1. On the definition of financial architecture, see J Eatwell The New Institutional Financial Architecture: Promise or Threat?, at 1, available at http://www.cerf.cam.ac.uk/publications/files/Cambridge.

2. For the purposes of this paper, the term ‘policy of rule use’ is broadly understood as encompassing the process of formation, application and enforcement of rules by the FSA. In a more abstract level, this term connotes the policy that underlies a ‘two-phase’ interpretive project through which the FSA four statutory objectives are first translated into more concrete regulatory provisions that comprise the content of the FSA Handbook, and then put into practice in the more refined form of regulatory requirements that are tailor-made to the idiosyncratic characteristics of each type of firm and business.

3. These changes constitute part of the so-called ‘Better Regulation Movement’, a broader initiative of the Labour Government to improve the performance of public administration, whose roots can be traced back to the deregulation policies of the Conservative Government in the 1980s: R Baldwin ‘Is better regulation smarter regulation?’ [2005] Public Law 485 at 485–487.Google Scholar

4. FSA, Designing the FSA Handbook of Rules and Guidance FSA Consultation Paper No 8 (April 1998).

5. Ibid, pp 10–12.

6. Ibid, pp 15–16.

7. On the principle of appropriate differentiation see, HM Treasury Financial Services and Market Bill: A Consultation Document. Part One Overview of Financial Regulatory Reform (July 1998); HM Treasury Financial Services and Market Bill: Progress Report (March 1999); FSA FSA: Meeting Our Responsibilities (August 1998).

8. FSA, above n 7.

9. Ibid, para 96.

10. Ibid, paras 87 and 88.

11 The Financial Services and Markets Act 2000 differed from its predecessor regime (Financial Services Act 1986) in various respects. A purely statutory approach to the UK financial regulation was launched for the first time. The scope of regulation was expanded and a single mega-regulator with a wind range of regulatory and supervisory powers emerged. Other remarkable changes were the inclusion of four regulatory objectives in the content of the statute and the assignment to the FSA of important policing functions especially with regard to combating money laundering and market abuse. Special care was also taken to ensure compatibility with the Human Rights Act 1998, while the regulator's accountability was enhanced and a series of safeguards were provided in relation to the exercise of certain investigative and enforcement powers: Hadjiemmanuil, C Institutional structure of financial regulation: a trend towards “megaregulators”?’ in Yearbook of International Financial and Economic Law 2000–2001 (London: BIICL, 2003) pp 127–190 Google Scholar; .

12. Part X of the FSMA 2000 confers upon the FSA its principle rule-making powers for authorised persons and, in addition, gives the FSA the power to issue guidance on regulatory matters.

13. Examples include FSMA 2000 provisions from Part I such as s 2 (the Authority's general duties), ss 3–6 (the regulatory objectives), s 7 (corporate governance) and ss 8–11 (arrangements for consulting practitioners and consumers).

14. See, eg, Part XXVI of FSMA 2000 on the issuance of notices, especially s 387 (warning notices), s 388 (decision notices), s 395 (the Authority's procedures) and s 396 (statements under s 395: consultation).

15. Blair, M and Walker, G Financial Services Law (Oxford: Oxford University Press, 2006) pp 108–112 Google Scholar. On the content of the FSA Handbook, see, generally, W Blair et al Banking and Financial Services Regulation (Haywards Heath: Tottel Publishing, 2002) para 2.87 and A Georgosouli The FSA Regulatory Policy of Rule Use: A Move Towards More Effective Regulation? SSRN_ID893453_code603386 (2006) pp 24–27, available at http://www.ssrn.com.

16. Including general principles for business; rules on senior management; systems and controls; threshold conditions for authorisation; a set of principles and a code of conduct for persons exercising certain regulated functions within authorised institutions (‘approved persons’: FSMA 2000, Part V); a fitness test for ‘approved persons’; and general provisions.

17. Including separate prudential sourcebooks for banks, building societies, insurers, friendly societies and investment business; and modules of conduct of business, market conduct, training and competence of staff and money laundering.

