Financial Services Regulation Literature Review

Financial Services Regulation literature ReviewLiterature review on pecuniary services standardConsider whether flexibility in implementation of financial services edict can undermine healthy certainty. Does a move towards principles- ground prescript of financial services presage a regulative creep without a statutory grounding or does it renounce regulators to bear on footstep with the financial services market?IntroductionRegulation is often unpopular, and may be viewed as unnecessary. However, the existence of market failure is a public in certain markets that essentials to be corrected by roughly form of government intervention. In the financial services industry, for face, there is clearly a need for some benevolent of command as demonstrated by, for example, the Nick Leeson affair or the Enron scandal. Yet such slips to a fault demonstrate the failure of regulation the regulatory systems in place did non succeed in preventing these two debacles. Hodgson (20 06247) takes a positive view of regulation, or at least of the right kind of regulation, arguing that regulation can and should be a necessary, proportional and beneficial approach to the organisation of society. It lets us police the supply of goods and services and maintain standards and resolve complaints within a properly established legal framework, but without inappropriate political involvement or, in roughly cases, resort to the courts.Financial services regulation in the UK objectivesIn the UK, the Financial Services Authority (FSA) has four statutory objectives market confidence (maintaining confidence in the financial system) public awargonness (promoting public sympathy of the financial system) consumer protection (securing the appropriate degree of protection for consumers) and reduction of financial crime ( cut the extent to which it is possible for a business carried on by a regulated person to be used for a purpose connected with financial crime). In addition, the FSA is guided by a set of principles to which it essential adhere. For example, it must use its resources efficiently, and any restrictions it imposes on an industry must be proportionate to the expected benefits of the restrictions. Further much it should avoid stifling innovation where possible. This means that the FSA must allow for different means of complaisance in order not to unduly restrict firms and industries from launching new products and services. In addition, the FSA should help to maintain the competitive correct of the UK internationally. In order to promote competition among the firms that it regulates, the FSA should avoid creating any unnecessary regulatory barriers to entry or expansion in any of the markets it regulates. Hodgson (2006251) explains that the FSA was set up to do rather a lot of things to promote market confidence and public awargonness of financial services (meaning encourage savings), protect consumers and reduce financial crime. It is also required to maintain the international success of Britains financial sector, promote competition whilst minimizing any adverse effects, and weight the costs and benefits of its own actions. potentiometer of scope for conflicts of stake there. An assessment of the move to more(prenominal) principles-based regulation must examine how such a move is likely to impact on all of the objectives of the FSA.Principles-based regulation and rules-based regulationCunningham (2007) explains that since the Enron scandal and other debacles in the financial services industry, there has been a trend to categorise rules-based regulatory systems as bad, and principles-based regulatory systems as good. However, he argues that the distinction being made between rules-based and principles-based systems is false and misleading. Cunningham (20073) claims that while an individual provision in a regulatory system may be rules-based or principles-based, these classifications are too crude to describe or g uide the design of corporate law, securities regulation or accounting systems. That is to say the terms are not scalable to the level of an entire system. Instead, Cunningham (20074) points to the necessity and value of combining rules and principles and the difficulty of designing systems warranting classification as rules-based or principles-based. While it may be the case that any regulatory system is necessarily a hybrid made up of a mixture of rules-based and principles-based individual provisions, that does not mean that some systems are not more rules-based or more principles-based than others. then this notion ties in with the reality of the UK financial services regulatory system. As will be seen below, the system is already a hybrid of rules-based and principles-based approaches, and it is moving towards more principles-based regulation.Regulatory creepThere are various definitions of regulatory creep. The Better Regulation proletariat get (20043) define it as the proce ss by which regulation is developed or enforced in a less than transparent fashion and not in accordance with our five Principles of Good Regulation. The BRTF (20045) goes on to identify four examples of how regulatory creep may occur when regulation takes place without transparency. In the starting time place, a lack of clarity about the intention of regulation, particularly goal-based regulation, both on the part of regulators and those being regulated, can lead to unnecessary compliance burdens. Secondly, the centering that way is developed and used can influence enforcement activity and compliance, again leading to unnecessary burdens that bring little benefit to those the professional regulation was intentional to protect. Thirdly, it is argued that enforcement activity can induce over compliance in those being regulated and finally, ombudsmens rulings can have wider regulatory implications. Jones (20046), on the other hand, points out that there is a positive aspect to cre