Insider trading laws - comments to SEBI

We sent out our views today on the proposed new insider trading norms to the high powered committee set up by SEBI. The views  in brief centre around the following three points:

1. Insider trading prohibition should be restricted to dishonest and fraudulent conduct not legitimate business. Today even investment post due diligence can be termed as insider trading.

2. For there to be  insider trading, there should be  an insider with access to information. The 'parity of information rule' which was never intended has been introduced. This does  violence not  only to the basic origins of insider trading (which arose out of the anti-fraud rule in the US),  but also  does violence to the statutory provision in the SEBI Act.

3. Outside information should be excluded from the prohibition. A company doing a hostile acquisition which has no access to inside information should never be charged with insider trading. Similar reasons as 2.

Note: Many people believe in the 'parity of information' rule. Here is an analogy, if you do. Imagine a Rs. 100 rupee note lying on the road and you pick it up. Now imagine another situation where a person steals another person's money by picking his pocket.  The former  is the parity rule,  unfair but not illegal, the latter is  the insider trading prohibition, both unfair and illegal.

SEBI reactive or active

I have a guest piece in today's Business Standard on whether SEBI is reactive or proactive. I argue that while by its nature SEBI has to be reactive (it's not a spy agency), the difference between the two need not be substantial given prompt action. So though an early remedial action may prevent the cancer of Ponzi or other such schemes from growing, it cannot Angelina Jolie like, excise the problem before it occurs or Lara Croft like prevent the bad guys from acting before they act. Here is the full piece and here is the link to the original:

"The recent crisis involving the Saradha group has brought to the fore the issues surrounding the supervision of schemes that style themselves investment vehicles, and attempt to get away with money-circulation or Ponzi schemes. The Securities and Exchange Board of India (Sebi), the capital market regulator, has a major role to play in effective enforcement of the rules of the game in the capital markets and some types of deposit-taking. As Sebi celebrates its 25th year, there is much to commend it. But it also needs to look ahead, because the road will continue to be long and treacherous.

The nature of enforcement action by Sebi and probably of all financial regulators is reactive rather than proactive. However, even a reactive response may be a proactive one, where on the basis of a single complaint, or suo motu cognisance, the market regulator may initiate investigations, call for information, suspend the business of deposit-taking and, if necessary, issue appropriate orders to the erring entity. While financial scams erode public confidence in genuine investment avenues, they may also occupy a dark space where the spotlight of financial regulation rarely falls, or exploit the possibilities that exist on the penumbra of such regulation. While the market regulator does not possess the resources or the ability to snoop and detect, it relies on information or complaints that may be received by investors. Unfortunately, such leads are only forthcoming when the scheme has attracted negative publicity, is on the verge of collapse or has defaulted. This, usually, is the point of little, or no, return and in the usual absence of any safety net in the form of assets, depositors are left staring at losses.

This fact of being reactive may rile some people since in an ideal world, the regulator ought to be proactive and prevent all frauds before they happen. Thus, the reactiveness of the regulator is seen by many as its ineffectiveness. The reality is that regulators have limited powers and resources. They don't have an intelligence bureau and much of a presence on the ground. This, however, doesn't mean that they are the police from Bollywood movies, arriving after the investor has been cheated and the money gone forever.

Enforcement being reactive or being proactive is not really a binary option. There are lots of shades in between and, therefore, there is a lot of scope for preventing harm to the investor before it is too late. To give one example, if a Ponzi scheme were to start in a small district in Madhya Pradesh, there could be three variations of enforcement. In the extreme and idyllic version, Sebi would know about the scheme before it is hatched, and the person is stopped from carrying out his (and it is usually a "he") crooked scheme. This could be by way of tapping phones, sending snoops in every district, and so on. In this ultra-idyllic version, no one is ever defrauded. The other extreme is the proactive version, where millions of investors have already been cheated over five years. Sebi comes in, does an investigation that goes on for several months, and then passes an order penalising the person and asking him to disgorge the money raised from the investors. Since the person has little money left, prosecution is launched. Investors get virtually nothing in this extreme.

