The challenges (and opportunities) facing firms operating under a principles based regulator…

18th February 2021 by Brielle Hewitt

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The puzzle, operating under principles based regulator

Principles-based regulation is intended to bring common sense to compliance, creating a culture of accountability within the firms regulated by the FCA, but all too often it leaves questions of regulation too open to interpretation.

The idea of principles-based regulation was adopted by the FCA as a way to ensure the UK’s financial services sector was well-regulated without losing its dynamism. As then-FCA Chief Executive Andrew Bailey noted in a 2019 speech, regulation governed by principles is better able to adapt to changing environments. A rules-based approach to the regulator’s three interlocking objectives – protecting consumers, maintaining the integrity of the financial system and promoting competition – would inevitably end up privileging one over the others.

A prescriptive approach runs the risk of being too broad, and therefore hampering dynamism, or too narrow and failing to control the behaviours it aims to regulate. By setting out principles, rather than concrete rules, regulators can foster a culture where firms are thinking about the spirit, rather than the letter, of the law.

Unfortunately, at times, the principles based approach suffers from the opposite problem. High level principles can leave people none the wiser as to their obligations. Firms should make sure their compliance is effective, proportionate, and evidence-based. No-one would argue it should be any different, but often these things are only definable once you have seen the opposite. And by then, it might well be too late.

There are also issues around accountability. The flexibility that makes a principles-based approach so appealing – especially in a market as dynamic as post-Brexit Britain aims to be – can also make it difficult to enforce. If rules are there to be followed, principles are there to be interpreted. Referring back to Andrew Bailey’s 2019 speech, attitudes towards what constitutes the public interest might change dramatically over time. Pre-2008, one could reasonably make the argument that light-touch regulation led to a rising tide, which would benefit everyone. That attitude has since changed considerably.

Without clear guidance, a principles-based approach gives rise to herding behaviour. Reasoning from first principles can be risky, so firms fall instead on what their peers are doing, even if it fails to adhere to the principles.Take random sampling for example, the high costs of recording and sampling have long been criticised as disproportionately expensive for small firms, while the low conviction rates speak poorly for its effectiveness. Until recently, effective monitoring and supervision systems were accessible only by tier one banks.

Katherine Leaman, Managing Director at regulatory consultancy Leaman Crellin, said that while many firms appreciate the flexibility of a principles-based approach compared to the inflexibility of black and white rules, “it leaves them exposed to hindsight where if the regulators – or indeed society – sees something it does not like then it will shoehorn a regulation to fit the perceived misdemeanour”.

She added that the challenge in regulated markets was making the principles both practical and relevant, which is where Leaman Crellin works with clients to understand the grey areas and develop their own internal guidelines.

“The relationship between firms and regulators right now is like a parent-teenager relationship,” said Steve Bennett, cofounder of Distributor Due Diligence. “The regulator says ‘do this’, the industry says it can’t. The regulator changes things, the industry says it can’t.”

This inevitably leads to the regulator putting their foot down and forcing the industry to comply, he added, although frequently the solution they adopt is sub-optimal.

So what can be done?

The problems firms are facing are problems both of direction (knowing what to do) and execution (having the resources to do it). We see the solution coming in three parts: collaboration, leadership and technology.

Collaboration

It is clear that if firms are going to get to grips with their regulatory obligations, especially in such a changing environment, they are going to need to work together. There needs to be opportunities for financial services organisations and compliance, risk and governance (GRC) professionals to share their knowledge and experience. The landscape is constantly changing, and firms that are able to learn from one another will be far better equipped to keep up.

We can already see this beginning to happen with strong voices on social media and  professionals using blogs, websites and virtual panels to share their experiences. However, we believe there is more to be done here, and are hard at work on a solution that could push the whole industry forward. More to come on this soon…

Leadership

As we noted in a recent article, perception of compliance professionals within their firms often still has a long way to go. Properly implemented compliance can lower risk, enhance competitiveness and make firms more appealing to institutions, but too often GRC teams are viewed as a necessary evil, rather than a valuable asset to their organisations.

This requires cultural change from within, and that needs to come from the top. Management must take personal responsibility for elevating GRC within their firms. This happens at a cultural level, by working to instill and cultivate the idea of compliance as an asset rather than a must have. However, it can also happen at a more formal organisational level, with more investment in education and up-skilling to bring staff up to speed.

Technology

Firms shouldn’t be in doubt about whether they are doing enough to meet their regulatory obligations. It doesn’t have to be this way. Up until now, the constraints of size have meant that small and medium-sized firms have been forced to choose between approaches that are effective, and those that are proportionate – often ending up with neither. The advancement of technology, and the ability to share experiences, challenges and best practice through multiple mediums changes that. Here at Fingerprint, we are able to be an important component in the solution that is necessary for your firm to push forward into 2021 and beyond. Effective monitoring that does not rely solely on human judgement, but automates menial tasks and empowers through reporting, gives us humans the time and drive to use our ‘human skills’ to do our jobs better, and add value in new ways.  These technologies are becoming more accessible and cost effective by the day, as Fintechs and Regtechs collaborate and find new ways of working with, and supporting their clients. Here at Fingerprint we have striven to create a voice and electronic communications monitoring platform that is both powerful and efficient, while being cost effective. Utilising the Fingerprint platform will empower your firm, by freeing up users time to add value to their firms in different ways.

Even the smallest firms can sign up and implement our systematic, scalable platform and know they and their clients are protected, and will continue to be protected as they grow. I can take you through how Fingerprint can help your firm move away from manual, ineffective process, and empower your compliance team to find more effective ways of running day to day. Drop me an email: robert@fingeprint-supervision.com


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