Unease spreads through D-Street over ‘regulatory risks’

Dalal Street is seized by a newfound worry – regulatory risk, or the likelihood of changing laws in an industry that could affect business. As investors, money managers, and equity strategists assess risks these days in a hot equity market, the one posed by possible actions by domestic authorities and regulators to temper fervent stock market activity – especially derivatives – is being increasingly debated, especially with the budget round the corner.

To be sure, the government has not signaled any clampdown yet, but recent remarks by financial market regulators indicating discomfort over the heightened buzz in various portions of the equity market have prompted some to sit up and take notice.

Last week, Sebi head Madhabi Puri Buch said the surge in F&O volumes is no longer a “micro objective of protecting investors” but a “macro issue.” The Sebi head said household savings are not going into capital formation but into speculative activity. Separately, RBI chief Shaktikanta Das warned of the likelihood of “structural liquidity” issues as banks struggle to raise deposits with a chunk of the money flowing into mutual funds. These comments have sparked discussions among market participants about whether authorities are preparing the Street for some sort of intervention by the government and regulators.

While Sebi is already working on streamlining contracts in the F&O segment in a bid to slow down activity, what these market participants are worried about is the probability of the government stepping in. One theory being debated among money managers and institutional brokers is that the government in the July 23 budget may make it more expensive to participate in equities and derivatives. Some are speculating that there could be an increase in taxes on gains from equities, especially those made in the short-term, while a section of the market is of the view that the focus may specifically be on areas that have seen unbridled activity such as derivatives. Others are of the opinion that the government may not want to rock the boat for now. Jefferies’ global equity strategist Chris Wood said concern over a potential increase in the capital gains tax rate in the budget has eased because of the government’s reduced mandate in the recent elections.

The phrase ‘regulatory risk’ has been seldom discussed by market participants in this context in recent times. Most of the chatter on Dalal Street before the budget on stock market-related taxes has been around calls for scrapping the securities transaction tax (STT). This time brokers and traders are mum on this, probably sensing that the timing of such a demand is inappropriate.The last time there were faint murmurs of regulatory risks was in 2018 before the budget when then finance minister Arun Jaitley re-introduced taxes on capital gains from equities sold after one year of holding. The move came as a trigger for a prolonged slide in the overvalued mid-cap and small-cap stocks.Wood warned in his Greed & Fear newsletter that if the government goes ahead with an increase in capital gains tax, it will likely trigger a sharper slump than that of June 4 in the initial response to the general election result.There is, however, little to show in the market that such worries are widespread. The Volatility Index (VIX) – the market’s fear indicator – inched up to 14.83 on Friday, but analysts said this level doesn’t signal any big sense of fear. VIX had almost doubled to nearly 25 in the run-up to the election results, suggesting options traders foresaw risks to the market from the outcome.

The absence of any concern around regulatory risks is probably worrying this section of the market participants. If the government decides to leave the current capital markets tax structure untouched, it may trigger a relief rally in equities on budget day.