MacroScan - Markets and the Role of Law?

The business press in India has been in an uproar of late because of the government's lack of commitment to liberal reforms. Reforms organized around the values of choice, competition, efficiency and growth are seen to be valued because they increase income, which even with a measure of inequality, benefit all or most in the end^[i].

The law in this picture, just as economic law is seen in most public, dominant or hegemonic discussions of the subject around the world, is presented as a source of frictions, transaction costs and bureaucracy. The law is depicted as outside the efficient functioning of markets and a scourge on entrepreneurial spirits which would otherwise deliver the aforementioned growth.

Yet all markets are highly regulated. Indeed, markets could not exist without the detailed, dedicated and rigorous enforcement of rules structuring commercial interactions. For example, the US Securities and Exchange Commission is formally considering a petition to amend Section 13D of the Securities and Exchange Act of 1934 to reduce the amount of time before owners of 5 percent or more of a public company's stock must disclose that position from 10 days to 1, a measure that affects the distribution of power between incumbent management and outside shareholders^[ii]. Extensive regulation of matters such as disclosure and companies law is central to the effective functioning of capital markets. In recent weeks, for example, among many other decisions, the Securities and Exchange Board of India (''SEBI'') has notified changes in regulations regarding the operations of stock exchanges and clearing corporations^[iii] and issued a circular limiting the class of offenses that can be eligible for settlement through consent orders^[iv]. The moments of free-exchange much celebrated by market talk would not exist without extensive state (and state-like) intervention, specifically the battery of regulations, enforcement mechanisms (courts, master agreements provided by trade associations^[v] etc) and institutions (SEBI, the Department of Industrial Policy and Promotion, etc) that allow these moments of exchange to proceed with certainty^[vi]. While typically not understood as state intervention, these are matters of much scrutiny and discussion in business and policy worlds.

Seen in this context, perhaps a richer discussion would explore what role these understandings of the law perform. Stated differently, we might ask, what are the ideological uses to which the law is made to service? More pointedly, we would also examine the particular structure of the economy and markets that are created by the law, by state intervention, and look more closely then at its distributional consequences^[vii]. In 2012, we might also do well to ask what is the character and specific role of financial markets, as constructed by the law, in the economy.

To this view, and the carping of the business press notwithstanding, India in 2012 is already largely integrated into the global economy. At the level of policy, a number of high-level government committees in recent years have advocated fuller capital account convertibility, greater financial integration and the development of Mumbai as a global financial center^[viii]. At the level of the law, foreign investors in 2000 could hold up to 100 percent ownership in most sectors, with the exception of sectors such as atomic energy, multi-brand retail trading, insurance and gambling. Looking at the numbers, the gross investment position, excluding official reserves, according to the Lane and Milesi-Ferretti database was 85 percent of GDP in 2007, up from 30 percent in 1990^[ix]. Net capital inflows were 4.55 percent of GDP between 2006 and 2010. Interestingly, two-thirds of foreign direct investment, nominally long-term investment, was provided by foreign private equity funds with decision making clearly linked to stock market valuations and prospects for exit. The recent devaluation of the rupee is perhaps only a confirmation of this trend.

Certainly, there have been false starts and contradictory positions. The government has been vilified for proposals in March to retroactively tax mergers and acquisitions going back 16 years. The government was responding to publicity from a Supreme Court decision relieving Vodafone of a 11,000 crore rupee (or roughly US $1.9 billion at late June exchange rates) tax bill on a merger with Hutchinson Essar, while simultaneously turning back on proposals to tax participatory notes, derivatives that allow foreign investors to collect the dividends and capital gains from Indian securities from registered share-holders without themselves having to register or disclose information to the securities regulator. Similarly, investors have complained that there is not the level of formalized stakeholder consultation with regards to policy changes and due process protections with regard to regulatory decisions that have been part of the regulatory landscape in OECD countries since the American New Deal in the 1940s^[x].

Public discourse on the Indian economy suggests a few competing narratives and questions. Is the all-powerful Pranab Mukherjee leaving the Finance Ministry for the Presidency at least in part due to the displeasure of business lobbies? Is inequality ameliorating as controversially suggested by the Planning Commission or widening? Are the years of 9 percent GDP growth the now-lost legacy of liberal reforms or a chimera induced by surplus global liquidity? And what is the political economy of support and resistance to liberalisation? Yet leaving aside positions on these charged topics to one side for now, one point to be made - a point perhaps widely accepted and yet not reflected in most representations of the law - is that the political compromises, resolutions and distributional outcomes of these matters will be codified in and actively shaped by the law.

[i] Debroy, Bibek (2012): ''We stupid brutes.'' Economic Times. (27 June 2012). Viewed on 27 June 2012
(http://blogs.economictimes.indiatimes.com/policypuzzles/entry/we-stupid-brutes).

[ii] See, Bebchuk, Lucian and Robert J. Jackson, Jr., (2012): ''Should the SEC Tighten its 13(d) Rules? The Harvard Law School Forum on Corporate Governance and Financial Regulation (27 June 2012). Viewed on 27 June 2012 (http://blogs.law.harvard.edu/corpgov/).

[iii] Securities and Exchange Board of India (2012): ''Ownership and Governance norms for Market Infrastructure Institutions.'' PR No. 66/12. (21 June 2012).

[iv] Securities and Exchange Board of India (2012): Streamlining of the consent process.'' PR No. 63/2012. (25 May 2012). Charges of insider trading, front running and failure to make an open offer can no longer be settled through the consent process. This limits the flexibility and discretionary power of SEBI, acting as a prosecutor, in settling these kinds of violations. SEBI would either have to establish these violations through full-fledged civil or administrative proceedings or not bring these cases.

[v] For example, the International Swaps and Derivatives Association or ''ISDA'' promulgates master agreements and offers model language for derivatives contracts that have been the subject of much consultation, deliberation and review by government officials and private sector stakeholders in the association. While ISDA is not a government entity, the incorporation and enforcement of these terms in contracts by courts or by internalization of these norms is necessary for derivatives markets to operate with any regularity. See generally, Riles, Annelise,(2008): ''Relations: The Anti-Network: Private Global Governance, Legal Knowledge, and the Legitimacy of the State,'' American Journal of Comparative Law, 56: 605.

[vi] See generally, Harcourt, Bernard E. (2011): The Illusion of Free Markets: Punishment and the Myth of Natural Order (Cambridge and London: Harvard University Press).

[vii] In considering the ritual call to growth, certain increased production and income is to be valued, though perhaps a better discussion would involve the ideological uses that ''growth'' is put to, or examinations of growth in light of alternative values such as distribution or ecological sustainability.

[viii] See generally, Report of the Committee on Fuller Capital Account Convertibility, 126 (2006) (Commonly known as the Tarapore Committee); Committee on Financial Sector Reforms, A Hundred Small Steps 35 (2009); The High Powered Expert Committee on Making Mumbai an International Financial Centre (2007) (Also known as the Percy Mistry Committee); Report of the Working Group on Foreign Investment (2010) (Also known as the UK Sinha report).

[ix] Shah, Ajay and Ila Patnaik, ''India's Financial Globalisation.'' Working Paper, National Institute of Public Finance and Policy, No. 79 (2011): 5.

[x] See, UK Sinha report, 55-65. The US Administrative Procedure Act specifying the procedures that administrative agencies of the federal government must follow in creating regulations was enacted in 1946. All stakeholders are, of course, not equally positioned, though this is a question for another article.