In between these extremes is where reality lies. So, in the third example, either because an investor complains after three months of the launch of a Ponzi scheme or because Sebi has a local office that keeps its eyes open for such schemes, the regulator swings into action. A few hundred people are, indeed, swindled, more money is recoverable since it is early days of the deceit, and the state government helps put the person behind bars. Clearly, this is possible and there are various versions possible between the two extremes, and the action could start from a few weeks after the fraud has started, or could start closer to the five-year mark. In addition, the speed and alacrity with which Sebi and state governments (perhaps also the Reserve Bank of India, which has some powers over chit funds) react and cooperate would result in the least damage to the investor.

This middle ground between proactive and reactive is not imaginary. In fact, it does happen. Sebi has taken action against several people who put advertisements in newspapers inviting investors for such schemes.

At a different level, Sebi does play a purely proactive role. That it does in a narrow area of activity, i.e. market surveillance of the transactions on exchanges in India. Thus, to take one example where Sebi discovered a massive fraud, it stopped the payouts and ensured return of money to investors. With the electronic paper trail and every rupee used on the stock exchange connected to the PAN number of an individual or company, it is relatively easy to catch people with their arm in the cookie jar. However, Ponzi schemes don't usually occur on the exchange, and there is need to look at the problem at the state level and the district level.

Here is what Sebi and others can do to improve their record on the scale between reactive and proactive. First, be more sensitive to complaints received from small, and sometimes even semi-literate people from small places. Information about fraudulent schemes can often be gathered from these poorly written letters of complaint.

Second, with 600-odd people, there is no way Sebi can address these schemes. Its manpower needs to increase by a substantial factor. The US Securities and Exchange Commission's enforcement staff alone is over a thousand for a country that has a third of India's population.

Third, the speed at which Sebi conducts investigations must be ramped up.

Fourth, state governments need some pressure to cooperate with Sebi, since senior politicians may be supporting the violators. Some accountability of politicians and bureaucrats is required so even if they don't help much, at least they don't get in the way of effective investigation.

Fifth, there should be an investors' charter, which give investors certain rights of redress within a time-bound period.

Lastly, our judicial system needs to be harsher towards economic offenders, who are often let off with a fine rather than a jail sentence."

Shareholder democracy - U of Chicago version

Just read a thought provoking piece in yesterday's financial times (linked here - but requires subscription). The piece by Profs. Eric Posner and Glen Weyl of the University of Chicago is sure to outrage many, but like all Chicago school ideas like legalising insider trading, it is thought provoking.

In brief their views can be summarised in their own words as: "Shareholders have virtually no influence over the composition of boards of directors or even major transactions, such as mergers. The situation is dire and decades of reform efforts have failed to solve it. But new economic ideas offer promise for improvement.
...
Suppose that when an investor buys a share of a publicly listed company, he or she is given only the right to a share of profits, and not any right to vote. Instead, when a board election or transaction requires a vote, each shareholder would have the right to buy as many votes as they want. The catch is that they must pay for each vote, and the more votes they cast, the more that they pay per vote. More precisely, the price for voting is the square of the number of votes cast: the cost of casting one vote is one dollar, casting two votes is four dollars, three votes is nine dollars, and so on. The money spent on voting goes into the corporate treasury, and is thus ultimately distributed back to shareholders in the form of profits."

The full paper can be found at SSRN linked here. Thought for the day is that the paper is geared towards the US shareholding pattern - which is diffused. Would the arguments hold (even theoretically) in the Indian context where there is a dominant promoter shareholder?

Ponzi schemes and financial exclusion

I have a piece in today's Financial Express connecting the proliferation of Ponzi schemes to financial exclusion by the formal financial channels in the name of KYC. If a professor at IIM (me) cannot open a bank account in the city he has moved into - what hope do we have of daily labourers opening bank accounts? I also look at some quick changes needed to reduce these schemes and frauds. The answer is a citizens charter and better cooperation, not new laws.

Here is the full piece:

Saradha is now synonymous with all that is wrong with India’s financial world. Financial exclusion, surfeit of laws, entrapment of gullible investors, political-scamster nexus, poor enforcement of existing laws and a complete and unmitigated disillusionment with the financial world. As if mocking us, the company’s website is still up and running and continues to market its castles in nowhere land.

