SEBI rules and insurance companies

Financial Express, 12 April 2010

The Securities and Exchanges Board of India (SEBI) has said that the products sold by many insurance companies require compliance with SEBI rules. It now insists that insurance companies must comply with these rules. The unstated follow-on action would be that if the sellers of these products fail to comply with these rules, SEBI would impose penalties upon them based on the powers conferred on it under the SEBI Act.

Three fallacies

If insurance companies were selling Unit Linked Insurance Products (ULIPs) for so many years, how could something change today?
Even if something has been done for years, that does not change its legality. We may criticise SEBI for not having undertaken such an enforcement action in prior years. But this does not change the legal position today.
The Insurance Regulatory and Development Authority (IRDA) chairman was quoted in the newspaper Mint as saying: The Sebi order is anti-policy holders. So, I am directing the 14 insurance companies to continue selling ULIP products, notwithstanding the Sebi order.
However, the issue is not whether the SEBI order hurts policy holders or not. The question is one of rule of law. The SEBI order, signed by Prashant Saran, is a well drafted and reasoned argument. It impinges upon certain insurance companies (and not IRDA). These insurance companies have a high speed and high quality appeals mechanism: the Securities Appellate Tribunal (SAT). If they believe that SEBI is wrong on questions of law, they should appeal at SAT.
"Insurance companies are the fiefdom of IRDA and SEBI should say nothing to them."
This feudal notion is inconsistent with the rule of law. Insurance companies have to comply with the Insurance Act (1938) and the IRDA Act (1999). They also have to comply with every other law of the land, including the Securities Contracts (Regulation) Act (SC(R)A) and the SEBI Act.

Rule of law

The single point which we should emphasise through this episode is: the rule of law. All of us must aspire to have an India which is governed by the rule of law. The letter of the law must drive the behaviour of every government agency. Government agencies must act in the public domain with full reasoning - as has been done by SEBI in the order which shows the full rationale of what is being done, and was immediately posted on the SEBI website. And it should be possible to appeal the order in an environment where the judges are competent and the appeals process gets handled swiftly.

But do the laws make sense?

The second order issue that needs to be addressed is: Does it make sense for the laws to be constructed in the present fashion? Should we have this combination of the Insurance Act, the IRDA Act, the SEBI Act and the SC(R) Act which imply that the production of ULIPs requires compliance with both SEBI and IRDA rules? This is a good question and merits a deeper examination.

Financial laws in India are a ramshackle mess and urgently require a comprehensive rewrite. The broad economic thinking for rewriting these laws has been done through three expert committee reports in the last three years -- the Percy Mistry report (on Bombay as an international financial centre), the Raghuram Rajan report (which focused on domestic aspects of finance) and the Jahangir Aziz report (which focused on debt management). In order to implement these plans for rewriting the laws, the budget speech this year announced the creation of the Financial Sector Law Reforms Commission (FSLRC) which should rewrite a host of these laws into a small, modern, internally consistent set.

Regulatory coordination

Even if the work of FSLRC goes well, putting these new laws into place will take a few years. Even after these laws are in place, a modern financial system inevitably involves a constant process of handling products and activities of financial firms which have either no regulation or are covered by overlapping laws. The way to handle this in a more graceful fashion is to have better inter-regulatory coordination.

The budget announcement of the Financial Stability and Development Council (FSDC), which will foster better inter-regulatory coordination, is key to improving the handling of these kinds of issues in the future. Conflicts such as these are best resolved internally. In recent years, two interesting inter-regulatory matters have worked out well: the launch of exchange traded funds on gold (which required cooperation of RBI, SEBI and FMC) and the launch of currency futures (which required cooperation between RBI and FMC). Yet, the existing method of regulatory coordination - the High Level Coordination Committee (HLCC) - has not been strong enough to solve myriad other such problems. The FSDC must be quickly put into place so as to play a strong role in identifying and resolving these inevitable frictions that will arise as finance becomes more sophisticated and the laws are constantly out of touch with reality.

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