RegionsEEAEffective regulation: crafting the right fit

Effective regulation: crafting the right fit

New regulation too often has to return to the drawing board for redrafting after it proves to have unintended or unwelcome consequences for business. Can corporates and regulators work more closely together to draft rules and ensure they are fit for purpose?

Crafting new regulations to protect economies, consumers and markets from the conduct of firms operating in those markets is challenging, time consuming and fraught with political ramifications.

Regulation in the European Union (EU), in particular, is complicated by the involvement of (until 2019) 28 member states operating through a central but highly inefficient bureaucracy. Those who draft the regulations must engage with these institutions, which themselves struggle to connect with the economies and consumers they serve. In addition, the legal and governmental frameworks in which statutes and regulations are created or modified are themselves highly inflexible and slow to reform.

It should therefore come as no surprise that regulations are often subject to challenges and frequently result in unintended consequences. Implementing change within any highly complex system with the backdrop of a set of powerful, demanding and – to some extent – conflicting stakeholders inevitably results in such outcomes.

The role of regulation is to hold, to high standards, firms that would otherwise seek short-term gain at the expense of long-term value creation and prioritise profit over risk and customer value. Self-regulation too often fails as a result of these pressures; thus formal regulation and government oversight are essential. However, because regulation requires firms to change, and change takes time, it is often costly – both to implement and in terms of its impact on the business model – and it generates risk, so firms inevitably resist it. The adversarial nature of regulation is probably inevitable.

An alternative approach

Yet what if we drew parallels with the lessons of corporate change management practices and business transformation initiatives? Would it be productive to model the development of market regulation on the same strategies that many firms use to redefine themselves? Consider how adhering to the following concepts might contribute to a more productive and mutually satisfactory regulatory process for both regulators and firms:

  • Clarity of outcomes – A change programme must be absolutely clear on desired outcomes, and measuring improvement is a key test of how transparent and attainable those outcomes are. Most regulators very clearly articulate the high-level outcomes they seek to achieve.
    For example, the goal of the UK’s Financial Conduct Authority (FCA) has been expressed as “to protect consumers, protect the integrity of UK markets and enhance competition.” However, the FCA’s current consultation process recognises the effort to make these outcomes meaningful for firms being regulated and to define the means by which success can be measured. As the FCA has understood, the corporate world can assist by engaging with these processes to help create more clarity and definition, establish a set of principles and aid in determining priorities.
  • Guiding principles – Establishing a set of guiding principles is a vital part of any change programme. An understanding of the key parameters within which to operate helps frame what needs to be done and, just as important, eliminate what doesn’t. Principles-based regulation has become a key tenet of much of the UK’s regulation of the financial services sector for some time. However, firms often struggle with the flexibility that principles afford and have sought the clarity of a rule. Principles are, by definition, open to interpretation. For them to be effective, all parties must have a fundamental understanding of their intent. For this to occur, it would be beneficial for firms to have an opportunity to engage more effectively with the definition and interpretation of the principles, and for regulators to be clearer about their intentions in establishing the principles-based regulation.
  • Communication – Communication is also critical in change management, and scaling up from communicating with one organisation to doing so throughout an entire market exponentially increases the challenge and complexity.
    Because large firms within most regulated sectors have visibility and market significance, their access to and communication with regulators is fairly straightforward. However, when new regulation impacts multiple smaller firms – and in Europe does so across many jurisdictions – the obstacles can be daunting; simply defining exactly who to communicate with can be a major challenge, let alone crafting effective communications.
    Corporates can help by forming better-funded, better-resourced and more proactive trade associations. Optimally, these bodies can provide the entire market with a voice and act as a two-way conduit through which information is disseminated. The regulators are normally very enthusiastic about trade associations as they aid the communication very considerably.
  • Agile transformation – The risks associated with any change process that has a long lead time to produce results and ends with a “big bang” implementation are significant. We know, from observing the world of IT that many such programmes fail to deliver the expected results.
    Does the change toward an agile approach of continuous delivery have anything to offer the world of regulation? Agile software delivery has at its core the concept of a minimum viable product (MVP) – creation of an outcome that “just does the job.” This allows firms to deliver value quickly, learn from mistakes and iterate to improve the MVP and extract the next level of value. To make this process work in a regulatory context would require redefining the relationship between the corporate and the regulator. Agile, iterative development of regulation would require a far more collaborative and less adversarial relationship with the regulator, and the corporates must be more amenable to the regulatory outcomes.
    Perhaps the FCA’s efforts to develop the “regulatory sandbox” is an example of best practice that could be extended to more mainstream regulation and larger firms. A similar concept could be used to pilot regulation with a subset of the market before being rolled out to the rest of the market. However might this create unfair detriment or benefit to those firms participating in the pilot a therefore destroy the regulators independence.

In summary, introduction of new regulation is difficult, inevitably adversarial, and subject to high levels of risk because of the nature of the stakeholder environment within which it is developed and implemented. However, corporates and regulators may have an opportunity to work together more effectively – and there are early signs that they are doing so.

However, consistent success requires a significant re definition of the relationship between the regulators and the corporates they regulate and this is likely to require further government intervention to achieve. The potential resulting from simplification of the regulator’s role, arising from Brexit, may provide an opportunity to begin this dialogue.

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