NATIONAL LAW SCHOOL OF INDIA UNIVERSITY

BANGALORE




NEED FOR A SUPER REGULATOR IN INDIA IN THE CONTEXT
OF JURISDICTIONAL OVERLAP OF FINANCIAL REGULATORS:
A COMPARATIVE ANALYSIS BETWEEN UK and INDIA

Dissertation submitted in the partial fulfilment of the requirements for
the Degree in Master of Law (LL.M.)

Under the supervision of Prof (Dr.) V. Vijayakumar

By
Ronak Karanpuria
ID NO. 534
June 2014

TABLE OF CONTENTS

Certificate I
Declaration II
Acknowledgment III
List of Abbreviation IV
List of statues V


Chapter I Introduction.01

Chapter II Overview of Financial Market
2.1 Financial Market and its Role in Nation Economy.09
2.2 Regulatory Function............10
2.3 Policy goals of Regulation...12

Chapter III Financial regulators in Indian Financial Market
3.1 Changing scenario in Indian Financial Sector............17
3.2 Multiple regulators in Indian Financial Market...........20

Chapter IV What does Super Regulator means in Financial Market?
4.1 Institutional Framework..25
4.2 Functional Framework25
4.3 Integrated Framework.26
4.4 Twin peak Framework...........26

Chapter V Indian Regulatory jurisdiction overlaps and arbitrage
5.1 Indias Financial Regulatory Jurisdiction overlaps..31
5.2 Regulatory gap.40


Chapter VI UK financial regulator model development
6.1 Pre FSA phase [1980]...44
6.2 Transactional Phase [1990].45
6.3 FSA regulation [1990-2007] 47
6.4 Post FSA [after 2007]: New Regime..54

Chapter VII Restructuring of Indian Financial Market: Need for a Super
Regulator
7.1 Problems with multiple regulator.58
7.2 Which regulatory model is suitable? ......................................60
7.3 Arguments in favour..61
7.4 Arguments against.62

Chapter VIII Conclusion.....66

Bibliography...71

Annexure I (fig 1 and 2)....78

Figure 1 The Financial Services System Regulatory Structure, India..78
Figure 2 The Financial Services System Regulatory Structure, UK79



I

CERTIFICATE


This is to certify that the work contained in this dissertation entitled NEED
FOR A SUPER REGULATOR IN INDIA IN THE CONTEXT OF
JURISDICTIONAL OVERLAP OF FINANCIAL REGULATORS: A
COMPARATIVE ANALYSIS BETWEEN UK and INDIA submitted by
Ronak Karanpuria for the Degree of Master of Law (LL.M.) for the session
2012-14, of NLSIU is the product of bonafide research carried out under my
guidance and supervision. The dissertation or any part thereof has not been
submitted elsewhere for any other degree













Place: NLSIU, Bangalore Prof. (Dr.) V. Vijayakumar
Date:



II

DECLARATION



I, Ronak Karanpuria, do hereby declare that this Dissertation titled NEED
FOR A SUPER REGULATOR IN INDIA IN THE CONTEXT OF
JURISDICTIONAL OVERLAP OF FINANCIAL REGULATORS: A
COMPARATIVE ANALYSIS BETWEEN UK and INDIA is a result
of bonafide research undertaken by me in partial fulfilment of LL.M. programme
at NLSIU, Bangalore. This dissertation has been prepared by me under the
guidance and supervision of Prof. (Dr.) V. Vijayakumar.

I hereby declare that this dissertation is the outcome of original work and the
relevant material taken from other sources have been properly cited at
appropriate places and which are duly acknowledge.

I further declare that this work has not been submitted either in part or whole
for any degree or any other University or like Institution.






Place: NLSIU, Bangalore Ronak Karanpuria
Date: I.D. No. 534
LL.M. (Business Law)
NLSIU, Bangalore


III

ACKNOWLEDGMENTS


I am enormously grateful to my supervisor, Prof. (Dr.) V. Vijayakumar for his
generous and thoughtful guidance throughout the course of this project.
I gratefully acknowledge the Librarian of NLSIU who helped me finding out
research materials. I am indebted to my friends and colleagues for many
sanity-preserving discussions over the years on law, academics, work, and
everything in between.

Finally, I thank my parents for their endless love and support throughout this
and every other stage of my lengthy student career.


















IV


LIST OF ABBREVIATIONS




CCI Competition Commission of India
CERC Central Electricity Regulatory Commission
DBOD Department of Banking Operations and Development
DBS Department of Banking Supervision
DNBS Department of Non-Banking Supervision
FCA Financial Conduct Authority
FMC Forward Markets Commission
FSAT Financial Sector Appellate Tribunal
FSA Financial Services Authority
FSLRC Financial Sector Legislative Reforms Commission
GOI Government of India
IMF International Monetary Fund
IRDA Insurance Regulatory and Development Authority
MCA Ministry of Company Affairs, Government of India
NABARD National Bank for Agriculture and Rural Development
NBFC Non-Banking Financial Company
PFRDA Pension Fund Regulatory and Development Authority
RBI Reserve Bank of India
RRB Regional Rural Bank
SEBI Securities and Exchange Board of India
UFA Unified Financial Agency
UK FSMA 2000 UK Financial Services and Markets Act, 2000
UK United Kingdom
ULIP Unit Linked Insurance Plan
US United States
V

LIST OF STATUTES



1. Banking Regulation Act, 1949
2. Chit Fund Act, 1982
3. Insurance Act, 1938
4. Insurance Regulatory And Development Authority Act, 1999
5. National Bank For Agriculture And Rural Development Act, 1981
6. Pensions Act, 1871
7. Pension Fund Regulatory And Development Authority Act, 2013
8. Reserve Bank Of India Act, 1934
9. Securities And Exchange Board Of India Act, 1992













1

CHAPTER I
INTRODUCTION



1.1 Problem of study

The financial system is regulated to achieve a wide variety of purposes.
However, the objective that distinguishes financial regulation from other kinds
of regulation is that of safeguarding the economy against systemic risk.
Regulators in India are statutory entities headed by a board. It is the
responsibility of the Government to appoint the members on the board of the
regulator. The financial System of any country consists of financial markets,
financial intermediaries and financial instruments or financial products.
1
A
financial system work as a medium to facilitate the flow of funds from the areas
of surplus to the areas of deficit. A financial System comprises of various
institutions, markets, regulations, instruments and laws, practices, analysts,
transactions and claims

The five key functions of a financial system in a country are: (i) information
production ex ante about possible investments and capital allocation; (ii)
monitoring investments and the exercise of corporate governance after
providing financing; (iii) facilitation of the trading, diversification, and
management of risk; (iv) mobilization and pooling of savings; and (v) promoting
the exchange of goods and services.
2




1
Ibid, at 1
2
Cihak, Martin and Levine, Benchmarking financial systems around the world, Policy
Research working paper; no. WPS 6175. Washington, DC: World Bank,
http://documents.worldbank.org/curated/en/2012/08/16669897/benchmarking-financial-
systems-around-world Accessed on7/5/14
2


A Financial Market
3
can be divided into following parts based on the nature of
transactions:

Money Market- The money market ifs a wholesale debt market for low-risk,
highly-liquid, short-term instrument. Funds are available in this market for
periods ranging from a single day up to a year. This market is dominated
mostly by government, banks and financial institutions. Some of the important
money market instruments are Treasury bills, term money, Certificate of
Deposit and Commercial papers.

Capital Market - The capital market is designed to finance the long-term
investments. The transactions taking place in this market will be for periods
over a year. Financial instruments involved in these market are Equity shares,
preference shares, convertible preference shares, non-convertible preference
shares etc. and in the debt segment debentures, zero coupon bonds, deep
discount bonds etc.

Forex Market - The Forex market deals with the multicurrency requirements,
which are met by the exchange of currencies. Depending on the exchange
rate that is applicable, the transfer of funds takes place in this market. This is
one of the most developed and integrated market across the globe.

Credit Market- Credit market is a place where banks, FIs and NBFCs purvey
short, medium and long-term loans to corporate and individuals.


3
D. Aruna Kumar, An Overview of Indian Financial System,
http://www.indianmba.com/Faculty_Column/FC177/fc177.html Accessed on2/5/14
3

The rationale for regulation is built on the objective of economic policy to create
a sustainable level of economic growth through investment, employment and
production and to cease the possibilities of market failure by regulation of
financial market. Neo-classical economics talks about three classes of market
failures: natural monopolies, asymmetric information and externalities. These
describe scenarios in which markets do not serve us well and have to be
regulated. The responsibility for ensuring healthy contributions from each
sector towards sustainable economic growth are generally split between three
parties. Firstly, governments responsibility is to create a stable environment
and infrastructure of legal rules supported by regulatory and supervisory
arrangements. Secondly, the central bank is responsible for contributing
towards the achievement and maintenance of a stable financial
system. Thirdly, the financial market regulators that enable the private sector
to create economic growth through investment, employment and physical
production by creating a competitive environment with legal rules and ensure
sufficient disclosures in the respective sectors following the pattern followed
throughout the world.

Generally financial regulator in any sector in a country has two main tasks
independent in itself i.e. regulation and supervision. Prudential financial
regulation refers to the set of general principles or legal rules that are standard
to pursue as their objective for stable and efficient performance of financial
institutions and markets. These rules represent boundaries and limitations
placed on the actions of financial intermediaries to ensure the safety and
soundness of the system. Regulation is a preventive action in that it limits the
range of permissible actions for the intermediary and specifies prohibited
activities. On the other hand, it do financial intermediary supervision in contrast
to regulation examination and monitoring mechanisms which the authorities
verify compliance with and enforce prudential financial regulation.

4

In view of these critical contributions to economic performance it is not
surprising that the health of the financial sector is a matter of public policy
concern and that nearly all national governments have chosen to regulate the
financial sector. It is undoubtedly correct that the overall objective of regulation
of the financial sector should be to ensure that the system functions efficiently
in helping to deploy, transfer and allocate resources across time and space
under conditions of uncertainty. In fact, at least four broad rationales for
financial regulation may be identified: safeguarding the financial system
against systemic risk, protecting consumers from opportunistic behaviour,
enhancing the efficiency of the financial system, and achieving a broad range
of social objectives from increasing home ownership to combating organized
crime.
4


In India different financial sectors are regulated by different sector regulators
but the financial market is evolving day by day. One consequence of this is
blurring of boundaries among these markets and inefficient handling of such
borderline behaviour by sector regulators, regulatory arbitrage and inefficient
governance. This has led to the demand for unification of regulation of different
sectors. In terms of sector regulation the evolution of new and innovative
financial products have created a scenario where the boundaries are blurring.
Unified regulatory approach may take many forms depending on maturity of a
financial market. One extreme of that is a single super regulator for the whole
economy. This model has been adopted by a few countries and is in operation
for a while. In this regard the experience gained by operation of such structure
in UK is very relevant.


4
Richard J. Herring and Anthony M. Santomero, What is optimal financial regulation? The
Wharton School University of Pennsylvania
< http://fic.wharton.upenn.edu/fic/papers/00/0034.pdf> Accessed on 1
st
May 2014
5

The slowdown of economy and failure of financial institutions like banking all
over the world and their cross border effect led to rethinking in four different
aspects (1) how financial institutions and markets work and operate (2)
innovation of financial instruments (3) the extent of market imperfections and
failures in the financial system and the power of regulation and supervision to
address them, and (4) the extent to which financial products and contracts are
significantly different from the generality of goods and services which are not
regulated to anywhere near the same degree as financial institutions.
5
To
address these issue, papers will cover such topics as the rationale for
regulation, the costs and benefits of various aspects of regulation, and the
structure and development of the financial services industry comparing with
UK regulatory model and challenges for regulators.


1.2 Aim and Objectives

The aim of the research is to understand the scope and functions of different
regulatory approach adopted in various jurisdiction, understanding their
breakdown and reason for success and need of super regulator in India to
overcome the financial arbitrage and regulatory overlap with improved
performance, consumer protection and stability. To understand the regulatory
aspect, it is necessary to understand following things as mentioned below:

1. Tracing the evolution of Unified Regulator in the Financial Market in UK.
2. Identifying the intrinsic differences and similarities of the nature of the
financial regulation under jurisdictions.

5
The Economic Rationale for Financial Regulation, April 1999, FSA working papers, 5,
<http://www.fsa.gov.uk/pubs/occpapers/op01.pdf> Accessed on 1
st
May 2014

6

3. Analysing the performance of Unified Regulator in respective financial
market.
4. Current trend in global scenario seems that almost 30-40 countries all
over the world have made major changes in financial regulatory system
which include reconstruction of regulatory structure.
5. To understand the effects of structural changes of financial sector
because it effect the economy of a country.
6. To understand that shape of Indias financial sector evolve over coming
decades. Whether the current regulatory system is hinder in financial
innovation.

1.3 Hypotheses

The blurring of financial market boundaries and with the advent of innovative
hybrid financial instruments calling for reform of existing financial market
regulators for controlling and supervision of financial market with the unification
of financial market regulators has been adopted in different countries as per
their market requirement based on economic, social and political
circumstances is not a strait jacket formula for each and every country not an
absolute method in reducing the instances of mismanagement, regulatory
overlap and regulatory gap to ensure efficient performance of financial
markets, stability and consumer protection.

