29 April 2013

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."

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