The process by which fashions change in the regulatory world, as in life, is an interesting one. Gradually, almost imperceptibly, ideas develop from initial theoretical suggestion until, having generated a momentum of their own, they become common currency. Such is the status, it would now appear, of the concept of "principles-based regulation".
Put short, the idea is that regulation is more effectively achieved, to the benefit of all participants and stakeholders, if detailed rules are replaced, at least to some extent, by high-level principles. The Financial Services Authority ("the FSA") is driving this apparent sea-change in regulatory thinking and published an outline of its strategy on this subject earlier this year (see http://www.fsa.gov.uk/pubs/other/principles.pdf). This initiative has been seen to inform the thinking of a range of professional bodies and regulators, including a number of those in the financial and legal services sectors.
The potential benefits of a more principles-based approach to regulation are clear and have been widely discussed. The FSA in particular has emphasised the merits of a more outcome-driven approach, in terms of which the desired objectives are clear and transparent, for members and consumers alike. Its 11 "principles for businesses" are a list of simple and accessible statements, including for example, an obligation on a firm to "conduct its business with integrity" and to "pay due regard to the interest of its customers and treat them fairly". These are requirements with which it would be difficult for anybody to take issue and, crucially, will be likely to make sense to consumers.
At the same time, a move towards higher-level principles-based regulation allows, says the FSA, for a more flexible and durable approach, which will not require wholesale rule revision with every new development in the financial services field. The underlying principles to be adhered to will remain unchanged. The attractiveness of this approach, focusing in particular upon the move away from detailed, voluminous and unwieldy rulebooks, is obvious.
The potential burden
With an increased emphasis on higher-level principles - contrasted with detailed rules - inevitably comes an increased responsibility on firms/professionals. The FSA explicitly recognises the increased responsibility this approach delegates to its regulated firms to interpret the principles to ensure compliance in the course of day-to-day practice. It is envisaged that the practical question as to what is required in any specific circumstance will no longer be spelled out by the regulatory body to the same extent. By the same token, provided that the overall policy objective is met, it is conceivable that a range of different approaches may be considered acceptable. Whilst offering flexibility, however, the interpretation of principles and development of appropriate compliance policies and procedures will inevitably prove to be a significant burden, especially for smaller firms and sole practitioners.
A legal viewpoint
From a legal perspective, there are live questions relating in particular to enforcement. Effective regulatory enforcement may be impeded or - in a worst case scenario - rendered impossible, by a failure to ensure that regulated members are adequately informed of what is required or expected of them. The FSA has itself acknowledged that principles cannot operate in a vacuum and that some degree of guidance must exist to ensure that sufficient clarity is preserved for all stakeholders. The important point for regulators in this respect is to ensure that the respective status of principles, rules and other guidance is sufficiently clear, distinguishing provisions which are deemed to be mandatory from those which are intended to be of a more advisory nature, and making sure that there is a clear and consistent approach to the entire regulatory structure.
The potential attractions of a more principles-based approach are easy to grasp. However, the associated challenges will also become evident with time, with principal attention focusing on the area of enforcement. As with any significant sea-change, it is important to ensure that such issues are given proper consideration at an early stage, in order to avoid problems down the line.