By James Hamilton, J.D., LL.M.
Anyone worried that rules will have no place in the FSA's new principles-based regime will be buoyed by the recent remarks of its CEO. While reaffirming the efficacy of principles-based regulation, particularly in light of the recent market turmoil, Financial Services Authority CEO Hector Sants said that detailed rules will remain an integral part of the regulatory regime. The FSA intends to maintain a balance of detailed rules, higher level rules, and principles. Indeed, he noted that in some cases detailed rules will continue to be the best means of delivering a regulatory outcome or mitigating a market failure. For example, consumers may benefit from rules prescribing the way in which firms provide key information to them.
The FSA’s discretion in minimizing the number of rules is somewhat prescribed by European Union Directives, observed the CEO, but he emphasized that the implementation of Directives will not compromise the move to principles-based regulation. Far from being incompatible with the principles-based approach, the Directives are often intentionally high-level and outcome-focused.
More broadly, the senior official said that a combination of rules and principles will afford firms more flexibility in their interpretation of FSA mandates. Principles-based regulation gives firms the opportunity to apply FSA requirements to their business models and make them relevant to those models.
In fact, in his view, the major consequence of granting firms this flexibility is that the FSA needs to understand the context in which firms are exercising their interpretive discretion. Just as firms will be able to interpret FSA principles in line with their business models, so FSA staff must be able to make outcome-focused judgments relating to the principles.
Thus, the key to the success of principles based regulation is that the FSA and regulated firms must work together to understand mutual aims and concerns. In that regard, the FSA needs to build lasting partnerships with the firms and the trade associations that represent them.
The FSA chief firmly rejected calls to reexamine principles-based regulation in light of recent market volatility. Quite the contrary, he emphasized that the market disturbances underline the benefits of the move to principles-based regulation. He said that principles are a more efficient and real-time means than rulemaking in enabling the FSA to meet its statutory objectives and assist firms' management to deal with the challenges they face.
Principles-based regulation means that firms are under a constant obligation to review the conformity of their business practices, he explained, whether in calm or in turbulent markets. In his view, the daily management review of questions such as whether customers are being treated fairly, whether conflicts of interest are being managed appropriately and, critically, whether business risks are being managed, should be the norm in the more principles-based world.
The FSA is not operating a no fail regulatory regime, assured Mr. Sants, adding that a successful financial marketplace requires innovation and competition, which in turn means some failures. But a principles-based regime provides the best chance of achieving the requisite balance between the benefits and risks of innovation.