# Should IFSRA's codes be principles based or detailed rules?



## Brendan Burgess (18 Mar 2004)

_This is the first question in the IFSRA consultation document_

A principles based approach sets out high level requirements within which financial services firms operate, while a rules based approach is more prescriptive in relation to the requirements that should be implemented in specific circumstances.

The codes that are currently in force are primarily principles based rather than comprising a set of detailed rules. They set out how each regulated entity should behave in a particular set of circumstances, although certain requirements are presented in more detail than others.

The Financial Services Regulator’s preference is to continue with this principles based approach and to supplement those principles with specific rules where it is considered to be in the best interests of consumers to do so.

*Arguments for and against the different approaches *

The arguments *in favour of a principles based approach* are that:
it allows financial services firms a certain flexibility to develop their own compliance ethos within the context of their own markets,legislative backgrounds and cultures;

it is more likely to encourage new entrants into the market,
particularly from outside the State, and thus foster  competition;

while a code comprising detailed rules:
may lead to an unthinking mechanical compliance culture rather than a realisation that the purpose of the codes is to promote the fair treatment of consumers;

may prompt firms to seek ways around rules rather than
complying with the principles of consumer protection;

can restrict innovation and impose additional costs on financial
services firms and perhaps ultimately consumers;

might create uncertainty for companies that are faced with a
situation for which no specific rule or requirement has been
decided.

The arguments *in favour of the rules based approach* are that:

it makes it clear to financial services firms how they should comply with rules in specific cases;

it is more likely to lead to a consistent approach between different firms, so consumers are aware of the level of compliance they can expect.

While a principles based approach may create uncertainty:
for firms that may be unsure if the approach adopted fully
complies with the codes; and
for consumers who are faced with different approaches to
compliance from different firms.

In certain areas, general principles may not be appropriate and more detailed codes are required. For example, a more complicated investment product may need specific rules to make sure that consumers are adequately informed of the costs, risks and potential returns associated with the product. In all circumstances, including those where detailed requirements are considered necessary, the overriding responsibility will be to comply with the spirit of the high
level principles.


In light of the outline of the two approaches above, we wish to hear your views. In particular, please comment on:

the merits of a principles based versus a detailed rules approach;
and
any areas in which more detailed rules would be more appropriate or could be used to supplement the high level principles.


----------



## daltonr (18 Mar 2004)

*Re: Should IFSRA's codes be principles based or detailed rul*

Before we discuss the Type of rules.  Do we have any idea what will happed to a company, product or service that breaks the rules.

If nothing happens to them it doesn't matter whether it's rule based or principle based.

Much like the ASAI who do nothing until the Ad is already out there doing it's job.

Is it feasible for the banks to apply to IFSRA for approval, which if given will allow the bank to state that the service is Approved by IFSRA?

-Rd


----------



## Nutter (18 Mar 2004)

*Above*

All depends on the cost / benefit, which we can only guess at. Rules are much more costly to regulate, and do encourage create avoidance, much like the rules based tax system. The Brits made a mess when they went rules based with the FSA 1984, and have been adding layer upon layer ever since. The cost is also huge.

I'd prefer to see us going principles based to keep costs down, because ultimately consumers fork out the money to financial firms to protect themselves against the very same firms.

So Principles I say, and hang the begrudgers. If it don't work we'll storm the Dame Street tower, overthrow the buggers, and appoint Comrade Illynichovavosci Burgess instead. Long live the revolution!


----------



## Brendan Burgess (19 Mar 2004)

*Re: Above*

Hi Rd



> Is it feasible for the banks to apply to IFSRA for approval, which if given will allow the bank to state that the service is Approved by IFSRA?



I don't think this would be feasible. First of all, there would be too many products and services to be approved. It would take a long time for them to be approved which would damage competition and innovation.

My own experience is that IFSRA don't have the technical skills anyway. They completely misunderstood tracker bonds and more or less gave geared tracker bonds their approval. I am sure that some brokers are quoting IFSRA in their marketing of geared bonds,saying that they can form part of an investor's portfolio in certain circumstances.



> Much like the ASAI who do nothing until the Ad is already out there doing it's job.



At least the ASAI do take action, even if it is often late. complained the advertising of the BCP Quadruple Growth bond to the ASAI and they responded fairly quickly. They didn't understand the answer they got from BCP and they asked IFSRA, who have buried the complaint, at least publicly. Because of their confidentiality obligations, IFSRA may have reprimanded BCP, but we will never know. It would have been much more effective if the ASAI had publicly rebuked their advertising.