1.4 Research Questions


1. What are common traits of different finance sector regulator and the
effect of consolidation of different functions in single regulator in
financial market?
2. Are there any inadequacies in current financial regulatory system in
India?
7

3. What does incorporation of single regulator mean and how is it different
from other regulatory concepts in a financial market in terms of
structure.
4. Does reconstruction and reforming of financial sector regulator
substantially improves the well-being of customer?
5. Whether single regulator can prevent regulatory arbitrage present
across different intermediaries and markets which circumvent the
macro-prudential regulations?
6. Whether the structural change of financial regulatory can brings stability
and increase efficiency in financial market.
7. What has been the experience in United Kingdom with unified
regulation?
8. How unification can help in solving the complications of Indian financial
market?
9. How apt are recommendations of FSLRC in arriving at optimum
regulatory architecture?

1.5 Research Methodology

The research methodology adopted is comparative and descriptive.


Sources: The researcher would be referring to primary resources like the
legislative enactments of the respective jurisdiction under study pertaining to
different financial regulator. The researcher would also be relying upon
secondary sources like Commission report, Legislative Committee reports,
Books and Journals

Chapter II entitled Overview of Financial Market deals with the basic
structure of financial market, financial instruments, functions of financial
8

regulator and policy goals of regulations namely safety, soundness, mitigation
of systemic risk, fairness and accountability and consumer protection. Chapter
III entitled Financial Regulators in Indian Financial Market deals with the
historical changes in Indian financial market, legal framework of regulatory
system in India and their regulatory functions and powers. Chapter IV entitled
What does Super Regulator means in Financial Market? deals with the
type of financial regulation typology adopted by various countries and its
benefits. Chapter V entitled Indian Financial Regulatory Mechanism
Pitfalls. Chapter VI entitled UK Model deals with the development in UK in
financial regulatory system, reason for such adoption with their fall back from
1960 to 2013. Chapter VII entitled Restructuring of Indian Financial
Market deals with the current regulatory system in India with FSLRC
commission report and scope of possibility of new financial regulator in India.
The concluding chapter provides an analysis of discussion of as well as about
the possibility of adoption of super regulator in India.

1.6 Limitation

This research is meant to analyse the effect of inclusion of Super Regulator in
the financial market. Due to the wide range of the topic, the researcher would
be confining the study to two jurisdictions namely United Kingdom and India
and for the purpose of achieving the objective.

1.7 Mode of Citation:

A uniform mode of citation will be followed throughout this paper.





9

CHAPTER II
OVERVIEW OF FINANCIAL MARKET


2.1 Financial Market and its Role in Indian Economy

The financial sector in any country relates to the economy it serves in a manner
in which the circulatory system serves. Financial System of any country
consists of financial markets, financial intermediaries and financial instruments
or financial products.
6
A financial system work as a medium to facilitate the
flow of funds from the areas of surplus to the areas of deficit. A financial
System comprises of various institutions, markets, regulations, instruments
and laws, practices, analysts, transactions and claims. At present, financial law
in India is fairly complex. Financial sector can be divided into banking and non-
banking activities which until 1993 was supervised and regulated by DBOD,
finally in the year 1997 DBOD was split into DBS and DNBS.

Indias growth although among the highest in the world projected at 4.6% in
2013 which rises to 5.4% in 2014 improved by export competitiveness, a
favourable monsoon and by approved investment projects through FDI
7
are
implemented and as global growth improves. But India should take substantive
measures to narrow external and fiscal imbalances, tighten monetary policy,
move forward on structural reforms,
8
and address market volatility.


6
Ibid, at 1
7
BCC Global Monthly Economic Review
<http://www.bcctaipei.com/bcc-global-monthly-economic-review-may-2014/ > Accessed on
9
th
June 2014
8
India: Economy Stabilizes, but High Inflation, Slow Growth Key Concerns,
<http://www.imf.org/external/pubs/ft/survey/so/2014/car022014a.htm> Accessed on 3
rd

May 2014
10

2.2 Regulatory Functions

Regulation refers to controlling human or societal behaviour by rules or
regulations or alternatively a rule or order issued by an executive authority or
regulatory agency of a government and having the force of law.
9
Regulation
covers all activities of private or public behaviour that may be detrimental to
societal or governmental interest but its scope varies across countries.

Generally financial regulator in any sector in a country has two main tasks
independent in itself i.e. regulation and supervision

Prudential financial regulation refers to the set of general principles or legal
rules that are standard to pursue as their objective for stable and efficient
performance of financial institutions and markets. These rules represent
boundaries and limitations placed on the actions of financial intermediaries to
ensure the safety and soundness of the system. Regulation is a preventive
action in that it limits the range of permissible actions for the intermediary and
specifies prohibited activities. The choice of weights between prevention in the
form of regulation and criminal prosecution and tort liability must be
differentiate and within the ambit of regulator to ensure regulation which varies
across countries.
10


Financial intermediary supervision
11
in contrast to regulation examination and
monitoring mechanisms which the authorities verify compliance with and
enforce prudential financial regulation. It refers to the specific procedures
adopted in order to determine the actual risks faced by an intermediary for

9
Regulation (2009), Merriam-Webster Online Dictionary, <www.merriam-
webster.com/dictionary/regulation> Accessed on 2
nd
May 2014
10
Rodrigo A. Chaves and Claudio Gonzalez-Vega, Principles of regulation and prudential
supervision: should they be different for microenterprise finance organizations?, Economics
and Sociology Occasional Paper No. 1979, 6, The Ohio State University, Ohio (1992)
11
Ibid
11

compliance. Objectives of supervision is to promote stability and efficiency
which is important for financial progress. An efficient mechanism for the
surveillance
12
of financial intermediaries should have two basic components.
The first component would be an early-warning system based on data reported
to the supervisory authority by the intermediaries themselves. This is the off-
site component of the supervisory structure. Its main purpose is to provide a
frequent depiction of the financial health and risks of each intermediary
supervised. On-site supervision is necessary to practice those inspections
that, because of their nature, cannot be performed by an off-site analysis (such
as quality of internal control) and to verify that the data fed to the off-site
surveillance system are correct. The supervision activities directly or indirectly
help to lay down proper regulation for compliance.

Why is regulation needed? Whether risk taken by one firm or companies
in one sector suffers loss which badly effects other market/sector can be
avoided by efficient regulation? Another question that raises the curiosity
is how much needs to be regulated by government. Well, the answers is
not more regulation or intervention by government but better and effective
regulation.
13
This is, in turn, divided into two sub-questions: Why do
markets by themselves not suffice? And if there is to be government
intervention, why does it take the form of regulations? Some economist
like Adam Smith (it is widely believed) argued that markets by themselves
are efficient and others believe that public has faith in government as a
neutral agency. We have regulation everywhere like air, water pollution
control, traffic and labor regulation etc. directly or indirectly everyone works
under regulation. Similarly to manage such financial market which are

12
Should Principles of Regulation and Prudential Supervision Be Different for Microenterprise
Finance Organizations?
13
<http://economix.blogs.nytimes.com/2008/10/28/better-not-just-more-
regulation/?_php=trueand_type=blogsand_r=0> Accessed on 6
th
May 2014
12

cross borders connected it is necessary to have regulation which suits the
demands of market player, safety and confidence to investors and brings
soundness and stability to financial market.

For the functioning of financial sector various arrangements and frameworks
are required which include the legal framework within which the financial sector
operates. Like most of the financial dealings are contracts, it is necessary to
formulate legal framework within which such contracts can be drawn, enforced
and the recourse in the event of breach of contract are very important
determinants of the efficacy of any financial system. As it needs to be
emphasised financial sector are intertwined and interdependent with
developments elsewhere in the economy. Therefore, the efficiency level of any
financial system to a large extent is constrained by the efficiency of the overall
economic set up within which it operates.

2.3 Policy goals of Regulation

Financial crisis and great depression worldwide creates unemployment, failing
businesses, falling home prices and declining savings. Sometimes
sophisticated financial firms, risk management systems did not keep pace with
the complexity of new financial products. The lack of transparency and
standards in markets for securitized loans helped to weaken underwriting
standards. Market discipline broke down as investors relied excessively on
credit rating agencies. Gaps and weaknesses in the supervision and regulation
of financial firms presented challenges to our governments ability to monitor,
prevent, or address risks as they built up in the system. No regulator saw its
job as protecting the economy and financial system as a whole. It is the duty
of regulator to restore confidence in the integrity of our financial system.
14
The

14
Richard A .Posner, Theories of Economic Regulation, Working Paper No. 41, Center
for Economic Analysis of Human Behavior and Social Institutions (2004)
13

objective of regulation is to achieve safety and soundness, mitigate systemic
risk, consumer protection, fairness and accountability.

2.3.1 Safety and soundness of Financial Regulation

Effective regulation should be designed to promote the safety and soundness
of individual financial institutions. They focuses on the solvency of institutions
and protection of customer assets which have been regulated through a
combination of rules and prudential examinations and supervision. The
regulatory bodies have their tools to analyse the working of institution lying in
their jurisdiction to maintain the stability in the system.

a. Robust Supervision:

Due to sudden economic failure of financial institutions which can directly or
indirectly effect other sectors institution make them critical to market
functioning and should be subject to strong oversight. No financial firm that
poses a significant risk to the financial system should be unregulated or weakly
regulated. Generally, a separate department or body is entrusted with the task
of identifying emerging systemic risks and to supervise all firms that could pose
a threat to financial stability, even those that do not own banks.
15


b. Risk Assessment:

The major financial markets must be strong enough to withstand both system
wide stress and the failure of one or more large institutions. Enhanced
regulation of securitization markets including new requirements for market
transparency, stronger regulation of credit rating agencies and a requirement

15
Regulatory And Supervisory Challenges in Banking
<http://rbidocs.rbi.org.in/rdocs/Publications/PDFs/86737.pdf > Accessed on 9
th
June 2014
14

that issuers and originators retain a financial interest in securitized loans. Due
to the fact that scam like Harshad Mehta Stock Market Scam (1992) and Ketan
Parek Scam (2001) taking benefit of loopholes challenge the market regulators
to better assess the risk and compliance of regulation which need to financial
regulator to tackle such situations.


2.3.2. Mitigation of systematic risk

The dominant goal of financial supervision is to monitor the overall functioning
of the financial system as a whole and to mitigate systemic risk that would
seem to be the most challenging to achieve. Financial systems cannot function
effectively without confidence in the markets and financial institutions. A major
disruption to the financial system can reduce confidence in the ability of
markets to function, impair the availability of credit and equity and adversely
impact real economic activity. Systemic risk generally refers to impairment of
the overall functioning of the system caused by the breakdown of one or more
of the key market components like failure of Lehman Brothers.
16
Systemically
important players would include multinational banks, hedge funds, securities
firms, and insurance companies.

2.3.3 Fairness and accountability

The main requirement of market is transparency of all material information to
investors, by mandating disclosure of key information, whether it is about
business and financial performance about the prices at which securities are
bought or sold, or other key information that is important to investors.

16
Wall St.s Turmoil Sends Stocks Reeling, The New York Times Business Day,
<http://www.nytimes.com/2008/09/16/business/worldbusiness/16markets.html?hpand_r=0 >
Accessed on 4
th
May 2014
15

Disclosure
17
permits market participants to make optimal decisions with
complete information. These transparency goals may conflict with the interests
of a particular institution at any point in time and thus they may be contrary to
other goals of regulation such as maintenance of safety and soundness and
market continuity. For example, a financial institution that is experiencing
liquidity issues may want to keep that information private in order to minimize
speculation that could disrupt efforts to work out its problems. At the same
time, investors in the institution would want the most timely and accurate
information in order to make an investment decision.
18
These divergent
considerations may lead to disparate responses by different regulators and
locations. Prof Nicolaides states that a regulator must be accountable for their
decisions which involves two dimensions: one democratic, and the other more
procedural, that is often used to justify regulators' decisions.
19


2.3.4 Consumer protection

Financial regulation is also designed to protect customers and investors
through business conduct rules by bringing transparency where investors are
protected by rules that mandate fair treatment and high standards of business
conduct by intermediaries. Conduct-of-business rules ultimately lead to greater
confidence in the financial system and therefore potentially greater market
participation. Business conduct regulation has a quite different focus from
safety and soundness oversight. Its emphasis is on transparency, disclosure,
suitability, and investor protection. It is designed to ensure fair dealing. Such

17
SEBI proposes new listing, disclosure requirement norms, The Hindu Business,
<http://www.thehindu.com/business/markets/sebi-proposes-new-listing-disclosure-
requirement-norms/article5979243.ece,> Accessed on 4
th
May 2014
18
Sebis arguments in Tayal case simply dont wash, Live Mint,
<http://www.livemint.com/Opinion/RbIhoxg4dcB4HLN6XkjQGP/Sebis-arguments-in-Tayal-
case-simply-dont-wash.html> Accessed on 4
th
May 2014
19
Designing independent and accountable regulatory authorities for high quality regulation,
OECD, 7, (10-11 January 2005) <http://www.oecd.org/regreform/regulatory-
policy/35028836.pdf> Accessed on 6
th
May 2014
16

standards have been widely adopted in securities regulation for several
decades. Classic examples of business conduct rules include conflict-of-
interest rules, advertising restrictions, and suitability standards. Some
observers claim that business conduct rules per se were less common in the
banking sector, although fiduciary principles applied. Even at global level, G20,
World Bank and OECD aimed at making policies which are favourable and in
the interest of consumers by promoting financial education and by developing
innovative communication channels.
20













