"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."
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