National Council of Applied Economic Research
Opinion: Udaibir Das.
Constitutional independence alone is not enough. It must be bolstered with strong public accountability and transparency.
Emerging market regulators face significant challenges in maintaining their credibility when domestic and external entities level allegations against them. The Hindenburg Report’s accusations against the Adani Group and India’s Securities and Exchange Board (SEBI) have thrust the integrity of financial regulators into the spotlight, highlighting the systemic hurdles that regulatory bodies in developing capital markets must overcome.
Without going into the specifics of this particular case, several instances have occurred in emerging markets where financial regulators have been scrutinised. These include Brazil’s Petrobras, South Africa’s Steinhoff, and Türkiye’s Turkcell. In all cases, the actions of financial regulators underwent scrutiny for potential biases influenced by corporate interests and the government’s overarching tactical economic agenda. It became clear that outside pressures only serve to make a bad situation worse. These incidents eroded public trust and necessitated years of reform to rebuild market and investor confidence.
While international firms such as Hindenburg Research are less common in emerging markets, the involvement of foreign shareholders, the global media, analysts, and credit rating agencies has amplified the attention paid to the regulatory environment in these markets. It underscores the international implications of regulatory actions undertaken by emerging market regulators and the need for a prompt and credible response.
In theory, regulatory bodies such as India’s SEBI operate independently, uphold high ethical standards, and resist undue influence. Their mission is to promote transparency and ensure fair play. But regulators sometimes find themselves trapped in the systems they oversee, serving the industry or political entities they should regulate rather than the public interest. International financial standard-setting bodies and the International Monetary Fund, as well as policy lessons from rounds of financial crisis, have strongly stressed good supervision and robust regulator governance as critical components of a stable financial system.
It is not as if advanced market economies have not experienced regulatory governance scandals. The United Kingdom (UK)’s Financial Conduct Authority (FCA) was severely criticised during the London Interbank Offered Rate (LIBOR) scandal for failing to prevent interest rate manipulation; similarly, despite numerous red flags, the Securities and Exchange Commission (SEC) in the United States faced intense scrutiny for its failure to detect Bernie Madoff’s ponzi scheme, and Germany’s financial regulator, BaFin, faced harsh criticism during the Wirecard scandal. In all instances, significant reforms to the framework governing the regulator ensued.
These demonstrate that regulatory bodies worldwide can face similar challenges in avoiding conflicts of interest, regulatory capture, and fairly and effectively policing financial markets. How the regulators react considerably depends upon the standards that govern the regulator itself.
The fortification of governance frameworks for regulators in emerging markets is paramount. One potential strategy involves constitutionally ensuring the independence of financial regulators, as Mexico has done with its central bank and other countries who have moved towards granting institutional independence to their regulators outside the executive and legislative branches of government.
Constitutional independence alone is not enough. Independence must be bolstered with mechanisms that will guarantee strong public accountability, and transparency. The role of stakeholders and whistle-blowers must be stepped up as a check and balance on regulatory governance standards allowing the reporting of unethical practices without fear of retaliation.
The following mechanisms could instill market confidence that financial regulators are operating under an accountable system of their own oversight.
One is parliamentary scrutiny (such as in the UK), where the parliament holds regulators accountable. Two, judicial review (such as in Brazil), where regulators operate within their legal mandates and the judiciary has a role in reviewing regulatory decisions. Third is active public engagement and transparency, through public consultations and transparent decision-making processes. Fourth, public disclosure of decisions and rationale where regulators regularly publish detailed and timely reports on regulatory actions. And five, engagement with stakeholders, where regulators foster open communication channels with market participants, investors, and the public to build trust and allow for feedback.
The design of the above mechanisms will be conditioned by the countries’ political culture, institutional context, and risk tolerance (in several markets, the highest importance is placed on reputational risk). Doing this is challenging in markets where political and economic institutions are weak, afflicted by State dominance, or are outmoded and in need of modernisation.
A relatively new element coming in the way of regulatory governance is the evolving financial landscape. The rapid pace of change in financial markets, the entry of new providers of financial services, and shifts in business practices, are increasing the complexity of regulatory mandates and generating new types of conflicts of interest and posing risks to a regulator’s integrity. As the economist and Nobel laureate George Stigler once said, agencies tend to respond to the wishes of the best-organised interest groups.
For SEBI, this means overcoming the public trust deficit and demonstrating its commitment to transparency and fairness. The situation with Adani and Hindenburg is special due to its international dimension. Swiftness and decisiveness are essential when a regulator like SEBI gets embroiled in a controversy or when foreign investors question its governance and integrity.
The response can take five forms. First, the regulator launches independent governance audits, makes findings public, and implements necessary reforms swiftly. Two, governments publicly reaffirm the regulator’s governance framework and independence when its credibility is threatened. Third, regulators are backed by the judiciary and legislature, particularly in contentious cases, for maintaining their governance integrity. Fourth, the regulator provides the public clear, factual, and timely information to address accusations. Fifth, regulators plan for potential crises and be prepared to respond to adverse spill-overs arising from the allegations.
The involvement of Hindenburg Research, known for its activism and short-selling strategies, is influenced by the practices followed in well-developed and internationally connected markets. Until now, such involvement was less evident in emerging markets. This was primarily due to the smaller size of companies and markets, lower levels of interconnectedness, and regulatory frameworks with a domestic bias. However, as the cross-border connections of India’s corporate and financial firms grow, and the Indian financial and capital markets integrate more with the global financial system, the likelihood of involvement of firms like Hindenburg Research will rise.
The allegations against SEBI are a stark reminder that financial regulators often are left alone to defend themselves. But, these also help regulators anticipate complex challenges. Emerging markets must construct resilient regulatory governance frameworks and put safeguards in place for regulators to act independently against the forces they oversee.
UdaiBir Das is formerly from the International Monetary Fund and currently affiliated with NCAER, and Kautilya School of Public Policy. The views expressed are personal.