18. That is authorisation, supervision, enforcement and decision making.

19. According to the FSMA 2000, the FSA is endowed with powers to promulgate secondary legislation in a variety of forms such as principles, rules, guidance and codes of practice, directions and requirements. See, particularly, FSMA 2000, Part X, ch I (rule-making powers) and ch II (guidance) and Part V, s 64 (conduct and statements and codes). Significantly, not all of them are legally binding, while some of them may be limited in their scope of application. For a detailed discussion on this point, see Blair et al, above n 15, pp 138–141.

20. Black, J Rules and Regulators (Oxford: Clarendon Press, 1997) ch 1CrossRefGoogle Scholar.

21. The FSA considers that there is such an intimate link between high-level principles and the detailed rules that surround them, so that in one of his recent speeches Callum McCarthy, the Chairman of the FSA, pointed out that it is misleading to characterise the FSA's regulation as ‘principles-based’. Taking into account that there are currently 8500 pages of rules, the FSA could ‘equally…be described as rule bound regulator’: C McCarthy Financial Regulation: Myth and Reality FSA Speech (13 February 2007).

22. FSA Reader's Guide: An Introduction to the Handbook ch 5.

23. FSA Better Regulation Action Plan (December 2005) p 6 and J Tiner Better Regulation: Objective or Oxymoron? FSA Speech (9 May 2006) p 2.

24. Tiner, above n 23, pp 1–4.

25. Ibid, pp 2–5.

26. Ibid, pp 4–5.

27. In particular, the FSA has produced 14 sector-specific handbooks for small firms. Each one of them is about 90% smaller than the full FSA Handbook: ibid, p 16.

28. FSA, above n 22, p 2.

29. These fall in either of two categories: non-FSA UK or EU materials that are directly applicable. The UK flag icon is used for the former, while the EU flag icon designates the latter.

30. Personalised handbooks present the content of the FSA Handbook in a manner that fits the peculiar features of the firm. Focus-on handbooks deliver the content of the FSA Handbook presented by subject matter: FSA, above n 23, p 11 and Tiner, above n 23, pp 5–6.

31. The adjective ‘purposive’ is introduced here instead of the commonly used term ‘principles-based’, in order to emphasise the rationale behind this policy (‘attaining certain outcomes’) rather than the typology of regulatory provisions that are chiefly deployed to put it into operation (‘high-level principles’). See also S Wilson Supervision in a Principles Based World FSA Speech (27 February 2007).

32. Tiner, above n 23, p 2.

33. FSMA 2000, s 2(1)(b) stipulates that ‘In discharging its general functions the Authority must, so far as reasonably possible, act in a way which is compatible with the regulatory objectives; and which the authority considers to be appropriate for the purpose of meeting those objectives’. The Authority is under the same duty when it comes to the issuance of guidance under s 157(3) of the Act.

34. In this manner the FSA acts in accordance with s 155(2)(b) of the FSMA 2000, which stipulates that the FSA must always explain the purpose of the rules that it proposes to put in practice. High-level statements of purpose are found at the beginning of each section of the Handbook. Significantly, the FSA Handbook is subject to its own rules of interpretation. To a considerable extent, these rules of interpretation deviate from the provisions of the Interpretation Act 1978, which applies to secondary legislation.

35. See, eg, FSMA 2000, s 148(4)(a). Similar consideration guides the FSA's choice of enforcement strategy in case of contravention of regulatory requirements.

36. High-level standards apply generally to authorised persons, approved persons and to senior management and they are principles based. At their centre stand the Principles of Business: 11 high-level principles, which set overarching objectives for all financial services firms. These are the regulatory equivalent of ‘first principles’, which provide the very backbone of the FSA's regulatory regime by explicating what actions and behaviours the FSA expects from firms: Blair and Walker, above n 15, pp 104–108; Tiner, above n 23, p 2.

37. On the importance of communication in a principles-based approach to regulation, see Tiner, above n 23, pp 4–6.

38. The drafters of the FSMA 2000 placed great emphasis on enhancing the openness, transparency and participatory character of the FSA's exercise of regulatory powers. In this connection, not only does s 8 of the FSMA 2000 provide that the regulator has a general duty to make and maintain effective arrangements for consulting practitioners and consumers on the extent to which its general policies and practices are consistent with its general duties specified in s 2 of the Act but the FSMA also contains a multitude of other provisions where a net of consultation procedures for specific purposes is laid down in considerable detail. One of these is s 155 of the Act, which places consultation at the heart of the rule-making process.

