European Systemic Risk Board Committee Publishes Report on Regulatory Complexity Risks

The European Systemic Risk Board's Advisory Scientific Committee has published a report on the risks of excessive regulatory complexity. The report considers the key drivers of regulatory complexity, the risks it entails and sets out seven principles designed to prioritize regulatory robustness, upon which it argues the design and reform of financial regulation should be based.
 
The key drivers of regulatory complexity identified in the report include: (i) the circumstances in which regulatory reforms typically occur (often a period of crisis when pressure to fix failures rapidly means regulation is developed on an issue-by-issue basis which may create duplication and imperfections); (ii) the complexity of the financial institutions and financial market infrastructure that regulation must govern; (iii) promotion of regulatory complexity by regulated institutions for their own advantages; and (iv) lobbyists demanding different regulatory treatment for different investment types.
 
The report then discusses how regulatory complexity can contribute to systemic risk. It argues that complex regulatory frameworks may give the impression of a well-controlled system which risks leaving room for market participants to manipulate the system. Complexity may also make regulation less well-equipped to deal with new forms of risk and less attuned to the evolving business models of the institutions it aims to regulate. Employing a variety of tools and institutions in the enforcement of regulation can reduce accountability and undermine public confidence. Other risk factors include: the development of niche expertise (on the part of both institutions and supervisors) on specific aspects of regulation which fails to keep perspective on the overarching regulatory landscape; an increasingly "tick-box" approach in which supervisors focus on strict compliance with regulation as opposed to assessing deeper underlying risks; and barriers to entry or new participants which may have a negative effect on competition and innovation.
 
The report then goes on consider how best to address regulatory complexity, including carrying out cost-benefit analyses and evaluating the effectiveness of regulations. It calls for more robust regulation, which it argues can be achieved by applying the following seven principles:
 

1. Adaptability: ensuring financial regulation evolves with the financial system, including through use of regulatory sandboxes and sunset clauses;
2. Diversity: preserving a variety of financial institutions and business practices provides fall-back options in the event that certain institutions or practices fail;
3. Proportionality: ensuring the burden of implementing regulation is commensurate with the harm it is designed to address;
4. Resolvability: creating a system in which unviable entities can be removed without creating systemic risk;
5. Systemic perspective: understanding the correlation between all entities within the financial system and macroeconomic factors to guarantee the ongoing provision of critical financial services and avoid over-reliance on a limited number of institutions;
6. Information availability: obtaining and disseminating information promptly to ensure vulnerabilities are quickly identified; and
7. Non-regulatory discipline: encouraging discipline from market participants, governance structures and ethical and personal responsibility standards alongside regulatory requirements.

 
View the Advisory Scientific Committee's Report.
 
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