The National Financial Reporting Authority Needs A New Legal Framework

The previous column examined the major shortcomings of the current legal framework of NFRA. This part presents a new legal framework for an independent regulator of financial reporting built on accepted principles of institutional design based on research and experience from India and abroad. These principles emphasise the regulator’s independence, efficiency, effectiveness, credibility, professionalism, decision-making openness, fairness, predictability, transparency, accountability, responsiveness, and governance. These are interrelated and reinforce each other.

Principles Of Institutional Design For Independent Regulators

The Organisation for Economic Co-operation and Development lays down seven principles of good governance for regulators. We can use them to develop an institutional design for NFRA. I consider these principles and apply them to the institutional design of NFRA. I draw on the discussion in the OECD report and the Better Regulation Task Force report. Further, the design takes into consideration the experience of regulation in India.

The principles and their application to NFRA are explained below.

1. Role Clarity

The legislation establishing a regulatory scheme or framework should be written so that the purpose of the regulator and the objectives of the regulatory scheme are clear to the regulator’s staff, regulated entities and citizens.

2. Independence

The regulator should have a high degree of independence from those whom it regulates and from the government. The legislation should provide the terms of the relationship between NFRA and the government. The legislation should specify the tenure of the chairperson and members of NFRA, conditions for termination of service, and pre-employment and post-employment restrictions in order to avoid conflicts of interest in performing their duties.

3. Decision-Making And Governing Body Structure

The governing body structure of a regulator should be determined by the nature of and reason for the regulated activities and the regulation being administered, including its level of risk, degree of discretion, level of strategic oversight required, and the importance of consistency over time.

• NFRA should be a five-member body including the chairperson. All of them should be full-time.

• The members should be selected on the basis of their technical or policy expertise or industry knowledge in the relevant fields. These fields would be accounting, auditing, finance, law, regulation, and public administration and policy-making.

• The members should represent the public interest and not the interests of the industry they may come from. In addition, methods for the resolution of conflicts of interest should be included in the legislation.

• The legislation should specify the members’ expertise and experience, the selection process, and the manner of appointment of members.

4. Accountability And Transparency

Regulators should be accountable to three groups of stakeholders: a) the government and the legislature; b) regulated entities; and c) the public.

• NFRA should be accountable to three groups of stakeholders: a) the government and the legislature including legislature committees; b) regulated entities; and c) the public. The legislation should provide for a fair and expeditious appeal of the regulator’s decisions.

• It should report to the government and the legislature at regular intervals on how it is performing its functions efficiently and effectively.

• It should develop a set of performance measures to facilitate oversight of its activities by the government and the legislature.

• The decisions of NFRA along with reasons and the annual work plan should be published.

• It should publish its operational policies and guidance materials.

• Regulatory priorities and expectations from regulated entities for the year ahead should be announced in order to improve predictability.

• Internal regulations for delegation of powers to inspectors should be clear and subject to regular review.

• The investing public, which would include shareholders and creditors, should be assured through transparent processes that the regulator is committed to fulfilling its legislative mandate in a fair and impartial manner.

5. Engagement

Regulators should undertake regular and purposeful engagement with regulated entities and other stakeholders focused on improving the operation and outcomes of the regulatory framework or scheme. Engagement processes used should protect against potential conflicts of interests of participants and guard against the risk that the regulator may be seen to be captured by special interests.

• NFRA should have effective engagement with all stakeholders.

• Advisory boards with members drawn from diverse backgrounds and expertise can reduce the dependence of NFRA on the regulated entities for expertise and skills.

• NFRA should publish a consultation policy.

• Inclusive and transparent processes are necessary to prevent engagement from being used to capture NFRA.

6. Funding

Funding levels should be adequate to enable the regulator to operate efficiently and effectively fulfil the objectives set by the government and the legislature including obligations imposed by other legislation. Funding processes should be transparent, efficient and as simple as possible.

• The sources of funding for NFRA should be budget funding from the government, user charges set on a cost-recovery basis, penalties and fines, and interest income.

• The funding should be adequate to pay for the activities of NFRA.

• The charges should not be burdensome on auditors and preparers.

• It is advisable to have an annual review of funding by an advisory board and a periodical external review.

7. Performance Evaluation

Regular independent external reviews of regulators should be arranged by the government, legislature or the regulator itself, in addition to any internal reviews. Regulators should clearly define and agree on the scope of their mandate that will be assessed by key stakeholders. This may already be contained within the legislation. Regulators should determine which regulatory decisions, actions and interventions will be evaluated in the performance assessment.

• Performance evaluation of NFRA should be conducted regularly.

• NFRA should develop key performance indicators relevant to its purpose and objectives.

• NFRA should report on its performance on these indicators in the annual report.

Conclusion

Separate legislation containing the legal framework built on the principles of institutional design for governance is a prerequisite for the successful working of NFRA. The legislation should ensure the independence of NFRA while making it accountable for performance.

R Narayanaswamy is a Retired Professor of Finance and Accounting, Indian Institute of Management, Bangalore, and Chair, Technical Advisory Committee of the National Financial Reporting Authority. Views are personal.

The views expressed here are those of the author, and do not necessarily represent the views of BQ Prime or its editorial team.