Before we talk of Saradha, we must invoke the God of pyramid schemes. In fact, he has so well found his place on mount Olympus along with other Gods that few people use the phrase pyramid scheme to describe the fraud. Most people instead say Ponzi scheme to describe the generic fraud.

The fraud is, of course, deceptively simple, but lethally effective. It is the payment of, often huge, interest to investors (who have invested previously) from the capital of others (who invest later). As word spreads about the excellent track record of the fund, more and more investors invest in the scheme (Saradha was dutiful in its payments in the first year). Some money goes to older investors who often bring in even more money to supplement their previous excellent investment. A fair bit goes to distributors who peddle the fraud, sometimes unwittingly (in Saradha, few distributors had much idea of the elaborate hoax) and the chunky residue goes to the promoter of the scheme to support his (it’s usually a ‘he’) lavish lifestyle.

The master, Charles Ponzi, at the peak of his pyramid scheme in 1920, had a queue of people which went on for several kilometres. People were ready to hand over their life’s savings to him in the hope of getting extraordinary returns. Of the three police investigators sent to investigate his financial affairs, two ended up investing in his scheme. In any case, like all other bogus bubbles, his burst too when investors got a whiff of what he was doing.

The root cause of the Indian story of such schemes is not the smartness of the crooks or the greed of investors. Rather it is the fact that formal banking and finance has so excluded the common man that less than half the eligible Indian population has a bank account. This is usually justified in the name of ‘know your customer’ or KYC.

Take my own case. When I moved to Ahmedabad several years ago, I found it nearly impossible to open a new bank account. My passport, driving licence and a dozen other proofs of ID and address were insufficient to open a bank account as I didn’t have a local lease deed or address proof. My ability to prove my ID and my real address were apparently not sufficient, even though I was teaching at IIM Ahmedabad.

Millions of people who work outside their hometowns are similarly excluded from opening bank accounts. These rules have not prevented scamsters from getting bogus IDs and opening unlimited number of bank accounts. One recent scamster had over two dozen IDs in different names. Poor people and even ordinary middle-class people are often left with no option but to invest in shady schemes. Lazy enforcement against black money has been substituted with nonsensical levels of so-called KYC.

It is also not correct to blame the victim, saying he or she was too greedy. Though that is often a red flag for more knowledgeable investors, many schemes do not even provide extraordinary returns. Saradha itself, for instance in one scheme, promised only 50% interest over five years, and in another scheme 12% per annum, neither of which is substantially above bank deposit rates. The whole idea of investor awareness, though clearly required, is not morally defensible as a means of reducing these schemes. It is the job of the state to prevent pyramid schemes with swift and preventive enforcement action. The credulity of small and sometimes even large investors can never be blamed for the effectiveness of such schemes.

The scam was not a result of either a lack of proper laws or because of unwillingness to enforce the law, though that often happens in other such scams. The Securities and Exchange Board of India (Sebi) has, for instance, been pursuing the group for several years and was stalled, sometimes with physical force, from doing its job. The problem is not so much of multiplicity of financial regulators but rather the ability of scamsters to play up between different laws, sometimes claiming the state’s jurisdiction and the often the laziness of some regulators using the same arguments of ‘we don’t have jurisdiction’ to support their behaviour.

Sebi has shown itself to be the exception to the lazy regulator moniker, particularly in this case. That, of course, begs the question, what is the regulatory maze that we have currently. A non-exhaustive list of financial products and structures are Sebi’s mutual funds, collective investment schemes, alternative investment funds; RBI’s non-banking financial companies, banks; Insurance Regulatory and Development Authority’s unit-linked insurance products; ministry of corporate affairs’ company public deposits; and lastly the regulatory orphans—state cooperative banks and chit funds. Technically, they have multiple parents, but factually they are somewhat orphaned.

While many are self-explanatory, Sebi’s collective investment schemes and chit funds deserve some explanation. Collective investment schemes are essentially a financial product where there is pooling of money, expectation of profit and efforts by others, i.e. not the investors. Since it is quite independent of the concept of securities, the concept can capture a vast array of financial products. Art funds have recently been held to be collective investment schemes; similarly, plantation schemes have been the origin of the drafting of the collective investment scheme law. Collective investment schemes are not prohibited, but require registration and various valuation and audits—something which most schemes have avoided and instead decided to litigate.

