G N Bajpai: Regulatory challenges

Ingenious ways of harnessing human capital have to be found, and this has been done by some Indian regulators.

Periodically, the newspapers carry information about the likely constitution of a new regulatory body (coal, metro rail, and petroleum are among those in the pipeline) to oversee the functioning of the relevant market segment. This is indicative of the pervasiveness of regulation in modern society.

Enterprise warrants the freedom to operate, which is enabled by the process of liberalisation. The natural tendencies amongst economic agents to profit from the inefficiencies and inadequacies of the market place (that markets are far from perfect has been established by research) necessitates laying down ground rules. The rapidity and profundity of the changes in the environment necessitate constant reorientation and refurbishing of the ground rules.

Governments' record of rendering this essential service has not been enviable. Further, governments in quite a few cases are a market participant, which can lead to conflicts of interests in case the government also assumes the role of regulator. The need to separate roles prompted the formation of independent regulatory bodies, with power and authority to regulate and protect the interests of market participants, including consumers. In the case of India, most of the regulatory bodies have been assigned the role of developing the market as well.

Society entrusts regulatory agencies with tremendous powers. They can impose financial penalties, place liens upon or seize property, limit business practices, suspend licences, and even destroy livelihoods. Hence, the importance of objectivity and impartiality in decision making by regulators becomes paramount.

Increasingly, though, questions are being asked as to whether the powerful and still growing regulatory apparatus delivers value for money; whether they are suitably focused; and whether these institutions actually succeed in reducing risks and protecting the interests of consumers. Instances of market misconduct are cited as examples to prove the point. Those being regulated concede that regulations are needed, but not the regulators""who are, in Malcolm Sparrow's words, "nitpicky, unreasonable, unnecessarily adversarial, rigidly bureaucratic, and incapable of applying discretion sensibly". So it might be worthwhile examining the role of regulators, which can be broadly classified into improving efficiencies, managing compliance and controlling risks.

In the emerging markets (which include India), where the paradigm shift from merit-based regulation to a transparency-based regime is recent, improving efficiencies is a formidable challenge. Switching processes in search of efficiencies is a journey to unknown areas of risk management. The experiences of the developed markets are often irrelevant, as the conduct of the economic agents who drive market processes and practices is greatly influenced by the socio-political-economic ethos of the regulatory jurisdiction. Increasing efficiency squeezes out opportunity for profiteering from inefficiencies, and therefore builds resistance amongst powerful economic agents. Tackling this calls for vision, perception, skills, courage of conviction and risk taking.

Innovation, as also customisation of solutions that have been successfully used in other markets, is the key. A notable example of customisation from the Indian securities market is the book-building process for public share issues, which has been hailed by the Financial Times, London, while commenting on Google IPO online: "The world's biggest democracy can show Google how to conduct an online IPO ... in India you cannot apply on the web but investors can access one of the world's largest financial networks with 7,000 terminals scattered around 350 cities. And every step of the book-building process is public. ... The Indian system is a refreshing example of a transparent IPO market but it is also a rare one, especially in the insider-friendly Asian markets."

The availability of high-quality human resources (who innovate and customise) at all levels of the regulatory apparatus has become the most serious of bottlenecks. Ingenious ways of harnessing human capital have to be found, and this has been done by some Indian regulators. Sebi's legal affairs committee under the chairmanship of the eminent jurist, Justice Venkatachelliah, is an example.

Putting the regulatory framework in place is much easier than ensuring compliance. It requires sustained effort, and involves costs. The natural tendency, therefore, is to circumvent and even evade. The public management service of the Organisation of Economic Cooperation and Development, summarising an evaluation of regulatory approaches, commented: "Even after the most rigorous decision-making process inside the administration, regulation has yet to pass the most demanding test of all""the public must agree to comply with it. Yet implementation""consisting of strategies such as education, assistance, persuasion, promotion, economic incentives, monitoring, enforcement, and sanctions""is a very weak phase in the regulatory process in OECD countries."

The answer may lie in building partnership with those being regulated, which begins with consultation while framing the regulations and extends to appreciating genuine difficulties and understanding the costs of compliance. The move forward is through problem-solving and facilitation. The focus must be on the spirit and substance of compliance, rather than on the form. While Sebi's process of consultation for revising Clause 49 of the listing Agreement (Corporate Governance) was under way, the CEO of a listed company told the author that he would comply with Sebi's requirement that a company's board must have 50 per cent independent directors, by having his driver and domestic servant on the board. What he may have meant was he would comply with the letter of the law but not its spirit.

The regulator's compliance strategy should consist of distinct phases. First comes experimentation, which begins with trying out a broad range of compliance tools, before testing different kinds of partnerships and rejecting aggregate compliance statistics as the important indicator of satisfaction. The spotlight should then shift to assessing the significance and usefulness of tools.

The next phase involves learning through experience and evaluating the value of the range of tools used. This is where the use of resources invested in partnership programmes, out-reach and facilitating timely and voluntary compliance has also to be appraised. The journey then advances to the phase of wrestling with difficult strategy questions that then prop up. This is where a choice has to be made sometimes between prevention and enforcement. The experience of OECD countries suggests that the leading objective should be to improve compliance.

While functioning as chairman of Sebi, I came to understand and appreciate the realities of operational life, wherein important decisions about resource allocation and tool selection have to be made in hurry, with imperfect information, without the luxury of control samples, and in the uncertain environment of a democratic polity.