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The model in Figure 2.1 describes a process of maturity. This is the development of regulation and compliance from start-up, through early and “teenage” years, to a more grownup state. This provides a model for understanding and evaluating each stage of a regulatory–compliance system. It also supplies a roadmap for future growth and improvement and may be considered at the levels of a:

● Jurisdiction

● Sector or subsector

● Firm

Figure 2.1 General Model of Regulatory and Compliance Development

It is not necessarily the case that all firms operating from or within a jurisdiction will be at the same level of maturity as the jurisdiction as a whole. There will be a range of maturities of individual firms or even subsectors, and this causes interesting problems both for the laggards and for the regulators concerned.

The model identifies five stages. These are clearly not mutually exclusive but blend one into another, each building on the others:

1. Start-up: Establishing credibility by using direct, often simple and easy-to-implement measures to combat an obvious and commonly agreed problem. Enforcement at this stage is often punitive, and rule breaches are described in technical terms. Regulation may operate in an apparently business-friendly way, and may be through self-regulatory organisations that are close to the issues and allow governance by peers. This stage may offer perfectly adequate protection for some societies and be a rational place to remain for some time, but regulators credibility and effectiveness may be undermined when crises emerge.

2. Crises: This stage is characterised by reactive and often disorganised or disproportional responses to emergent problems (e.g., 2008 GFC), or the unexpected consequences of earlier interventions (e.g., UK 1980s and 1990s pensions mis-selling). Changes are often driven by public opinion and political necessity that may see extra regulation as the only credible quick fix. This may be the trigger for a secondary wave of reform involving the rationalisation of regulatory and compliance structures. Societies may revert to these crisis conditions at any time in the development path and can cause progress to temporarily retreat down the curve.

3. Expansion: Here, regulation becomes more proactive and confident, often associated with clearer objectives (e.g., UK Financial Services and Markets Act 2000), and extensions of scope into more fringe areas (e.g., insurance and mortgages), usually based on the pressing consumer protection expectations of a newly wealthy middle-class. Regulation almost inevitably becomes more expensive, bureaucratic, and unresponsive under the pressure of size, and therefore potentially higher risk. This is compounded by resistance and lack of consensus within the industry, which now seems more distant.

4. Sustainability: Recognition that expansion cannot continue exponentially. Regulatory and compliance toolboxes become more fit-for-purpose and sophisticated. Methods of rationalisation and performance improvement now include:

● Risk-focused compliance

● Cost-benefit analysis

● Principles-based regulation

● Emphasis on prevention – focusing on corporate culture (conduct risk), ethics, and governance

The emphasis here shifts significantly from controlling precisely individual internal process to framing the internal and external environment around a firm or sector in such a way as to increase the likelihood of positive behaviours.

5. Outcomes-led: Focus on systemic outcomes on the wider economy and society (and occasionally, environment). By evaluating impacts as part of the regulatory mix, regulation incorporates an understanding of the community purposes of regulation and the effects in social and economic terms that interventions are seeking to create. An outcomes-based system allows for far more creative methods of compliance and regulation where systems and processes is not the ultimate goal. New external criteria bring new criteria for success and enforcement, and allow regulation to be employed for a wider range of objectives.

The Difficult Step – Stage 3 to 4/5

Each stage builds on the last and introduces additional regulatory and compliance tools and priorities. Part II will focus on the new components introduced in stages 4 and 5. In Part III we will see how these stages add the essential components of an infrastructure (we shall call this the Ethical Space) necessary to enable compliance to be strategically effective and contribute towards corporate maturity. We will also find in Part III that the processes at work in stages 1–3 reach a critical point when entering stages 4 and 5. This “difficult step” is from stage 3 to 4/5 and requires a revolution in commitment and the depth and rate of change.

Limitations of the Model

Any development model has limitations and some of the questions to consider are:

● Is the length of each stage the same, or can stages be elongated or shortened?

● Is it possible to skip a stage entirely and move from one stage to the next without, for example, the stage of crises?

● Is it possible to regress? Is progress irreversible?

● Can you get stuck in one stage? If so, why?

● Is a final downturn inevitable, or will the curve continue upwards?

In some cases crises set the underlying development curve back a stage or two as regulators can often feel more secure and demonstrate credibility by resorting to “tougher,” more familiar ways. But this effect is usually short-lived and can be detrimental to restoring confidence because enforcement actions become more visible and numerous and undermine the maturity of the relationship between regulator and industry sector. It is better in the long term for regulators to keep their eye fixed on the development model and to return to the trajectory as soon as possible.

In the specific case of the 2008 financial crisis, the progression to a more sustainable stage had started before the crisis broke. The shift of approach was not dependent on the crisis as a trigger. However, the crisis, while causing a short-term step backwards in the way suggested above, further drove the progression of regulation and set more favourable conditions for both achieving sustainable regulation and also refocusing on outcomes. The foremost lesson for politicians and the public from the 2008 crisis is that “Problems of Wall Street cause problems on Main Street.”