by Shubho Roy and Deepaloke Chatterjee.
Rule-making process: A critical component of the rule of law
A despotic king has absolute power. When a society matures, the
rule of law emerges in two stages. First, the despotic ruler writes
down a set of rules, and the main body of government implements the
law. So the interface between citizen and State is now governed by
law, but a despotic king has the god-given power to enact new law.
The next stage of the evolution of the rule of law is where the
very law-making process is enveloped in checks and balances. It is
useful to think of three levels:
- In the worst scenario, there is only the command of a few
men that purports to be the law of the land. Governments can act
capriciously, violate stated laws, and courts (if they exist at all)
are no help.
- The next step up, in history, was the despotic rulers of
Continental Europe who preserved the absolute right of the king to
make law, but built a fairly sophisticated system of civil servants,
judges and courts through which citizens faced the consistently
applied rule of law. At the same time, the ruler retains unbridled
power in changing laws. With the high quality judges who hear cases
at the the Dubai International Financial Centre (DIFC), we may now
place DIFC in this league.
- The next step up is a liberal democracy, where legitimacy is
won because the very rule making process is governed by checks
and balances; is enveloped in the rule of law.
The rule-making process in independent regulators
In this post, we focus on independent regulators, which are a
fascinating combination of law-making and law-enforcement. Parliament
empowers them to write law. At the same time, this does not mean that
a regulator is a despotic king who can issue law based on any whim and
fancy. Democratic accountability requires that the very process
through which an independent regulator writes law should also be
enveloped in a system of checks and balances.
The Indian situation
While the above is well understood in developed countries, in India
this is still very new terrain. Most finance practitioners would not
be surprised if they are surprised by the newspapers with a completely
new regulation issued by a financial regulator. In the field of
financial regulation, the best practices in India are usually found at
SEBI. However, on this issue -- the rule-making process -- SEBI
remains relatively weak. At other financial regulators, rules are
often issued like fatwas.
We recently came across a remarkably good arrangement in an
unexpected place: the Airports Economic Regulatory Authority
(AERA). In this blog post, we describe this process. While this is not
yet state of the art by world standards, we think this is state of the
art by Indian standards.
The rule-making process in AERA
AERA was established in 2008. As with all regulators, it has to set
out regulations governing the stake-holders in its domain. The steps
AERA undertakes before making regulations display a level of
transparency and organization rarely seen in Indian regulators.
The
AERA Act requires the regulator to maintain transparency through
the following mandates:
- Hold consultation with all stake-holders.
- Allow all stake-holders to make submissions.
- Document and explain all decisions.
One of the first actions of the AERA was to establish its approach
and philosophy towards regulation. This was done through the method
mentioned above. Let us look at the steps AERA went through:
- A white
paper was released in December 2009. It contained major issues
impacting formulation of a regulatory philosophy and approach. - An opportunity was given to stake-holders to consider the issues
highlighted and provide feedback, comments and suggestions. - AERA considered all the submissions and released a
paper in February 2010. This consultation paper contained not only
the submissions received for the White Paper (the relevant
paragraphs were annotated) but also detailed responses from AERA to each
submission. Apart from the response, it also provided reasons for
the approach taken (and the economic rationale where possible). - After the release of the consultation paper, another meeting was
held where comments were received. The minutes of the meeting were uploaded on the Authority's web page. - AERA finalised its regulatory approach (for determination of
tariffs) and issued an Order
in January 2011. The order stated that the guidelines would be
drafted in consonance with the consultation paper. - The AERA then issued the
draft guidelines in February 2011. The stake-holders were again
given an opportunity to comment, and another meeting was held with the
stakeholders.
Analysis
This process is important for the healthy functioning of
democracy. As Robert Conquest wrote in his article Downloading
Democracy in The National Interest in Winter 2004-05:
A civic society is a society in which the various
elements can express themselves politically, in which an articulation
exists between those elements at a political level. A civic society is
not a perfect social order - which is in any case unobtainable - but a
society that hears, considers and reforms grievances. It is not
necessarily democratic, but it contains the possibility of
democracy.
Most regulators in India invite comments from stake-holders. What
is unique about AERA is the level of documentation and detail it
provides in response to the comments. The entire procedure is
available publicly. The parties who provided comments may not agree
with the position of the regulator but they know that their comments
were heard and considered. This helps create the incentive for the
larger community to engage with the regulator in future
consultations. A sure sign of difficulty in the rule-making process at
a regulator is the event of a `consultation process' that attracts a
negligible amount of comments: that tells us that the wider community
has lost confidence in the regulator.
The entire process is not a one-off incident. AERA has created a
detailed
guideline on how it will go about inviting comments and involve
stake-holders in their discussion. This creates benefits for both the
regulator and the regulated as:
- The regulator can now clearly state that it is fulfilling its
requirements for meeting the mandate of transparency and
consultation as required under its parent legislation. - The regulated entities/ stake-holders are clearly aware of
process that goes into the drafting of regulations.
The legal process surrounding rule-making at AERA takes away
arbitrary and discretionary power in the hands of the senior staff of
AERA to issue rules based on whim or fancy, and thus reduces the
chances of mistakes being made or of rules being hijacked through
ignorance or corruption.
Economists and the Ministry of Finance are generally confident that
some of the best governance in India happens on their watch
(e.g. SEBI). It may come as a surprise to see sophisticated legal
process in an unexpected place: AERA. As we attempt to build more
sophisticated regulators in finance and infrastructure, AERA's work
needs to be studied, emulated and improved.
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