FINANCIAL SERVICES & PENSIONS: The principle argument.

(From The Lawyer)

The Financial Services Authority is changing its mode of regulation, relying more on its 11 Principles of Business. But can such an approach be enforced? Peter Bibby reports

The Financial Services Authority (FSA) and its predecessors have historically relied on detailed rules to regulate the UK's financial services industry. Accordingly, firms and the regulator have been clear about what is required and when. But recently the FSA has changed its approach, relying increasingly on general principles.

The FSA's 11 high-level Principles for Business, in place since 2001, set out the essence of its expectations for firms. The principles cover issues from market and business integrity and the management of conflicts of interest through to the protection of client assets and fair behaviour in dealings with customers. The principles are, however, currently underpinned by a set of detailed, prescriptive rules supported by guidance.

The FSA is open about its intention to become a principles-led regulator. Principles-led regulation has, however, raised concerns about a period of regulatory uncertainty and increased risk: uncertainty could stifle innovation, while the risk is that a behaviour, when judged with the benefit of hindsight by the FSA (as is always the case in an enforcement situation) may be considered in breach of a principle.

When investing in business initiatives, firms are looking for reliability and predictability, and reliance on principles is an unstable foundation on which to make decisions. The key concepts on which the principles are based, such as integrity (principle one) and fairness (principle six), are not defined by the FSA, nor are the standards ('adequate', 'proper' and 'appropriate') against which firms' behaviour will be measured.

What does this mean in practice?