20
Draft effective Approaches to support the Implementation of the Remaining G20/ECD high
level principles on Financial consumer Protection, OECD, 6, (14 May, 2014)
<http://www.oecd.org/daf/fin/financial-education/FCP-Effective-Approaches-2014.pdf>
Accessed on 6
th
May14
Financial consumer protection should be an integral part of the legal, regulatory and
supervisory framework, and should reflect the diversity of national circumstances and global
market and regulatory developments within the financial sector. Financial consumer
protection legislation can cover the following areas; institutional frameworks; the role of
oversight bodies; financial literacy/education; access to basic financial products and services;
disclosure requirements and transparency; responsible business conduct; responsible
lending practices; data protection and privacy; effective resolution schemes and complaint
handling mechanisms.
17

CHAPTER III
FINANCIAL REGULATORS IN INDIAN FINANCIAL MARKET

3.1 Changing Scenario in India

A. Deregulation of 1990s

The financial sector in India has undergone dramatic changes during the last
fifteen years. Deregulation and liberalization of the financial industry had led to
the development of the financial sector. This period also witnessed the
emergence of new players in the financial services industry. The financial
industry was no longer confined to banks and development financial
institutions. The development and growth of the securities markets
21
and the
insurance industry has increased the breadth of the Indian financial markets.
It appeared that the distinction between these financial service providers
blurred significantly as they were providing services which were not falling
within the realm of the regulators e.g. Nonbanking financial companies,
collective investment schemes. It was also felt that the growing complexity of
the financial conglomerates was putting an enormous strain on the existing
system with multiple and often overlapped supervisory structure.
22


B. Financial Conglomerates

The existing regulatory and supervisory framework in India is based on
institutional lines. In some cases, like RRBs, the regulation is directed at the

21
Mr. Mohammad Fazal, A Historical Perspective of the Securities Market Reforms in India ,
<http://www.sebi.gov.in/sebiweb/home/document_detail.jsp?link=http://www.sebi.gov.in/cms/
sebi_data/docfiles/2975_t.html> Accessed on 10
th
May 2014
22
Ankit Sharma, Should there be an integrated regulator for the Indian Financial System, SEBI
BULLETIN, Vol 1 no 12(Dec.2003) p7
< http://www.sebi.gov.in/bulletin/bulldec03.pdf> Accessed on 9
th
May 2014
18

specific institution, whereas activities related to securities markets are being
regulated and supervised by a specific regulator. Critics have argued that
multiple regulatory agencies reduce regulatory efficiency and leaves regulatory
gaps which may lead to financial contagion. The idea of a super regulator for
the Indian financial system was first mooted by the Khan Working Group for
harmonizing the Role and Operations of Banks and DFIs in 1998. It appears
that though the Group had used the term super regulator, it meant creation of
an agency which would function as a lead regulator and would coordinate the
activities of various regulators. The Narasimhan Committee II (1998) did not
comment on this issue. However, it had recommended that an integrated
system of regulation and supervision be put in place to regulate and supervise
the activities of banks, financial institutions and NBFCs. The Deepak Parekh
Advisory Group on Securities Market Regulation (2001) referred to the
diffusion of regulatory responsibilities and suggested granting of legal status
to the High Level Group on Capital Markets (HLGCM). The Group also
recommended creation of a system to allow sharing specified market
information between the regulators on a routine and automatic basis. Dr. Y.V.
Reddy, former Governor, Reserve Bank of India, propounded the Reddy
Formula which recommended creation of an umbrella regulatory legislation
which creates an apex regulatory authority without disturbing the existing
jurisdiction. The Joint Parliamentary Committee (2002) in its report has also
cursorily mentioned about super regulator but stresses upon more co-
ordination amongst the various regulatory and supervisory agencies.
23


The issue for having an integrated regulator in India has emanated for two
basic reasons:
1. Eliminate regulatory overlaps, gaps and inconsistencies in order to
reduce risk.

23
Ibid at 8
19

2. Emergence of financial conglomerates in the Indian financial sector.
24


The existence of a range of supervisory and regulatory authorities also poses
the risk that financial firms will engage in some form of regulatory arbitrage.
This involves placement of financial services in such a sector where the
supervisory sight is least intrusive. Examples which immediately come to mind
are NBFCs and plantation companies. Since, these entities did not fall under
the ambit of RBI, SEBI and DCA as far as their fund raising activities were
concerned, the hapless investor was left to the mercies of the unscrupulous
promoters of these companies. It was only after the amendment of the RBI Act
and the SEBI Act, the NBFCs and the Plantation companies were brought
under the regulatory and supervisory jurisdiction of the respective regulators.
With the financial sector expanding at a dramatic speed, it is very difficult to
imagine as to which regulatory gap may be exploited by an unscrupulous
individuals.

During the last decade, several significant developments have taken place in
the Indian financial sector. The Indian financial system has expanded and is
developing at a breakneck speed. The introduction of new products and new
concepts has revolutionized the markets and has also led to development of
financial conglomerates. In terms of major changes for example the banks
have diversified into a number of activities including insurance, securities,
mutual fund etc. (e.g. SBI, ICICI, etc.). Some banks have set up subsidiaries
to conduct merchant banking business, launch mutual funds (e.g. Canara
Bank, Bank of Baroda etc.).Then a DFI (IDBI) has set up subsidiaries to
undertake banking and mutual fund business. A mutual fund (UTI) has set up
a bank. Two insurance companies (LIC and GIC) have entered into mutual
fund business. A Housing Finance Company (HDFC) has set up a bank,

24
Ibid
20

mutual fund and insurance company. An NBFC (Kotak Mahindra) has set up
a bank, mutual fund, broking and merchant banking outfit.
25



3.2 Multiple regulators in Indian Financial Market

The financial system in India is regulated by independent and specialized
regulators in the respective field of banking, insurance, capital market,
commodities market, and pension funds. However, Government of India plays
a significant role in controlling the financial system in India and influences the
roles of such regulators at least to some extent.

The five major financial regulatory bodies in India.

3.2.1 Reserve Bank of India

Reserve Bank of India
26
is the apex monetary Institution of India. It is also
called as the central bank of the country. It acts as the apex monetary authority
of the country. The Central Office is where the Governor sits and is
where policies are formulated. Though originally privately owned, since
nationalization in 1949, the Reserve Bank is fully owned by the Government of
India.

The preamble of the Reserve bank of India Act 1934 is as follows"...to regulate
the issue of Bank Notes and keeping of reserves with a view to securing

25
Ibid at 9
26
<http://www.rbi.org.in/scripts/AboutusDisplay.aspx> Accessed on 10
th
May 2014
The Reserve Bank of India was established on April 1, 1935 in accordance with the provisions
of the Reserve Bank of India Act, 1934. The Central Office of the Reserve Bank was initially
established in Calcutta but was permanently moved to Mumbai in 1937. The Central Office is
where the Governor sits and where policies are formulated. Though originally privately owned,
since nationalization in 1949, the Reserve Bank is fully owned by the Government of India.
21

monetary stability in India and generally to operate the currency and
credit system of the country to its advantage."

RBI focuses on:
supervision of financial institutions
consolidated accounting
legal issues in bank frauds
divergence in assessments of non-performing assets and
supervisory rating model for banks

In terms of section 20 of the RBI Act 1934, RBI has the obligation to undertake
the receipts and payments of the Central Government and to carry out the
exchange, remittance and other banking operations, including the
management of the public debt of the Union.

3.2.2 Securities and Exchange Board of India: SEBI Act, 1992

Securities and Exchange Board of India (SEBI)
27
was first established in the
year 1988 as a non-statutory body for regulating the securities market. It
became an autonomous body in 1992 and more powers
28
were given through
an ordinance.

27
http://www.sebi.gov.in/sebiweb/stpages/about_sebi.jsp Accessed on10th May 2014
28
S. 11 SEBI Act, 1992
Powers and Functions of SEBI as follows
(a) regulating the business in stock exchanges and any other securities markets; (b)
registering and regulating the working of stock brokers, sub-brokers, share transfer agents,
bankers to an issue, trustees of trust deeds, registrars to an issue, merchant bankers,
underwriters, portfolio managers, investment advisers and such other intermediaries who may
be associated with securities markets in any manner;[(ba) registering and regulating the
working of the depositories, [participants,] custodians of securities, foreign institutional
investors, credit rating agencies and such other intermediaries as the Board may, by
notification, specify in this behalf;](c) registering and regulating the working of [venture capital
funds and collective investment schemes],including mutual funds; (d) promoting and regulating
self-regulatory organisations; (e) prohibiting fraudulent and unfair trade practices relating to
securities markets; (f) promoting investors' education and training of intermediaries of
22

SEBIs basic function is "...to protect the interests of investors in securities and
to promote the development of, and to regulate the securities market and for
matters connected therewith or incidental thereto"

3.2.3 Insurance Authority

The Insurance Regulatory and Development Authority (IRDA)
29
is a national
agency of the Government of India. The mission of IRDA as stated in the act
is "to protect the interests of the policyholders, to regulate, promote and ensure
orderly growth of the insurance industry and for matters connected therewith
or incidental thereto."

Sec 14 of IRDA Act, prescribes the duties to regulate the insurance companies
and to attain the mission.
30


securities markets; (g) prohibiting insider trading in securities; (h) regulating substantial
acquisition of shares and take-over of companies; (i) calling for information from, undertaking
inspection, conducting inquiries and audits of the [ stock exchanges, mutual funds, other
persons associated with the securities market] intermediaries and self- regulatory
organizations in the securities market; [(ia) calling for information and record from any bank
or any other authority or board or corporation established or constituted by or under any
Central, State or Provincial Act in respect of any transaction in securities which is under
investigation or inquiry by the Board;] (j) performing such functions and exercising such
powers under the provisions of [...]the Securities Contracts (Regulation) Act, 1956(42 of
1956), as may be delegated to it by the Central Government; (k) levying fees or other charges
for carrying out the purposes of this section; (l) conducting research for the above
purposes; [(la) calling from or furnishing to any such agencies, as may be specified by the
Board, such information as may be considered necessary by it for the efficient discharge of its
functions;](m) performing such other functions as may be prescribed.

29
<http://www.irda.gov.in/ADMINCMS/cms/NormalData_Layout.aspx?page=PageNo1332an
dmid=1.9> Accessed on 10th May 2014
30
S. 14 of IRDA Act, 1999 lays down the duties, powers and functions of IRDA..
Without prejudice to the generality of the provisions contained in sub-section (1), the powers
and functions of the Authority shall include, -
(1) issue to the applicant a certificate of registration, renew, modify, withdraw, suspend or
cancel such registration; (2) protection of the interests of the policy holders in matters
concerning assigning of policy, nomination by policy holders, insurable interest, settlement of
insurance claim, surrender value of policy and other terms and conditions of contracts of
insurance; (3)specifying requisite qualifications, code of conduct and practical training for
intermediary or insurance intermediaries and agents, (4) specifying the code of conduct for
surveyors and loss assessors; (5) promoting efficiency in the conduct of insurance business;
23

3.2.4 Forward Market Commission India (FMC)

Forward Markets Commission (FMC)
31
headquartered at Mumbai, is a
regulatory authority which is overseen by the Ministry of Consumer Affairs,
Food and Public Distribution, Government of India.

Its mission is: to provide for the regulation of certain matters relating to forward
contracts, the prohibition of options in goods and for matters connected
therewith.

The functions
32
of the Forward Markets Commission are as follows:
(a) To advise the Central Government in respect of the recognition or the
withdrawal of recognition from any association or in respect of any other matter
arising out of the administration of the Forward Contracts (Regulation) Act
1952.
(b) To keep forward markets under observation and to take such action in
relation to them.
(c) To collect and whenever the Commission thinks it necessary, to publish
information regarding the trading conditions in respect of goods including
information regarding supply, demand and prices

(6)promoting and regulating professional organisations connected with the insurance and re-
insurance business; (7)levying fees and other charges for carrying out the purposes of this
Act; (8)calling for information from, undertaking inspection of, conducting enquiries and
investigations including audit of the insurers, intermediaries, insurance intermediaries and
other organisations connected with the insurance business
31
, http://www.fmc.gov.in/index1.aspx?lid=26andlangid=2andlinkid=18 Accessed on10th May
2014
It is a statutory body set up in 1953 under the Forward Contracts (Regulation) Act, 1952.
The Commission has been keeping the commodity futures markets well regulated. In order to
protect market integrity, the Commission has prescribed the following measures
1. Limit on open position of an individual members as well as client to prevent over trading;
2. Limit on price fluctuation (daily/weekly) to prevent abrupt upswing or downswing in prices;
3. Special margin deposits to be collected on outstanding purchases or sales to curb
excessive speculative activity through financial restraints;

32
<http://www.fmc.gov.in/index3.aspx?sslid=27andsubsublinkid=13andlangid=2> Accessed
on 12th May 2014
24

(d) To make recommendations generally with a view to improving the
organization and working of forward markets;
(e) To undertake the inspection of the accounts and other documents of any
recognized association or registered association or any member of such
association whenever it considers it necessary.























25

CHAPTER IV
WHAT DOES SUPER REGULATOR MEAN IN FINANCIAL MARKET?

