Principles-Based Regulation (1/2)

Principles-based regulation and rules-based regulation are two different regulatory approaches. The former sets out the regulations in terms of high level principles and defines violation by outcomes (e.g. a case of unfair treatment of customer is found). The latter makes regulations as specific rules and identifies violation by "box ticking" (e.g. failure to take a step required by the rulebook is identified).

Last week FSA published its proposals for a radical simplification of the rules that firms must follow in carrying out investment business with customers. The reform of the Conduct Of Business (COB) rules is a flagship project for FSA in the move towards more principles-based regulation and away from detailed prescriptive rules.

FSA's Conduct of Business rules for investment business have been in operation since the FSA took on its regulatory responsibilities in December 2001. The rules cover, among other things financial promotions, how firms provide information and advice to clients, non-advised services, and dealing in and managing investments. The new COB rules are strongly in favor of high level principles.

FSA also set out plans to encourage greater use of Industry Guidance to help their members understand and follow good practice in meeting regulatory requirments. A Discussion Paper sets out the FSA's thinking on the role of Industry Guidance in a more principles-based regulatory structure. The paper:

• recognises that industry guidance is not new, but already exists in different parts of the regulatory system;
• makes clear that industry guidance will supplement rules not replace them;
• sets out a standard process for FSA to recognise industry guidance;
• makes clear the standards that will be applied in recognising such guidance; and
• confirms that the FSA will not take action against a firm which has complied with recognised guidance covering the issue concerned.

The move toward principles-based regulation means focusing on the outcomes that really matter rather than on procedural box-ticking. It also gives firms the flexibility and innovation to achieve those outcomes in the context of their particular business models.

As a compliance officer, which regulatory approach do you prefer?