Big, better, best?

A smooth rollout is unlikely for the proposed super regulator

The finance minister in his Budget speech of 2011-12 announced the formation of the Financial Sector Legislative Reforms Commission (FSLRC) with the task of rewriting and harmonising financial sector legislations, rules and regulations. The commission was formed in March 2011 and submitted its final report to the finance minister in March 2013. The finance ministry had invited all stakeholders to put forth their comments and suggestions on the final FSLRC report by July 15, 2013. In a nutshell, the commission has proposed the merging of various financial sector regulators, i.e., Sebi, Forward Markets Commission, IRDA and Pension Fund Regulatory and Development Authority into a Unified Financial Agency (UFA), which would act as a super regulator.

The commission has further sought to address the issue of overlapping jurisdictions by clearly demarcating the role of different institutions. The proposed arrangement would have seven primary agencies — RBI, UFA, Financial Sector Appellate Tribunal (FSAT), the Financial Stability and Development Council (FSDC), the Resolution Corporation, Financial Redress Agency (FRA) and the Public Debt Management Agency (PDMA) — with the main objective of setting the highest standards of consumer protection. One cannot dispute that this is one of the most progressive developments in the history of the Indian financial sector; however, as the consultative process continues, there are several concerns that the stakeholders in the financial sector face.

The FSLRC report adopts a principle-based approach of regulation. In such an approach, broad guidelines are provided and the judiciary interprets them in particular situations to explain their meaning. In a rule-based approach, on the other hand, detailed rules are provided. According to the FSLRC, in a rules-based system, people would develop complex structures to avoid rules and, therefore, general principles should be adopted. Although a principle-based approach does bring uniformity in the regulatory mechanism, there are certain essential characteristics that distinguish various sectors. Therefore, even within a principle-based approach, there should be sufficient rules to meet the specific needs of different sectors.

The Indian economy needs clearly defined rules for financial transactions, or else more cases such as Vodafone will happen, where financial transactions will be questioned by the regulator on principles of equity, leading to more uncertainty in financial markets. This will hamper investment activities in India. A strict principle-based approach will result in more disputes. Further, judicial officers may not be trained to understand complex financial transactions. The judiciary may not be able to provide sustainable interpretation to such principles, leading to more confusion and uncertainty in financial transactions.

The FSLRC prefers a non-sectoral approach towards financial regulation because there is a possibility that some financial sectors may impose a more lenient standard for consumer protection than others. Also, according to the FSLRC, uniformity in a non-sectoral approach would reduce forum-shopping by financial intermediaries. The commission’s opinion is based on the assumption that every sector should be treated equally with respect to consumer protection. But it fails to recognise that different sectors are at different stages of growth and require unequal treatment.

Along with consumer protection, the regulator should also make policies towards development of the sector. A unified structure will take away the attention that each sector requires to solve specific problems that arise only in a particular sector.

One of most debated proposals is the Unified Financial Agency. The report says that multiple regulators lead to economic inefficiency and one regulator never gets the full picture. However, there are huge differences in the way every regulator functions and bringing them under one roof would lead to conflicts. The proposal to unify regulators will only provide administrative ease for the functioning of financial regulators and it is based on a short-sighted view. In a developing nation like India, we need regulators that don’t merely regulate sectors but also focus on the development of the sector.

Creation of a super regulator will give birth to a very powerful organisation, which will have its own inherent problems. Without a focused approach, the chances of grey areas may increase. A better regulatory framework would be to have a co-ordination committee between all regulators that meets every quarter to discuss issues of common interest. Creating a super regulator for all financial transactions in a country with a population of more than 1 billion may lead to delays in actions, increased red-tapism, lowered accountability and ineffective governance. The failure of the FSA in the UK highlights the drawbacks of a unified financial agency.

Another proposal that is absent in the FSLRC report is a clear code of ethics and governance. The FSLRC should constitute a mandatory code of ethics and governance for financial institutions and financial intermediaries in India, with penalties for non-compliance.

As far as rulemaking is concerned, the FSLRC has suggested a structured regulation-making process. There are two ways for framing regulations. One is a detailed method, which involves the publication of draft regulations followed by a public consultation process. The second way would be used for emergency regulation-making and such regulations would become ineffective after six months. This model of rulemaking satisfies the need to formulate regulations based on requirement and given time constrains. The proposed structure emphasises democratic legitimacy and also provides for speedy rulemaking at the same time.

The proposed selection procedure for the board of the regulator is elaborate and the guiding principle for selection has been clearly identified. The process includes a well-balanced mix of experts, members from public services, government nominees and academicians. Transparency should be most important at every stage of the selection process in order to safeguard the sanctity of the regulator.

The FSLRC recognises the role of healthy competition in financial markets for ensuring the best interests of consumers. It is of the opinion that perfect competition alone will not protect consumers. The commission believes greater competition along with a well-functioning consumer protection framework is a powerful tool to enhance consumer welfare. The CCI has overlapping jurisdiction with many independent regulators and the FSLRC has recommended a mechanism for interaction and co-operation between the CCI and financial regulators.

In order to effectively meet the objectives of enhancing competition in the financial sector, the FSLRC and CCI should call for suggestions for a competition policy specific to the financial sector from all stakeholders. Such a policy would form an integral part of the unified draft law. 

The FSLRC report has laid the foundation for a remarkable development from the existent regulatory regime of the financial sector in India. However, the extent of reforms and the practical implications will only become clearer with time.