This chapter examines the concept of a unified financial services regulator,
highlighting differences in the approaches taken by different countries.
Countries such as UK had formed an informal club of integrated supervisors
after 1997 financial crisis all over the world to restructure their financial market
based on their social, economic and political environment. In many countries,
the unified regulator is structured on either a functional or principal or a silos
matrix, depending on local conditions and the objectives of regulation and to
incorporate various departments of a regulatory agency, such as the legal,
licensing, supervision, and investment Policy Departments etc.

To mitigate the problems posed by the blurring of activities among
providers of various financial services and operations of financial
conglomerates, the following four broad approaches
33
have been suggested:
4.1 Institutional
Approach
The Institutional Approach is one in which a firms
legal status (for example, a bank, broker dealer or
insurance company) determines which regulator is
tasked with overseeing its activity from both a safety
and soundness
Eg. China, Hong Kong and Mexico
4.2 Functional
Approach
The Functional approach is one in which supervision
is oversight is determined by business that is being
transacted by the entity without regards to its legal

33
The Structure Of Financial Supervision Approaches And Challenges In A Global
Marketplace, Group 30 report, <
http://www.group30.org/images/PDF/The%20Structure%20of%20Financial%20Supervision.p
df > Accessed on 9
th
June 2014
26

status. Each type of business has its own functional
regulator.
E.g. Brazil, France.
4.3 Integrated
Approach
The Integrated approach is one in which a single
universal regulator conducts both safety and
soundness oversight and conduct of business
regulation of all financial sectors
E.g. U.K., Singapore and Germany
4.4 Twin Peak
Approach
The Twin peak approach, a form of regulation by
objective is one in which there is a separation of
regulatory function between two regulators one that
performs the safety and soundness supervision
function and the other focus on conduct of business
regulation
Eg. Australia, U.S.

In practicality No pure form of regulatory model actually exist but mixed
approaches are prevalent. Some countries have single regulators regulating
all major segments of the financial sector like banking, insurance, pension and
securities. The reconstruction of regulatory architecture involve substantive
issues of the design and performance of financial markets which are important
when considering supervisory and regulatory reforms. Central bank,
supervisors and ministries of finance must ensure that important public policy
goals continue to be achieved in a dynamic global marketplace. Financial
innovation enhanced the profitability of the financial sector for a period of time
but at the same time create significant challenges in managing the risks of
these cutting-edge products. For example, derivative or CCD or ULIP clearly
altered the financial sector over a period of time, involvement of banks in
27

insurance sector and securities market. Private equity firms and hedge funds
represent an increasing percentage of financial markets activity, but they have
generally not been subject to direct supervisory oversight. The specific way in
which regulation and supervision have been structured in each jurisdiction
reflects, among other things their unique history, politics, culture, size,
economic development, and local business structure.

In an attempt to focus on the topic of unified financial services supervision, de
Luna Martinez and Rose conducted a survey in 15 countries that have adopted
integrated supervision. They examined (a) the reasons countries cited for
establishing an integrated supervisory agency; (b) the scope of the regulatory
and supervisory powers of these agencies; (c) the progress these agencies
had made in harmonizing their regulatory and supervisory practices across the
intermediaries they supervise; and (d) the practical problems policy makers
faced in adopting integrated supervision.
34


In their analysis they concluded that integrated supervisory agencies is not as
homogeneous as it seems, differences arise with regard to the scope of
regulatory and supervisory powers the agencies have been given and less
than that 50 per cent of the agencies can be categorized as mega-supervisors.
Another finding is that in most countries progress toward the harmonization of
prudential regulation and supervision across financial intermediaries remains
limited. Interestingly, the survey revealed that practically all countries believed
that they have achieved a higher degree of harmonization in the regulation and
supervision of banks and securities companies than between banks and
insurance firms.
35


34
J. de Luna Martinez and T. A. Rose, International Survey of Integrated Financial Sector
Supervision, Financial Sector Operations Policy Department, Policy Research Working Paper
No. 3096, Abstract(World Bank 2003)
<http://elibrary.worldbank.org/doi/pdf/10.1596/1813-9450-3096> Accessed on 13th May 2014
35
Ibid
28


A set of question arosed whether professionals, policy makers, and institutions
are concerned with restructuring of new frameworks for financial services
supervision via a single or multiple independent regulator? What are the key
features or them to consider when promoting the independence of a financial
services regulator? Is it important that regulator should be politically
independent, transparent and accountable? Whether central bank in making
of monetary and fiscal policy and regulation of currency should be separated
from prudential regulation?

World Bank,
36
puts it succinctly that an independent central bank when
focused exclusively on price stability has become a central part of the mantra
of economic reform. Research suggests that if central banks focus on
inflation, they do a better job at controlling inflation. But controlling inflation is
not an end in itself: it is merely a means of achieving faster, more stable growth,
with lower unemployment. These are the real variables that matter, and there
is little evidence that independent central banks focusing exclusively on price
stability do better in these crucial respects....

While the term independence, in its ordinary meaning, could entail the idea
of not being influenced or controlled by others, the independence of any
regulatory agency can be viewed from four related angles: regulatory,
supervisory, institutional, and budgetary.
37
Regulatory independence in the
financial sector means that regulators have wide autonomy in setting, at a
minimum, prudential regulations that follow from the special nature of financial

36
Kenneth Kaoma Mwenda, Legal Aspects of Banking Regulation: Common Law Perspectives
from Zambia, 81 (2010) <http://www.pulp.up.ac.za/cat_2010_07.html> Accessed on 16th May
2014
37
M. Quintyn and M. W. Taylor, Should Financial Sector Regulators Be Independent?34
Economic Issues, 6 (IMF 2004),
<www.imf.org/external/pubs/ft/issues/issues39/ei39.pdf> Accessed on16th May 2014
29

intermediation.
38
These regulations concern practices that financial institutions
must adopt to maintain their safety and stability, including minimum capital
adequacy ratios, exposure limits, and loan provisioning.
39
It has been argued
that regulators who are able to set these rules independently are more likely
to be motivated to enforce them. But is the fact that the regulators and
supervising financial services business are independent an end in itself, or
should these regulators also be committed to transparency and accountability?

Supervisory regulation is crucial to financial sector difficult to establish and
guarantee not only in inspecting and monitoring but also in enforcing sanctions.
Thus, steps to protect supervisors integrity include offering legal protection
(for example, repealing laws that, in some countries, allow supervisors to be
sued personally for their work) and providing financial incentives that allow
supervisory agencies to attract and keep competent staff and discourage
bribery. Crafting a rules-based system of sanctions and interventions also
lessens the scope for supervisory discretion and thus for political or industry
interference.
40


To protect supervisors from political or industry intimidation during a lengthy
court process, banking law should also limit the time allowed for appeals by
institutions facing sanctions. Independent supervisors, not a government
agency or minister, should be given sole authority to grant and withdraw
licenses because they best understand the financial sectors proper
compositionand because the threat to revoke a license is a powerful
supervisory tool.
41



38
Ibid.
39
Ibid.
40
Ibid
41
Ibid.
30

Other issues that should be considered while examining the concept of an
independent financial services regulator include as what impact would rampant
corruption in either the financial services industry or the civil service have on
the efficacy of the legal, regulatory, and institutional framework for financial
services supervision? ; and If a financial services regulator is part of the civil
service, and is housed in the Ministry of Finance, how independent could the
regulator be and to what extent can the regulator be shielded from corrupt
practices.


























31

CHAPTER V
INDIAS FINANCIAL REGULATORY MECHANISM PITFALLS

5.1 Indias Financial Regulatory Jurisdiction overlaps cases

With the introduction of competition and sector regulatory laws, new
mechanisms are needed to ensure effective interface between the two
regimes. There is an increased need to exploit complementary expertise
and perspectives of different financial regulators. The regulatory interface
problem is centered on the degree to which sectors being opened up to greater
competition should also be subject to general competition laws and how and
by whom such laws are to be administered. One of the functions of economic
policy is to enable markets to play their role. Well-functioning, efficient markets
are an important factor in the creation and safeguarding of welfare, as they are
one of the drivers of the competitiveness of an economy. As a branch of
economic policy, competition policy is an important instrument to keep markets
efficient. The core business of competition policy is to fight restrictive
competitive practices. Usually, a control mechanism on mergers and
acquisitions is part of the coverage of competition policy Except for merger
cases, competition policy is applied ex post (i.e. competition authorities only
take action after certain facts have occurred). Moreover, it is general in nature,
as it covers all economic activities, in all sectors and markets. The observation
of competition rules by companies is usually controlled by specially designed
institutions, competition authorities which as a rule act relatively independently
from politics. These competition authorities prohibit activities that are deemed
to be incompatible with competition rules and impose fines on the companies
that engage in such activities.

The overlap is situated at several levels. First of all, there can be an overlap
between general competition rules and sector-specific rules. Many issues
32

situated in the nucleus of sector regulation can be translated towards
competition law (cf. access to markets). Access in network industries can also
be dealt with by competition policy using the doctrine of the 'essential facilities'.
The same broadly applies to issues such as cross-subsidization and the non-
discrimination between affiliates and other clients. Another kind of overlap can
occur between jurisdictions. Competition authorities as well as sector
regulators can offer remedies, while sector regulators sometimes have dispute
settlement procedures to offer to operators. Furthermore, several countries
have given sanctioning powers to sector regulators. Finally, there can be
regulatory inconsistencies and jurisdictional confusion when plaintiffs have
several options, e.g. in the choice of dispute settlement procedure. This can
lead to contradictory decisions, thus introducing the need for a system of case
allocation.

5.1.1 SEBI v/s IRDA (ULIP)

Unit-linked insurance plans (ULIP), a favourite among the investor community
and insurance industry, is a product offered by insurance companies that
unlike a pure insurance policy gives investors the benefits of both insurance
and investment under a single integrated plan. A part of the premium paid is
utilized to provide insurance cover to the policy holder while the remaining
portion is invested in various equity and debt schemes. The money collected
by the insurance provider is utilized to form a pool of fund that is used to invest
in various markets instruments (debt and equity) in varying proportions just the
way it is done for mutual funds. Policy holders have the option of selecting the
type of funds (debt or equity) or a mix of both based on their investment need
and appetite.

An important dispute aroused between regulators i.e. SEBI and IRDA as to
which regulator has jurisdiction to deal with the ULIP. The tussle is due to the
33

fact that the money charged for ULIP as insurance product which comes under
IRDA at the same time charged money are investment in securities market
under the control of SEBI. For which SEBI has issued the order
42
restraining
the 14 insurance companies to deal further.

Certain controversies arose are (1) aren't all companies dealing with securities
and mutual funds in India registered with SEBI and following its Regulations?
Why are the insurance companies so special that they are not required to
follow these Regulations? And most importantly, what brings IRDA in picture?;
(2) What are those 14 insurance companies, required to do? To follow the
SEBI order and stop business or to follow IRDA order and continue business
in ULIPs?; (3) What is the recourse available to either SEBI or IRDA if the
insurance companies defy either of their orders? Will legal sanctions follow the
insurance companies in case of their failure to meet out either of the orders?;
and (4) What happens to investors in these ULIPs? What is the legal status of
the policies purchased/renewed by them after the SEBI order?

In the financial year 2008-09, 7.03 crore ULIP policies were sold and
companies garnered premium of more than Rs 90,645 crores. Till February
2010, the life insurance industry had sold 16.7 lakh policies.
43
It is due to the
fact that IRDA which has jurisdiction to regulate and monitor insurance
companies has already sanction the scheme proposed by insurance
companies relating to ULIP, on the contrary SEBI has passed the restraining
order to carry out further operations. In such situation, companies has no
further choice has to which order should they appeal and before whom? Either
way, they are bound to face regulatory action from either SEBI or IRDA,
depending upon which order they decide to follow. Another big question arose

42
<http://www.sebi.gov.in/cmorder/ULIPOrder.pdf> Accessed on16th May 2014
43
Suneet Ahuja Kholi, SEBI vs IRDA, The Indian Express, (12 April 2010)
<http://archive.indianexpress.com/news/sebi-vs-irda/604835/2> Accessed on 14th May 2014
34

is that both SEBI and IRDA is the creature of statute and neither has power to
restrain other or interfere or give directions to each other, till that time matter
is sub-judice. As the matter is stayed for a period of time, companies are legally
barred from renewing or offering any ULIPs. Thus the new/renewed scrips are
contrary to law (being the order passed in terms of the SEBI Act). The law of
contracts entitles the agreements not enforceable by law as 'void'. Thus the
ULIPs, which are nothing but agreements between the subscribers and the
insurance companies, are void till the time the SEBI order stay. In this scenario,
a subscriber cannot bring an action for violation of any of the terms of the ULIP
by the company and vice versa.

