Regulation that encourages innovation
Abide by a set of basic principles and, as an overseas investor, you’ll find few barriers to innovation in the UK. That’s because UK regulation is based on principles rather than rules. The regulator recognises that principles-based regulation allows more flexibility. For example, investors don’t need approval for each and every new product they produce.
The point of financial services regulation is to promote “efficient, orderly and fair markets” – not to stultify competition. Aligning business with the principles of good management, UK regulation focuses on the proportionate management of risk.
The fact that the regulator operates independently of political interference means that it’s also, above all, fair. With regulation covered by a single legislative framework, the financial services regulator both operates outside the government sphere and independent of the central bank’s monetary policy role.
- Market-friendly regulation
The UK’s principles-based approach places the emphasis on regulatory outcomes rather than prescription – an approach better adapted to changing market conditions because it eliminates the need constantly to update rules. In addition, principles-based regulation fosters innovation by enabling new financial products to be brought quickly to market without their developers needing to secure product-by-product approval.
The 11 regulatory principles set out by the Financial Services Authority, the regulator, are principles of good management – from financial prudence to fair treatment of customers. Compliance is designed to be part of the regular management process, which is why the FSA provides firms with the flexibility to decide which controls they need to operate to ensure compliance.
In a speech at the 2008 FSA Retail Firms Conference, chief executive Hector Sants said: “The regulatory framework is not designed with the intention of ensuring that any given institution cannot fail. This would involve a degree of regulatory caution, and regulatory intervention, which would severely restrict innovation, to the cost of us all. The freedom to innovate allows firms to take risks which, in turn, means that some may fail.”
The upside is that the fact they’re free to take risks is precisely why so many succeed.
“We are an evidence-based regulator,” said Sants. “We seek only to intervene, and intervene in a cost-effective way, where there is evidence of market failure and where the market itself cannot provide the necessary solutions. We are and remain a risk-based and evidence-based regulator.”
In other words, the FSA intervenes where necessary – never for the sake of it.
The FSA bases its operation on a set of clearly set-out regulatory principles – among them, efficiency, proportionality and innovation. Its approach is only to impose restrictions where it can demonstrate the benefits will be proportionate to the action taken. Each proposed regulation undergoes a cost-benefit analysis that includes costs to businesses and consumers.
Senior managers, rather than regulators, are responsible for complying with legal requirements “to guard against unnecessary intrusion by the FSA into firms’ business”.
This is how it works: the regulator sets out the outcomes firms need to achieve – then lets the firms’ managers decide how they achieve them.
“Principles-based regulation means, where possible, moving away from dictating through detailed, prescriptive rules and supervisory actions how firms should operate their business,” said the FSA’s Michael Ainley. “A principles-based system gives firms greater flexibility in the way that they meet our regulatory requirements.”
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