Wednesday, April 18, 2007

UK FSA Officials Discuss Principles-Based Regulation

By James Hamilton, J.D., LL.M.

Principles-based regulation places the responsibility squarely on the shoulders of a firm’s senior management, said UK Financial Services Authority CEO John Tiner, since senior managers are in a position to judge how best to deliver the outcome that will satisfy investors and the markets. At the same time, the principles-based regime will give senior managers greater flexibility to decide how to do this in the most cost-effective way.

The CEO called the FSA’s move to principles-based regulation an audacious step involving firms, investors and the authority. Analogizing the implementation of principles-based regulation to a movie production, the official cast the industry in the lead role, with the FSA in the director’s chair. However, he also said that there will still be many rules for those who take comfort in prescription. This statement dovetails with recent remarks by FSA Chair Callum McCarthy that UK financial regulation will remain a mix of principles-based and rules-based regulation.

I consider John Tiner to be one of the most thoughtful regulators on the planet. That said, I believe that even he is having a hard time fully explaining what a principles-based regulatory regime will look like and how well it will function.

But make no mistake, principles-based regulation is on a roll and many people have jumped on the bandwagon. I also believe that it is an elusive concept with no consistently acceptable definition.

Principles are themselves rules, explained FSA Deputy Chair Deidre Hutton, they set forth the outcomes the FSA expects firms to deliver. That is an interesting statement. Given that rules and principles will co-exist in the new regime, she continued, the FSA is going to rebalance the mix between principles and detailed rules and tip that balance significantly towards a more principles-based approach. In her view, the trick is to strike the right balance between helping firms to meet their responsibilities and being overly prescriptive. And that balance will vary from one area of regulation to another.

Weighting the balance towards principles is proper, noted the deputy chair, since detailed rules allow firms follow the letter but not the spirit of such rules. Moreover, detailed rules cannot cover every circumstance and are not responsive to market innovations. They also foster a narrow approach to compliance. That was well said by the deputy chair.