In fact the object of such agreements, under the law of contracts, is also
unlawful as it is forbidden by law and thus no legal rights flow from ULIP. The
effective stoppage of the sale of the said products will cause a complete drying
up of the revenue flows to the insurance companies which could disrupt the
payment of benefits on maturity, on death and on other admissible claims,
putting the policyholder and the general public to irreparable financial loss. The
financial position of the insurers will be seriously jeopardized thus destabilizing
the market and upsetting financial stability are the concerns of IRDA. It means
that subscribers of ULIP has to wait till the further direction by SEBI, or if the
matter is settled by court of law.
44


The issue at hand is not simple reason being it concerns with the power and
jurisdiction of various market regulator to be defined, financial effect of order
issued by respective regulator and incapacity of other regulator in such
scenario. When the matter raised before Supreme Court, the government

44
Tarun Jain, SEBI vs IRDA: Exploring the tussle between regulators over ULIPS, Law in
Perspective, <http://legalperspectives.blogspot.in/2010/04/sebi-v-irbi-exploring-tussle-
between.html> Accessed on 15th May 2014
35

instead of giving their arguments issue an ordinance
45
, provides that "the
decision of the Joint Committee shall be binding on the Reserve Bank of India,
the Securities and Exchange Board of India, the Insurance Regulatory and
Development Authority and the Pension Fund Regulatory and Development
Authority". It give the authority to override any other act which are contrary to
their provision, it would now not be open to the regulators to go ahead and act
contrary to the Ministry's instructions. Thus its not just for SEBI or IRDA but
the Government has gone ahead to ensure that no such jurisdictional tussles
do not take place in full public view in future.

Another effect of this ordinance is that it create a virtual extension of jurisdiction
of IRDA contrary to SEBI in which Life Insurance product has been extended
to "include any unit linked insurance policy or scrips or any such instrument
or unit, by whatever name called, which provides a component of investment
and a component of insurance issued by an insurer" while simultaneously
excluding them from within the definition of 'securities' such that SEBI shall not
be able to bring them within its fold. This raised another aspects that regulators
are creature of statute passed by parliament i.e. supreme authority but Joint
Committee established by executive order of Ministry get an edge over
respective regulators and undermine the laws in force in India, as the decisions
of joint committee is binding on regulators which has overturn the power and
duties concepts of institutional mechanics.

The SEBI took into account the provisions of the SEBI Act, Securities Contract
Regulation Act and the IRDA Act, all three of which stand amended to the
effect that ULIPs and other similar insurance products are not covered within
the definition of 'securities' but are instead a part and parcel of 'life insurance'

45
, Securities and Insurance Laws (Amendment and Validation) Ordinance, 2010
<http://www.taxmann.com/TaxmannFlashes/flashst21-6-10_1.htm> Accessed on14th May
2014
36

products, then deleting the very basis on which the SEBI order was passed.
Further the aspect of having given retrospective operation to the Ordinance
implies that legally it would be presumed that the amended provisions as
introduced by the Ordinance were in place at all times and thus the very basis
(i.e. the statutory provisions) which were examined by the SEBI to find giving
jurisdiction to SEBI over ULIPs never existed and thus the SEBI order is now
without legal basis looking elsewhere for its sustenance.

However, after this court restrain themselves to entertain the matter due to
which questions raised before court of law are unsettled and create an
ambiguity in the institutional framework.

Firstly that there has been constantly rise in new types of financial products
being developed by financial firms, the joint committee would need frequent
legislative interventions to be operable. For example, the joint committee in its
current form, does not include the Forwards Markets Commission (FMC) and
if in case products of hybrid nature like steel futures and steel companies
futures were formulated then the FMC would not be allowed to approach the
joint committee as the Commission is not a recognized regulator under the
ordinance. Secondly there is possibility of involving issues concerning ``hybrid"
or ``composite" instruments disputes could arise between regulators that do
not involve an underlying hybrid or composite instrument. Thirdly an instrument
governed by one regulator that has a negative effect on the market regulated
by another regulator, as with the regulatory arbitrage hypothesis suggested
above, could not be referred to the joint committee.

Fourth, the structure of the joint committee points to problems of institutional
design. The ordinance is largely silent about the procedures the joint
committee would follow. This is not simply a technical matter. How would
differences of opinion in the board be settled? By majority vote? Consensus?
37

Would there be staffing? Who would be responsible for expenses? In case of
discrepancies which is the higher forum to deal with issues in case matter is
unsettled? The method adopted by executive in large are arbitrary yet these
are not simply mundane questions and impact, materially, how extensively the
committee could study and resolve matters before it. Fifth, the process by
which the ordinance was passed is worrisome, regulators were not consulted
on the ordinance that amends four major acts of parliament, and there is no
consultation as to expertness and democratic process?

Sixth, the ULIP dispute has been presented as a contest between SEBI and
IRDA. Implicitly, one regulator had to win, and the other, lose. This is
misleading. One scenario would have each regulator govern the portion of
ULIPs which fall within their domain. IRDA would govern the insurance
component of these instruments and SEBI would govern the investment
component. For example, take an example of case of motor vehicle in case it
cause damage matter goes to civil liability but when it cause hurt or injury or
death criminal liability occur and simultaneously remedy is in MV Act, IPC and
Tort law. The government would never declare that all motor vehicle drivers
are immune from civil or criminal laws. The more complex the transaction, the
more regulation might apply.


5.1.2 SEBI v/s RBI (CURRENCY DERIVATIVE)

Currency derivative
46
are efficient risk management tools which means an
instrument derivative indicates its value from some underlying based
inference is foreign exchange rates and flow. Another controversial issue
aroused between the Reserve Bank of India and the Securities and Exchange

46
<http://www.moneycontrol.com/glossary/currency/what-is-currency-derivatives_845.html>
Accessed on12th May 2014
38

Board of India about the currency futures market. By definition, a currency
futures is an exchange-traded product, where on one hand currency is involved
as well as trading where one matter is regulated by RBI and another by SEBI.
Perhaps currency trading is important based on four arguments that it
concerns with economies of scope and economies of scale for India to become
international financial center then it will require charges for trading on
exchanges which are competitive against the top five exchanges of the world.
Another is currency risk involve and spread all over the country, including many
firms and individuals who have no apparent trade exposure. The international
experience shows that currency futures trading is squarely the job of the
securities regulator, which deals with all derivatives markets: equities,
commodities, interest rates, currencies, etc. In mature market economies,
central banks have no role in policy, regulation or supervision of currency
futures markets. India being different from other countries in term of role of
central bank which focus on inflation and interest rates, as RBI has tried to set
up a debt market and a currency market.

So, here the issue raised is who should regulate currency trading either RBI or
SEBI because RBI has a role to manage currency control in India while SEBI
alone has the power to control the trading of securities or derivative. The SEBI
approach has delivered results on the equity market, while the RBI approach
has failed to deliver results on the debt market and on the currency market.
Hence, the task of regulating and supervising the currency futures market
should be placed with SEBI.
47
As seen if the financial product comes under
regulation of different regulator it a challenge for both regulator because any
regulation or scheme can have deep impact on other sector. As seen from the
fact both SEBI and RBI simultaneously regulating currency trading market,

47
Ajay Shah, Currency futures through RBI or SEBI, Ajay Shah Blog,
<http://ajayshahblog.blogspot.in/2007/06/currency-futures-through-rbi-or-sebi.html>
Accessed on 17th May 2014
39

when SEBI suspects the foul play of traders they ban them, while RBI given
general permission which currency to be traded and the same time RBI has
enough powers to ban Banks from trading in currency derivate although banks
are companies too.

5.1.3 FMC v/s SEBI (GOLD TRADED FUND)

Another regulation turf emerge when National Stock Exchange (NSE) decided
not to launch derivatives on gold exchange-traded funds (ETFs).The launch
was postponed after Forward Markets Commission (FMC),the regulatory body
for commodities trades in India, intervened and said that regulation of such
products were under the purview of FMC and not SEBI.
48
Earlier, NSE had
taken permission from SEBI to launch futures and options products with gold
ETFs as the underlying asset Contrary to their earlier stand to move court
jointly for settling the issue of control over ULIPs, difference have surfaced
between insurance regulator IRDA and market watchdog SEBI on the legal
recourse. Insurance regulatory development authority (IRDA) said that it
wanted to seek a legal mandate jointly with SEBI but the market regulator has
reservations. Issue raised between the two regulators is about the regulator
restrictions and simplification of process. Similarly Silver ETF is also a cause
of dispute between FMC and SEBI.
49





48
NSE delays gold fund over turf war, Times Business,
<http://mobilepaper.timesofindia.com/mobile.aspx?article=yesandpageid=14andsectid=edid=
andedlabel=TOICHandmydateHid=30-04-2010andpubname=Times+of+India+-
+Chennaiandedname=andarticleid=Ar01403andpublabel=TOI> Accessed on17th May 2014
49
FMC vs SEBI: Who will regulate Silver ETFs?, Money Control
<http://www.moneycontrol.com/news/cnbc-tv18-comments/fmc-vs-sebi-who-will-regulate-
silver-etfs_540286.html> Accessed on19th May 2014
40

5.2 Regulatory arbitrage

Regulatory arbitrage is a consequence of a legal system with generally
applicable laws that purport to define, in advance, how the legal system will
treat transactions that fit within defined legal forms. Because the legal definition
cannot precisely track the underlying economic relationship between the
parties, gaps arise, and these gaps create opportunities. The phenomenon is
similar to inefficiencies in the capital markets. Financial arbitrage is defined as
the simultaneous purchase and sale of the same, or essentially similar,
security in two different markets for advantageously different prices.
50


Differences in regulation which make the financial institution or products
beyond the scope of regulators threatens the sovereignty of nations and well
beings of national economies. This is the problem of so-called regulatory
arbitrage: in both examples, the regulatory challenge is part of the business
model. The very purpose of booking the transaction offshore, or through a kind
of entity that is not subject to particular kind of regulation, is to circumvent
regulatory authority. So theres an arbitrage. So what? This desk has a lot of
money on arbitrages. Steven Roach, chief economist at Morgan Stanley, gives
reasons for the arbitrage process:
(a) The maturation of global offshore outsourcing platforms. This comes from
heavy capital investment in emerging markets and a low cost workforce ready
to use new tools.
(b) The new imperatives of cost control. With a world economic landscape
comprised of nations- each with its comparative advantage (low cost labor) will
see labor intensive work migrate to them from higher labor cost markets.
(c) E-based connectivity


50
Advances in Behavioral Finance, Volume 2, 79 (Richard H. Thaler, 2005)

41

Though in theory it is said arbitrage involves no risk, in a diverse world we live
in, risks are unavoidable, though of small scale. For financial economists,
arbitrage is not inherently a bad thing. On the contrary, we often hear financiers
themselves make arguments for the economic importance of their activity by
claiming that it is arbitrage or not.
51
In the cat and mouse game between
regulators and financiers, it often seems that finance is the more creative
partner, always one step ahead of regulator, what needed is the laws as tool
to coordinate among regulatory differences.

Regulatory arbitrage as the manipulation of the structure of a deal to take
advantage of a gap between the economic substance of a transaction and its
regulatory treatment. Regulatory arbitrage opportunities, under this broad
definition, are pervasive. But the arbitrage only works if the lawyers involved
can successfully navigate a series of planning constraints: (1) legal
constraints, (2) transaction costs, (3) professional constraints, (4) ethical
constraints, and (5) political constraints.
52


Regulatory arbitrage opportunities can be framed in a similar fashion as
financial arbitrage, taking place when one of three conditions are met:

Regulatory regime inconsistency: The same transaction receives
different regulatory treatment under different regulatory regimes.
Economic substance inconsistency: Two transactions with identical
cash flows receive different regulatory treatment under the same
regulatory regime.

51
Annelise Riles ,Managing Regulatory Arbitrage: A conflict of laws approach, Cornell.edu
<http://blogs.cornell.edu/collateralknowledge/2012/11/12/managing-regulatory-arbitrage-a-
conflict-of-laws-approach/> Accessed on11th May 2014
52
Victor Fleischer, Regulatory Arbitrage, Editorial express, <https://editorialexpress.com/cgi-
bin/conference/download.cgi?db_name=ALEA2010andpaper_id=385> Accessed on 16th
May 2014
42

Time inconsistency: The same transaction receives different regulatory
treatment in the future than it does today

5.2.1 Ponzi scheme

A Ponzi scheme is a fraudulent investment operation where the operator, an
individual or organization, pays returns to its investors from new capital paid to
the operators by new investors, rather than from profit earned by the
operator. Some of the famous Ponzi schemes are Invest Card, Bitcoin, Chit
funds, pyramid scheme etc. Concerned over the rising menace of Ponzi
schemes, the government will bring in a new law to remove regulatory gaps in
this regard, the then finance minister P Chidambaram has said We are
considering a law to fill the regulatory gap... We are trying to see that people
do not take advantage of the regulatory gaps,
53


The problem raised before government is that these Ponzi scheme do not
come under any regulatory body. These are regulatory gaps and what we are
trying to do is to reduce these gaps to maximum possible extent, so that
everyone falls either under the RBI, or SEBI, or the registrar of chits, or under
the state government etc.