Chit funds have been held by court rulings to fall within the scope of both the Centre and the states under the Constitution. Besides, RBI has the power to inspect the books of chit funds. Therefore, even though chit funds can be legitimate business, they can often be the best source of a fraudulent scheme. A chit fund can ostensibly be used to raise money and, with friendly state politicians, can be an ideal breeding ground for fraud.

While it is difficult to stamp out these schemes completely, they require at least three immediate actions. First, an investors’ charter by each regulator should specifically mention what all is covered by them and what timelines investors should expect from the regulator for taking action. Second, a small statutory amendment should give one regulator all the residuary power to enforce where a subject falls under more than one areas of investment. This should also provide that no person should be able to raise money from investors unless they fall within one or other regulatory structure. Finally, and most difficult, there will need to be some level of intelligence gathering about any deposit taking place outside the formal channels, so the horse does not bolt before the stables are locked.

Regulatory impact assessment - Outlook Business

If you did not get the time to read the paper on regulatory impact assessment  here is an article "Weigh all options" from  my monthly column in Outlook Business on the same subject:

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

It has become a crucial goal for the regulators to regulate better, especially in industries as dynamic and continually-evolving 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 primary 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 like India, providing adequate protection to customers of financial services offered by intermediaries.

How to achieve this?

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 which show that “doing nothing” is a real option, particularly where action, or the cost of creation of regulation, far outweigh the benefits of implementing the regulations.

Why is RIA required?

RIA ensures a good understanding of who will be affected by a new regulation. When integrated with a public consultation process, it provides better information to underpin the analyses and gives the affected parties an opportunity to identify and correct faulty assumptions. The costs of financial regulation can usefully be broken down into three broad categories: direct costs, compliance costs and indirect costs. Subsequently, these identified mechanisms should be allocated to different regulatory structures keeping in mind what exactly needs to be regulated and what is to be left for self-regulation. This aspect of ascertaining what, if any, regulatory framework is required, holds true even for securities regulators, like the Securities and Exchange Board of India (SEBI).

How it has been implemented?

Globally, policy makers are increasingly valuing regulation that produces desired results as cost-effectively as possible. The US is the leading country as far as RIA is concerned. During the 1970’s, companies were faced with higher cost of compliance due to the evolving regulatory climate. The government promoted cost-benefit analysis to minimise regulatory burdens faced by the economy. The US SEC, their equivalent of SEBI, although not subject to an express statutory requirement, still conducts cost-benefit analyses 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 in advance of adopting new rules. Similarly, Financial Services and Markets Act, 2000 was enacted in UK, obliging the Financial Services Authority (FSA) to undertake a cost-benefit analysis (CBA) of any rules or regulations it proposes for the efficient governance of the financial markets. Similarly, OECD has proposed to the regulators in its member-states to keep in mind, the one-off costs over an extended period of time that 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. Towards this end, many rules (by the government), regulations, circulars and guidelines have been issued, each with the intent of governing a specific entity, its operations or its interaction with other regulated entities. 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 that comes to the fore is that 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, 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.

Is self regulation the answer?

Self-regulation, as an alternative to the multiplicity of regulations, is a viable alternative that may be explored by the regulator for keeping a check on intermediaries and other market participants. Self Regulating Organisations (SROs) encompass authority to create, amend, implement and enforce rules of trading, business conduct and to resolve disputes through appropriate dispute resolution mechanisms. For instance, in USA, FINRA (Financial Industry Regulatory Authority) is the largest SRO in the securities industry, operating under SEC oversight.

Long term benefits, high short term costs

One of the most remarkable impacts of the SEBI’s regulatory mandate was felt in the dematerialization of shares. Though the initial costs imposed by the regulation was very high, SEBI kept in mind the scale of the changes it was bringing about and 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).

Summary and Conclusion

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 cost-benefit analysis 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 its purpose for considerable periods of time.

