It used to be relatively easy to regulate financial services. This was because the range of entities providing financial services was relatively narrow, as was the range of financial services provided to the market. Financial and technological innovation over the past two decades, however, has radically changed both the entities involved in delivering financial services and the nature of the financial services themselves. New entities such as financial technology firms or ‘Fintechs’ are now delivering financial services through innovative mechanisms that bypass traditional institutions and systems. Examples on point include digital payment platforms and decentralised autonomous organisations, supported by blockchain technology and smart contracts. Further, new financial services are now competing with traditional services to achieve similar outcomes on a more cost-effective or efficient basis. An example on point is the emergence of buy now pay later services that provide an alternative to credit.
Technological innovation presents a huge dilemma for financial regulation: how should financial services be regulated if entities delivering financial services do not adopt the conventional corporate form, financial services do not fall into conventional categories and the conventional terminology of regulation is no longer fully applicable?
A possible solution lies in revisiting the question of regulatory design and moving away from a prescriptive, rules-based approach, towards a more principles-based, outcomes-focused approach to financial services regulation. The question of regulatory design in corporations and financial services regulation is currently the subject of an inquiry by the Australian Law Reform Commission. The inquiry is part of the Australian government’s response to the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, which released its final report in February 2019. The inquiry is technical in nature, and seeks to facilitate a more adaptive, efficient, and navigable framework of legislation within the context of existing policy settings. The ultimate goal is to achieve meaningful compliance with the substance and intent of the law.
One might assume that greater detail in regulation leads to greater clarity and easier compliance. However, detail often leads to complexity and the need to recognise exceptions and qualifications. In turn, a high level of detail often leads to a prescriptive, ‘tick-the-box’ approach, which ends up concealing the intent of the law and making it difficult to glean the underlying norms and policy settings. The impact of technology, as outlined above, makes these difficulties even greater.
An overly prescriptive, rules-based approach can impose constraints on regulators in performing their supervisory functions and achieving desired outcomes. Highly prescriptive, process-oriented regulatory approaches can also increase incentives to engage in ‘creative compliance’ on the part of the regulated community.
Adopting a more principles-based approach would mirror the approach in jurisdictions such as the United Kingdom, where a principles-based, outcome-focused framework has been adopted in the financial services legislation, and is supported by regulatory guidance. The Financial Conduct Authority (FCA) defines principles as ‘high level statements of the core obligations of firms, [which] act as an overarching framework to govern the actions of firms’. It states that a ‘breach of one or more of the Principles for Businesses will make a firm liable to disciplinary action’ and, ‘[w]here appropriate, a firm can be disciplined on the basis of a breach of the Principles alone’. The FCA defines outcomes as ‘[setting] the baseline of our expectations of how firms should treat consumers and … [providing] the basis of what consumers can expect to see when firms are treating them fairly’.
In 2012, the United Kingdom learned from the experience of Australia in adopting the Twin Peaks model of financial regulation, which was pioneered by Australia in 1998. Perhaps it is time for Australia to learn from the United Kingdom, by moving towards a more principles-based, outcomes-focused approach to regulating financial services?
Andrew Godwin is Special Counsel assisting the Australian Law Reform Commission in its inquiry into corporations and financial services regulation. Andrew Godwin and Andrew Schmulow are the editors of The Cambridge Handbook of Twin Peaks Financial Regulation (Cambridge University Press, 2021), which provides an in-depth analysis of the similarities and differences in the Twin Peaks regimes that have been adopted around the world and includes chapters on jurisdictions that have contemplated adopting the Twin Peaks model.