In India, present system offer various deposit or investment services without
any form of approval or regulation by institutions due to fuzzy line drawn
between financial regulators, the Central Government and State Governments
and these scheme fall out of jurisdiction of regulation. Take an example of

53
Govt considering new law to plug regulatory gaps in ponzi schemes, Financial Chronicle,
(Jul 07, 2013)
<http://www.mydigitalfc.com/personal-finance/govt-considering-new-law-plug-regulatory-
gaps-ponzi-schemes-662> Accessed on 09th May 2014

43

Saradha scheme
54
which has duped 1.4 million investors of Rs. 4000 crore
driven due to lack of inadequate regulations presents a good example - its
activities could be argued to fall under any of the following categories: running
a collective investment scheme (regulated by SEBI); running a chit fund
(regulated by the state government); a private company taking deposits for its
business (regulated by the Registrar of Companies); and taking public deposits
as a non-banking financial company (regulated by RBI). For instance, about
265 non-banking financial companies and 18 housing finance companies are
allowed to take public deposits, but they don't enjoy the same deposit
insurance protection that is available to banks. If the main rationale for deposit
insurance is to protect depositors from the risk of a financial institution
becoming unable to make good on its promise to refund public deposits, should
the same logic not apply to all deposit takers? Chit funds, which are governed
by State governments, also suffer from the problem of inconsistent treatment.
Differences in enforcement levels across States have resulted in some States
becoming more prone to Ponzi schemes. In addition, most this sector may be
operating in the form of unregistered chit funds: it is estimated that registered
chit funds have collected Rs.300 billion worth of deposits while the collection
of unregistered funds is much higher at Rs.30 trillion.
55







54
M.G. Arun, Unsafe deposit, Business Today (May 26, 2013)
<http://businesstoday.intoday.in/story/saradha-group-chit-fund-scam/1/194622.html>
Accessed on 5th May 2014
55
Attack of the ponzi schemes
<http://www.citizeneconomists.com/blogs/2013/04/> Accessed on 9
th
June 2014.
44

CHAPTER VI
FINANCIAL REGULATORY FRAMEWORK OF UK

6.1 Pre FSA Phase [1980]

The liberation of capital market in UK in 1980s make remarkable change in
financial market of the country, most importantly control over exchange were
abolished, capital market tight controls are loosened, virtual abolition of bank
reserve requirement, control over consumer credit were relaxed and
subsequently deregulation of securities market. It became the open economy,
also changes in self-regulatory mechanism. SRO were most vulnerable to
regulatory system and detriment to investors. It created dilemma which create
confusion for industry as well as consumers.

The evolution of UK financial sector in 1980, stock exchange big bang,
encourage competition, diversified different sectors building securities and
insurance companies exhibited different style and nature of regulation, needed
a reform to control and regulate with the aim to protect investor, bring changes
in Banking Act 1979, established a new board of Bank supervision, monitored
and supervised by Bank of England.

Introduction of the modern regulatory system; self-regulation among asset
managers, statutory oversight of banks and insurers. The Financial Services
Act 1986 (FSA 1986) marks a step change in the nature and extent of UK
investment business regulation. The system is based on ve self- regulating
organizations (SROs); membership organizations tasked with the creation,
monitoring and enforcement of rules for their respective members. The SROs
cover ve different areas of nancial services; futures broking and dealing,
nancial intermediation, investment management, life assurance broking and
securities broking. Asset managers are represented by the IMRO. The SROs
45

are approved and overseen by the Securities and Investments Board (SIB), a
regulator with statutory powers. Banks and insurers are under statutory
regulation by the Bank of England and the Department of Trade and Industry
(DTI), respectively. Prior to the establishment of the FSA, the UKs financial
regulatory regime was based on specialist functional regulation involving
numerous separate agencies. The Bank of England was responsible for the
supervision of banks; the Department of Trade and Industry for insurance; and
the Securities and Investments Board (SIB) for securities business.

According to the Chancellor's statement, there were three key reasons for the
new approach:
1. The existing system was failing to deliver the standards of investor
protection and supervision that the industry and the public had the right
to expect;
2. The two tier structure under the Financial Services Act 1986 was
inefficient, confusing, and lacked accountability and a clear allocation of
responsibilities; and
3. The need for a regulatory structure that would reflect the nature of the
markets where the old distinctions between banks, securities firms, and
insurance companies had become increasingly blurred.

6.2 Transactional phase [1990]

The controlling of financial market based on functional regulation i.e. self -
regulation has number of failures and increasingly diluted the financial
instrument. In April 1990, the New Settlement, proposed by SIB Chairman,
Sir David Walker, introduces a three-tier structure of standards imposed upon
rms.
56


56
Timeline of UK regulatory Event,
46

1. At the top tier, the Ten Principles of business seek to present a universal
statement of the expected standards, applying directly to the conduct of
investment business and to the nancial standing of all authorized
persons. They are qualitative, high-level and frequently behavioural in
their expression.
2. The second tier designates a number of Core Rules, binding upon SRO
members in certain key areas, such as those relating to nancial
resources, conduct of business and client money.
3. The third tier are the SRO rules. A series of perceived regulatory failures
(not least the Maxwell pension funds scandal), provides the context for
the 1993 Large report.

In stopping short of proposing the end of self- regulation, Andrew Large
proposes more leadership by the SIB, while recognizing that the objectives of
regulation are not sufciently clear and self-regulation can be too synonymous
with self-interest. The EU Investment Services Directive 1993 (ISD)
57
imposes
from the beginning of 1996 some capital and reporting requirements upon
managers on an EU-wide basis and further self-regulation. Due to
organizational mergers in 1991 and 1994 reduce the number of SROs to three,
with the IMRO as the only surviving original body. The failure of Barings Bank
in 1995 and a change of political administration in 1997 result in independent
monetary policymaking for the Bank of England, and a name-change of the
SIB into the Financial Services Authority (FSA), ushering in the end of self-
regulation.


<www.investmentfunds.org.uk/assets/files/research/figure9.pdf> Accessed on12th May 2014
57
, Manning Gilbert Warren III, The European Union Investment Service Directive 1995,
Journal of International Law, (Vol 15, 1995),
,<http://scholarship.law.upenn.edu/cgi/viewcontent.cgi?article=1509andcontext=jil>
Accessed on10th May 2014
47

6.3 FSA regulation [1990-2007]

Introduction of a unitary regulatory structure and an era of more principles-
based regulation. While the legislative balance of power shifts to the EU,
supervisory approaches remain national. Introduced by the Financial Services
and Markets Act 2000, from late 2001 the FSA oversees a statutory and unitary
system for the regulation of investment business, banking and insurance in the
UK.

The FSA
58
now has four statutory objectives supported by a set of principles
of good regulation. The objectives are:
1. Market condence (maintaining condence in the UK nancial system).
2. Public awareness (promoting public understanding of the nancial
system).
3. Consumer protection (securing an appropriate degree of protection for
consumers).
4. Financial crime reduction (reducing the possibility of regulated
businesses to be used for purposes connected with nancial crime).

The supervisory culture at the FSA is often characterized as more principles-
based regulation and Treating Customers Fairly.
59
In general, more principle
based regulation means moving away from reliance on detailed, prescriptive
rules and relying more on broad principle standard rules. The FSA Handbook
contain a set of rules to which regulated rms are subject, becomes
increasingly prescribed by EU legislation. This is aided by the FSAs move to

58
Financial Services and Markets Act (FSMA),
<http://www.bcrm.co.uk/reg_financial_services_act.php> Accessed on18th May 2014
59
Julia Black, Making a success of Principles-based regulation, Law and Financial Review,
(2007) <http://www.lse.ac.uk/collections/law/projects/lfm/lfmr_13_blacketal_191to206.pdf>
Accessed on18th May 2014
48

the so- called copy-out approach, transposing directives word for word, where
possible, in order to avoid gold-plating.

However, during functioning period of FSA,
60
its elements attributed as:
1. Broad principles instead of detailed rules,
2. Outcome based regulation,
3. Increasing senior management responsibility

The principle based regulation provide the flexibility to work, are more likely to
produce behaviour which fulfils the regulatory objectives which are easier to
comply with. On the other hand, detailed rules provide certainty, a clear
standard of behaviour and are easier to apply consistently and without
retrospectively. However they can lead to gaps, inconsistencies, rigidity and
are prone to creative compliance, which need for constant adjustment to new
situations and to address new problems or close new gaps, creating more gaps
and difficult to create new rule for every problems.

FSA: powers, scope and structure
By most standards the FSA is a very broadly based single regulator, with rather
extensive powers within the regulator itself, albeit set within a rigorous
framework of accountability, with many built-in checks and balances.

(a) Powers of FSA
The structure, function and power of single regulator varies from country to
country like in England FSA is both a regulator and a supervisor and indeed,
the FSA might even be called a legislator in some countries, including
Germany. The authority give considerable latitude to draw up rules and codes
within that general framework. The FSA carries the full responsibility for

60
Ibid
49

authorizing and licensing financial institutions while in some countries the
licensing function remains with the Ministry while regulator prepares
recommendations which has a wide range of disciplinary powers, may
prosecute bring either civil or criminal prosecutions for insider dealing offences
or in relation to money laundering, levy fines, cancel, suspend authorization
and may ultimately ban from entering into financial market for indefinite period.
There is, furthermore, an independent tribunal, in the judicial system, to which
we must go if firms refuse to accept the penalties we seek to impose.

(b) Scope of FSA
The FSA is also quite broadly-based in terms of the scope of integrated
regulation, it incorporates the previous responsibilities of 10 separate
regulatory bodies. It handle both prudential and conduct of business regulation
for banks, insurance companies and investment firms. It cover a wide range of
other bodies, including building societies, mutual societies of one kind or
another, credit unions, financial advisers and fund managers which brings
around 10,000 separate firms into our authorization. It also oversee all markets
and exchanges in the UK, both cash markets and futures and derivatives,
which takes us into commodity markets, including the oil and metal exchanges,
and also increasingly into energy markets and oversee the information
disclosure of all listed companies in the UK. This is, therefore, a very broad
definition of an integrated regulator, in terms of scope as well as powers.

(c) Structure of FSA
In terms of the structure of the authority highly integrated model had many
functions like single window clearance system, single enforcement division i.e.
single authorization department, to which any organization wishing to come
into our fold must apply. The teams are multi-functional, handling both
prudential and conduct of business activities in the same teams, in case of
50

Deposit Takers Division which includes other banks, building societies and
credit unions.

Rationale for an integrated national financial services regulator
Previous regulation in England had wide range of different sectorial based
regulators whose responsibilities were interlocking and overlapping in complex
ways. A second situational factor was the Governments plan for the Bank of
England. The United Kingdom was one of the last developed countries to move
to a fully independent central bank, with the power to set interest rates. The
Government took the view that an independent monetary authority should not
at the same time carry responsibility for government debt issuance or for the
prudential supervision of banks.

In the UK, the rationale
61
for an integrated national financial services regulator
reflects primary considerations. First, the increase in the number of financial
conglomerates and the blurring of the boundaries between financial products
make sectorial regulation increasingly less viable. Second, that the availability
of economies of scale and scope to an integrated regulator and the value of
being able to allocate scarce regulatory resources efficiently and effectively.
Third, there are benefits from setting a single regulator clear and consistent
objectives and responsibilities and resolving any trade-offs between those
objectives and responsibilities within a single agency. Fourth, there is an
argument for making the single regulator clearly accountable for its
performance against statutory objectives, for the regulatory regime, for the cost
of regulation and for regulatory failures where they occur and they will.


61
Clive Briault ,The Rationale for a Single National Financial Services Regulator, FSA
Occasional Working Paper series 2 (May 1999)
<http://www.betterregulation.com/external/OP2%20The%20Rationale%20for%20a%20Singl
e%20National%20Financial%20Services%20Regulator.pdf> Accessed on19th May 2014
51

(a) Financial Market Convergence
To amplify the first point, about convergence, I would say the following.
"Convergence between sectors within the banking, insurance industries and
the securities firms is growing and with the markets change, there is a need
for action on the regulatory level to maintain the future stability of the financial
system. When markets change and reconstitute on a cross sector basis,
government regulation of such markets needs to be reorganized. Universal
financial regulation is the best way of reacting to the dynamics of changes in
the financial markets".

The first argument is essentially one about the way in which financial markets
are expected to develop in the future. With increasing number of cross-
sectorial acquisitions in the financial sector, with the creation of financial
hypermarkets offering a broad range of products to a wide spread of
customers. In the UK, for example, Lloyds TSB acquired Scottish Widows, one
of our largest life insurers. The Prudential Insurance Company bought MandG,
an enormous fund manager, and has opened a bank, called EGG. Merrill
Lynch acquired Mercury, a major asset manager, and have gone into
partnership with HSBC in search of deposits and wealth management
opportunities in the middle market of the personal sector.

(b) Economies of scale and scope
The second argument was that a single regulator would be able to achieve
economies of both scale and scope and to allocate scarce resources more
efficiently and effectively. Certainly, in the UK over the last few years, the
volume of financial transactions has continued to expand, and indeed the
number of firms has continued to grow in all parts of the market.
A single financial services regulator should be able to tackle cross-sectorial
issues more efficiently and effectively than can a multiplicity of separate or
specialist regulators. FSA focused on three main areas: the setting of
52

standards for regulated firms, the supervision of individual firms, and the
analysis of industry and of market-wide developments. FSA have a single set
of principles for businesses and a single statement of requirement for high-
level systems and controls, a single set of regulatory manuals setting out the
FSAs approach to authorization, supervision and enforcement with different
degrees of protection required by different types of customers and the different
ways in which the FSAs requirements can be met according to the nature and
size of a firms business.

Meanwhile, the supervision of each regulated firm brings together all of the
regulatory requirements prudential and conduct of business to which each
firm is subject. Since most firms are subject to both conduct of business and
prudential requirements and since compliance with these requirements
depends to a large extent on the quality of firms senior management and
controls, there are considerable advantages in integrating the two types of
regulation in one institution.

