A conflict of interest

Trimming Sebi's financial independence is potentially regressive

The spotlight is back on regulatory independence with the Finance Bill, 2019, proposals to amend the Securities and Exchange Board of India (Sebi) Act. If brought into force, Sebi must transfer 75 per cent of its annual surplus to the government, retaining 25 per cent in a newly constituted “reserve fund” (which cannot exceed a total of previous two years’ annual expenditure). Sebi must also obtain the central government’s approval for its capital expenditure. All remaining amounts, after expenditures and transfers, must be credited to the Consolidated Fund of India. 

Sebi is financed by market participants and does not depend on government funds. It is statutorily required to credit only penalties to the Consolidated Fund, and maintains funds in a separate general fund. The proposals therefore impinge on Sebi’s financial freedom. The concentration of state power in unelected bodies (like regulators) requires accountability, including, for finances. Both the Organisation for Economic Co-operation and Development (OECD) and the Financial Sector Legislative Reforms Commission (FSLRC) which was constituted to review the Indian financial sector recognise this. 

Accountability may be the intent behind the new proposals. The matter however predates them. Two principal arguments have been offered by the government and the Comptroller and Auditor General (CAG). As “state” and a “delegatee” of sovereign functions, Sebi must maintain funds and surpluses in government accounts, and transfer monies it collects back to the sovereign. This is a prevalent practice in “similarly placed” organisations in India (like the judiciary, CAG and Central Electricity Regulatory Commission or CERC) and abroad, and does not impact regulatory independence.  

So far, Sebi has resisted, citing compromise to its financial freedom. As both OECD and FSLRC note, independent regulators can deliver better outcomes by attracting requisite talent unhindered by government’s traditional constraints of budget or process. They strengthen regulatory neutrality and certainty, inspiring trust in markets and are not meant to be mere extensions of government. Financial independence — from stakeholders, including the government —enables this by preventing regulatory capture. 

The proposals therefore raise concerns. One, dependence on the executive for the regulator’s capex blurs the separation between the two. The proposals introduce dependence on the executive and Parliament for funds. Two, no rationale is provided for these specific caps, which may be restrictive. For instance, reference to prior period expenditures could inhibit the organisational growth/modernisation required to meet the challenges of regulating rapidly evolving markets. Sebi is already understaffed, with one employee for every seven companies. The ratio is 1:1 for the US securities regulator, SEC (Securities and Exchange Commission). The need for Parliamentary approval to amend the caps compounds the issue.  The prevailing practice too requires examination. The power ministry has de jure control over utilisation and maintenance of the CERC’s funds under the public account. Such accountability to individual ministry needs to be evaluated carefully. Both the judiciary and CAG may not be apt comparisons as they are constitutional authorities whose compensation is charged to the Consolidated Fund, not voted upon.

Also, the proposed amendments seem inspired by SEC (which can transfer up to $ 50 million a year to a reserve fund capped at $100 million). This may be inappropriate since unlike Sebi, the SEC is funded by budgetary appropriations. The reserve fund was introduced following the financial crisis to provide greater autonomy to the SEC. Sebi already enjoys more financial freedom today so we may be regressing. A suitable reference may be the UK’s Financial Conduct Authority which, like Sebi, is funded by fees and charges from market participants, turns in penalties to the exchequer and transfers the benefit of surplus funds to market participants through reduced fees. The last more closely aligns with the objective of developing efficient and competitive markets. Treating surpluses as budgetary revenues may not. 

At the heart of the matter is the balance required between regulatory independence and accountability. Both are needed for good regulatory governance and outcomes. Pertinently, the FSLRC did not recommend changes to funding provisions of Sebi (only principles for levying fees). It however proposed, in the Indian Financial Code accompanying its report, stronger mechanisms for regulatory reporting and evaluation, which enhance parliamentary/ executive trust. For example, efficiency and performance reports along with annual reports and delinking regulators’ performance from that of regulated entities (a current practice). These recommendations are useful given the FSLRC’s comprehensive review of Indian financial sector. 

Also, the presence of state-owned entities within insurance and pension regulators’ jurisdiction raise potential conflicts of interest. Since these regulators may have to follow suit, introducing similar measures needs to be deliberated.

The author is a fellow at the National Institute of Public Finance and Policy Views are personal