I found Commodities Futures Trading Commission (CFTC) Chairman Heath Tarbert’s recently published article on the benefits of principles-based regulation versus rules-based regulation illuminating from a “Compliance 101” perspective.
It’s rare that we get this kind of glimpse into the philosophy of why a particular regulator (CFTC) chooses to regulate a particular industry (commodities and futures trading) a particular way (primarily a principles-based approach).
You can read it all yourself (his article in the Harvard Business Law Review is about a 30-minute time commitment), but here are a few key takeaways:
- Tarbert, who is approaching the one-year anniversary of his chairmanship of the Commission, said one of his main goals is “reinvigorating the CFTC’s primarily principles-based approach to regulation” of the derivatives market. He stressed that “principles-based” was not a euphemism for deregulation or “light-touch” regulation. Tarbert’s goal remains “sound regulation” that leaves space for “flexibility and innovation” in a still-evolving marketplace. He added that there were areas within the CFTC’s purview that called for more prescriptive rules (position limits, for example) as a way of couching the perception that the Commission was taking an entirely principles-based approach.
- He cited a simple, easy-to-understand example of what makes principles-based regulation different than a rules-based regime: “A rule might say, ‘Do not drive faster than 55 mph.’ A principle might say, ‘Drive carefully under the circumstances’ or ‘Drive prudently.’ ” This approach places the responsibility for “finding the most efficient way of achieving regulatory objectives” on companies and their compliance programs.
- The chairman reasserted his belief that a principles-based approach to regulating digital assets (fintech, blockchain, crypto, etc.) was preferable because it would allow “a period of development and observation” in this ever-changing space. He warned that overly prescriptive rules “could stunt the development of this important market.” He couched that stance, however, by noting that once the Commission better understands the risks in this particular area, and once “retail participation” in these markets increases, “more tailored and targeted rules may be appropriate.”
- Because principles-based regulation is “premised on the idea that, in certain cases, firms and their management are better placed than regulators to determine what processes are most desirable within their businesses to achieve a given regulatory objective,” it encourages senior leadership to take a more hands-on approach to compliance. That alone, suggests Tarbert, can improve the tone at the top while also encouraging buy-in from leaders across the company. By contrast, a regulatory regime with bright-line rules can push such compliance decisions to the lower ranks, because specific rules leave “less space to craft solutions.”
Tarbert expands on all of these points and many more—including the many benefits of a rules-based approach for regulators in other markets—in the nearly 12,000-word piece, titled “Rules for Principles and Principles for Rules: Tools for Crafting Sound Regulation.” It’s definitely worth a read, if only as a way to get yourself to think more about the differing regulatory philosophies.