It may also be worthwhile to take guidance from the Planning Commission of India, which points out that India’s business regulations lack ‘Periodic Review Clauses’, prescribing an automatic review of their functioning and efficacy from time to time. The recently released Report of the Financial Sector Legislative Reforms Commission (“FSLRC”) also makes certain critical recommendations in favour of RIA. It advocates mandatory cost-benefit analysis as a part of regulatory rule-making along with public comment process.

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 which costs the least and investigate and repeal provisions that place an unnecessary burden on entities without any justifiable benefit and reduce the larger economic costs, at the same time.

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, the costs to be incurred, the regulators will be better able to justify the imposition of rules and expect stronger, and possibly even voluntary, compliance by the entities it governs.

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 not) 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."

Finsec Law Advisors - featured law firm in IBLJ

Time for some firm promotion.

I was delighted to see our firm - Finsec Law Advisors being featured in the Indian Business Law Journal. We have been featured with  the following  introduction "India Business Law Journal introduces 50+ high quality law firms that prospective clients and referral partners would do well to know about." and specifically "Finsec Law Advisors, set up in 2010 by Sandeep Parekh, a former executive director of the Securities and Exchange Board of India, is one such firm. Its impressive list of clients includes MCX Stock Exchange, Birla Sun Life Mutual Fund and Goldman Sachs. Finsec reports that it recently represented an Indian broker in an enforcement action by the US Securities and Exchange Commission." The full article is linked here.

India Business Law Journal is the first internationally circulating business-law magazine to focus exclusively on India and is published out of Hong Kong. Thanks to my entire team at Finsec for these 3 years of hard work and sharp focus, on providing clients with the highest quality service. We do not try to be everything to everybody but what we do, we do rather well. We also provide substantial time to policy work, whether in the form of comment letters to regulators and government or formally advising regulators or otherwise improving the state of financial regulations - most of it thankless in the short term, but rewarding in the longer. Finally, thanks to those people who have had faith in us, clients, press and even other law firms.

PS: Please see other international law firm rankings: Chambers 2013 Capital Markets and  Private Equity

Legal 500 2013 Capital Markets and Investment funds

IFLR1000 2013 Banking and Private Equity

Asialaw Profiles 2013 Banking and finance

FSLRC Report - Greek tragedy with a deus ex machina

My monthly column for the Financial Express starts today. The editors have given a nice push to the piece with a small graphic reference on page 1 across all editions, link on FE home page and top link in the iPad app. And, not to forget - pasting my non-balding photo on the edit page.

My piece is on the recently released Financial Sector Legislative Reforms Commission report. While there are many things to like about in the report, it goes tragically wrong on the role of regulators being made subservient to the Finance Ministry. This will take us back to the dark ages of the 'Controller of Capital Issues' and such monstrosities and full on political interference in the workings of not just other regulators but the godly RBI itself. The report also fails to make an intellectually consistent view on having one financial regulator - it just rehashes the alphabet soup to create 7 new regulators. In any case, as I said, the argument that one regulator (though that is not the case) can solve all the problems by being one regulator is itself wrong on a mythological scale. If having one state could solve all of India's problems, we would have done so long back. The real issue is of discovering the glue which binds citizens to state through accountability and governance, just as it is for regulators to discover the same glue through an investor charter, other accountability norms and governance structures.

I argue, there is also much to like about the report and the hard work done should not be junked because of the above argument.

Here is the full piece FSLRC: Commission and omission (single page link):

"I must confess that reading the Financial Sector Legislative Reforms Commission (FSLRC) report made me feel like I had entered the world of the Matrix (the movie). There were premises and hypothesis interconnected to each other, powering the proposed amendments for rewriting all financial laws in India. One can hardly imagine the finance ministry analyse ‘a system-wide database’ in step one and prevent a systemic crisis in the fifth. A bit like the deus ex machina or ‘god out of the machine’ from the Greek plays—where the plot is stuck at the end, and there is literally no resolution. And, whoa, a crane comes from nowhere with a Greek god sitting on its end, lands and solves the entire set of problems, and of course there is a happy ending. While the report veers into abstract and untested theories at times, there is of course much to like about the report. I will try to bring out both the good and not so good parts of the report.

