Ulips, joint mechanism and FSDC

K P Krishnan, Jul 22, 2010, 06.34am IST

cThere has been much attention, in the media, on inter-regulatory conflicts in finance, and on the proposed institutional arrangements on financial stability. While these issues have been with us for a while, the present debate falls within the context of announcements in the Budget 2010 speech.

In this speech, the finance minister announced the setting up of an agency called Financial Stability and Development Council (FSDC) to deal with financial stability and macroprudential supervision, inter-regulatory coordination and financial literacy and inclusion. Equally important but less noticed was the announcement relating to the creation of a Financial Sector Legislative Reforms Commission (FSLRC).

Inter-regulatory conflicts, over products and policy that straddle regulators, are neither new nor peculiar to India. The dispute about Ulips is only the most recent, and publicly visible, manifestation of this problem. There are many other existing and future products where identical difficulties could arise. The root cause is not regulatory cussedness or turf concerns: it is financial laws that are out of tune with the present state of Indian finance. As an example, consider the core question of the Ulip dispute: should a Ulip with 1% or 2% insurance be treated as an insurance product, or like a mutual fund product? An answer to this question requires a combined reading of Section 12(1B) of Sebi Act, 1992, Section 2(11) of Insurance Act, 1938, and Regulation 3(3) of Irda Investment Regulations, 2000.

Some of these laws were drafted at a time when the country had one government monopoly insurance company. Hence, these laws did not deal with the complexities of today's financial system. The law of 1938 did not deal with a statutory regulator, Sebi, which would be established more than 50 years later, which regulates other products that look like Ulips. These laws did not plan for the complexities of a competitive insurance industry where sales practices evolve in response to profit maximisation by private firms.

The recognition that financial laws require fundamental reform, rooted in a series of expert committee recommendations, led to the FSLRC announcement by the FM in his Budget 2010 speech. To go to the root cause of the problem requires a comprehensive and contemporaneous re-examination of all the relevant laws. Such an effort needs to address overlaps and gaps, clarify roles of agencies, and bring laws up-to-date with today's requirements.

Drafting and enacting new laws after scrutiny by the Parliamentary Standing Committee will inevitably take time. Until a full set of new laws is put into place, a mechanism to deal with the problem of inter-regulatory coordination and conflicts is required to address the difficulties faced today. This issue has been emphasised by the Joint Parliamentary Committee (JPC) that enquired into the Harshad Mehta scam and the JPC that enquired into the Ketan Parekh scam. For the foreseeable future, Indian finance will be regulated by multiple regulators. Given the fastpaced changes in Indian finance, greater and more effective inter-regulatory coordination is essential.