Balancing regulatory approaches

Source: The post is based on the article “Balancing regulatory approaches” published in Business Standard on 11^th May 2023.

Syllabus: GS 3 – Economy – Capital Market

Relevance: concerns with SEBI

News: There have been debates over whether regulators should follow a principle-based or rule-based approach (PBA or RBA) in framing regulations for the financial markets.

What is PBA and RBA?

Principle-based approach (PBA): It involves providing broad guiding factors in regulations while giving flexibility to regulated entities to work out on operational requirements.

Rule-based approach (RBA): It involves listing out possible scenarios and detailing specific penal consequences for violations.

Which is a better form of regulatory practice?

PBA is effective in developed countries with mature markets, wherein the reputational risks are taken seriously and the law enforcement mechanisms are robust.

Whereas, RBA may be effective in developing countries which lack market maturity and do not have a robust law enforcement mechanism.

While PBA appears to be more in line with free market philosophy, RBA appears intrusive with a control and command approach.

How does the Securities and Exchange Board of India (Sebi) regulate the financial markets in India?

Sebi follows a well-established procedure in drafting various regulations. It has subject-specific committees and various stakeholders as members to make recommendations.

These recommendations and changes are generally influenced by tribunals’/ courts’ rulings, and changes in the parliamentary laws.

What are the challenges with SEBI?

The most challenging part of the SEBI is the effective implementation of the law.

A law framed for the financial market needs to be strong enough to cater the demand of stakeholders as well as prevent miscreants to misuse the loopholes in the law.

Further, at times even a straightforward regulation may also create trouble for the regulator.

SEBI is often criticized for over-regulation. For instance, the primary function of the SEBI is to protect the investors interest. At times, the concerns over the investors in case of scam gets highlighted.

In such a case, SEBI comes up with more rule-based regulation, which also might have unintended consequences, giving a negative image of SEBI in the market.

Therefore, while SEBI is trying its best to function as an effective regulator, still it has to face the criticism and often finds itself isolated when a market mishap or scam happens.

What can be the way ahead?

Looking at the present scenario, the financial sector regulators in India are likely to continue favouring the RBA. However, this may be problematic for technology-driven regulated activities due to the rapid changing technology.

Moreover, if the industry favours principle-based laws, it must go beyond just wanting “ease of doing business” and show maturity, responsible behaviour, and self-discipline.

There is also a need to strengthen the tribunals/courts dealing with the financial sector in terms of trained manpower and infrastructure.

Hence, for a responsive and effective regulatory system, the entire ecosystem needs to support and encourage the regulatory practices.