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Friday, January 13, 2017

South Africa vs. India: alternative paths to financial reforms

by Radhika Pandey and Smriti Parsheera.

As finance evolves, so must the legal systems designed to govern it. These changes often come about in firefighting mode. As an example, a discord between IRDA and SEBI on Unit Linked Insurance Plans led to a hasty amendment to the Reserve Bank of India ("RBI") Act to create a joint committee mechanism to resolve regulatory jurisdiction issues. The outburst of ponzi schemes and unregulated financial activities has led to attempts at legal reforms concerning unregulated deposit taking activities.

While there is a case for addressing felt needs, one at a time, there is also a need for mapping the big picture of financial law and the organisation diagram of financial agencies. This design work requires deep thinking based on long years of experience, research and debate. It is not a quick response to a crisis.

There are, thus, three ways through which the financial regulatory apparatus can evolve:
  1. Addressing a felt need that arises at a point of time, without thinking on a system scale; or
  2. A full redesign of the financial regulatory landscape through a comprehensive financial sector law; or
  3. A full scale research and design effort, which establishes a strategy for reform, but this is implemented through numerous small steps.
By default, most countries pursue Method 1. It allows for prompt action to fix an immediate issue. This comes with the risk of missing the woods for the trees, with being stuck with financial regulatory structures that are decades out of date. However many countries have, from time to time, also followed the second or third paths.

In this article, we examine the recent South African and Indian approaches to large-scale financial reform. South Africa is pursuing Method 2 while India is pursuing Method 3. Our emphasis is on the policy process employed in both countries. We note, in passing, that there are remarkable similarities in the ideas shaping their financial reform, but this article is about policy process and not substantive content.

South Africa's reform process


South Africa initiated a formal review of its financial sector in 2007, which culminated in the release of the report on A safer financial sector to serve South Africa better ("SA Report") by the National Treasury in February 2011. Prepared in the wake of the global financial crisis, this report strongly emphasised stability as a key policy objective, along with the goals of consumer protection, expanding financial inclusion and combating financial crime.

In July 2011, the South African Cabinet approved the SA Report's proposal to shift to a "twin peaks" system of financial regulation, which would separate prudential regulation from market conduct supervision. This was followed by a budget announcement to that effect in the subsequent year. In February, 2013, the Financial Regulatory Reform Steering Committee, comprised of representatives from South Africa's three key financial regulatory institutions - Reserve Bank, Financial Services Board and National Treasury, published a report on Implementing a twin peaks model of financial regulation in South Africa. This document, along with the SA Report, formed the basis for widespread consultations and preparation of a draft legislation to give effect to the proposed reforms.

Building on these documents, the Treasury put together the first draft of the Financial Sector Regulation Bill ("FSR Bill") in December 2013, followed by a second version in December 2014. Comments were invited at each stage, and public workshops were held to spread awareness about the proposals. A provision-wise summary of the comments received from stakeholders and the National Treasury's response to them was placed in the public domain.

The FSR Bill was then tabled in Parliament in October 2015, and referred to the Standing Committee on Finance ("SCOF"). SCOF held yet another round of public consultations between November 2015 and May 2016 and the Treasury declared its response to the comments received. In parallel, the government also released an Impact Study Report setting out the motivation behind the FSR Bill; the costs and benefits of its implementation for stakeholders and the government; measures for managing risks; and summary of the expected impact on national priorities.

Since then, the Treasury has published further revised drafts of the FSR Bill on 21st July 2016 and 21st October 2016, taking into account the matters raised by the Standing Committee as well as various stakeholders. South Africa's National Assembly voted on the Bill in December 2016 and it will now be placed before the National Council of Provinces.

The FSLRC's reform agenda


India's work in financial reform was proceeding in similar years. In 2011, the Ministry of Finance setup the Financial Sector Legislative Reforms Commission ("FSLRC") with the mandate to review and recast the legal and institutional structures of the Indian financial system.

FSLRC released a report and a draft law in March 2013. This draft law is termed Indian Financial Code (IFC), v1.0. This was refined into IFC version 1.1 that was put out for public comments in July 2015.

IFC has not been tabled in Parliament. A large number of steps have, however, put this strategy in action:
  1. IFC envisages many new elements of the financial regulatory architecture. The Ministry of Finance adopted a `Task Forces' approach of setting up a group of wise people that would build the implementation strategy for setting up each new agency. Task Forces were set up for five financial agencies: the Public Debt Management Agency ("PDMA") under Dhirendra Swarup, Financial Sector Appellate Tribunal under N.K. Sodhi, Resolution Corporation ("RC") under M. Damodaran, Financial Data Management Centre (FDMC) under Subir Gokarn and then Financial Redress Agency (FRA) under Dhirendra Swarup. The FRA Task Force Report is open for public comments till 31st January 2017.
  2. IFC envisaged an objective for RBI -- inflation targeting -- and a shift in rate setting power from the Governor to the Monetary Policy Committee. This was achieved in two steps: the Monetary Policy Framework Agreement and then the amendments to the RBI Act through the Finance Act, 2016.
  3. The IFC chapters that established the RC were adapted into a standalone draft law and released for public comments.
  4. An interim cell has been set up within the Ministry of Finance in the run up to building a statutory PDMA.
  5. The appointments process for senior regulatory staff that is embedded in IFC has been implemented as the Financial Sector Regulatory Appointment Search Committee that will be used for all senior appointments in financial sector regulatory bodies.
  6. IFC envisages a unification of financial markets regulation. The number of financial markets regulators went down from three -- RBI, Securities Exchange Board of India ("SEBI") and Forward Markets Commission ("FMC") -- to two (RBI, SEBI) with the merger of FMC into SEBI through the Finance Act, 2015.
  7. IFC envisages that the power to issue capital control regulations should be with the Ministry of Finance. This was partially done, for non-debt flows, through an amendment to the Foreign Exchange Management Act, 1999 in May 2015.

Comparing the two pathways to reform


There is a clear difference in the way the financial reform story has unfolded in these two countries. In South Africa, the Treasury drafted and owned the report from the very start. They were able to stay focused on the basic idea. This however comes with its own costs. A complete recast of the financial regulatory framework, having wide-ranging implications, implies that considerable time needs to be spent on building consensus among stakeholders. This is illustrated by the fact that South Africa initiated the idea for reforms in 2007 but almost a decade later, they are yet to adopt a final law. Due diligence of stakeholder consultations, impact assessments, and publishing responses to comments to each step of a comprehensive code adds to the complexity of the exercise.

In the Indian case, there is greater policy uncertainty as one piece is being done at a time. There is no assurance that the full vision will unfold successfully. As a self-contained draft, the different parts of IFC 1.1 speak closely to one another. Its full effect can therefore be achieved only if this consistency is maintained. Picking and choosing specific parts for implementation casts a greater responsibility to ensure that the proposals being adopted are consistent, not just with the myriad set of existing financial laws but also with the full concepts of FSLRC's report. If even one or two components stray away from the original vision, there is a danger of getting messy outcomes. It also leads to a duplication of drafting efforts to ensure that each part is consistent with the whole.

But there are some advantages. It gives the Ministry of Finance the ability to pick one battle at a time. In India, there are severe constraints on State capacity. If all parts of IFC had to be implemented at the same time, the project management would likely face more difficulties.

The authors are researchers at the National Institute of Public Finance and Policy. They were part of the FSLRC research secretariat.

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