Principles-Based Regulation (2/2)

FSA Chairman expressed in his recent speech that FSA would not move to a regulatory regime based exclusively on principles. There is always a balance between general principles and specific rules. Nevertheless, such a shift would make regulatory enforcement more subjective, but may not reduce the compliance cost.

From the legal / compliance perspective, rules-based approach is definitely making the compliance work easier because the regulations are more certain and so less judgmental. The compliance officer can simply reproduce the specific rules to a checklist and conduct the monitoring by box ticking. This kind of regulation would lead to a large number of "technical breaches" which do not cause any harm to the customers and the market.

On the other hand, the business people would prefer principles-based approach as it is more "flexible", where they can push for a "favorable" interpretation and enforcement of the principles. This would create more confrontation between business units and compliance function.

For example, "treat customers fairly" (TCF) is high level principle always emphasized by FSA. But how many steps are considered sufficent to ensure TCF? Compliance officers may prudently highlight 10 necessary steps, while the sales team may argue that only 8 steps are enough. Eventually the compliance status is judged by the regulator by the "outcome" (e.g. a customer complaint for unfair selling process). The problem is how the compliance officer could anticipate the outcome and convince the management beforehand.

So that's why high level principles must be supplemented by industry guidelines to facilitate the interpretation. In HK, SFC has heavily relied on rules-based regulations, especially in the areas of operational issues (e.g. safeguarding of client assets). To cope with the complex and ever-changing market practices, I think SFC should issue more practical industry guidelines for different regulated activities. As a minimum, the "Management, Supervision & Internal Control Guidelines" should be updated or even re-written.