Prof. Jayanth R. Varma’s Financial Markets Blog

A blog on financial markets and their regulation

Time for a Financial Sector Appellate Tribunal

I wrote a column in the Financial Express today on why a Financial Sector Appellate Tribunal is superior to the bureaucratic solution created by last month’s ordinance to deal with turf battles between financial sector regulators.

The old saying that “your freedom to swing your fist ends where my nose begins” is as true of regulators as it is of individuals. In a regime of multiple regulators, the autonomy of each regulator is effectively limited by the autonomy of other regulators. What this means is that regulatory autonomy is a delusion and regulatory heteronomy is the reality.

The only real question is whether this heteronomy should be judicial or bureaucratic. I argued for the judicial option in these columns four months ago (‘Fill the gaps with apex regulator’, FE, March 19). Some degree of competition between regulators is a healthy regulatory dynamic, but ultimately any dispute between two regulators must be resolved in the courts.

My recommendation was based on the well-established proposition that the legislature frames laws, the judiciary interprets them and the executive implements the law as so interpreted. If there is a dispute about a law, the judiciary can step in and interpret the law or the legislature can step in and rewrite the law to eliminate the ambiguity. The executive has to await guidance from either of these two branches. I realise that this principle is perhaps totally old-fashioned in an environment where all three branches of the government are increasingly inclined to step on each others’ turf.

However, the judicial option at least had the advantage of being acceptable to the regulators. Three months ago, when the government suggested that the dispute between Sebi and Irda regarding the regulation of Ulips be resolved by the court, none of the regulators complained about loss of regulatory autonomy.

Last month, however, the President promulgated the Securities and Insurance Laws (Amendment and Validation) Ordinance, 2010, which not only settled the Ulips dispute in favour of Irda legislatively, but also provided a new bureaucratic arbitration mechanism for certain future disputes.

Most of the regulators are upset with this on the ground that it undermines their autonomy. This is not quite the correct way of looking at it because what it does is to replace judicial arbitration of disputes by bureaucratic arbitration. A better reason for scepticism is that, in general, bureaucratic arbitration is inferior in terms of process and in terms of outcomes.

The drafting of the ordinance itself is a good example of how bureaucratic processes tend to go wrong. The intention of the new section 45Y that has been inserted into the RBI Act is to ensure that future disputes can be resolved quickly. However, as one reads the section, one realises that this section is hopelessly inadequate.

First of all, section 45Y deals only with instruments. It essentially says that if any difference of opinion arises as to whether a certain instrument is a hybrid or composite instrument and falls under the jurisdiction of RBI, Sebi or Irda, then such difference of opinion shall be referred to a joint committee consisting of the finance minister, two top finance ministry officials and the key financial regulators.

Because the Ulips dispute was about a certain instrument, the government created a statute to deal with disputed instruments. What happens if the next dispute is about institutions and intermediaries? For example, RBI may want to regulate as an NBFC an entity that Sebi regulates as a capital market intermediary. Section 45Y is helpless to deal with this dispute because the dispute is not about instruments.

The second problem with the statute is that it says: “The Joint Committee shall follow such procedure as it may consider expedient and give, within a period of three months… its decisions thereon to the Central Government.” One would have liked to see an explicit provision of decision making by majority or qualified majority. The fundamental problem with the existing HLCC is its quasi-consensual and secretive procedure and its unwillingness to rely on transparent voting. The joint committee inherits this fatal weakness.

The third problem is that the ordinance provides that the decision of the joint committee shall be binding on the regulators—RBI, Sebi, Irda and PFRDA. It does not say that the decision is binding on anybody else. In particular, it is not binding on any of the regulated entities.

Suppose, for example, the joint committee decides that a particular product offered by a bank is actually a security that falls under the jurisdiction of Sebi. If Sebi then imposes a penalty on the bank, the latter could well go to court challenging the jurisdiction of Sebi. Neither the bank nor the court is bound by the decision of the joint committee. The decision is binding on RBI, but surely RBI cannot impose a penalty for violation of a Sebi regulation.

I remain convinced that when we have swinging regulatory fists and bleeding regulatory noses, a judicial solution is far more viable and sensible than section 45Y. The time for a Financial Sector Appellate Tribunal is now.


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