There are a number of other, more specific areas in which risks have been
transferred around the financial sector, and where there is considerable value
in being able to monitor the effects of risk transfer. I think, for example, of the
reinsurance market or, indeed, of credit risk transfer between banks and
insurance companies often intermediated in the securities markets. There is
huge advantage in being able to look at these trends from the perspective of
both ends of the transaction.

(c) Reconciling conflicting objectives
The third argument was that a single agency within a clear frame of
accountability, to reconcile the potentially conflicting aims of prudential and
conduct of business regulation.
53

There are those who maintain that there is a fundamental incompatibility
between the aims of the prudential regulator and the aims of the monitor of
market information and conduct of business. The conduct of business
regulator wants an individual consumer or market counterparty to be given fair
information on which to base her decisions and to deliver compensation when
deceived. The prudential regulator wants to protect the depositor or investor
by ensuring that the firms with which he deals are reasonably safe. Similarly,
in the case of a life insurance fund owned by the policyholders collectively,
certain groups of policyholders may have a legal right to compensation. But if
pursuing that compensation to the maximum extent destabilizes the fund, such
as it can no longer continue to accept new business and must close down,
even those seeking compensation could be disadvantaged. So there is an
argument for the regulator striking a balance between the interests of particular
groups of policyholders, and the interests of policyholders as a whole.

(d) Clear accountability
That links with the fourth argument, in favour of clear regulatory accountability.
This is an area where there are different cultural norms from country to country.
It is necessary for regulators to explain the basis on which they take their
decisions, and to be prepared to defend the trade-offs they make in the political
and public arena.

However there found certain weaknesses in integrated regulation which are as
follows:
Five main criticisms have been advanced against the FSA model:
(i) That there is the fundamental incompatibility between prudential and
conduct of business regulation, making it appropriate to manage those strands
of regulation in different institutions.
54

(ii) That divorcing prudential regulation, particularly of banks, from the central
bank is dangerous, reducing the central banks ability to monitor financial
stability and respond to threats to it.
(iii) That the single regulator divorced from the central bank may adopt a purely
domestic focus, driven by its conduct of business concerns, thus ignoring the
important international dimension of regulation.
(iv) That a single regulator responsible for the whole financial sector may be
an over- mighty institution, inclined to act in a high-handed manner, which may
perhaps damage the markets.
(v) That a very broad regulator with an extensive reach, may lack expertise
and focus on the problems of individual sectors, and may lose touch with the
markets as a result.


6.4 Post FSA [After 2007]: New Regime

The single regulatory structure is restructured as a response to the crisis. With
the Financial Services Bill having received Royal Assent in December 2013,
UK has adopted a new regulatory regime the twin peaks of the Prudential
Regulatory Authority (PRA) and Financial Conduct Authority (FCA).

Within the Bank will sit the Financial Policy Committee (FPC), responsible for
horizon scanning for systemic risks and the Prudential Regulation Authority
(PRA) responsible for the solvency and resolution of systemically important
institutions. A new regulator, the Financial Conduct Authority (FCA),
62
will be
responsible for ensuring consumer protection and markets regulation.


62
Towards Twin Peaks: The UKs Emerging Regulatory Landscape, (January 2013), CII Policy
and Public Affairs Chartered Insurance Institute,
<http://www.cii.co.uk/media/4119720/regulatory_landscape_dec_2012__20_dec_.pdf>
Accessed on19th May 2014
55




The new structure is seeking to close gaps in regulatory information gathering
and legal powers and has raised expectations regarding its performance from
political areas.

Financial Conduct Authority (FCA):
Separate independent regulator responsible for conduct of business
and market issues for all firms and prudential regulation of small firms,
like insurance brokerages and financial advisory firms
63
.

63
, Ibid,
It is proposed that the FCA will regulate approximately 27,500 firms. This includes:
24,496 firms solely regulated (for prudential and conduct issues) by the FCA. These
are firms that are deemed of limited systemic importance. Examples include: personal
investment firms, investment management firms, mortgage or insurance
intermediaries, authorised professional firms, providers of market trading
infrastructure, and non-bank mortgage lenders. It will also include Lloyds members
agents and Lloyds brokers.
56

Will be focused on taking action early by better supervision
64
and risk
assessment, before consumer detriment occurs.
Shift towards thematic reviews and market-wide analysis to identify
potential problems in areas like financial incentives.
Will review the full product lifecycle from design to distribution with the
power to ban products where necessary.

Prudential Regulation Authority (PRA)
65

Will sit within the Bank of England and is responsible for the stability
and resolvability of systemically important financial institutions.
Will not seek to prevent all firm failures but will seek to ensure that firms
can fail without bringing down the entire financial system.

2,143 firms purely for conduct of business issues. These firms, deemed to be
systemically important are prudentially regulated by the PRA and conduct regulated
by the FCA. They include banks, building societies, credit unions and general insurers
and life insurers, Lloyds and Lloyds Agents.
64
Ibid
General principles: the supervisory system will be designed so that firms are encouraged to
base their business model, culture and how they run the business on a foundation of fair
treatment of customers set out in the TCF initiative. The system will act more quickly and
decisively and be more pre-emptive in identifying and addressing issues before they cause
harm, with senior staff involved in decisions at an early stage.
Supervisor organisation: this approach will require a more flexible focus on bigger issues as
they emerge, either in individual firms or across sectors. This will mean that some larger-risk
firms might have an assigned supervisor with highly intensive contact, whereas others might
be contacted once every 3-4 years.
Firm categorisation: a new system is being introduced and firms will be contacted in early
2013 about which category they fall into. The system covers risk categories C1 (large banking
and insurance groups with very large number of retail customers) to C4 (smaller firms including
most intermediaries).
65
Ibid
According to the draft legislation, the PRA will be responsible for the prudential regulation of
all systemically important firms defined as those firms that pose a risk to the financial system
if they were to fail. The PRA will be responsible for the regulation of all institutions that accept
deposits or which accept insurance contracts. This will mean that the PRA will authorise and
supervise all banks, building societies, credit unions, general insurers and life insurers.
57

Will place emphasis on judgment based approach
66
to supervision
focusing on: the external environment, business risk, management and
governance, risk management and controls and capital and liquidity.

Financial Policy Committee (FPC):
A committee within the Bank of England responsible for horizon
scanning for emerging risks to the financial system as a whole and
providing strategic direction for the entire regulatory regime.
The FPC will have the power to use so-called macro-prudential tools
to counteract systemic risk. The tools might include imposing leverage
limits on banks or enforcing particular capital requirements for given
asset classes.
With the Bank of England set to be in charge of micro-prudential and
macro-prudential regulation, on top of its existing responsibilities for
monetary policy, it is fast becoming one of the worlds most powerful
central banks.







66
The PRAs proposed judgment-led approach to supervision will be characterised by a move
away from rules and a focus on forward looking analysis including an assessment of how a
firm would be resolved if it were to fail, the impact this would have on the system as a whole
and the use of public funds. The aim is therefore to pre-empt risks before they crystalise.
Central to the new approach is a new risk assessment framework.
58

CHAPTER VII
RESTRUCTURING OF INDIAN FINANCIAL MARKET: NEED FOR SUPER
REGULATOR

At present, financial regulation in India is oriented towards product regulation,
i.e. each product is separately regulated. For example, fixed deposits and
other banking products are regulated by the Reserve Bank of India (RBI),
small savings products by the Government of India, mutual funds and equity
markets by the Securities and Exchange Board of India (SEBI), insurance by
the Insurance Regulatory Development Authority of India (IRDA) and the
New Pension Scheme (NPS) by the Pension Fund Regulatory and
Development Authority (PFRDA).
67
All these regulators have a key
mandate to protect the interests of customers - these may be investors,
policy holders or pension fund subscribers, depending on the product.
68
The
present work allocation between RBI, SEBI, IRDA, PFRDA, and Forward
Market Commission (FMC) was not designed in a structural manner as it has
evolved over the years with the demand in market and with a sequence of
piecemeal decisions responding to immediate pressures from time to time.
69




7.1 Problems with multiple regulators in India

With multiple regulators in India some operating in functional manner while
other in sectorial manner and there are varying regulatory requirements which

67
Anupam Prakash and Rajiv Ranjan , India. RBI, Working Paper on Benchmarking Indian
Regulatory Practices to the G20 Financial Reforms Agenda (27 March 2012), p. 26
<http://rbidocs.rbi.org.in/rdocs/PressRelease/PDFs/IEPR1523WP0312.pdf> Accessed on5th
May 2014
68
Shubho Roy, Consumer Protection in the Indian Financial Code, Charted Secretary: The
Journal for Corporate Professional, (Vol XLIII, May 2013), p. 521
<http://www.icsi.edu/docs/cs/May%202013/May.pdf> Accessed on18th May 2014
69
India. Ministry of Finance, Financial Sector Legislative Reform Commission, chaired by
Justice B.N. Srikrishna, Vol. I, p. xxiv
59

often leads to regulatory arbitrage and overlap. For example there is a
functional similarity between mutual funds and ULIPs, but first was regulated
by the SEBI while other was regulated by the IRDA. SEBI imposes very
different levels of disclosure and ongoing transparency on the outcomes of
mutual funds compared to the standards of disclosure required by the IRDA.
In an example on differing standards of regulation on distributors, employees
of banks who come under regulation by the RBI can distribute financial
products such as mutual funds and insurance products, without adhering to
the rules and regulation of SEBI and IRDA. The present arrangement has
gaps for which no regulator is in charge such as the diverse kinds of Ponzi
schemes like pyramid schemes, chit funds etc. that periodically emerge in India
which are not regulated by any of the existing agencies. The existing
framework also contains overlaps between laws and agencies leading to
incidences in which conflicts between regulators has consumed the energy of
economic policy makers and held back market development.

The present scenario of financial law unsatisfactory in certain respects where
at present there are 60 Acts, several rules and regulations in India from 1950s
which are anti-development. For example The RBI Act and the Insurance Act
were enacted in 1934 and 1938 respectively while Securities Contracts
Regulation Act, which governs securities transactions, was legislated in 1956
when the financial landscape was very different from that seen today. To
understand this let take an example that when take the banking regulations
where passed there were not technology like ATMs, credit cards, internet
banking, investment advisory services, private banking, selling mutual funds
and debt products, direct selling agents, vehicle loans, derivatives and a whole
lot of other new products and services existed, although acts were amended
60

from time to time but its legal structure is baseless which is at times complex,
ambiguous, inconsistent, and occasionally open to regulatory arbitrage.
70


7.2 Which regulatory models is suitable for Indian financial market?


The question arose is whether integrated model, functional, twin peak or
multiple regulatory system is best suitable for Indian financial market. Why
supervisory structures for the financial sector differ so much across
United States, UK, France, Singapore, Germany, Japan and other
developed countries concerning the degree of integration in micro-
prudential supervision and its proximity to macro-prudential supervision and
business conduct supervision? What models does emerging market
economies and developing countries should follow and why? What are the
certain benchmarks to attain before changing the structure of financial
regulator? The attributes behind the supervisory structure for a particular
country financial system, such as the size, depth and complexity of the
financial system, the size of financial subsectors and operation of financial
groups in the country, financial sector lobbying power and other political
economy factors, the overall quality and independence of public institutions
and experience of past financial crises, among others, come to mind.

The impact of the global financial crisis across countries and regions
weakened the rigidity with which countries adhere to their existing supervisory
structures and open a window of opportunity for reforms. At the same time,
the ongoing debates suggest a tendency towards the adoption of more
unified and harmonized designs for the institutional structure of financial sector
supervision, going forward. While framing supervisory structures mechanism
should be made to address the following issues namely: (i) countries general

70
FSLRC: Transformational and Pioneering, p. 524
61

and economic development indicators; (ii) political and governance indicators,
such as the quality of governance and the autonomy of the central bank; (iii)
financial sector development indicators such as the depth and complexity of
the financial system, including banking sector characteristics such as
concentration, efficiency, profitability and liquidity and (iv) the number of past
financial crises experienced by a country, based on which regulatory
framework can be designed.
71




7.3 Arguments in Favour

If a countrys financial system evolves towards a model of universal banking,
in which banks are allowed to offer a large variety of financial products and
services with few restrictions, then there may be good reasons for adopting
integrated supervision instead of having multiple agencies monitoring different
segments of the financial system
72
. A unified supervisory system seems to be
better prepared to mitigate regulatory arbitrage, because it is better prepared
to develop and apply regulations and supervisory processes consistently.
Unification of supervisory agencies tend to enjoy greater consistency in quality
of supervision across supervised institutions, associated with a higher quality
of regulation in other sectors, Integrating supervision does not seem to be
associated with significant reduction of supervisory staff.
73
In addition, the
information available to the integrated supervisor can be more quickly and

71
Martin Melecky and Anca Maria Podpiera, Institutional Structures Of Financial Sector
Supervision, Their Drivers And Emerging Benchmark Models, (February 27, 2012)
<http://mpra.ub.uni-muenchen.de/37059/1/MPRA_paper_37059.pdf> Accessed on12th May
2014
72
Supra 33, at 6
73
Martin ihk and Richard Podpiera, Is One Watchdog Better Than Three? International
Experience with Integrated Financial Sector Supervision, IMF Working paper WP/06/57 , IMF
(2006) p.23 <http://www.imf.org/external/pubs/ft/wp/2006/wp0657.pdf> Accessed on20th
May 2014
62

effectively utilized. Moreover, by becoming the only contact point for entities
for all regulatory and supervisory issues, a single regulator becomes
responsible in preventing gaps in regulation and supervision.

