Regulation > Predicting the future just got easier

Published: 4th January 2010 by William Webster

Leafing through the pages of the Sunday Times late in December 2009 reminded me how dangerous predictions can be. Economic forecasts made a year earlier by leading institutions proved in many cases to be well off the mark. To be fair it's always been a mine field. But there is one area that I can safely predict in the coming year. That's regulation.

I first wrote about this in 2007.  It will continue to affect you whether you are on the board, work in treasury or support it. What can you expect this year? Here are seven predictions, the final one may surprise you:

1. Expect a lot more. The regulator is the last line of defense for the taxpayer. Decisions will not always please the industry but that will matter little. About the only way to keep on top of what the regulator is thinking is to read more. The consultation papers warn you well in advance about the intended direction of policy. Use them as leading indicators of necessary changes in your business.

2. Prescription continues to replace principles. When you insist on things being done you apply a rule based regime. Selective application by the regulator means that firms can be brought to heel quickly should more subtle hints be ignored. However it's not all black and white. How will changes affect the way you do business? Interpretation is crucial. Make sure you can cogently defend your decisions.

3. Questioning about how risk is managed at a senior level will be robust. Risk appetite, executive challenge, stress testing, risk metrics and MI will get the full supervisory treatment. (If it doesn’t the taxpayer is being let down). The Walker Review will be acted upon even if it has been watered down. NEDs beware.

4. Perceptions of weak management will reduce profitability. The regulator has indicated that "add-ons" will apply where the management and control functions are considered insufficient. The immediate areas to be affected are capital and liquidity. Shareholders and members will be aware that the costs are real. This is an opportunity and threat to all boards.

5. Detailed reporting will be mandatory. Systemic regulation is now being fed by the information you deliver. It needs to be timely and accurate. The regulator will assume that if your systems cannot cope effective management is compromised. Expect flash detailed reporting requirements on all material risks.

6. Regulatory sanction will be invoked.  In 2009 non compliance led to some very large fines. This will continue in 2010. The bar will go higher and some firms may wish to reassess the business they conduct. Expect more action to be taken against individuals in positions of responsibility. It's how the regulator will influence behavior. Reputational risk is now at a personal level. 

7. Since 2007 regulation has focused on "high level" issues. The regulator leads a discussion with the industry. The rules are published. There's a transitional period, "snagging" and then compliance. This process has a substantial weakness. What is it?

It is apparent (in many firms) that Parato's Law operates. Relatively few people understand why things have changed, how they have changed and what this means for the firm they work for. This weakness can be found at all levels. It is the Achilles' heel of regulation post 2007.

It has been fostered by keeping discussion limited to those who already know. Furthermore it's one of the main reasons why firms got in trouble in the first place. Well managed firms spread information and knowledge and they keep it up to date. (See The Turner Review and The Walker Review).

I've heard the regulator intends to address this (not before time either). What will it do? Rules will be tightened up and the issue will be in your hands. Under scrutiny will be how you put regulation into practice. What is the breadth and depth of knowledge in your firm? Expect in depth interviews for senior management and training and competence across the firm.

If you thought that this was an area that you could be cut back ask yourself one question. If knowledge is expensive what will be the price of ignorance? I suspect it's higher than you anticipated.

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