4.6 The overall mission or objective of the Financial Regulator as consistently stated since 2003 was:
―To help consumers make informed financial decisions in a safe and fair market and to foster sound dynamic institutions in Ireland, thereby contributing to financial stability.‖36
Within this overall objective are a series of high-level goals one of which (number two in fact) related to micro-prudential supervision:
―Having a regulatory system that fosters safe and sound financial institutions while operating in a competitive and expanding market of high reputation.‖37
4.7 Consistent with this goal, six strategies are to be followed:
Adopting a principles-based approach to regulation;
Requiring financial service providers to assume their responsibilities;
Making the best use of supervisory resources;
Putting a comprehensive on-site review process in place;
Implementing sector-specific initiatives; and
Working in partnership with the Central Bank.38
Although principles-based regulation and supervision continues to be stressed in subsequent strategic plans and annual reports, there is some slight rewording of high-level goal two.39
- Content
4.8 There are many statements and restatements by the Chair of the Authority, the CEO of the FR and others defining principles-based regulation. A typical statement would be the following from the CEO:
―We are committed to a principles-based approach to regulation. This is achieved by the boards and top management of financial institutions committing fully to a culture of integrity, competence and best practice.
In turn, we will expect them to ensure that this culture flows throughout all levels of their organisations. It is also achieved by financial service
36 See, for example, IFSRA (2004a, inside cover).
37 See, for example, IFSRA (2004a, p. 13) where high level goal two is ―We will set and monitor standards for the running of sound financial service providers and fair markets.‖
38 IFSRA (2004a, p. 13).
39 For example, FR (2007b, pp. 31-36)
providers having compliance systems, controls and internal audit departments that have the standing and the powers to meet the standards of behaviour that we now expect of those we regulate. We set out those standards; they must invest in the system and staff to ensure those standards are met.‖40
The Chair of the Authority also pointed out that for the ―principles based approach to work there must be mutual trust, between ourselves and industry and a shared aspiration to do our best together.‖41
4.9 The Financial Regulator eventually set out nine principles to reflect what the FR expected from the financial institutions (Box 4.1). They first appeared in the FR‘s Annual Report for 200642. However, it appears that the nine principles were not the focus of any systematic checks, either desktop or on inspection; and, unlike the FR‘s principles for the protection of consumers, they were never incorporated into a unitary Code.43 Hence breaches of the general principles for financial institutions were not subject to the Administrative Sanctions Procedure discussed below.
Box 4.1: The Authority’s Principles for Financial Service Providers 1. Conduct their functions in a transparent and accountable manner.
2. Act with prudence and integrity and in the best interests of their customers at all times.
3. To maintain at all times sufficient financial resources to meet their commitments.
4. Have in place sound corporate governance structures.
5. Have oversight and reporting systems that allow board and management to monitor and control all operations.
6. Have in place internal controls that are adequate for the nature, scale and complexity of their operations.
7. Have risk management policies systems appropriate to the nature, scale and complexity of their operations.
8. Comply with any regulatory rules set down by the Financial Regulator in relation to, for example, solvency and capital adequacy, segregation of client funds, consumer protection codes.
9. When required, to produce accurate, complete and timely information.
Source: FR (2007a, p. 33).
40 IFRSA (2004b, p. 4)
41 Patterson (2007).
42 They were subsequently repeated in the FR‘s Strategic Plan for 2008-2010 (FR, 2007b, p.19). In both the Annual Report and the Strategic Plan the nine principles were introduced as guiding the FR‘s approach to regulation.
43 See FR (2006i) for the consumer principles embodied in the Consumer Protection Code. If the nine principles had been formally imposed on all firms in a general code, then the FR would have been committed to take responsibility for their supervision and enforcement. At the same time the code itself would send a strong signal to credit institutions concerning the importance that the FR attached to them in terms of prudential supervision.
4.10 The FR also noted that to assist financial ―providers to become aware of their legal obligations and to clarify what we mean by ‗principles led‘ we issued a number of regulatory rules and guidance notes ...‖ (FR, 2007a, p. 33).
4.11 Reference was made on occasion to the existence of rules in defining and discussing principles-based regulation. For example, the Authority‘s second strategic plan states:
―We believe that a mainly principles-based supervisory system will deliver a good balance between having a competitive industry and requiring high entry standards for doing business. A principles-based approach, with technical rules applied as appropriate, encourages adherence to the spirit of sound regulatory standards, without being overly bureaucratic. This continues to represent the appropriate supervisory model for Ireland.‖44
Hence principles-based regulation referred not just to the principles but also to the various rules, codes and regulations that underpin financial regulation.
- Rationale
4.12 There was relatively little discussion of the merits of principles-based regulation compared to alternatives such as a rules-based approach. However, in 2005 the CEO of the FR stated that:
―... the present Irish principles-based system mandates the broad regulatory framework within which we expect institutions to be in compliance. It sets out basic principles ... It is relatively flexible. ... It is also I would suggest, easier and cheaper to comply with. It is a model that has worked well in the Irish context.
―An alternative is a rules-based system. Here detailed rules across the whole range of regulatory powers are set out. The rules set out clearly what must be done and, importantly, what will happen in the event that something is not done. This method implies a very legalistic approach. It suggests doing things right rather than doing the right thing. It allows no scope for interpretation. It is slow to react to change. It punishes the compliant equally with the non-compliant. It suggests a system that is more costly to comply with because of detailed reporting requirements. Is it better?‖45
4.13 In the light of this rather one-sided characterisation of the two regulatory approaches, it is hardly surprising that the CEO answers in the negative. In support of that conclusion reference is made to the differing approaches to capital gains taxation in Canada and Hong Kong. In Canada much human ingenuity is spent in finding ways around the complex Canadian tax code, while in contrast, although it has no capital gains taxation,
44 FR (2006a, p. 12).
45 O‘Reilly (2005, pp. 4-5).
Hong Kong ―prevents very effectively income shifting through the use of principles -based regulation, which quite simply states that current income and profits must not be converted deliberately into capital gains to avoid the payment of taxes.‖46 In terms of enforcement a Hong Kong government agency watches over tax returns for violations.
There are few violations because ―business fully understands the principles and knows it does not pay to violate them.‖47
4.14 To a considerable extent, the rules-versus-principles debate presents a false dichotomy.
As the tax examples offered by the FR suggest, relying solely on rules is a recipe for an arms race between any regulated entities determined to find ways through the rule book, and the Regulator‘s continual redrafting of the rules. Some aspects of safe and sound banking simply cannot be codified. There must be principles to back up the rule book.
Any sensible model has both rules and principles. The more distinctive characteristic of the Irish FR‘s regulatory philosophy is rather the degree to which it deferred without much challenge to managerial decision-making in the regulated firms and relied on governance structures, and on verifying the status of formal or informal risk control procedures.