As we head into 2014, here is a new year resolution our financial sector regulators would do well, do adopt: shun intuition in making regulations, and instead, focus on behavioural science and empirical cost-benefit analysis.
New year resolutions are typically based on recent learnings. Year 2013 has demonstrated how the most well-intentioned and intuitively seemingly obvious regulatory measure can deliver counter-productive results. Some examples will make it clear.
Take the market for initial public offerings (IPOs) of equity shares. Since April 1, 2013, there has been but one new IPO, in calendar year 2013, three IPOs. Consider the recent policy measures aimed at tightening the screws purportedly to improve the quality of IPOs.
The intention was to make the securities market safe for investors in public offerings. The safety net concept was never officially introduced and never officially withdrawn.
But the effect achieved by such policy is there for all to see - in this financial year, just one new company felt comfortable listing its shares on stock exchanges of the third largest economy in the world.
Also in 2013, the Reserve Bank of India made it mandatory to use a secret PIN (personal identification number) to authorise every payment transaction using credit cards and debit cards. The intention was to make card payments even more secure in India for consumers using credit cards.
However, the regulator took the eye off the ball and a material execution failure on the part of card issuers has led to a contrary outcome. In recent weeks, after the introduction of the PIN requirement, card customers have faced so much inconvenience that a number of payments have migrated from card payments to cash payments.
Merchant establishments have had an inadequate number of chip-card reading machines to replace card swiping machines.
Most restaurants could not acquire wi-fi enabled credit card readers, resulting in customers having to walk up to the cash counter to enter the PIN even in five-star hotels akin to cash payments in college canteens. Worse, many merchants simply ask the customer for the PIN and the gullible routinely hand it over. Most merchant establishments enter the amount directly and all the customer gets to see is the request for the PIN, effectively signing off without seeing the amount being signed off.
Another example from the capital markets in 2013 is the extraordinary measure aimed at protecting small investors against stock brokers, by asking the latter to put away the amount claimed by the investor in a dispute.
Having to block amounts however small regardless of the merits of the claim has led to brokers being fearful of unscrupulous small investors making false claims. Driven by such fear, many brokers apprehensive of suffering financial injury from multiple fake claims, which would force them to settle disputes unfavourably have decided to play safe by quitting servicing small investors.
Each of these examples has one common feature: that the regulators have achieved a result diametrically opposite to regulatory objectives, however laudable their intent. In the conflict between the objective to keep the market safe from abuse, and the objective of letting markets function normally and efficiently, regulators have unwittingly hurt the very markets they regulate.
Indeed, if there were no market at all, there can be no abuse at all. But that is too high a price to pay for ensuring absence of controversy.
To draw on a parallel, if in the fear of terror attacks one were to adopt a strip search of every guest entering a hotel to ensure security, the hotel would perhaps feel quite secure but would need to shut down owing to guests staying away from patronising it.
When the learning from 2013 is that regulatory measures can unwittingly nudge market behaviour into a direction diametrically opposite to intended objectives, the new year resolution for 2014 should appropriately respond.
Measuring costs and benefits of introducing new regulations is easy to advocate. Actually computing them meaningfully and truthfully is much harder.
However, if one were serious about meeting regulatory objectives meaningfully, there is no other alternative. Indeed many a new year resolution is adhered to only in breach - following that trend with this one would be at great peril to our markets.
The author is a partner of JSA, Advocates & Solicitors. The views expressed herein are his own. somasekhar@jsalaw.com
New year resolutions are typically based on recent learnings. Year 2013 has demonstrated how the most well-intentioned and intuitively seemingly obvious regulatory measure can deliver counter-productive results. Some examples will make it clear.
Take the market for initial public offerings (IPOs) of equity shares. Since April 1, 2013, there has been but one new IPO, in calendar year 2013, three IPOs. Consider the recent policy measures aimed at tightening the screws purportedly to improve the quality of IPOs.
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The Securities and Exchange Board of India (Sebi) had announced a regulatory policy of moving from a disclosure-based regime to a merit-based regime whereby Sebi would disallow IPOs that are of a bad quality in its view. Sebi also floated the concept of a "mandatory safety net" where investors would be protected against a steep fall in price of shares after listing, with promoters having to buy shares from allottees in the IPO at the IPO price.
The intention was to make the securities market safe for investors in public offerings. The safety net concept was never officially introduced and never officially withdrawn.
But the effect achieved by such policy is there for all to see - in this financial year, just one new company felt comfortable listing its shares on stock exchanges of the third largest economy in the world.
Also in 2013, the Reserve Bank of India made it mandatory to use a secret PIN (personal identification number) to authorise every payment transaction using credit cards and debit cards. The intention was to make card payments even more secure in India for consumers using credit cards.
However, the regulator took the eye off the ball and a material execution failure on the part of card issuers has led to a contrary outcome. In recent weeks, after the introduction of the PIN requirement, card customers have faced so much inconvenience that a number of payments have migrated from card payments to cash payments.
Merchant establishments have had an inadequate number of chip-card reading machines to replace card swiping machines.
Most restaurants could not acquire wi-fi enabled credit card readers, resulting in customers having to walk up to the cash counter to enter the PIN even in five-star hotels akin to cash payments in college canteens. Worse, many merchants simply ask the customer for the PIN and the gullible routinely hand it over. Most merchant establishments enter the amount directly and all the customer gets to see is the request for the PIN, effectively signing off without seeing the amount being signed off.
Another example from the capital markets in 2013 is the extraordinary measure aimed at protecting small investors against stock brokers, by asking the latter to put away the amount claimed by the investor in a dispute.
Having to block amounts however small regardless of the merits of the claim has led to brokers being fearful of unscrupulous small investors making false claims. Driven by such fear, many brokers apprehensive of suffering financial injury from multiple fake claims, which would force them to settle disputes unfavourably have decided to play safe by quitting servicing small investors.
Each of these examples has one common feature: that the regulators have achieved a result diametrically opposite to regulatory objectives, however laudable their intent. In the conflict between the objective to keep the market safe from abuse, and the objective of letting markets function normally and efficiently, regulators have unwittingly hurt the very markets they regulate.
Indeed, if there were no market at all, there can be no abuse at all. But that is too high a price to pay for ensuring absence of controversy.
To draw on a parallel, if in the fear of terror attacks one were to adopt a strip search of every guest entering a hotel to ensure security, the hotel would perhaps feel quite secure but would need to shut down owing to guests staying away from patronising it.
When the learning from 2013 is that regulatory measures can unwittingly nudge market behaviour into a direction diametrically opposite to intended objectives, the new year resolution for 2014 should appropriately respond.
Measuring costs and benefits of introducing new regulations is easy to advocate. Actually computing them meaningfully and truthfully is much harder.
However, if one were serious about meeting regulatory objectives meaningfully, there is no other alternative. Indeed many a new year resolution is adhered to only in breach - following that trend with this one would be at great peril to our markets.
The author is a partner of JSA, Advocates & Solicitors. The views expressed herein are his own. somasekhar@jsalaw.com