund

• Equity research is independent of merchant banking business.

• Securities business (i.e. stock broking) has to be separated into a

• The selection of banks in the sample for computation of Systemic Important

• Based on the methodology provided in the D-SIB Framework and data

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