Weigh all options | Outlook Business
Home  /  Perspective  / Weigh all options | MAY 11 , 2013

Illustration by Kishore Das

Perspective

Weigh all options
Impact assessment can lead to better and fewer regulations

Sandeep Parekh

Regulation is fundamental to governing complex, open and diverse economies. It allows policy makers to balance competing interests and has been critical to the development of the modern state. However, when a regulation is framed, many of its effects are “hidden” or at least difficult to identify when its content and scope of applicability is being considered. Often, this results in costs exceeding the benefits expected from the regulation.

It has become crucial for regulators to regulate better, especially in industries as dynamic as the financial market. Improving the quality of regulation has shifted its focus from identifying problem areas, advocating specific reforms and eliminating burdensome regulations, to a broader reform agenda. The goals sought to be achieved by regulatory supervision include safeguarding the stability of the financial system, promoting efficiency and compliance of market intermediaries. And, most importantly in the case of developing markets such as India, providing adequate protection to customers of financial services offered by intermediaries. 

How can this be achieved? Regulatory impact assessment (RIA), used by many regulators in developed markets, is a method for identifying the costs of regulation on the business sector. This perspective has led the call for better regulation, rather than more regulation. Interestingly, an RIA can throw up results that show that “doing nothing” is a real option, particularly where action, or the cost of creation of regulation, far outweighs the benefits of implementing the regulations.

Globally, policy makers are increasingly valuing regulation that produces desired results as cost-effectively as possible. The US is the leading country for RIA. During the 1970s, companies were faced with higher cost of compliance due to the evolving regulatory climate. The government promoted cost-benefit analysis (CBA) to minimise regulatory burdens faced by the economy. The SEC, the American equivalent of Securities and Exchange Board of India (Sebi), although not subject to an express statutory requirement, still conducts CBAs for its rule makings.

The US enacted the Financial Regulatory Responsibility Act, 2011, to ensure that all financial regulators conduct comprehensive and transparent economic analysis ahead of adopting new rules. Similarly, the Financial Services and Markets Act, 2000, was enacted in the UK, obliging the Financial Services Authority to undertake a CBA of any rules or regulations it proposes for the efficient governance of the financial markets. The OECD, too, has proposed to the regulators in its member-states to keep in mind the one-off costs over the extended period of time the regulation is expected to be in force. 

RIA in India: Are we on the right track?

In India, Sebi has been vested with the power to regulate the securities markets. The statutory framework, which has been continually evolving since 1992, has withstood the test of time and broadly ensures quality intermediation in the marketplace. However, what is often alleged by the regulated participants is that Sebi imposes a heavy burden of compliance on the market participants. 

One of the prominent issues in Sebi’s regulatory environment is of over-regulation of brokers. Brokers have to undergo several layers of inspection and audits throughout the year. The underlying impact of frequent audits and inspections every year increase the compliance costs, are time-consuming and are considered to be duplication of effort that may easily be carried by a nodal agency on behalf of all the stock exchanges, clearing corporations, depositories and regulators of the broker.

Repeated inspections, notices and requests for information distract the focus of the senior management and constrict the ability of brokers to expand operations without any gross or net benefit to society. A typical broker may be inspected in one year by three exchanges, three clearing corporations and two depositories, besides Sebi — each of these being duplicative. 

RIA has been carried out by Sebi, though in a limited scope, in a few situations. In fact, Sebi had initiated a process of introducing RIA in its board’s decision-making for introducing new regulations around 2007, but has since not been used routinely. A most remarkable impact of Sebi’s regulatory mandate was felt in the dematerialisation of shares. Though the initial costs imposed by the regulation was very high, Sebi phased the implementation of its proposal. As history stands testament, the benefits in the long-term have far outweighed the short-term costs (which was protested at that time).  

The benefits of RIA

Conducting an impact analysis is not a novel concept, or one whose importance may ebb with the passage of time. The calls for conducting such exercises on the larger regulatory environment, rather than just for securities regulations, have been growing for a while.

RIA is primarily a methodological approach that allows for the ex-ante or ex-post outcomes to be assessed against the goals set for the regulation. A CBA is expected to help regulators and the concerned decision-makers think through what each proposed rule intends to accomplish and what the acceptable costs of achieving those objectives might be. An RIA will be an efficient method of identifying long-term costs and benefits as opposed to the immediate costs and benefits that are visible without it. This assumes importance since regulations are drafted to serve their purpose for considerable periods of time.

It must be understood that RIA is not against regulation. It is not against a decrease of regulatory authority either. What it stands for is smart regulation, where the regulator can develop mechanisms for enforcement of its mandate, achieve its objectives in a manner that costs the least and investigate and repeal provisions that place an unnecessary burden on entities without any justifiable benefit and, at the same time, reduce the larger economic costs. 

A participative and consultative RIA mechanism brings in a certain level of consistency in the regulatory framework while avoiding the possibility of overlap of regulatory reach, over-regulation of entities and distortion of competitive forces. By making clear the expected benefit, quantitative or qualitative, as well as the costs to be incurred, regulators will be better able to justify the imposition of rules and expect stronger, and possibly even voluntary, compliance by the entities they govern. 

The use of RIA is not merely semantics but forces a strong analytical framework for judging and introspecting before new regulations are introduced. Sebi and every regulator (financial or otherwise) should incorporate RIA along with the current public consultation process into every proposed regulation. This will create the seemingly impossible duality of better regulation with less regulation at the same time. 

Here's your chance to read the latest issue of Outlook Business for free! Download the Outlook ​Magazines app now. Available on Play Store and App Store
On Stands Now