The last 45 days have witnessed several events that may have been of interest to the world of finance and have received considerable news coverage across the country. After years of political wrangling and months of rumours, India finally received its first tranche of FDI into the aviation sector when Jet Airways and Etihad announced their strategic partnership. The West Bengal based Saradha Group turned out to be yet another elaborate ponzi scheme that recycled deposits of vulnerable sections of the public. Worse, the financial institution went bust and cannot now return its investors’ money.
But one event of significance that went relatively unnoticed was the release of the report of the Financial Sector Legislative Reforms Commission (FSLRC). The Report recommends a paradigm shift in the regulation of our country’s financial system and is bound to evoke diverse reactions from different stakeholders. The FSLRC was headed by Justice B.N. Srikrishna (Retd.), who is a veteran of several key reports, and included several noted persons like Mr. Y. H. Malegam.
The present regulatory system has gaps, overlaps, inconsistencies and opportunity for regulatory arbitrage. The Report calls for several fundamental changes in the way financial sector is regulated in India. While some of these changes were long overdue, others are innovative and will require some debate before their acceptance. As noted by the FSLRC, financial regulators are unique in the sense that three functions – legislative, executive and judicial – are placed in the single agency. This concentration of power needs to go along with strong accountability mechanisms.
Unlike most commissions, the FSLRC’s Report includes a draft ‘Indian Financial Code’ that is the first step towards the consolidation of all existing regulations into a single piece of legislation. The Code proposes an equal regulatory environment that is non-sectoral and ownership neutral. This means that the same regulations would apply to all firms, irrespective of what sector they operate in, be it banking, securities or insurance. Further, all firms would be treated on par without regard to their ownership structure. So the regulator would not discriminate between private and public, Indian and foreign, private and government undertakings, or companies and cooperatives.
The Report recommends an overhaul of the existing regulatory agencies. This overhaul, though characterised only as “a modest step away from present practice” includes modifying the mandate for the RBI, setting up of a Unified Financial Agency (replacing SEBI, IRDA, Forward Market Commission and Pension Fund Regulatory and Development Authority), a Financial Sector Appellate Tribunal (replacing SAT), Resolution Corporation (replacing Deposit Insurance and Credit Guarantee Corporation of India), a Public Debt Management Agency, instituting a single unified consumer redressal mechanism comprising of a Financial Redressal Agency and giving statutory recognition to Financial Stability and Development Council. Other note-worthy recommendations in the Draft Code proposed by the Commission include legalisation of and bringing clarity to validity of non-exchange traded derivative contracts between sophisticated counterparties and an internal control system for all regulated firms that may involve compulsory reporting of some findings to the concerned regulator. FSLRC recommends setting up of Resolution editorial Financial Sector Reforms Bombay Chartered Acountant Journal, may 2013 7 editorial 139 (2013) 45-A BCAJ BCAJ Corporation to keep a check on the health and stability of financial firms and resolve swiftly problems arising out of the instability of one or more firms.
While the implementation of these path-breaking changes will no doubt address many of the problems and shortcomings of the existing regulatory regime, it will also have a cost. A large number of businesses have already been set up and transactions executed keeping in mind the existing regulations. Many of these may need to be reworked. Secondly, setting up of institutions staffed with qualified professionals is expensive. The present day RBI, SEBI and consumer fora are a result of evolution and years of institution building that required intensive investment into infrastructure and human resource development. This will have to be repeated all over again for the new institutions to be set up under the draft Code. Other non-monetary costs include the cost of developing new precedents and case-law on the new Code. The present legislations and regulations have been the subject of substantial litigation and it has taken years for the tribunals and Courts to clarify the scope, intent and interpretation of the various provisions of the existing laws. New laws will mean several rounds of long drawn litigation before the meaning of the laws become reasonably final.
The Commission recognises that its recommendations are ambitious and will require many of the Acts to be repealed or amended. There are also issues of jurisdiction, e.g. co-operative sector, chit funds come within the purview of the States. But these will also have to be regulated, being part of the financial sector.
The Commission has emphasised that piecemeal modifications to the existing system will not work and will not have the desired effect. The Finance Minister has indicated that no time limit can be set for taking action on the report. It is a mammoth work and a big exercise. If experience is any guide, change of such nature will take at least a few years before it sees the light of the day.
“The foundations of modern financial legal regulatory structures should be erected during peaceful times rather than wait for a crisis to unfold and then embark on a fire-fighting mode of institution building, which would be muddled and fragile”. – Report of FSLRC
