How to Regulate the Regulators: Applying Principles of Good Corporate Governance to Financial Regulatory Authorities.

Author:Jabotinsky, Hadar
  1. INTRODUCTION II. OVERVIEW OF GENERAL ACADEMIC AND POLICY LITERATURE ON THE GOVERNANCE AND INSTITUTIONAL DESIGN OF FINANCIAL REGULATORY AUTHORITIES. III. CONCEPTUAL DIFFERENCES AND SIMILARITIES BETWEEN FINANCIAL REGULATORY AUTHORITIES AND COMPANIES A. The Literature on Differences Between Private and Public Sector Firms and Their Application to Financial Regulatory Authorities i. Differences in Organizational Environments ii. Differences in Goals iii. Differences in Organizational Structures iv. Differences in Employees' Commitment and Values B. General Similarities Between the Governance of Financial Regulatory Authorities and Corporate Governance i. Similarities to Corporate Governance of all Firms ii. Similarities to Corporate Governance of SOEs IV. GOOD CORPORATE GOVERNANCE AND THE GOVERNANCE OF FINANCIAL REGULATORY AUTHORITIES A. Appointment to the Board B. General Board Composition C. Other Relevant Persons and Bodies D. Powers and Responsibility of Boards E. Transparency of Objectives and Operations V. CONCLUSION I. INTRODUCTION

    There are currently extensive public debates about fixing perceived deficiencies of the Securities and Exchange Commission (SEC), the Federal Reserve System, and other regulatory authorities. (1) Financial regulatory authorities are also at the center of intensive academic discussions in international commercial law. Many of them are concerned with the regulatory tools to supervise financial firms and markets, but there is also a growing literature that focuses on the financial regulatory authorities themselves. Here, following Juvenal's famous phrase quis custodiet ipsos custodes, the literature has often been concerned with the question of who should regulate the regulators. (2) This Article argues we should extend the debate and ask not just who should regulate the regulators, but also how they should be regulated. (3)

    The question of how to regulate organizations is not unique to financial regulatory authorities. Thus, it is worth exploring whether there are general principles for organizations in different fields. This Article contributes to this debate. Yet, it is also clear that such general principles could only be phrased at a high degree of abstraction. Therefore, this Article will draw on lessons learned from corporate governance, a field where questions of good governance have been discussed in depth. (4) Even though private sector companies differ from financial regulatory authorities, this Article will show that some analogies can be made. (5)

    On the side of financial regulatory authorities, there can also be forms of public-private structural hybrids if they are established as limited companies, such as the U.K.'s regulatory authorities. (6) This Article focuses on the more common status of financial regulatory authorities as independent bodies of public law with own legal personality, such as the SEC in the U.S. and most regulatory authorities in continental Europe. This is also distinguished from the less common scenario where the regulatory authority is a unit of the government with some independence but without a separate legal personality.

    This article fills a gap in the literature on financial regulatory authorities as it maps the general suitability of lessons from corporate governance for financial regulatory authorities. It therefore aims for a broader scope than the majority of the existing literature, which mainly focuses on the structure of a specific financial regulatory authority in a specific jurisdiction. The corresponding limitation is that it is beyond the scope of this Article to assess how the implementation of our suggestions could be embedded in the precise national and institutional context of the corresponding financial regulatory authority. However, this Article suggests that there is an urgent need to reflect on the structure of financial regulatory authorities at a general level given the growth of international regulatory activity in this field. (9)

    This article is structured as follows: Part II presents an overview of the academic and policy literature on the governance and institutional design of financial regulatory authorities. Part III analyzes the conceptual differences and similarities between financial regulatory authorities and private firms. Based on these general considerations, Part IV turns to the question how far specific standards of good corporate governance can and should be applied to the governance of financial regulatory authorities. Part V concludes.


    There is no general agreement about the proper governance and institutional design of financial regulatory authorities. The academic debate is also fragmented due to the fact that many publications only address issues of specific authorities: for example, in the U.S., the governance of the Federal Reserve has been the subject of study by several scholars, (10) and in Europe the consolidation of authorities has been a main point of discussion. (11) By contrast, as explained in the introduction, this Article--and this Part--focuses on the more general international academic and policy literature.

    The tasks of financial regulatory authorities as supervisors of banking, insurance, and securities markets relates to an initial divide between different institutional designs. A frequent point of reference is a report by the Group of Thirty, (12) an international body composed of central bank governors, private sector financial experts, and leading economists. This report outlines the different approaches (institutional, functional, consolidated or "twin peaks") in 17 jurisdictions. Some have found that the need to give special consideration to problems of systemic risk and financial instability reflects more recent trends of institutional design. (13) Overall, however, real-world supervisory systems often mix models, reflecting the conclusion that there is unlikely to be a one- size-fits-all solution for the right supervisory oversight structure. (14)

    For more specific questions of governance design, possible starting points are the (non-binding) principles published by the Basel Committee on Banking Supervision (BCBS), the International Organization of Securities Commissions (IOSCO), and the International Association of Insurance Supervisors (IAIS). (15) These principles contain brief sections on the role of the respective financial regulatory authorities, with some further details also discussed in the literature. (16)

    The need for independence of the financial regulatory authority is mentioned in all of these principles, (17) and the literature has also explored how far, in reality, supervisors can be classified as independent. (18) In the BCBS and IAIS Principles, there is a section on the questions of appointment and removal of the governing body of the financial regulatory authority, stating that its members should be appointed for a minimum term and can only be removed from office "for reasons specified in law or if (s)he is not physically or mentally capable of carrying out the role or has been found guilty of misconduct." (19) The literature discusses further distinctions, for example, how far such appointment and dismissal decisions are in the competence of the government or the legislature. (20)

    The BCBS Principles also relate the independence requirement to the finances of the financial regulatory authority, recommending "budgetary processes that do not undermine autonomy and adequate resources." (21) More specifically, a document by the Financial Stability Board expresses a preference for funding through fees paid by the regulated industry (as opposed to drawing on the general fund). (22) The literature on this topic has explored further approaches, such as, how it may be possible to create the right financial incentives for regulators. (23)

    All three principles would also generally require a financial regulatory authority to be "accountable." (24) Some of the literature explains that this may create tension with the requirement of independence. (25) Yet, it is clear that without accountability there is the risk that regulators may "deviate from their task of guarding finance for the benefit of society as a whole." (26) The principles provide only a few specific examples, namely that financial regulatory authorities have some reporting duties, (27) that regulators should avoid conflicts of interest and implement risk mitigation strategies, (28) and that statutory liability may be possible for actions taken in bad faith. (29) The corresponding literature addresses some further aspects, for example, the linkage between transparency and accountability, (30) possible procedural requirements, (31) and variations of actual liability of regulators. (32)

    Some of the literature relates this topic to other fields where the need for accountability has been discussed. Research by Quintyn and Taylor and Armour et al. refers to the political dimension of financial regulatory authorities: thus, by assuming that politicians and regulators, as their appointees, may act selfishly, the situation can be presented in terms of a principal-agent relationship. (33) Similarly, Enriques and Hertig provide suggestions on how to improve the governance of financial supervisors, partly drawing on concepts such as the principal-agent theory. (34)

    It follows that there is some asymmetry in the general academic and policy literature on the governance and institutional design of financial regulatory authorities: the choice between institutional, functional, consolidated and "twin peaks" approaches is discussed in detail, while specific questions of governance are only addressed in a fragmentary way. Thus, this Article will focus on these latter topics, suggesting that insights from corporate governance can be potentially rewarding.


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