Sebi Reforms: Housing Societies and Co-operative Requirements Boost Financial Inclusion

In a consultation paper published on October 16, 2024, the market regulator proposed allowing associations of persons (AoPs) to open call accounts in their name to hold non-equity securities. This reform aims to improve ease of doing business for organizations such as housing societies, joint ventures and co-operative associations by streamlining asset management.

Easing regulatory barriers

Currently, AOPs, unregistered trusts and partnership firms in the country can open demat accounts in the name of individuals associated with them. This structure reduces the efficiency of collective investment management because assets must be distributed among individual members. Sebi’s new proposal will allow AoPs to directly hold non-equity securities such as corporate bonds, government securities (G-Secs) and mutual fund units in their own accounts.

AoPs will have a legal responsibility to ensure that they only subscribe to financial instruments permitted by the laws governing their structure. Importantly, the proposal excludes equities, indicating Sebi’s cautious approach in limiting AoP to less volatile investments. The move is in line with Sebi’s broader objective of promoting dematerialization, moving away from physical securities and simplifying financial processes for collective entities.

Legal and Regulatory Aspects

The consultation paper highlights that Indian laws are currently unclear as to whether AOPs, unregistered trusts and partnership firms can hold certain financial assets in demat form. Sebi has concluded that no changes will be made in respect of partnership firms and unregistered trusts due to legal complexities.

However, joint stock companies, which can take such forms as joint ventures and cooperative societies, are recognized under current legislation as having the right to own non-stock securities.

The proposal is open for public comment until November 5, 2024. This reform is part of Sebi’s ongoing efforts to simplify the regulatory environment and ease of doing business, especially by reducing the administrative burden on AoPs. By allowing AoPs to collectively manage their financial assets, the reform is expected to reduce individual members’ personal liabilities and increase their participation in capital markets.

Conservative approach

Sebi’s proposal, while progressive for India, is more conservative compared to global markets where entities like AoP have greater access to financial instruments. In the US, structures such as limited liability companies (LLCs) and joint ventures can own both equity and non-equity securities, giving them greater flexibility for collective investing and risk management.

Similarly, in countries such as Germany and France, AoP-equivalent entities such as associations or cooperative groups are fully recognized as legal entities and can hold both equity and non-equity securities, allowing greater autonomy in the management of diversified portfolios.

Russia is also giving its non-profit partnerships greater ownership rights to various financial assets, including shares, reflecting a more open regulatory framework.

In contrast, Sebi’s proposal limits AoP in India to non-equity securities, which is aimed at protecting them from the volatility and risks of equity markets.

A cautious but necessary step

Sebi’s proposal reflects a careful balance between promoting financial inclusion and maintaining market stability. By limiting AoP to non-equity securities, Sebi aims to provide ease of doing business for these entities while protecting them from the risks associated with equity markets. This approach is especially important because many AoPs are small, unincorporated entities that may lack the resources to navigate the complexities of equity investing.

AoPs will have to provide their Permanent Account Number (PAN) while opening demat accounts and ensure that they only hold legally permitted securities. This focus on compliance is aimed at reducing the likelihood of mismanagement and fraud, as well as simplifying the asset management process for AoP. Sebi’s cautious approach aims to protect small businesses and encourage their participation in the capital markets.

Future prospects

While Sebi’s proposal currently excludes equities, there is potential for reforms in the future. In international markets, collective enterprises typically hold both equity and non-equity securities, which allows them to diversify their portfolios and manage risk more effectively. As India’s financial markets develop, Sebi may consider relaxing restrictions on JSC share ownership, bringing India’s regulatory framework in line with global standards.

For now, Sebi is focused on promoting dematerialization and simplifying asset management for AoPs. While this proposal is a significant step forward, future reforms that allow AoPs to participate in capital markets could unlock even greater financial potential for these organizations.

Sebi’s proposal to allow AoPs to open demat accounts is a vital reform aimed at simplifying asset management and ease of doing business for collective entities in India. By allowing AoPs to hold corporate bonds, G-Secs and mutual fund units, Sebi addresses long-standing regulatory inefficiencies and reduces personal liability of individual participants. However, the exclusion of equity shares reflects a conservative approach aimed at protecting AoP from stock market volatility.

While India’s regulatory framework remains more cautious than international standards, Sebi’s proposal is an important step towards modernizing India’s financial landscape. As the country’s capital markets further develop, future reforms could expand the scope of AoP participation to include equity markets, bringing India’s regulatory environment closer to global norms.

Simarjeet Singh is an assistant professor and Sumyojit Paul and Ritwik C are students at the Great Lakes Institute of Management, Gurugram. Opinions are individual.