The five good things I would unconditionally praise are as follows. First, the concept of ownership neutrality. The report correctly states that giving preferential treatment to public sector units distorts the market. All public sector bodies must operate within the regulatory superstructure applicable to other competitors. Second, the report highlights the need for transparency, accountability and a consultative approach before enacting new regulations. This includes a rigorous cost-benefit analysis of new regulations. Third, the concept of disinterested administrative law judges sitting inside the regulator reduces the perception or reality of the regulator acting as judge, jury and executioner. Fourth, the draft bill is very well drafted and should be the benchmark for any future overhauling of any regulatory authority even if it is not adopted by Parliament as proposed. Finally, a clearly stated objective of RBI in its monetary policy will bring substantial clarity and transparency of objectives without interference from political forces (but for other sources of interferences proposed).

The five things I would change are as follows. First, as argued by the dissent note of PJ Nayak, two decades of empowerment of financial regulators is sought to be reversed with this report. The hideous governmental regulation through the controller of capital issues caused untold misery in the capital markets. Substantial powers are sought to be taken from RBI and other regulators and given to the finance ministry. These include such important areas as crisis management and monitoring systematically important institutions. A task globally given to a central bank and a task the finance ministry would have no apparatus to deal with.

Second, connected to the first, creating a statutory body called the Financial Stability and Development Council (FSDC) chaired by the finance minister, which will sit over the regulators, would further take away the independence and expertise of regulators, is regressive and deeply disturbing.

Third, the infatuation of the report with principles-based approach to regulations as opposed to the rule-based approach is wrong. Financial regulations cannot be principles-based. Imagine a principles-based requirement that margins collected should be ‘fair’ replacing the current mathematically determined number. I can think of no more than a part of the code of conduct of intermediaries (which already is) and few other things possibly being principles-based.

Fourth, there is no internal consistency of reducing the number of regulators to reduce regulatory arbitrage. Either there should be one regulator for the entire financial sector if the story is that there is possibility of gaps and turf wars between regulators, or the status quo should continue. Why does regulation of banking and payment systems continue with RBI? Creating a different alphabet soup of regulators, seven-strong, cannot be consistent with the story of gaps and wars. Similarly, creating a separate Financial Redressal Agency does not add any value—often the problem is with the quality of the regulation rather than with its redressal, for example charging 40% commissions in financial products may be legal but is not desirable as permissible. Thus, where the substantive regulator passes improper laws, the redressal agency will be handicapped in enforcing what would clearly be legal and clearly wrong. There will be a new game of football between the substantive regulator and the redressal agency, to name but two of the proposed seven regulators. In addition, if merely reducing the number of states in India would solve all of India’s problems, we would have abolished states long ago. There is a solution for gaps between regulators and the Constitution of India does that simply between the states and the Centre by giving the Centre power over residuary areas. The fundamental problem is the quality of enforcement of our regulators, rather than a once-in-a-20-year turf war between two regulators.

Fifth, the concept of a Resolution Corporation that is able to track tens of thousands of corporate entities which make ‘highly intense’ promises to consumers and catch them in the act even before they are bankrupt seems a bit of impossible. How can one possibly guess a firm is going to go bankrupt sitting in a regulatory ivory tower. Even the boards of Lehman Brothers and Bear Stearns didn’t know they were going bankrupt (the Board of Lehman was discussing multi-million dollar bonus payments shortly before) and the board of Goldman Sachs did not know they would survive (they were successfully rescued).

All in all, this is a good report and even if there is staunch opposition to the recommendations, and political priorities lie elsewhere rather than a bill on something of no interest to political parties, and positively opposed by some ministries. However, large parts of the report can be salvaged and used. In fact the draft bill attached can be used as a benchmark for future overhauling of various Acts, one step at a time. Various ideas of accountability, consumer focus, cost-benefit analysis (see our firm’s recent paper on this at bit.ly/YdsG9X) should be immediately adopted by various regulators without statutory amendments. The emasculation of RBI and the other financial regulators should be immediately junked without a second thought. The government is simply not good at regulation and putting the government in charge of not just the fiscal situation but also the monetary policy of India and financial crisis management sounds suicidal, besides risking politicisation of regulators and the central bank. The Roman god Janus with two heads looking in opposite directions, and god of beginnings and transitions, would advise caution ahead."