Regulatory fee or unjust enrichment?

Regulators are empowered to levy fees for services rendered, not to impose tax-like levies to create surpluses for themselves

In an exchange filing recently, BSE stated that the Securities and Exchange Board of India (Sebi) has asked it to pay the regulatory fee on the annual turnover, considering the “notional value” in the case of options contracts. The communication from Sebi further advised BSE to pay this amount retrospectively, i.e., from the financial year (FY) 2006-07, with 15 per cent interest per annum. The amount is expected to be close to Rs 70 crore. Financial and fiscal experts find this odd and wrong.

How does a regulator get resourced? One of the reasons why we have regulators is the desire to distance them from the fray of politics and the elected government. This domain autonomy, in turn, requires financial autonomy. Arm’s length regulators should not be dependent on the government for their spending, as this could undermine their independence. The regulator may feel pressured to align its decisions with the interests of the people controlling its purse strings. Even if the regulator maintains formal independence in its decision-making processes, financial dependence can create a perception of bias in the eyes of stakeholders. One of the reasons to have an independent regulator is to persuade private investors that there is a predictable rule-of-law environment. Hence, it is essential to establish mechanisms that achieve adequate and secure funding for regulators. This has been done through the power to charge fees.

The single big idea of public policy is that every power of a state organisation must be surrounded by an elaborate system of checks and balances. In India, regulators have had the power to impose fees without commensurate checks and balances. As a consequence, we have seen episodes of self-aggrandising behaviour. There is a propensity to levy high fees, support expansive expenditure programmes, and amass pools of assets. The inexplicable events around the charges placed upon BSE are part of this larger pattern.

As an example, in the last five financial years, Sebi has reported a large and growing surplus of income over expenditure (including capital expenditure). Of its total income of Rs 1,404 crore in 2022-23, around 86 per cent was generated through the fees/subscriptions it charges from entities. It generated an income not only sufficient to perform and fulfil its regulatory duties but also large enough to be in surplus of more than Rs 500 crore in this FY. In fact, it ended the FY with a closing balance of Rs 4,508 crore. The surplus has been approximately Rs 484 crore in FY22, Rs 158 crore in FY21, Rs 225 crore in FY20, and Rs 471 crore in FY19. Sebi’s income and profits are now larger than those of many financial firms.

How can we do things better? What is the design to ensure autonomy without empire building by regulators?

1. Indian courts have repeatedly ruled on the distinction between taxes and fees levied by public authorities. A tax is a compulsory extraction of money by a public authority for public purposes enforceable by law, whereas fees are payment for services rendered. In fees, there is an element of quid pro quo between the individual payer and the public authority, which is absent in a tax. Bodies like Sebi are authorised to only levy fees which have relation to the service rendered. This implies that ad valorem charges are inappropriate: The fees charged by Sebi to any one organisation (such as BSE) should be connected to the cost incurred at Sebi in regulating BSE.

This is not a new issue. Many years ago, Sebi proposed increasing the ad valorem fee for renewal of the annual registration of some regulated entities. Questions were raised in the Sebi Board on this and the nexus between the fee and the service rendered by Sebi. Sebi was forced to reduce the fee, and since then, Sebi has moved away from an ad valorem fee to a fixed fee for most such registrations and renewals.

2. A government organisation that charges high fees and amasses a large corpus is probably also a government organisation that spends too much. Greater care needs to be taken in establishing the spending envelope of these organisations. A Sebi that has a lower resource envelope will be more selective in choosing important regulation making and supervision projects.

3. The place where all these issues come together is the board of the organisation. Modern thinking on regulation has emphasised the importance of the role and composition of the board. The board of every organisation is about protecting the interests of the ultimate stakeholders against the self-interest of the full time staff of the organisation. The board must apply constitutional principles and block ad-valorem fees. The board must push asset pools out of the organisation up to the Ministry of Finance. The board must run a budget process each year, where cost control is implemented, and where the managers are held accountable to deliver improvements in the working of the organisation in return for increases in the budget.

4. It is unwise for Indian public finance to have multiple treasuries all over the Indian government landscape.  Hence,the parliament amended the Sebi Act through the Finance Act, 2019, for transfer of the surplus. Oddly, after this amendment was passed by Parliament and approved by the President, it has not been notified. Sebi has remitted about Rs 1,000 crore to the Consolidated Fund of India, but the Sebi Act amendment has been put into cold storage.

5. The energy and human talent available to engage in these questions is limited. It is difficult to solve these problems separately for the Reserve Bank of India (RBI), Sebi, or others. Ensuring financial propriety and extracting pools of cash that have built up at the Insurance Regulatory and Development Authority, RBI, Sebi, and other such regulators has consumed many years of effort by India’s scarce public policy resources. It is better to use the approach of the Financial Sector Legislative Reforms Commission, where the idea is to have a single parliamentary law that sets forth the correct framework to shape the workings of all financial agencies.

The writer is an honorary senior fellow at the Isaac Centre for Public Policy, and a former civil servant