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Regulation by rules or principles? Discuss

  • 02/02/2017
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The Financial Conduct Authority has thrown open several questions to the industry as it looks to shape its mission statement, one of which firmly divides opinion; regulation by rules or principles? Samantha Partington investigates.

It is one of four themes which emerged from the regulator’s consultation which rolled into a second phase, seeking details from its stakeholders on how challenges like the application of regulation should be tackled.

The FCA said some respondents to its consultation wanted clear sets of principles rather than prescriptive rules while others preferred more clarity on existing rules as they were too vague, leading the regulator to ask: “In which circumstances are prescriptive rules or higher level principles more appropriate?”

Regulation by gossip

David Carrington, sales and marketing director, Personal Touch Financial Services, describes the FCA’s principles-based approach as ‘regulation by gossip’. He says the move away from regulating by the rulebook which began under the stewardship of the Financial Services Authority has created a regulatory environment which is in some cases is too vague. He sees the trends in regulation as coming full circle. “Regulators in the life assurance sector, around before mortgages were regulated, were rulebook driven, and when they merged into the Personal Investment Authority, it continued this style,” says Carrington.

“When the Financial Services Authority came along it moved towards principles and this was continued by chief executive Martin Wheatley. Now we see his successor Andrew Bailey’s influence coming from the rulebook-background of the Prudential Regulation Authority, which I hope will add a better balance to the FCA’s style of governance.”

In Carrington’s view, any aspect of financial services which relates to people, customers or advice should be dealt with by principles because ‘everyone is different’. “There may be a scenario where a customer is trying to do something but is unable, because it is against the rules despite being in the customer’s best interests,” he adds. Areas related to business, for example capital adequacy, are better suited to rules. Rules, says Carrington, can be bent whereas principles cannot.

Principles such as conducting your business with integrity and observing proper standards of market conduct are hard to wiggle around, however, the more the specific the rule the easier it is for lawyers to find a way round it.

Martin Reynolds, chief executive, Simply Biz, says he would welcome the use of prescriptive rules in some elements of mortgage regulation as long as they were clearly marked up as being rules. “If you are going to use a mix, it needs to be clear which is which so there is clarity for the advisers. If it is left too vague, this will lead to confusing expectations.”

Blunt instruments

The mortgage boss of a lender, who preferred to be remain unnamed, described rules as a blunt instrument as not all businesses are the same and added that he wanted to remain operating in a purely principles environment. He says he would be surprised if the regulator was keen to switch to a rules-based system. “Regulators don’t want to write down rules because they end up running your business for you and making your credit decisions.”

The Council of Mortgage Lenders (CML) agrees that mortgage regulation by rules will not achieve healthy market outcomes. “We want firms to spend more time understanding and responding to the spirit of what the regulator wants, rather than poring over the wording of the rules and trying to avoid a technical breach,” says Bernard Clarke of the CML.

“The regulator can help encourage this approach by signaling more clearly what the outcome is that they want. The emphasis should be on what the regulator wants to achieve, rather than a technical breach of the rules.”

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