From UPSC perspective, the following things are important :
Prelims level : NA
Mains level : Stock Market, Role of regulators and investors, SEBI
- On 25 January, US-based Hindenburg Research put out a tweet, talking about a negative report on the Adani Group that it had published. The report made many allegations against the group which triggered a fall in the price of their listed stocks.
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Just think of this situation
- A research report is released by a global firm that is also a short seller (that is, one who sells shares that it does not own, but buys them back at a lower price once the price falls).
- The report outlines areas of concern in a company that is listed in another jurisdiction. The issues raised could relate to the firm’s accounting or market practices.
- The report is released, quite curiously, before the company is going in for an equity issuance.
What happens after the news?
- Panic sale: As equity markets run on sentiments, such news leads to a panic sale and the share price of the company comes down sharply.
- Widespread uncertainty: The market sees investor wealth eroding sharply, leading to widespread uncertainty, as this is how contagions progress.
- Outrage: Denials are issued by the concerned company while the short seller stands firm on its views. However, shareholders have seen an erosion in their wealth and there is outrage everywhere.
In such a situation, what can the regulator do?
- Policies and system in place to put verified facts in public domain: It is for regulators in other jurisdictions to have policies/systems in place for verified facts to be put in the public domain.
- In the current context: The Securities and Exchange Commission of the US would matter and if the broker complied with its rules, then there is nothing to stop their views from being aired in a globalised world. This is why it is said that if any company opts for listing in overseas markets, there is more reason to ensure that its accounts are in place and there are no deviations from best practices.
What can regulators do to protect investors?
- It is necessary to understand that when share prices tumble: Only when someone sells the shares that have declined in value will a loss be actually incurred. This is the first point that ordinary investors need to keep in mind. While the media will talk of the loss of value and wealth, it is notional for those shareholders who don’t sell. And stock prices will return to their equilibrium once the storm passes.
- There is a need to have a wide market intelligence network: A special division that continuously analyses the messaging about Indian companies across the world. Given that such reports do not come up without signals being sent along the way, monitoring of views on companies listed overseas would be essential.
- While citing financial accounting irregularities need to be looked into: the accounting and auditing firms need to take on more responsibility to ensure that the Generally Accepted Accounting Practices (GAAP) are followed for overseas-listed firms. They will have to be made partners in any such crisis in terms of taking ownership and clarifying the same.
- Detecting price manipulation: Price manipulation, for instance, is one practice that has always been a concern for regulators. And it takes a lot of experience to detect it. Thus exchanges need to ensure that their market watch and surveillance practices are robust. This is where trading patterns can show if there has been market manipulation.
- Restoring assurance and sanity in the market: It is necessary that investors have some assurance from the regulator, which may be needed to restore sanity in the markets. However, this should be an immediate and time-bound investigation which looks at the allegations or the shortcomings of the report.
- Investing derivative segments too: As a corollary, the regulator needs to investigate the derivative segment too and probably talk to other regulators to analyse how the short positions have been created and whether they were in order. This will mean being in touch with other regulators, especially the SEC which regulates the jurisdiction for most overseas listings.
- Audit firms can be employed to flag off the concerns: The regulator should insist that all overseas listed companies have regular investor calls with stakeholders where meetings are recorded and transmitted back home for special teams to examine so that there is a sense of how potential investors feel about the companies.
- In the cases of overseas reports, investors must have some assurance from the regulator, which can restore sanity in the markets. But investors also need to be proactive when investing. Those who are more active investors would perhaps need to be aware of developments in the companies that they have invested in.
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