What Makes Good Financial Regulation? (1) | Independent Newspapers Limited
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What Makes Good Financial Regulation? (1)

Posted: Nov 8, 2016 at 9:14 am   /   by   /   comments (0)

By Seun Onatoye

I was invited by a group of scholars to participate in the discussion of what makes a good regulation.  There are two compelling reasons why I accepted the offer to participate on the panel. First, I hope share some perspectives from my experience of regulator over the years and the insights I have gained from my work. Secondly, as a regulation researcher, I firmly believe that good regulation must start with a clear understanding of the objective; and this necessitates a trilateral dialogue between regulators, the regulated community, and the beneficiaries of regulation.

My immediate response to the question of “What makes good regulation?” is actually very simple – “Good Regulation serves the public interest through supporting ongoing confidence in processes, such as the market process, in which the public participates and in activities, such as auditing, on which the public relies”. Let me start by outlining why I see regulation as necessary to support confidence in markets, and trust in the reliability of financial reporting and financial services generally.

To this end, I also plan to explore the issue of whether regulation should take the form of high-level principles or detailed rules, as well as making some observations regarding self regulation and external regulation.

As a very basic premise let me say that regulation must act, and be seen to act, in the public interest. But for good regulation to deliver public interest results it must take into account different and often competing aims and objectives. This necessitates that I address some criteria that may be useful in assessing whether particular regulation is “good”.

  1. Trust & Confidence

Markets function more effectively when supported by an underlying sense of trust. I don’t need to justify this statement with a complex explanation of economic decision making theories. As employees we trust that we will receive payment for our services. As employers we trust that those we employ will provide the services for which we pay. As investors we trust that those we engage to act according to our interest will do so. The maintenance of trust and confidence depends not only on promises but more importantly on consistency of actions.

Regulation is an outcome of the way society perceives and responds to risk and to excessive risk taking. Regulation may be defined as the combination of organizations, rules, and sanctions that result in behaviours consistent with orderly markets, accountability, transparency and stability. A major objective of regulation is to safeguard the public interest by maintaining protection of economies from systemic risks, and protection of market participants from unwanted, opaque or unacknowledged private risks. This applies especially to investors who feed the markets with their savings. It is in that context that good regulation should be viewed as a driving force for reliable and high quality financial services.

Regulatory reform, more often than not, is a response to widespread perceptions of inadequacy of existing systems, and to crises when they happen. Whether we like it or not, very clear problems do require urgent action to avoid a complete loss of trust and confidence that would undermine the entire market system. In the same way that air will move swiftly to fill a vacuum, regulation too increases swiftly to fill a perceived vacuum in governance, transparency, accountability or confidence.

So my first question to you is the following: As a profession can you do more to ensure an improvement in quality and an ongoing positive perception of the quality of financial reporting?

Principles versus rules

There has been significant debate about the relative merits of principles and rules that would tend to suggest that the two approaches are mutually exclusive. This is certainly not the case. Principles often include rules to assist in their implementation. Similarly, rulebooks often contain options where different actions and potentially quite different results still meet the objectives of the rules.

Personally, I prefer the use of principles to guide the actions of individuals and groups rather than establishing detailed sets of rules.

We can be confident that some people will ignore legal requirements regardless of their form of expression. Others will look to circumvent the law by acting within its letter but ignoring its spirit, exploiting small print and loopholes. However, the vast majority that aim to do the right thing will achieve that outcome equally well under a system guided by principles or by rules.