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Assessing Risk in the Regulation

Tony Cash(Better Regulation Consultant and Former

Department for Business and Department for

International Development Official)

The Risks OF/ IN Regulation• Risk is a key governance issue• As well as risk involving addressing likelihood and

impact of things going wrong…• It is also about the risk of missing out on an

opportunity• There is the risk of what will happen if we do not

intervene

• But in this session we will be exploring the risks IN intervention (ie how can we assess the risks that the regulation itself may create)

Four Examples of Risks of Regulation

• Burdens on business (especially smaller business)

• Constraining innovation

• Creating opportunities for corruption

• Misleading consumers about their level of protection.

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How Regulation Affects Business

Can be force for good, or not. Consider impact on Porter’s ‘five competitive forces that shape strategy’:

- Rivalry (e.g. regulation might reduce or increase numbers in industry)

- Customers (e.g. regulation can make customers more powerful)

- Suppliers (e.g. regulation can make suppliers more expensive to other companies)

- Potential entrants (e.g. regulation may deter, unintentionally)

- Substitute products (e.g. regulation on one product may make another more attractive e.g. green energy) 4

Unintended Consequences

• Well intended actions can have side effects that show up later in time e.g.– Rent controls (impact on supply etc)– Restricting lending rates for payday loans

(risk of people going to “loan sharks” instead)– Restrictions on entry to a profession (could

lead to staff shortages if pay does not compensate for entry requirements)

– Etc.

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Table Discussion

• (Tomorrow there will be a session on delegates’ practices in evaluating and managing risk)

• Very briefly, please discuss some examples of risks that might arise from your regulations.

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Possible Regulator Roles (Wide View)?• Regulating (pre-emptive or after)

• Measuring / assessing and disclosure of findings

• Providing information and advice– to regulated groups, public, government

• Emergencies and crisis management

• Providing services (charged or free)

• Each of these roles carry risks – for rest of session we are are focusing on risks of regulation

Possible Regulatory Functions

• Allocation and protection of rights• Certification or licensing of a product,

service, person or business • Registration of professionals and non‐

professionals • Setting and/or imposing industry standards • Collection of taxes, fees or other revenue.

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Responding to Risk of Burdens - Simplifying Regulation

• Remove, reduce, merge or improve regulations

• Simplify the process to comply with regulations

• Data-sharing and joined-up government• Develop ICT solutions and services• Provide better guidance and information.• http://www.administrative-burdens.com/default.asp?page=122

Other Examples of How to Reduce Burden

• Exemptions (e.g. small firms)

• Phased implementation (e.g. new rules of displaying cigarettes in shops)

• Longer notice periods for new regulation

• Common commencement dates e.g. beginning of April and October

• Etc.

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Right Touch Regulation: The Core Principle

• Distinguish between those who will– exceed our standards anyway– meet the basic standards, perhaps needing

help– only comply with standards with strong

incentives

• If using regulation, make sure the first two categories don’t suffer because of the latter

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Risk and Regulation- Hampton Report

• Need risk based, targeted regulation – a key means of reducing burdens on business

• “Unless risk assessment is carried through into resource allocations and regulatory practice, it is wasted effort.”

• Risk assessment needs to be comprehensive, and inform all aspects of the regulatory lifecycle from the selection and development of appropriate regulatory and policy instruments through to the regulators [ongoing] work including data collection, inspection and prosecution.

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Light Touch / Risk Based?

• “When we talk about risk-based, what it means is really understanding that risk in depth. That is not a light-touch option and it can be done very effectively.”

(Stephen Haddrill, Association of British Insurers)

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Risk Based – What It Means

• “ ‘risk-based’ regulation remains a valid approach. Put at its simplest terms, all it means is that you allocate your scarce resources to where you think the harm is most likely to occur and if that is to be successful that depends on having the right intelligence in place”

(Steve Brooker, Consumer Focus)

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Hampton on Risk Assessment

• “The best risk assessment takes in all relevant information, and can be used to set priorities across a large scale – even to allocate resources between different regulatory functions at national level.

• “Risk assessment should:

•be open to scrutiny;

•be balanced in including past performance as well as potential future risk;

•use all available good quality data;

•be implemented uniformly and impartially;

•be expressed simply, preferably mathematically;

•be dynamic, not static;

•be carried through into funding decisions;

•incorporate deterrent effects; and

•always include a small element of random inspection.”15

The Risk of Hindering Innovation

• This risk can be oversold e.g. before financial crisis was made as an argument against tougher regulation on banks

• But nonetheless, the more prescriptive the regulation, the more you: – i) assume regulator knows best ways of

doing things– ii) risk directly or indirectly constraining

innovation. 16

Addressing the Risk of Hindering Innovation - Principles-Based

Regulation• PBR is an alternative to being prescriptive and rules based• Depends on sufficient self-observing, responsible

organisations• Needs regulatory conversations between regulators and

regulatees to achieve a common interpration of the principles in practice

• Problem of “ill-disposed and low capacity firms”• Principles rarely free standing, often supplemented by

explanatory guidance, court decisions, policy statements etc

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Principles/ Outcomes/ Standards?“The dilemma is well-illustrated by research carried out in Australia and the

United States on the regulation of nursing homes. The Australian regime deployed broad performance or outcomes standards, a key example of which was that nursing homes should offer to residents a ‘home-like environment.” Colin Scott (Oxford Handbook of Regulation)

• At first it seemed the US approach, which used detailed standards of care would be superior because it made it easier for all concerned to monitor compliance

• But the US specification of detailed rules “appeared to have encouraged a mentality which prioritised the ticking of the appropriate boxes over the care of the elderly, and to have robbed both managers and staff of the capacity for creativity in offering even better care than set down in the minimum standards.”

