The benefits and problems of principles-based regulation

An important lesson of the recent responsible lending decision in ASIC v Westpac is that principles-based regulation can be interpreted by a business differently from ASIC’s interpretation and the business’s interpretation can still be lawful as long as it achieves the right outcome.

Principles-based legislation relies on general principles to express the outcomes to be achieved by regulated businesses rather than detailed prescriptive rules and processes.

If a law does not prescribe exactly what a business must do then it is up to the business to carry out its operations in a lawful way consistent with its business plan and values.

Businesses will then be free to find the most efficient or innovative way of achieving the outcome required.

Principles-based regulation allows for “future-proofing”, enabling the law to respond to new issues as they arise without having to create new rules.

This is the benefit of the flexibility of principles-based regulation, even if it may lead to uncertainty and possibly conflict with ASIC.

The problem with principles-based regulation is that because of ambiguity a regulator might act retrospectively if it disagrees with how principles have been interpreted.

ASIC’s Regulatory Guides can give “best practice” guidance but do not replace the law.

Does that mean that businesses can do anything they like?

No. There are laws about anti-avoidance, abuse of market power and dishonest and misleading conduct as well as laws of contract and equity.

Business ethics and corporate culture are important to how a business interprets the operation of the law.

Staff must be trained in values so that their decisions are consistent with the business’s values.

This allows businesses to observe the spirit of the law by developing policies or other mechanisms that simultaneously comply with the principle and meet the business’s needs.

In ASIC v Westpac the Federal Court decided that the bank’s obligation was to make a loan assessment. And it found that the bank did and that how it made that assessment was a matter for it. ASIC has appealed the decision.

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