style="font-size:15px;"> Using Regulatory Toolkits
It is the combination of approaches and tools that delivers effective compliance and regulation, not one set replacing the previous set. There exists a growing compliance and regulatory menu or toolkit, but it is how the elements are selected and used together that is the real skill. The range of tools available and the sophistication with which they are combined and used determines the maturity of the jurisdiction and the professionalism of the compliance sector. How the mix is balanced and selected for any one firm or set of circumstances is decided upon and delivered by regulators and compliance officers making critical judgments, not following checklists or risk models only. How good these professional judgments are really matters. Quality judgment is what firms and societies pay for.
To decide how successful a regulator is in using this toolkit, the Monetary Authority of Singapore (MAS), has the following tests or tenets:
● Is the financial system as a whole stable even in the instance of the failure of one or more financial institutions?
● Is the financial system serving the needs of customers and the economy efficiently?
● Are regulatory standards of a high quality, consistent with international standards and best practice, yet appropriate to the local context?
● Is there shared ownership of the desired outcomes of regulation among stakeholders?
● Does the balance of benefits and costs weigh in favour of regulation?
● Are market incentives alone likely to deliver a desired outcome?
● Are the obligations imposed by regulation on regulated entities clear?
● Does regulation take into proper account market practices and legitimate commercial considerations?
● Does regulation provide regulated entities with legal certainty and predictability where it is needed and, where appropriate, flexibility to apply their own practices to meet regulatory objectives?
● Does the regulation provide a level playing field for potentially competing activities and institutions?
● Does regulation recognise that some institutions may have lower risk profiles and stronger governance and controls? Does it provide differentiated treatment where appropriate and can it adjust in a timely fashion if the risk profile changes?
● Is the regulatory framework able to adapt to fast-changing practices and products as well as to new risks in the financial services industry so that it can continue to be effective in respect of its intended regulatory objective and impose obligations that remain appropriate?1
Conclusion
This chapter provides the framework for the remainder of the book: a model to evaluate differing regulatory systems and a roadmap for the future.
Before we explore stages 4 and 5 in detail, and even suggest a stage 6, we will just reflect on recent experience and the difficulty some leading jurisdictions have had in stepping up from stage 3 to 4/5. Obviously, this transition, which we recognize is the most difficult in conceptual and practical terms, has been made even more difficult by the 2008 GFC. The GFC placed strains on the early steps in this transition as change had not had the chance to become sufficiently embedded. So now these jurisdictions have a chance to make the transition for a second time and ensure that it sticks.
Chapter 3
Is Compliance Worth the Money?
Bolt pulls up the ladder, secures the hatch.
An Unfortunate Unconformity
Compliance has not had a happy record since 2008. This is partly because the apparent development in compliance and regulation into stage 4 of the General Model may have been superficial and not properly embedded. Also other firms and regulators were either complacent or comfortable in stage 3 and had failed to improve. In general, where regulators had been trying to press forward into stage 4, such as the UK's Treating Customers Fairly (TCF) initiative, compliance may not have had the frame of reference to have really got it, and so were unable to keep in step with changing regulatory expectations. This created an unstable unconformity between pioneering regulators and compliance. This is a high-risk situation for a regulatory and compliance system.
This unconformity may have left compliance looking somewhat bewildered and embarrassed. Remedial actions have also seemed hasty and superficial, rather than embedded. So, despite regulation beginning to enter stages 4 and 5, the compliance results in the same period have been uncertain and fragile – as 2008 unearthed. It is reasonable to assume that development in compliance needs to progress further and faster, as Part II suggests, as some firms start from a position well behind the curve. Compliance must play catchup. But before setting out in a determined fashion it is necessary to consider the shortcomings we saw first time around, and this may help focus on how best to change.
The 2008 Global Financial Crisis
In 2006, the author wrote an article in the financial press warning that “the emperor has no clothes,”2 and so it proved. There were many causes of the 2008 GFC. Compliance failings were central. But it is also fair to say that the roots of the crisis and the contributory factors were many and various. The undoubted compliance failings were by no means the only factors adding to international instability. Causes and accelerators were to be found in almost every component of the financial system, including:
● Encouragement of the subprime sector by government policies, starting in the 1990s or even before.
● Target-driven selling in banks.
● Bonus culture.
● Relaxed and competitive credit policies.
● Consumer greed – wants became needs.
● Regulators, governments, and banks were happy to sustain the myth of continuing runaway growth. UK Chancellor Gordon Brown announced that New Labour had “abolished the cycle of boom and bust” as far back as 19973– all seemed delighted to believe him.
● Voters and consumers were comfortable and complacent and therefore unchallenging.
● Inadequacy of capital models and business-as-usual stress-tests.
● Panic due to a lack of understanding of complex products, the real levels of toxicity and liquidity.
● Retail banks trying to behave as though they were investment banks or being led by their investment bank arms (and acquiring such arms if need be, e.g., RBS's takeover of ABN AMRO in the midst of the crisis).
● Lack of product due diligence by buyers of complex products such as collateralized debt obligations (CDOs)
● Sometimes knowing connivance amongst the producers of complex products as disclosed by the U.S. Congressional hearings.
● Interconnectedness of the global financial system and some banks discovered to be “too big to fail” (e.g., Lehman Brothers).
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Monetary Authority of Singapore,
D. Summers, “No Return to Boom and Bust: What Brown Said When He Was Chancellor,”