----------



## Brendan Burgess (19 Mar 2004)

*Re: Should IFSRA's codes be principles based or detailed rul*



> The Financial Services Regulator’s preference is to continue with this principles based approach and to supplement those principles with specific rules where it is considered to be in the best interests of consumers to do so.
> 
> In all circumstances, including those where detailed requirements are considered necessary, the overriding responsibility will be to comply with the spirit of the high
> level principles.



I support this approach and the recognition that firms will be obliged to observe the spirit of the principles. 

It is presumably a lot easier to generate a set of high level principles than a set of rules. It would be easier for the companies and consumers to understand these principles. Few of us would read the rule book, but we might read a one page set of principles. 

The principles should be backed up with guidelines rather than rules. Guidelines could be broken if it made sense to do so. 

IFSRA wouldn't have to create a new set of rules for new classes of products. The existing principles and guidelines would tell providers what they should and should not do.

IFSRA could also compile a set of precedents. They should publish their responses to complaints about products to allow providers see how IFSRA are interpreting the guidelines.

An example would be APRs. The principle would be that potential customers should be told the APR on any loan. 
However, quoting the APR on fixed rate loans is meaningless and confusing. But the principle or guideline might say something along the lines that they should say something like this " When the fixed rate period expires, you will be put on our standard variable rate by default. The standard variable rate is the rate we charge all our home loan customers and is currently 3.5%".  

Another principle might be that all advertising and documentation must contain a prominent "Key Features Box" or even "Warnings Box".  

The guideline might be that this should contain 5 such warnings in order of importance. For some products e.g. deposits, there might be no need for any warning. For more complex products, there might need to be 10 key warnings.

Brendan


----------



## d53 (19 Mar 2004)

*Rules or principles*

A principle based system is cheaper, and, in theory at least, can be more flexible: under a rules system, everything is allowed until a rule forbids it, no matter how anti-consumer it may be.

But there are problems with principle based systems, and it is not for nothing that the UK (and US) have gone with rules. The biggest problem is deciding whether or not some particular action is in keeping with the principles or not.  If it is up to the regulator to decide, there is a risk that they will be inconsistent: often they end up drawing up a set of implementation rules, if only for their own use.  If each practitioner decides what is or is not allowed, someone is going to start playing fast and loose, and the competitors will end up at a commerical disadvantage unless they follow.

A principle based system works best when there is someone in each company whose responsibility it is to certify that they have complied - directors, or auditors, or compliance officer or suchlike.  Even then, these people often end up getting legal advice to enable them to push the rules as far as possible.  This approach can be made to work when there are a few large players in the market - banks, or insurers, say.  It has no chance of working when there are thousands of participants, as in insurance or mortgage broking.

d


----------



## Brendan Burgess (19 Mar 2004)

*Re: Rules or principles*

Another example of principles being more important than rules:

Let's say that AIB offered a personal loan with an APR of 9.5%, but they insisted that you leave money in a deposit account at 3.25% as security for the loan.  The APR of 9.5% would be totally misleading and they should quote a true APR to allow for the fact that you must keep money on deposit at a lower interest rate.

Brendan


----------



## Statler (19 Mar 2004)

*Re: Rules or principles*

I do not believe a switch to a rules based approach would be wise from a consumer perspective.
Competition ultimately benefits the consumer and a highly prescriptive regulatory system would IMO serve to limit competition and further concentrate market power in the hands of the large incumbent operators. 
- The larger the institution, the great the resources that are available to ensure or design compliance with a given set of rules. The more complex the regulatory environment, the more important economies of scale become, thereby marginalising smaller players. 
- It also creates an effective barrier to entry by increasing the cost of entering a market/ segment or launching a new product. 
- Additionally, it increases the cost base for existing providers and reduces their ability to alter products and provide them to customers.

If a rules based system were to be introduced, rules to protect the integrity of the financial system would also have to form a part of this. Current principles cover the idea of prudent lending, but rules by their nature would be far more prescriptive. For example, would consumers be happy with rules that limited the amount they could borrow, how long they could borrow for or other terms/ conditions/ criteria attached to financial products? Or should/ could the rules attempt to cater for every individual case, such as somebody that expects to qualify as a doctor, solicitor or accountant in 1 month, 3 months, or 6 months and could justifiably expect an increase in income and their ability to service a debt? It should be remembered that consumers are not one large homogenous group that can be easily classified, labeled and have rules applied on this basis. Every individual has individual financial circumstances and a principles based system caters for this far more effectively.


----------