Furthermore, a unified supervisor becomes accountable for its statutory
objectives. The blame cannot be passed from one supervisor to another if
supervisory failure occurs. There are other important arguments in favour of
unification, such as the maximization of economies of scale resulting from
merging two or more of the existing supervisory agencies. Economies of scale
arise from the move to a single set of unified management, a unified approach
to standard-setting, authorization, supervision, enforcement, and a single set
of central support services, etc. Furthermore, the consolidation of human
capital can increase efficiency by permitting management to direct the best
people to the most critical situations.

Moreover, integrated supervision can reduce the amount of information that
financial intermediaries need to report to supervisory agencies. A unified
supervisor becomes the only authority that requests information from financial
intermediaries, mitigating duplications in the type of information that
supervised entities have to report to different financial authorities, usually
under different formats.
74


7.4 Arguments against

A serious disadvantage of a decision to create a unified regulatory agency can
be the unpredictability of the change process itself. One of the biggest risks is
that of the nature, functions, scope and the powers of the newly created
authority by legislative means where political interest clashes, possible

74
Ibid at p10
63

reduction in regulatory capacity by loss of key personnel, unification needs
high demands from management, unified agencies had to make laws for every
aspects of financial sector lead to diversion from primary goal, finally the moral
hazard which means that public will aspect regulator to treat people from
different sector equally.
75
It will be difficult for the newly created authority to
strike an appropriate balance between the different objectives of regulation.
76

A single regulator may not have a clear focus on the objectives and rationales
of regulation and might not be able to adequately differentiate between
different types of institutions.

Conflicts
77
between these different objectives cannot be avoided. A first field
has already been mentioned: it refers to the conflict between prudential
objectives and market disclosure. If the bank is making losses, or is less
profitable, disclosing its results, what is necessary for the correct functioning
of the market, might lead to a withdrawal of deposits, and hence may
jeopardize the bank. The issue might also arise under the ad hoc market
disclosures: a company can be allowed to delay disclosure of price sensitive
information to protect its legitimate interests, but provided that this non-
disclosure is not likely to mislead the public.
78
The problem can similarly arise
with securities supervision: should a bank be allowed to issue subordinated
debt to small investors, although its solvency has come under threat, or in case
the bank is being restructured? The problem is more general, and well known

75
Richard k Abrams and Michael W. Taylor, Issue In Unification Of Financial Sector
Supervision, IMF Working paper WP/00/13, IMF, (2000),
<http://www.fep.up.pt/disciplinas/pgaf924/PGAF/issues_in_unification_supervision.pdf>
Accessed on20th May 2014
76
Wymeersch, Eddy, The Structure of Financial Supervision in Europe: About Single, Twin
Peaks and Multiple Financial Supervisors (2006). http://ssrn.com/abstract=946695 Accessed
on7/5/14
77
Tison,M., Do not attack the watchdog! Banking supervisors liability after Peter Paul,
Common Market L. Rev., 2005
78
Proctor, C., Financial regulators, risks and liabilities, Butterworths Journal of International
Banking and Financial law, 2002, 71
64

to banking supervisors: if a bank shows signs of serious weakness, can one
let it continue to receive deposits? Deposit guarantee schemes are obviously
not a valid answer. Therefore, careful balancing of the interests involved is
required, and must be based on a rational analysis of the survival prospects.
Law suits in liability of banking supervisors illustrate the limits of decision
making.
79
Comparable situations arise within financial services groups, where
the interest of one group entity may threaten the existence of another one,
while prudential action may have to give priority to one over the other.

Several authors believe that there are good reasons for keeping financial
supervisory agencies separate. In their view, specialized agencies may be
better prepared than a single agency to recognize and properly address the
unique characteristics of each type of financial intermediary.
80
There is also
the risk that the effectiveness of supervision may be affected if the new
integrated agency fails to develop a consistent framework of regulation and
supervision for the financial sector. While a certain degree of harmonization of
supervisory practices between the banking, securities and insurance
supervisors is desirable to reduce regulatory arbitrage, it is important to
recognize the particular characteristics of each industry, each one requiring
specific regulations.

A unified supervisor may fail to develop such a framework, affecting the overall
quality of supervision. Despite the strength of the economies of scale argument
in favour of unified regulation, it has been recognized that a single unified
regulator may also suffer from some diseconomies of scale. A particular
concern about an integrated regulator voiced by many scholars is that the new

79
Rossi, F., Tort liability of financial regulators, A comparative study of Italian and English law
in a European context, EBLR, 2003, 643
80
Prof. Charles Goodhart (2001): The Organisational Structure of Banking
Supervision.(Basel,Switzerland, FSI Occasional Papers, No 1, Financial Stability Institute,
<http://bis.hasbeenforeclosed.com/fsi/fsipapers01.pdf> Accessed on13th May 2014
65

function could be more rigid and bureaucratic than separate specialist
agencies. Another source of diseconomies of scale is the tendency for unified
agencies to be assigned an ever-increasing range of functions. Some critics
argue that synergy gains from unification will not be very large. It is true that
the cultures, focus and skills of the various regulators vary markedly. E.g. while
most of the sources of risks in the banking sector are on the asset side, on the
other hand, the sources of risk in the insurance sector are on the liability side.

The behaviour of supervisors vary markedly with some describing banking
supervisors as being more like doctors examining the health of the patients,
while securities supervisors are more like policemen trying to catch the
miscreant securities dealers. With the creation of an integrated regulator and
supervisor the public may tend to assume that all creditors of institutions being
regulated and supervised by the integrated regulator will receive equal
protection. e.g. if the depositors of a bank are protected in case of a bank
failure, the customers of a securities broking outfit may also assume the same
treatment from the regulator.

Finally, the change management process may go off track, leaving the whole
financial system in a quandary. The process of creating a unified agency
places heavy demand on management resources. The unification process
requires a well-conceived and carefully monitored change. An unintended
consequence of the unification of supervisory agencies has been the voluntary
departure of experienced personnel of the merging institutions. Another related
problem has been the demoralization of the staff of the merged entities during
and after the unification process.
81


81
Ibid at p11
66

CHAPTER VIII
CONCLUSION


The Financial Sector Legislative Reforms Commission (FSLRC), in its report
of March 2013, has made sweeping recommendations in the regulations of
financial sector. Wherever a sector is de-regulated, one actually needs a
strong and independent regulator. The main thrust of the commission is to
discourage multiplicity of regulatory bodies and instead institute an umbrella
body taking care of most of the financial services. Hence, the FSLRC
recommends that SEBI (capital market regulator), FMC (commodities market
regulator), IRDA (insurance sector regulator), and PFRDA (pension sector
regulator) be merged into a single body, the Unified Financial Authority (UFA).

Many experts believe that such a single agency would make the regulation
more effective and clear all ambiguity with regard to overlap areas. These
experts also opine that RBI and SEBI have failed in controlling the rampant
and unscrupulous growth of chit funds and Ponzi schemes. The regulatory
bodies and the state government are debating on whose territory the
operations of the chit fund fall. It is said that these unscrupulous entrepreneurs
are taking advantage of huge ambiguity in the regulatory space and hence
deriving benefits of regulatory arbitrage and done a huge revenue loss of India.

Another argument in favour of a single regulatory body is that there are many
financial conglomerates which operate in multiple areas of financial sector
(e.g., universal banking) and hence fragmented supervision may raise
concerns about the ability of the financial sector supervisors to form an overall
risk assessment of the institution on a consolidated basis, as well as their
ability to ensure that supervision is seamless and free of gaps. There are at
times arguments that financial institutions offer very complex and diverse
67

products and hence regulating them by a single agency might be difficult as
well as ineffective. Proponents of this view advocate that a distinction needs
to be made between financial institutions and financial products.

But the counter argument could be that with the evolvement of financial
systems, the distinction between financial institutions and products have
become blurred and multiple supervisory body for different institutions may
create a situation where institutions offering similar products are regulated by
different agencies (an example could be the recent tussle between SEBI and
IRDA on regulating market-linked products of insurance companies). The third
argument, in favour of a single agency supervision system, is that even
financial institutions would prefer reporting to a single agency rather than
responding to the queries of multiple agencies for different products.

The existence of a range of supervisory authorities also poses the risk that
financial firms will engage in some form of supervisory arbitrage. The fourth
argument favouring a single agency system is borrowed from economics and
it is said that a larger and unified regulatory body will derive benefits of
economies of scale. It would be possible for a large regulator to adopt finer
specialization and save costs through shared infrastructure, administration and
support system. A recent study observes that regulatory structure in the
financial sector depends on several factors and finds that as countries
advance to a higher stage of economic development, they tend to integrate
more their financial sector supervisory structures.
82
Thus, although there is
increasing trend amongst advanced nations to embrace a unified supervision
structure, such structure may not be effective for smaller countries. The UK,

82
Prof. Ashok Banerjee, Unified Regulatory Authority Is It Desirable, A newsletter of finance
lab, IIM Calcutta, (vol 1, 9, April 2013), p6 http://financelab.iimcal.ac.in/download/mag/april-
2013-Volume-1-Issue-9.pdf Accessed on21/5/14

68

surprisingly, have found that the single supervisory structure has not been
working efficiently.

In the UK, till March 2013, the responsibility of financial regulation and financial
stability was bestowed on the treasury, the Bank of England and the Financial
Services Authority (FSA). FSA was set up in 1997, combining nine separate
agencies, as an integrated supervisor following the examples of Canada,
Japan, Germany, Singapore and Switzerland. However, FSAs performance
during the financial crisis has been criticized on three grounds- (a) ineffective
communication between FSA and the other two regulatory agencies; (b)
neglecting macro-prudential supervision before the crisis, and (c) over-
emphasising conduct of business supervision over macro-prudential
supervision. It was also believed that FSA has been generally ineffective in
ensuring consumer protection. The new UK government in 2010 launched
fundamental reforms of the financial supervisory architecture which led to
recommendations of breaking up the FSA into two bodies- the Prudential
Regulatory Authority (PRA) and the Financial Conduct Authority (FCA). The
recommendations of disbanding FSA were made into laws in the UK through
the promulgation of the Financial Services Act, 2012, which came into effect
from April 2013. The PRA is set up to implement prudential regulation of
deposit-taking institutions (e.g., banks, chit funds etc.), insurance firms and
systematically important financial institutions. The FCA, on the other hand, is
created to conduct prudential regulation of other financial institutions,
consumer protection and regulation of financial institutions business conduct.

The Financial Services Act established a new and independent Financial
Policy Committee (FPC) at the Bank of England as its subsidiary. The main
objective of the FPC is to identify, monitor and take action to remove or reduce
systemic risks with a view to protecting and enhancing the resilience of the UK
financial system. The FPC has a secondary objective to support the economic
69

policies of the government. Thus, the UK legislators have sought to empower
the central bank (Bank of England).

The FSLRC, on the other hand, has recommended that the systematic risk
should be managed by the Ministry of Finance (and not RBI) through FSDC.
The commission has suggested further reduction of role of the RBI in
managing financial sector; (a) it prescribes that public debt management
services should be carved out of the central bank and entrusted with the
Ministry of Finance (through a new debt management office); (b) it also
prescribes that the rules for inward capital flows would be made by the Central
Government and the central bank will only be regulating outward flows. Thus,
the FSLRCs position on the role of the central bank in regulating financial
services is quite contrary to the position taken by the UK legislation. The
commission could not provide, in its voluminous report, very convincing
argument for reducing the role of the central bank.

The analysis of World Bank report
83
shows that (i) countries advancing to a
higher stage of economic development tend to integrate their financial
sector supervisory structure. Similarly, improvements in overall public
governance drive countries to adopting more integrated supervisory
arrangements. (ii) Greater independence of the central bank could entail less
integration of prudential supervision, but not necessarily of business conduct.
(iii) Small open economies opt for more integrated structures of financial
sector supervision, especially on the prudential side. (iv) Financial
deepening makes countries integrate supervision progressively more,
however, greater development of the non-bank financial system including
capital markets and the insurance industry makes countries opt for less
integrated prudential supervision but not business conduct supervision

83
Supra 68
70

structures. (v) The lobbying power of concentrated and highly profitable
banking sectors acts as a significant negative force against business
conduct integration. (vi) Countries with banking sectors that have been more
exposed to aggregate liquidity risk, due to their high share of external
funding, tend to integrate more their prudential supervision. Finally, (vii) a
country that has experienced past financial crises is more likely to integrate
its supervisory structure for financial services. The analysis of World Bank
and OECD in respect of financial regulator supervision and in addition to failure
of UK integrated model shows that instead of adopting single regulator there
should be a twin peak regulatory model which is quite successful in U.S. and
Australia. Further as the commission could not lay down sound framework for
co-ordinating activities between sector regulator and general regulator. But
definitely there is an urgent need of some form of reform needed in financial
sector and codification of law and repeal of old acts which does not supplement
fuel to Indian Economy. This leaves a lot to be done.













71

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78

Annexure I









Figure 1 The Financial Services System Regulatory Structure, India










79











Figure 2 The Financial Services System Regulatory Structure, UK