Overview:
It is the duty of every government of a civilised society to regulate economic activity. The function of regulation is to encourage economic activity with ethics which benefits society. However, our (Indian) experience has been that of having ‘over-regulation’ leading to corruption and unethical practices. Reversal of ‘over-regulation’ in the past two decades has changed the environment to an extent, but over regulation and desire to increase the same continues to manifest itself. Let us not forget that too many and that too, complex laws convert ordinary honest citizens into criminals – e.g. – everyone who drinks in areas where prohibition prevails becomes converted from an ordinary citizen into a criminal in the eyes of law. Today there exist many laws which impact normal economic activity. In addition to laws which are common to all businesses – there are industry-specific laws, e.g. – pharma, food, health, chemicals, refineries etc. Compliance with the applicable laws, rules and regulation is an integral part of running a business.
Hence, business runs the risk of non-compliance with laws, rules and regulations resulting at times even in the suspension or closure of business in addition to the levy of penalties, legal action by customers, bureaucratic hassles and corruption.
Non-compliance also at times entails prosecution and imprisonment.
Regulatory Risk is the risk that a change in laws and regulations will materially impact a business, industry and activity, an organisation or an entity. However there is another dimension to regulatory risk. This is the risk of government agencies exercising control over the functioning of commercial and other activities of various entities.
Thus on the one hand a change in laws and regulations can disturb a level playing field; it can give skewed advantage to certain entities, organisations and companies. These regulations can be those pertaining to taxes, duties, licences, other regulations and procedures or relating to human operations.
On the other hand regulatory authorities at the behest of the government, the public or even on its own may step in to regulate, control and guide business or other activity by way of certain norms, rules and regulations which have to be followed and involve a cost, compliance load, and impact the operations, returns and profitability of enterprises. e.g. Drug price control order and the rules there-under is a case in point. The website – ‘Investopedia’ has given the well known example of utility companies like electricity companies to explain regulatory risk. The government through legislation and administrative orders introduces a significant amount of regulation in the way they operate, set their tariffs and even the quality of infra-structure and the controls on the system. Regulations also affect investment market and investment activity which means that any change in these (for example margin requirements) can affect prices, returns and valuations.
The first significant characteristic of regulatory risk is that it is an additional source of risk due to the wide variation in regulations across countries, regions, industries and even regulators. The second significant characteristic is that due to the diversity of cause and effect, the nature of regulatory risks is difficult to understand, perceive, capture and communicate. As a result such risk is not well understood and consequently at times difficult to quantify, estimate, measure and manage.
Also many times this type of risk materialises without any warning or indication and takes most of us by surprise. Thus on the one hand a change in laws and regulations can disturb a level playing field; it can give skewed advantage to certain entities, organisations and companies. These regulations can be those pertaining to taxes, duties, licences, other regulations and procedures or relating to human operations.
The first step for mitigating the risk of violation is to identify applicable laws and put in place, compliance procedures. To ensure compliance there should also exist means of ensuring that the pre-scribed procedures are followed. This is normally achieved by having an effective internal audit or periodic review of functioning of ‘internal controls’.
The regulatory risk can be captured as under:
Regulatory risk
- Risk of changes in legislation and its impact.
- Risk of changes in rules and regulations and its impact
- Risk emanating from government agencies exercising controls by way of regulations and compliances on business.
- Risk of corrective controls and palliative measures that can affect businesses and organisations.
A formal analysis of this risk is difficult because it is an external risk that is affected by the frequency of changes in the several laws applicable to a business. The risk also depends directly on the duration of regulation, nature of regulation, whether involving strategy, operations or procedures and finally the extent of discretion exercised by the regulatory agencies. In fact business and industry would do well to study and understand regulatory preferences, styles, policies and trends. To summarise, regulatory risk even in the least regulated free environment is inevitable. The magnitude of risk is inversely proportional to the credibility, accountability and- stability, of the regulators.
