Indian regulators seem to be brought up on a steady reading diet of stories of romance (the sheer poetry of the latest RBI State of the Economy report is a prime example), often unrelated to non-fiction realities of the world we live in. What else can explain a touching naivete and earnest innocence that often informs proposed policy?

A recent consultation paper put out last week by the Securities and Exchange Board of India (SEBI), the capital markets regulator, proposes—inter alia—two key changes. The first is a reduction in post IPO lock-in period for promoter holdings if the issue is an Offer for Sale (OFS) or for a purpose other than capital expenditure on a project. The second is a change in the definition of “Promoters”, with its attendant powers of the market regulator impounding shareholdings in case of transgression, to a broader and more ambiguous “Persons in Control”.

Both have been prompted primarily by real-time difficulties faced by private equity investors with existing regulations/disclosure norms, which were meant for an earlier era and stage of market development.

Ongoing review of policy and undertaking necessary changes in an evolving scenario is an essential part of the regulatory framework, No comments are therefore offered on the specific technicalities of the recommendations. It is however essential from a public policy perspective to parse their underlying rationale, to conclude if they reflect an accurate understanding of the reality of market trends and if these changes meet desired regulatory outcomes.

“Nowadays companies going public are well established with mature businesses, have pre-existing institutional investors like private equity firms, alternate investment firms etc. and their promoters have demonstrated “skin-in-the-game” for several years before listing”, states the SEBI rationale for the first proposed change. In contrast to the earlier period, when IPOs were used for greenfield project financing, and therefore the lock-in period was necessary to ensure promoter skin-in-the-game. And therefore suggesting that equity lock-in requirements for promoters now be reduced.

Equity lock-in has always been a contentious and hotly contested, element of permitting capital market access in India. Its philosophical roots lie in the fact that the sale of shares to retail investors, listing, and access to future public fundraising, marks a major milestone in the life journey of a company—a responsible coming of financial age. In the process, the company—along with its management and controlling shareholders—makes certain representations through its prospectus to the public.

Thus the argument for greater investor protection through a reasonable period of “seasoning” of its statements/representations, during which the promoter/controlling shareholder is “locked-in” for a minimum equity requirement. In an environment of poor corporate governance mechanisms—internal (quality of financial statements, auditors, directors, controlling shareholders, management agency) and external (rating agencies, banks, regulators, legal recourse for contract enforcement and rights) in an emerging economy, this has often been among the few and limited skin-in-the-game comforts available to retail investors.

The veracity of claims of “maturity” of businesses, promoters, management and “institutional” private equity investors going in for IPO/OFS and listing— their skin-in-the-game, and for acting in any capacity beyond narrow self-interest—is now only too well evidenced by examples like Reliance Power, ITNL, Yes Bank et al.

As for purportedly “mature” new-age businesses, their private equity fuelled merry-go-funding-round spiralling valuations have reached astronomical, and unsustainable, levels. With little underlying profitability, cash flows, or now even expectations to justify most of them, the "future" for many of these “high on cash-burn” companies is so distant as to be invisible even to a financial Hubble telescope. Very few will survive to be genuine Unicorns.

For the rest, with the PE clock fast ticking to midnight, there is an urgent need for an exit before the carriages they are riding on turn to pumpkin. The only way for investors to encash these investments is to urgently fix a horn on faltering quadrupeds, dusted and powdered to appear attractive, and offload into a frothy IPO momentum market to frenzied, unsuspecting retail investors at unicorn valuations. Uber, Lyft and WeWork IPOs are but examples and likely precursors of the next IPO wave trend in emerging markets like India.

Which therefore begets the obvious question. Without reasonable equity lock-in, what other mechanism then keeps skin-in-the-game for private equity investors—who are also “persons in control” of the company and “acting in concert” with promoters/management by virtue of shareholding, directorships and control of Key Managerial Personnel (KMP) appointments—from a regulatory viewpoint?

The second proposed change from “Promoters” to “Persons in Control” offers the argument that “Increasingly, there is focus on better corporate governance with the responsibilities and liabilities of shifting to the boards and management. Shareholders now look to the board of directors and management to protect their rights and add value, while discharging their duties. This increased focus on board and management has also reduced the relevance of the concept of promoter”.

While directors have come some way away from being among family retainers of promoter families, the claim of Indian companies being independent board and management driven is not borne out by evidence, anecdotal or empirical. Controlling shareholders continue to dominate and control cash flows beyond their proportion of shareholding and “tunneling-of funds” concerns remain in family businesses. For independent, management-driven companies—significantly fewer in number than suggested, the issue of their agency self-interest acting to the detriment of other stakeholders has also been evident. There is little evidence to support the contention that the overall Indian corporate environment has representatively evolved to a higher level of board and market-driven governance structures as prevailing in similar Anglo-Saxon common-law markets like the USA or UK.

While alternate mechanisms to bring accountability to management-driven companies and reduce their issues of agency can be examined, there is no doubt that the power to freeze promoter equity holdings in family-controlled firms has been an important tool in the regulatory armoury. If that is to be surrendered, what then replaces it as a tool for enforcement and ensuring regulatory compliance for promoters/controlling shareholders?

Again, the constant and ongoing review of the regulatory framework is a welcome and essential evolutionary step. As are efforts to move corporate practices to board and market-led mechanisms of governance.

However, for policy to be effective, its rationale has to be embedded in insightful learnings from the past, a keen and clear-eyed understanding of the present, and a reasoned estimate of future outcomes. Wishful thinking is not sound public policy.

As Deng Xiaoping is reported to have said—“ It doesn't matter if the cat is black or white. As long as it catches mice.”

An adage that regulatory cats would do well to keep in mind. Before dubious unicorns pulling PE Cinderella carriages to the Market Ball turn into rodents that gnaw away at market and investor confidence.

—Sandeep Hasurkar is an ex-investment banker, and author of Never Too Big to Fail: The Collapse of IL&FS and its trillion rupee maze. The views expressed in the column are his own

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(Edited by : Ajay Vaishnav)