Winter Advisory Forum

1
Winter Advisory Forum

• 19 November 2007
• Dali Universe
• County Hall Gallery
• Modern Masters

2
Principles-based regulation a broad-brush
approach?
Martyn Hopper Herbert Smith LLP
3

• Ours is an age of substitutes instead of
  language we have jargon instead of principles,
  slogans and, instead of genuine ideas, Bright
  ideas
• Eric Bentley, New Republic (1952)

4
Background havent we been here before?

• Principles-based regulation is not new
• Takeover code
• Other forms of professional regulation
• Power to make Principles introduced in financial
  regulation by Companies Act 1989 New Settlement
• FSA implemented current Principles as rules under
  Financial Services Markets Act 2000
• The scheme of the FSA Handbook at N2
• Tiered structure principles fleshed out by
  rules and guidance
• Principles, rules and standing guidance subject
  to consultation and cost-benefit analysis
• Enforcement on the basis of principles would be
  rare

5
What is more principles-based regulation?

• Standard setting
• A move towards greater reliance on broad-based
  standards rather than detailed rules
• Greater reliance on informal FSA guidance
• FSA confirmation of industry guidance
• Outcomes-based regulation
• Increased focus on outcomes
• Outcomes specified in the Principles and by the
  FSA informally
• Greater freedom/flexibility for firms as to how
  those outcomes are achieved
• A more managerial approach to regulation
• Greater onus on firms/senior management to
  determine
• what the Principles / outcomes mean for their
  business
• what particular processes and procedures are
  required to deliver those outcomes
• Construction, implementation and documentation of
  internal review processes is increasingly
  important

6
Why is this happening? What are the benefits?

• Drivers for change
• Better regulation agenda
• Perceived failure of prescriptive regulation
• PBR has achieved some success
• Benefits
• Focus on regulatory goals rather than box
  ticking
• Flexibility for firms
• Better fit with business practices
• More engagement from senior management and
  business
• More efficient regulatory outcomes
• Responsive to changing, innovative markets

7
Challenges and pitfalls

• Certainty, predictability and consistency
• In standard setting
• In supervision
• In enforcement
• Proliferation of guidance
• Increased reliance on informal guidance from FSA
• Confirmation of industry guidance
• Increased significance of enforcement actions
• Accountability and regulatory creep
• Prescription by the back door?
• Use of informal guidance to effect significant
  change without formal consultation or CBA?
• Blurring the line between minimum standards and
  best practice?

8
Challenges and pitfalls (2)

• Legal obstacles
• EC law (eg need to implement detailed MiFID
  requirements)
• Possible public law challenge to guidance
• Risk of divergent interpretations of Principles
  by
• FSA
• Financial Services and Markets Tribunal
• Financial Ombudsman
• The Courts
• Section 150 FSMA
• CP07/9 proposals are controversial
• MiFID derived principles-based requirements would
  be in scope
• Will this lead to more litigation?
• Will the Principles remain outside section 150?

9
Does the Emperor have any clothes?

• FSA Principle 2 due skill, care and diligence
• Behavioural not outcome based
• Fault based
• How is it enforced?
• Self-assessment / Supervision / Enforcement
• In an enforcement action, FSA must particularise
  breach
• Where does FSA look for standards?
• Other rules and guidance?
• Old rules and guidance?
• Informal guidance / confirmed industry guidance?
• The firms own policies?
• Experts?
• Past enforcement cases?

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What will PBR mean in practice?

• Establishing FSAs expectations is more
  challenging
• Need to keep abreast of broader range of sources
  of guidance DPs, FSA reports on thematic work,
  Dear CEO letters, speeches, industry guidance,
  enforcement decisions etc
• Changes in regulatory policy through
  re-interpretation of Principles
• Change in nature of supervisory relationship
• Developing compliance policies and procedures is
  more
• challenging
• Simply hard-wiring specific FSA rules into
  internal processes is not enough
• A more holistic, judgemental process
• Engagement of senior management and the business
  is even more critical
• Enforcement
• Use of informal FSA/industry guidance
• Use of firms own internal policies and
  procedures
• Use of industry experts
• Scope for greater debate as to what the
  Principles mean

11
PBR a new approach to compliance?
12
An integrated approach to compliance?