by Ajay Shah, ajayshahblog
Yu Hua has a great piece in the New York Times titled In China, Power is Arrogant where he says:
Several of these rules have since been revoked, but their wacky and arbitrary nature demonstrates the arrogance of power in China. One can imagine all too easily their creators — sitting in comfortable armchairs, drinking high-grade tea and smoking fine cigarettes — discussing the issues at hand as if they were purely intellectual abstractions, never considering how ordinary people might react. That people will be unhappy is no cause for concern because, for so long, the power of the state has trampled on individual rights. Only when rules are so onerous that they stir actual protest do higher-ups take notice: “You guys are just making a mess of things,” they’ll tell their bureaucrat underlings.
This is in China, where the law is a bit of a joke; they do not have a Constitution, an independent judiciary, and the rule of law. Sadly, I often feel similarly about regulation-making in India, where we have much more rule of law, and the law matters much more!
It is rare and unusual, in liberal democracy, for Parliament to contract-out the power to make law. We do this, with regulators. Regulators are bodies created by Parliament and given the power to issue law. The agencies, and unelected bureaucrats, that issue law should be possessed with thought and care in wielding this power. All too often, they are not. Regulation-making in finance, all too often, is devoid of reason.
The draft Indian Financial Code, drafted by FSLRC, features an elaborate regulation-making process – with details encoded into the law – that will check such abuses and help bring more sanity to the outcome. It requires that regulators walk through the following steps:
- What is the market failure that I have identified? Can I demonstrate that this is a market failure?
- Is solving this market failure within my objectives as stated in the law?
- What intervention am I proposing?
- Is this intervention within my powers?
- Will the proposed intervention hit at the claimed market failure? (All too often, financial regulators in India talk about a certain stated malady and then propose an intervention which does something unrelated).
- What costs will this proposed intervention impose upon society? Will these costs be larger than the benefits?
This six-step procedure will have to be followed by regulatory agencies, when the Indian Financial Code is enacted as law. This will force staff of regulators to think more and speak in the public domain about what they are thinking. Documentation answering these six questions will have to be released into the public domain. This will achieve two things: Market participants will not be caught by surprise, and criticism (if any) will be voiced by independent observers and stakeholders. The regulatory agency will then have to respond to criticism, also in the public domain. The board of the agency (no less) will take in all this documentation and decide whether to issue the regulation and in what form. The documentation tabled in Parliament will also reflect this full process; it will not merely be the text of the regulation.
Compare this idealised process against a recent episode: RBI regulation on Indian entities owning overseas trading facilities that trade on Indian underlyings. Here is the full text of the RBI ‘regulation’:
It has been observed that eligible Indian parties are using overseas direct investments (ODI) automatic route to set up certain structures facilitating trading in currencies, securities and commodities. It has come to the notice of the Reserve Bank that such structures having equity participation of Indian parties have also started offering financial products linked to Indian Rupee (e.g. non-deliverable trades involving foreign currency, rupee exchange rates, stock indices linked to Indian market, etc.). It is clarified that any overseas entity having equity participation directly / indirectly shall not offer such products without the specific approval of the Reserve Bank of India given that currently Indian Rupee is not fully convertible and such products could have implications for the exchange rate management of the country. Any incidence of such product facilitation would be treated as a contravention of the extant FEMA regulations and would consequently attract action under the relevant provisions of FEMA, 1999.
… And here is an opinion piece by Ila Patnaik about it.
RBI is perfectly within its powers in issuing this – and that is the problem with the existing laws. However, this behaviour of RBI is riddled with problems:
- Regulation making should be the power of the board and not of officials. It should go through a full formal regulation-making process. This one has not.
- The announcement by RBI came out with zero notice. It suddenly imposes negative consequences on MCX and Financial Technologies. This is not fair.
- The regulation really makes no sense. What is the economic objective that is being pursued? What is the cost that is being imposed? What do we gain as society from it? The document says nothing. It is a statement of arrogant power, that reminds me of the stories about China at the outset.
Suppose the economic objective was blocking FEMA violations that might take place through such structures. If so, the intervention proposed should directly address these. Suppose the economic objective was blocking PMLA violations that might take place through such structures. If so, the intervention proposed should directly address these. In either event, it is important for RBI to fully articulate what is the problem they’re trying to solve; under the present law they have no obligation to say what they are trying. The present law creates arrogance of the regulator.
This is just an example. I see this all the time with RBI, SEBI, FMC, etc. Regulations are issued in much the same mode as the Chinese story: ‘One can imagine all too easily their creators — sitting in comfortable armchairs, drinking high-grade tea and smoking fine cigarettes — discussing the issues at hand…’.
Under the rule of law, the power to write law is a sacred one, and should be exercised with commensurate care. The present structure of financial law in India is riddled with bad laws that feature inappropriate delegation of powers to semi-autonomous agencies that are not sufficiently careful about using this power, that are arrogant in their use of this power. The regulation-making process of the Indian Financial Code will put regulation-making on a sound foundation, and prevent episodes like this one.