ep. Formal responsibilities may leave gaps in enforcement. Shifting priorities and creative interpretation of a regulators brief may be necessary to tackle newly emergent issues.Moving towards more principles-based regulation the case of the UKThe first point to make is that in the UK, Principles-based regulation has existed since 1990, and the eleven lofty-level Principles for firms (see box 1) have been in place since 2001 (FSA 2007a4). The FSA is now talking about a more Principles-based approach. This shift is based on a move towards broad-based standards instead of detailed rules together with an increased focus on outcomes-based regulation and an increase in senior management responsibility. fit to the FSA (2007a4), Principles-based regulation means, where possible, moving away from dictating through detailed, prescriptive rules and supervisory actions how firms should operate their business. We indispensableness to give firms the responsibility to go under how best to al ign their business objectives and processes with the regulatory outcomes we have specified.Moving towards more principles-based regulation pros and consThere are clear advantages to a principles-based approach to regulation, but such an approach also carries certain seeks (of which regulatory creep is just one). The challenge is to achieve the right balance between principles and rules. As the BRTF (20046) explains, part of the attraction of goal-setting regulation is its flexibility and we do not want to discourage this. Nor do we want to discourage the use of guidance as a useful alternative to regulation for driving up standards. But where does guidance as a useful alternative in driving up standards end, and regulatory creep begin? In this section, I will review the pros of a move towards more principles-based regulation, and I will then outline the various risks or cons associated with such a move.One major advantage of more principles-based approaches to regulation is increas ed flexibility and responsiveness to innovation and market developments. de Serres et al (200632) find that financial system regulation has a statistically significant influence on output and productivity growth as well as on firm entry, via the impact on industrial sectors relying more heavily on foreign sources of funding. The economic impact is also found to be substantial enough to matter, yet sufficiently small to remain credible. This highlights the need for financial system regulation to minimise unnecessary regulatory barriers to entry or expansion in the financial services market.According to the FSA (2007a5), a principles-based system is likely to be more durable than a rules-based system precisely because of its flexibility. Financial markets are constantly changing. Continuous innovation and new product development are important ship canal in which the financial services industry generates benefits for consumers and markets. It is important that regulation can respond r apidly to the pace of change in markets and so allow them to prevent to develop for the benefit of their users. We believe regulation that focuses on outcomes rather than prescription is more likely to support this development and innovation. Any set of prescriptive rules is unable(p) to address changing market circumstances and practices at all times, and it inevitably delays, and in some instances prevents, innovation.Another benefit of more principles-based regulation is that it should provide greater freedom for firms to develop their own approach to compliance. According to the FSA (2007a7), a more principled-based approach does in practice mean giving firms increased flexibility to decide more often for themselves what business processes and controls they should operate.In addition, a move to principles implies less need for detailed rules which leads to a simplification of the rules or handbook. The FSA (2007a8) views a simplified handbook as a side benefit of a move to mo re principles-based regulation, rather than a key driver behind the move, additionally arguing that, reducing the overall size of the Handbook, however desirable, does not in itself deliver principles-based regulation. Even a substantially reduced Handbook will still be regarded by many as a daunting prospect. We should therefore not measure our success in achieving principles-based regulation by the hail of Handbook pages or the number of rules they contain, but by the effect that the Handbook review, together with other initiatives, achieves over time.Perhaps one of the most important potential advantages of a move to more principles-based regulation, if properly implemented, is a greater degree of substantive compliance as individuals and firms come to comply with outcomes and the general principles rather than on the detailed rules as the tone of voice of the law is prioritised over the letter of the law.Another key advantage is the increased engagement of senior management. The FSA (2007a12) explains that Moving towards principles-based regulation has significant implications for how we work with firms on a day-to-day basis We are looking for firms to take greater responsibility for how they meet their regulatory obligations. This responsibility in many cases will be taken on at senior management and Board level, using the various materials that will be available and, where necessary, conversations with us Firms will see a release in how we behave towards them. We will give greater recognition to firms own management and controls and this will be reflected in areas such as capital requirements and supervisory intensity. Well controlled and managed firms that engage positively and openly with us should expect to experience real benefits from our more principles-based approach in the form of a regulatory dividend, for example relatively lower levels of regulatory capital, less frequent risk assessments, greater reliance on firms senior management or a less intensive risk mitigation