Strong Enforcement Is Condition Precedent of Principles-Based Regulation

The drive for principles-based regulation is becoming inexorable. From Sarbanes-Oxley to the European Union to the SEC to the IASB, and even to FASB, there is almost universal support and striving for this Holy Grail of regulation. Recently, John Tiner, the chief executive of the UK Financial Services Authority delivered remarks that were really about the philosophy of financial regulation. In that context, he had some very interesting things to say about principles-based regulation. Importantly, he emphasized that strong enforcement is a fundamental counterweight to the freedom that comes with a principles-based regulatory system. And he is absolutely correct in this brilliant observation. It is really a warning that principles-based regulation is not going to be easy.

Make no mistake; the FSA is a firm advocate of principles-based regulation. But, according to the chief executive, both regulator and regulated must be bold enough to accept some uncertainty and ambiguity in the new regime and manage consequent legal risks for the good of the financial markets. There must also be a good degree of trust between the regulator and the regulated and the regulator must have the market insight to make good judgments. Realistically, the former CESR-Fin chief believes that there will always be a combination of principles and detailed rules in the regulatory tool box.

The senior official also points out that both regulators and the regulated community finds a sense of safety and security in detailed rules that define the scope of their legal exposure. I believe that is a true statement. And I will go further. I believe, as some other regulators have said, that many people advocate principles-based regulation but, at the end of the day, they want the certainty of prescriptive rules. This is a very important debate that goes to the very heart of financial regulation. It will not be resolved any time soon. But John Tiner, one of the most thoughtful financial regulators on the planet, will have an important role to play in the debate.