The example for this month is the case study of a company engaged in conducting coaching classes for students in the context of regulatory risk. Expert Coaching Classes Ltd is one of the leading coach-ing classes for the 10th SSC and ICSE examinations, the 11th & 12th HSC, CBSE and for entrance exami-nations of lIT like JEE and Engineering and Medi-cal CET and others.
Expert Coaching Classes began as a small venture in the living room of Sri Prakash – a retired senior teacher from Vidya Mandir School about twenty years back with three students. Today it has over 50 in house faculty, 25 visiting faculty, 5000 + students and over 10 branches in two metro cities. In the good old days students were charged Rs.SO per month, today the fees for a year is in lakhs. The business model comprises holding awareness and introductory lectures that are attended by students and their parents. This is followed by a rigorous program for students using in-house well developed material and question bank. The course is inter-spersed with tests, the results of which are periodically communicated to the parents directly apart from communicating the same to the students. Intensive coaching takes place and students’ doubts are cleared. Expert coaching classes thus imparts quality education by limiting the number of students in a batch. Discussions are also held with parents of non-performing students.
There is some turnover in staff and faculty, and at times the advent of new classes means losing a few existing and potential students. Of late on the heels of the use of ‘Right to Information Act’ to uncover overcharging of fees by schools and the ever increasing pressure on the education system following issues have emerged:
i) There is a growing awareness of the need for quality education with adequate facilities, infrastructure and good faculty at school among students and their parents.
ii) After regulating functioning of schools, their admission procedures and fees, there is now a demand to regulate coaching classes.
iii) There is a move to mandate registration for coaching classes which is fast gaining ground.
At present ‘coaching classes’ are fairly independent of the regulatory system except obtaining some municipal licenses. Hence, coaching classes do not face any serious regulation. The risk is that some serious regulation is likely to be put in place. If this happens it is bound to affect the infrastructure needs, working, and functioning of the classes substantially in as much as the fees charged per student are likely to be also regulated. This change will affect both the top and bottom line. Further with conflicting reports emerging about scrapping of CETs, it is not clear if students would continue to patronise these coaching classes. It is in this context that the CEO of the classes has invited you, as the risk manager, to prepare a note identifying, estimating and measuring risks likely to be faced and advise the possible course of action to prevent, protect and mitigate the identified risks and come up with an action plan.
Regulatory Risk Analysis & Solution:
An analysis of the case reveals the following issues:
Well drafted regulations when fairly implemented help in the smooth functioning of business. Hence fair monitoring of certain sets of activities is necessary for implementation of law. However experience tells us clear language is rare and the absence of clear language leads to chaos and corruption. This has a bad impact on both the business and the organisation. It is because of this aspect that business advocates free market with minimum regulation and giving a free hand to the market forces. The following challenges and their impact have been identified:
- changes in law and regulations will impact size, fees and profitability.
- cost of compliance will increase.
- possible increase in unhealthy practice by unregistered, flyby night, small operators.
- possible increase in working school teachers conducting private tuitions.
- lower profitability could lead to lower standards
- cost cutting measures could lead to increase in faculty turnover – impacting quality.
- reduction in visiting faculty to reduce cost – impacting quality.
- reduction in investment in infrastructure – impacting quality.
- reduction in the number of students because of the above and proposed abolition of Std. X exams – impacting profitability.
Solutions for Expert Coaching Classes (ECC) :
The possible solution to deal with this risk is out-lined in the steps given below:
1. Preparing a sensitivity analysis and assessing its impact on revenue and faculty related concerns.
2. Channelise existing cash flow into higher savings to meet unforeseen contingencies.
3. Centralise operations to reduce costs.
4. Preparing online version of coaching sessions whereby it gives flexibility of time to students, reduces dependence on faculty and investment in infrastructure and reduces operating costs. – encourage e-learning.
5. Identifying areas of diversification – e.g. – corporate training, starting hobby classes, starting health education classes.
6. Initiate a network of coaching classes and form a trade association to take on unfair regulations.
Anticipating risk and taking planned and persistent steps are today essential elements of running a successful business. Suggestions made by the risk adviser have been appreciated by the management. The management has initiated steps in line with the suggestions made.