programme.Finally, proponents of a more principles-based approach argue that it should lead to more efficient solutions to regulatory problems. This, however, depends on the system for the resolution of any such problems and could in fact be more or less efficient with a more principles-based approach, depending on how that system is designed and implemented.A major risk associated with a move to principles-based regulation is the lack of certainty or predictability. This is a risk that needs to be managed carefully in order to ensure that firms and individuals actualize their obligations in the absence of specific rules as to how they should act. The FSA (2007a12) acknowledges the need to address this risk and explains that with a less prescriptive Handbook we are convinced that we must go further than we have been inclined to in the past in responding to firms queries. We will need to work with firms and the practitioner panels to find the right bal ance in achieving this. accountability issues are, arguably, also more likely to arise in the absence of detailed rules. Wilson (2007) explains that the FSA approach to accountability and governance issues has always been principles-based, explaining that we take a strong interest in how firms govern and organise their affairs because we take the view that if you get this right, much else follows. In doing this, our approach is generally to ask for explanations as to why the building put in place offers the necessary challenge and level of control, and where such explanations are unconvincing, to seek change that achieves a better outcome.There may also be certain legal obstacles to a more principles-based approach to regulation. Obviously any regulatory body needs to remain within the law, and in the case of the UK FSA this includes, for example, EU law. It is important to recap at this stage that a move to more principles-based regulation does not mean the abolition of all detail ed rules. Indeed the FSA (2007a20) cites European legislation as one of the challenges or constraints that will remain as they move in the direction of a more principles-based system of regulation.Finally, and most pertinent to this review, is the increased risk of regulatory creep with a move to a more principles-based system of regulation. The BRTF (200411) identify two principal means through which a principles-based approach may lead to regulatory creep. The first of these is through a possible proliferation of guidance and overzealous enforcement. High level goal-setting objectives may need further clarification. Goalsetting regulation can leave a vacuum that Government, regulators and industry will seek to fill with guidance. The guidance may stray beyond the original intention and/or it may be applied prescriptively by regulators and those being regulated. The second occurs if insufficient thought is given to how firms will demonstrate compliance with the principles, or if co mpliance staff lack adequate skills. Regulators argue that it is their job to prove noncompliance and that there is no legal requirement for duty holders to demonstrate compliance. However, compliance should not be a guessing game. Those being regulated do need to understand what is required of them in practice.ConclusionClearly there are some advantages to Principles-based regulation of financial services, but there are also some risks. There will always be a place for rules in regulation, and the key to successful Principles-based regulation is to know when it is appropriate to rely on Principles, and when to specify detailed rules. Reliance on principles requires the provision of consistent advice to firms, and a loyalty to ensure the regulators accountability mechanisms are not bypassed. These requirements in turn point to the need to ensure that compliance staff are sufficiently skilled and trained.The OECD (20054) highlights the need to pay close attention to the institutiona l setting, with a view towards fostering accountability, transparency and trust in order to achieve high quality regulation. This is the case whether a more rules-based or a more principles-based approach is taken. As the BRTF (200414) points out, it is not only goal-setting regulation that can lead to regulatory creep. A lack of clarity about the scope of any type of regulation can lead to regulatory creep.A move to more principles-based regulation has the potential to presage a regulatory creep without a statutory grounding as well as the potential to allow regulators to keep pace with the financial services market. The aim of any such move must be to realise this latter potential whilst avoiding the former.BibliographyBetter Regulation Task Force (2004) Avoiding Regulatory Creep. October 2004. London Better Regulation Task Force.Cunningham, L. (2007) A Prescription to Retire the Rhetoric of Principles-Based Systems in Corporate Law, Securities Regulation and Accounting. Boston Co llege Law work Legal Studies Research Paper Series, Research Paper 127, 13 March 2007.de Serres, A. et al. (2006) Regulation of Financial Systems and Economic Growth, OECD Economics Department Working Papers, No. 506. genus Paris OECD Publishing.FSA (2007a) Principles-based regulation Focusing on the outcomes that matter. April 2007. London FSA.FSA (2007b) FSA Handbook, Release 065, May 2007Hodgson, P. (2006) The Rise and Rise of the Regulatory State. The Political Quarterly 77(2) April-June 2006. pp247-254Jones, C. (2004) Regulatory Creep Myths and Misunderstandings, in gamble and Regulation, No 8 Winter 2004 p.6OECD (2005) Designing independent and accountable regulatory authorities for high quality regulation. Proceedings of an Expert Meeting in London, coupled Kingdom, 10-11 January 2005. Paris OECD.Wilson, S. (2007) Supervision in a Principles Based World. Speech given to the FSA Retail Firms Division Conference, London, 27 February 2007 (available from http//www.fsa.gov.uk/ pages/Library/Communication/Speeches/2007/0227_sw.shtml)