17th March 2009

Goodbye "principles", Hello "outcomes"

Hector Sants, chief executive of the Financial Services Authority says the regulator will be moving away from a principles-based regulation towards a more "outcomes-based regulation".

Well, after all that effort and expenses, what was the point of moving toward principles based regulation in the first place. This whole process seems to suggest a state of self delusion with a mindset of “what can we spend someone else’s money on next to justify what we do” rather than getting the model right!!

Sants is quoted by Mortgage Strategy as saying “Historically, the FSA characterised its approach as evidence-based, risk-based and principles-based. We remain, and must remain, evidence- and risk-based but the phrase 'principles-based' has, I think, been misunderstood.”

Not by the IFA community who have understood it very well. For most if not all IFAs it was flawed from the start. Regulation requires focus and structure to provide a framework to judge what is good or bad in relation to clearly defined standards and expectations when things go wrong.

IFAs have for a long time expressed concern about retrospective regulation and the prospect of principles based regulation was laying an unmarked “Hindsight” minefield of regulatory booby traps to catch those that operated in good faith to suit some pressure group agenda for review, retribution and compensation even though a business had acted in good faith, worked within the rules and observed appropriate and prudential standards of operation.

Sants says to suggest it can operate on principles alone is illusory particularly because the policy-making framework does not allow it. This is a case of the FSA living in “Ivory Towers”. Does he have any idea of the real world that IFA businesses in particular have to operate in? It is certainly not in the environment of “smoke and mirrors” that would appear to be the case with the FSA.

How is it that only now have the limitations of principles based regulation been recognized? Sants goes on to say that he “continues to believe the majority of market participants are decent people; however, a principles-based approach does not work with individuals who have no principles.”

Correct, that is why rules provide the tracks to run on and it is those individuals who should be rooted out. Efforts should be focused on that mission and not some esoteric process thought out by an ever growing and unaccountable bunch of lawyers and accountants striving to justify their existence, inflated incomes and self propagation.

Sants says “what principles-based regulation does mean and should mean, is moving away from prescriptive rules to a higher level articulation of what the FSA expects firms to do. This will of course carry significant risk and our (FSA) judgments will necessarily not always be correct with hindsight. In other words, it helps emphasise that what really matters is not that any particular box has been ticked but rather that when making decisions, executives know they will be judged on the consequences - the results of those actions”.

That is not unreasonable until we look back on the application of retrospective regulation based upon the benefit of hindsight by organisations like the FOS as well as the FSA. It seems the application of benefit of hindsight only applies in the support of one directional plane.

Sants adds: “If we are an 'outcomes-focused' regulator two questions then arise. Firstly, what do we mean by that? Secondly, how do we deliver it or what is our operating model? Explaining what we mean is best achieved by contrasting it with the past. The historical philosophy was that supervision was focused on ensuring that the appropriate systems and controls were in place and relied on management to make the right judgements.”

The future of regulation is that the FSA will seek to make judgements on the judgements of senior management and take actions if in its view those actions will lead to risks to our statutory objectives.

So what have the FSA been doing over the years since it was given regulatory powers?

Sants has warned that he is determined to ensure people are frightened of the FSA yet he believes that too aggressive intervention will stifle innovation and arguably reduce risk to a level that inhibits economic prosperity and that this is the preference of society and possibly will always be what society as a whole expects regulators to be doing. Indeed, it was what they thought we were doing."

I suspect he is right in this regard, but if this is what the public believed the FSA was doing, what was the FSA actually doing? Should regulation be “threat or fear” based? We need your answers please. Send to help@panaceaadviser.com or post in our forum.

Mr. Sants has now blamed Gordon Brown for contributing to the economic crisis. Coming close to accusing him of stoking the credit-fuelled housing boom and bust, with the pro-debt view of government ministers giving rise to the structural failures that led to the current crisis, I suspect that Mr. Sants will soon be on garden leave with a healthy redundancy and inflated pension package to follow.

If so, will the next snout please approach the trough?

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