• “By contrast the broad general standards deployed in Australia gave wide discretion to managers and staff … this involved matters which would be difficult to capture in a check-list of standards.”

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Regulation and Corruption

• The more regulation (especially permit and licensing requirements) there is, the more potential for officials to extort bribes (e.g. to speed up issuing of permits)

• (Bad) regulation can deter enterprise, and so contribute towards a cultural attitude that there are not legitimate ways to make money

• If there is an inadequate regulatory framework, contracts cannot easily be enforced (people may resort to bribes to get necessary action taken)

• If regulatory regime insufficiently independent, politicians can influence their decisions (for gain)

Tim Harford’s Example

“The [World] Bank discovered that in order to set up a small business, an entrepreneur in Cameroon must spend as much on official fees nearly as much as the average Cameroonian makes in two years… To buy or sell property costs nearly a fifth of the property’s value. To get the courts to enforce an unpaid invoice takes nearly two years, costs over a third of the invoice’s value and requires fifty-eight separate procedures. These ridiculous regulations are good news for the bureaucrats who enforce them. Every procedure is an opportunity to extract a bribe. The slower the standard process, the greater is the temptation to pay ‘speed money’.”

(The Undercover Economist, 2006 p 190) 20

Bad Regulations Nurture Corruption (OECD 2008)

Design Application

Enforcement

Compliance

Appeal and Review

Capture by special interests of entire regulatory regimes

Excessive discretion on how and when to deliver services

Inconsistent inspection and control criteria

Institutions with insufficient resources, skills and independence

Information about regulations are insufficient, inconsistent, not available

Appeal mechanisms are bureaucratic, biased or non-existing

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Consumer Protection Example: What Activities Might be Subject to Rules?

• Advertising and customer communications

• Customer agreements

• Conflicts of interest

• Customer understanding and suitability

• Customer due diligence

• Client assets and money

• Customer service levels

• Rights of cancellation and return

• Etc? s22

Robust Consumer Protection

• “There are four pillars necessary to create a robust system of consumer protection: – advocacy – advice and education – enforcement – and redress.”

Consumer Protection and Representation in an Independent Scotland: Options’ (2013) p3

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Consumer Protection: A Challenge

• Risk that once consumer protection is in place, consumers will imagine they are more protected than they actually are?

• How can we address this?

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Assessing the Risk in the Regulation

In this part of the talk we will consider these points:

• Follow best practice principles

• Use impact assessment

• Be aware of side effects and potential for failure

• Consult all stakeholders

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UK Better Regulation Five Principles

Any regulation should be:

• Transparent

• Accountable

• Proportionate

• Consistent

• Targeted

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Another Example of Better Regulation Principles: Ireland

White Paper ‘Regulating Better’ 2004 referred to

• Necessity

• Effectiveness

• Proportionality

• Transparency

• Accountability

• Consistency

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Impact Assessments: Format Example• Summary and Interventions

– What is the problem under consideration? Why is government intervention necessary?

– What are the policy objectives and intended effects– What policy options have been considered (including

any alternatives to regulation)? Please justify any preferred option

– When will policy be reviewed

• Ministerial sign-off• Summary Analysis and Evidence: cost benefit

summary for each options• Evidence Base (detail) • [Alongside there are also specific impact tests]

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Cost- Benefit Analysis

• Cost Benefit Analysis is an economic tool to aid decision-making

• Aim is to gauge efficiency of intervention relative to the status quo. Costs and benefits of impacts of an intervention are evaluated in terms of benefits to stakeholders (or willingness to pay for impacts) and costs (or willingness to pay to avoid them).

• Guiding principle is to list all parties affected by an intervention, and place monetary value of effect it has on their welfare as it would be valued by them

• Important to consider cost and benefits of all policy options under consideration.

Levels of Impact Analysis

• Level 1: Include a description of who will be affected by the proposals. The main groups affected will include business, public sector and consumers.

• Level 2: Include a full description of the costs and benefits.

• Level 3: Quantify the effect (e.g. 1000 planning applications per year, 100 hours of management time, 500,000 new houses built per year).

• Level 4: Monetise the effect. It may be the case that the costs but not benefits can be monetised. The use of indicators may help further qualify non-monetised costs and benefits.

• Level 5: Monetise fully all costs and benefits.

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The Key to Addressing Risks of Side-Effects of Regulation

• Involve stakeholders in design of regulation

• Empower the less powerful / vocal stakeholders.

• Address risk in your impact assessment.• Take account of social and economic

context.

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Your Questions/ Observations

• Thanks

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