The new principles-based SEBI regulations
The new SEBI regulations on advertisement show the shift towards principles-based regulation. For example a regulation reads:
In audio-visual media based advertisements, the standard warning in visual and accompanying voice over reiteration shall be audible in a clear and understandable manner. For example, in standard warning both the visual and the voice over reiteration containing 14 words running for at least 5 seconds may be considered as clear and understandable.
Instead of mandating that the warning should be at least 5 seconds long, it has stated that that it must be clear and audible. The 14 words in 5 seconds is now not a legal requirement: it is only an illustration of how the principle can be satisfied.
The valuation of investments shall be based on the principles of fair valuation i.e. valuation shall be reflective of the realizable value of the securities/assets. The valuation shall be done in good faith and in true and fair manner through appropriate valuation policies and procedures.
This regulation recognises that there are many different types of assets a mutual fund may acquire, stocks, securitisation papers, derivatives, bonds, etc. Each of them may have different forms of valuation. More importantly the list of assets mutual funds may buy is not exhaustive: as the Indian financial markets develop there may be other instruments that mutual funds may purchase. The principle however, will hold true for different assets and valuation methods. The objective of the regulation is to ensure that the investors get a fair picture of the assets their fund holds.
Assessment
We do not know what forms of media the mutual funds will use in the future: billboards will go 3D, holograms will be used, mobile phones will explode with targeted advertising. Mutual funds will also invest in new financial instruments in global markets. As long as the provide warnings in a clear and understandable manner and value their assets in a fair and truthful system, the will be compliant with SEBI regulations and can innovate freely.
Principles based regulations have two major advantages over rules based system:
- The regulations require the regulated to strive towards an outcome and not mechanistic compliance.
- The regulations allow for innovation to be absorbed quickly by the industry as long as they meet the objective of the regulation. Imagine if the Contract Act had specified that all acceptance of contracts should be done by letters. All the innovation of e-commerce, mobile telephony based commerce, telephonic negotiation and trading would have been illegal till the statute was amended. This would have required Indian law-makers to constantly update the Contract Act.
Moving to a principles based system is a crucial step forward, away from the command and control mindset that many regulators suffer from. Instead of prohibiting malpractices, all too often, laws in India micro-manage the regulated business. This is a recipe for stagnation.
However, principles based financial regulation also has costs. Rules are black and white - there is legal certainty. With principles based regulation, the precise nature of a government response to a new idea by the private sector is less predictable.
More complex behaviours are, then, required of the regulator. More litigation will arise. This will impose a greater burden on staff in regulators, courts and law firms. They will need to understand principles (and their underlying drafting intent), alongside practical knowledge about how the real world works, so as to be able to intelligently apply the principles. This requires a great deal of understanding of technology, business and regulatory objectives. Moving towards a principles based system requires commensurate strengthening of staff capabilities at SEBI, the Securities Appellate Tribunal (SAT), and the Supreme Court
