Strategies of Financial Regulation

The chapter explains the objectives and research framework of the book. One of the objectives of this book is to find better ways in implementing conduct of business regulation. To achieve the objective, the study adopts a comparative-analytical methodology to compare the UK’s and South Korea’s COB regimes. Using this methodology, the regulatory regimes of both countries are considered in a wider context, and subjected to deeper scrutiny than it has been hitherto. A regulatory regime should pursue stability and rationality, which can be contradictory values. The book argues that both stability and rationality must be harmoniously pursued for the regulatory regime to obtain effectiveness. In comparing how stability and rationality are pursed by the two countries, the book selects as subjects of comparison: (1) rule-making method, (2) rule-enforcing strategy, and (3) interplay between public enforcement and private enforcement.

The chapter evaluates the effectiveness of conduct of business regulation ‘on books’ through a comparative study of rule-making between the UK and South Korea. Based on the analysis of the two countries’ rulebooks of COB, it is found that they have contrasting rule-making approaches. As the name of ‘principle-based regulation’ suggests, the UK formulates rules as purposive and vague rule-types. To complement uncertainty, a weakness of such rule-types, the UK has adopted Guidance consisting of informative and non-binding rule-types. However, in South Korea all rules are formulated to be precise and clear. The contrasting rule-making styles of the two countries created different regulatory outcomes. In South Korea, the precise and clear rules created the problem of rigid interpretation and application of ‘letters’ of rules. This has led to results that are distant from the objective of the regulatory rule, and a decline in the rationality of the regulatory regime. In the UK, by using various rule-types such as Principles, Rules and Guidance, they have created a foundation where the regulatory regime can pursue stability and rationality, although a good rulebook does not necessarily guarantee the achievement of the two values.

The chapter analyses the public enforcement of the conduct of business regulation of South Korea and the UK. The UK’s public enforcement by the regulator is a compliance-focused approach. This approach relies on the goodwill of financial institutions and focuses on helping to improve the internal control system to facilitate compliance. However, as the UK regulator has admitted, the compliance-oriented enforcement strategy failed to internalize the regulatory objectives into the norms of the regulated. Based on such failure, the UK has adjusted its stance one click toward a deterrence-focused enforcement by adopting the Senior Management and Certification Regime, which makes individuals at financial institutions more accountable. South Korea has experienced failure in its deterrence-focused enforcement strategy. South Korea’s deterrence-oriented and legalistic enforcement focused on compliance, not of the spirit but the process. Sanctions on breaches of processes set by the proxy rules made the regulated also focus on only complying with ‘letters of rules’. The unreasonable situations, where the COB regime has produced results distant from the objective, have bred hostility and ignorance towards it. As a conclusion, the chapter proposes a balanced enforcement approach which involves the following: first, proactive sanctions with sufficient deterrent effects against regulatory breach; second, being outcome-focused; and third, responding and adapting to its performance and changing environments. The chapter also extends into prudential regulation by analysing failures in liquidity regulation in both countries and confirms that balanced enforcement is needed in prudential regulation as well.

The chapter examines the interplay between private law and the statutory conduct of business regulation. The striking characteristic of the relationship between the UK’s private law and COB is dissonance in their requirements and causation assessments. The UK’s private law recognizes a contract as the most important basis for determining whether there was mis-behaviour. However, the COB mandatory requirements overrides the contract and are applied to financial institutions irrespective of what is in the contract. With respect to causality assessment between the financial institution’s misbehaviour and a consumer’s loss, private law requires tight tests to be passed but the regulator determines whether there is a fair and recognizable causality. Due to such dissonance in requirements and causation assessment, situations arise where COB determines certain acts of a financial institution to be subject to sanctions while private law does not accept that compensation is required. With such cases, it is difficult to say that there is harmonious interplay between private and public enforcement. The chapter also examines credit rating agency (‘CRA’) regulation which is one of the areas where statutory regulation and private law overlaps. In CRA regulation, unification of standards is not enough but also lessening the burden of proof is needed to improve the complementarity between the two institutions. In South Korea, because COB is adopted through legislation and so binds the court, the standards that apply to ‘mis-selling’ disputes are the same between private law and regulation. Regarding enforcement, the South Korean regulator’s enforcement approach focuses more on breaches of procedures than substance. But the court adopts the substance of regulation as the reference for its adjudications. It is deemed that private enforcement focusing on substance of regulation is complementing public enforcement which focuses on procedures.

The chapter summarizes the lessons learned from rule-making, rule-enforcing, and private enforcement of financial regulation based on the analysis of the UK’s and South Korea’s COB, prudential regulation, and CRA regulation. With respect to rule-making, vague and purposive rules are more effective for achieving the regulatory goals with minimal undesirable results. However, a rule-making system with vague and purposive rules can only work on a foundation of trust among rule-makers, enforcers, and the regulatees. With respect to public enforcement, a balanced strategy that combines the compliance-oriented and deterrence-oriented approaches is needed to achieve regulatory goals. And also the current enforcement strategy must be continuously adjusted based on close monitoring of the regulatees’ compliance and regulatory outcomes. In private enforcement, regulation should be instituted as the minimum requirement in private law. The writer’s key argument is that in the UK, one of the biggest causes for regulatory failure is the defective culture in the financial services industry, and the dissonance of orders between private law and COB contributes to the defective culture. The lesson is to harmonize the dissonant orders by placing the COB as the minimum requirement of the private law.