Principle-based regulation has been the fashion for some years, not least in the financial services sector.
The FSA says principle-based regulation is proportionate, efficient, effective and, above all, flexible, although it has to be said that the regulator never did quite wean itself off detailed rules.
On the surface, there is much to welcome in this approach. The regulator says what outcomes are to be achieved and firms are free to decide for themselves how to achieve them. Much better than a top-down, rule-driven approach surely.
However, there is a limit to how far the principle-based approach to regulation can go. That limit may be tested in the judicial review being brought on behalf of the British Bankers’ Association to challenge the FSA’s policy statement on redress of payment protection insurance complaints.
The claim asserts that a breach of principles, which the FSA argues justifies its policy on redress, cannot create legal liability. The principles are too vague, it is said.
Making firms liable to pay compensation as a result runs contrary to the principle of legal certainty, which is an essential component of the rule of law itself. A stable and predictable regulatory environment is also a key commercial requirement. Firms need to know where the boundaries are and that everyone is playing by the same rules.
Has the BBA discovered a magic bullet? Is the FSA’s house built on sand? Well, maybe. There are limits to principlebased regulation and it is not always obvious that regulators take this seriously enough. The need for legal certainty is real. It may be difficult to anticipate where or what rules may be needed but that alone cannot excuse a regulator from at least making the attempt.
Further, there is an inherent danger of retrospective regulation in a regulator relying heavily on principles applied after the event. The danger is even more stark with the current buzzword of “outcome-foc-used” regulation, which seems positively to invite a retrospective approach.
Standards change over time. It requires backbone to make due allowance for the wisdom of hindsight when the tabloid press, claim companies and the Financial Ombudsman Service are breathing down the regu- lator’s neck. Many firms feel the FSA knew all about how PPI was being sold. If the breaches it now claims took place were so serious, why did it do nothing at the time, for example, by amending its rules to make the position clear?
It will be interesting to see what the FSA’s answer to this is although it has to be said that the BBA will have to do better than “you should have caught us earlier” if it wants to win the court’s sympathy.
More broadly, does the PPI saga highlight a general weakness in principle-based regulation? Good regulation secures up-front compliance, a point which the FSA says it acknowledges in adopting “outcomefocused” regulation.
A sanctions’ regime is clearly necessary but it should be mainly a deterrent. It is better for the public and for the industry if there are no breaches rather than that breaches are compensated. The FSA’s regulation has failed against this objective. The failure is not trivial, with costs of anywhere up to and in excess of £3.2bn. Even if the FSA successfully defends itself this time in court, it must shoulder its share of the blame for allowing the industry to get into this position.