39. The implementation of the ‘Treating Customers Fairly’ initiative offers a standard example of methods that the FSA deplores to communicate with the regulated population: D Waters Implementing Principles-Based Regulation FSA Speech (7 December 06).

40. Baldwin, above n 3, at 493.

41. Ibid.

42. Similar problems have been addressed nearly in the same way during the earlier regimes of self-regulation and self-regulation within a statutory framework (the Financial Services Act 1986 regime), although currently the preservation of conversational elements in financial regulation became a more conscious project.

43. Here I draw on Black's account of interpretive communities although I do not strictly follow it: Black, above n 20, pp 30–31.

44. Arguably, the FSA's policy of rule use as currently practised pushes towards a new phase of de facto changes in the institutional layout of financial regulation in the UK. I return to this point below, when I discuss certain difficulties that pertain to the implementation of a conversational approach to rule use.

45. Davies, above n 11, pp 23–24 and FSA A New Regulator for the New Millenium (January 2000).

46. FSMA 2000, s 2. This general duty finds special expression in a range of other provisions in the Act. Examples include ss 155 and 65 explicating the procedural aspects of rule formation and the procedure for the issuance of statements of principle and codes of practice under s 64, respectively, Part X, ch III subjecting the FSA's regulatory requirements under competition scrutiny, s 148(4) stipulating that waivers and modifications are justified provided that the FSA is satisfied that compliance with regulatory requirements as they stand would be unduly burdensome or would not achieve the purpose for which the rules are made.

47. ARROW stands for the advanced, risk-responsive, operating framework: FSA The FSA's Risk-Based Approach (November 2006) p 3. On the evolution of the FSA's risk-based approach to regulation, see FSA The FSA's Risk-Assessment Framework (August 2006) and J Black ‘The emergence of risk-based regulation and the new public risk management regime in the United Kingdom’ [2005] Public Law 512 at 524–530. ARROW II constitutes a revised version of the earlier risk-based framework (ARROW I). Compared to its predecessor, ARROW II concentrates the following advantages: (a) it allowed a more accurate comparison of risks in different areas; (b) it made it possible for the FSA to have better control of the supervisory process and to ensure a more consistent approach is applied; (c) the revised ARROW assessment letters increased practitioners' involvement in the risk assessment process, so that the FSA now gets a more accurate picture of the risks imposed by each firm; and (d) it improved the FSA's capacity to undertake sector intelligence and analysis work, so that it becomes better informed of emerging risks and other trends in the industry.Google Scholar

48. As with the earlier risk-based regime (ARROW I), ARROW II is used to determine regulatory priorities and resource allocation, to assess firm-specific risk for monitoring purposes; to assess market and industry-wide risks, to determine policy objectives on an annual basis; and assess possible changes in regulatory scope (eg additional responsibilities): FSA The FSA'S Risk-Based Approach – A Guide for Non-Executive Directors (November 2006) and FSA The FSA's Risk-Assessment Framework, above n 47, ch 2, paras 6–9.

49. FSA The FSA's Risk-Assessment Framework, above n 47, ch 2, para 4.

50. Ibid, ch 2, para 5 and ch 3, para 33.

51. Ibid, ch 2, paras 13–20.

52. Ibid.

53. Ibid, ch 2, para 3.

54. Indicative of this point is the fact that the FSA places great importance in engendering a shared appreciation of the regulatory outcomes that it seeks to achieve and the range of risks that threatens them: ibid, ch 2, para 15; FSA The Open Approach to Regulation FSA Policy Statement (1998) and D Waters and M Hopper ‘Regulatory discipline and the European Convention of Human Rights’ in Ferran and Goodhart, above n 11, ch 8, p 99.

55 In light of the scientific status of ARROW II, the contingency of disobedience as a manifestation of a deeper disagreement with the regulator's interpretation of rules becomes a remote threat to the FSA's agenda and, in any case, an eventuality that is much easier to manage: Mayer, J and Rowan, B Institutionalised organisation: formal structure as myth and ceremony’ (1977) 83(2) American Journal of Sociology 340 CrossRefGoogle Scholar.

56. Strictly speaking, neither simplicity nor clarity is an inherent feature of the Handbook. Rather they are states of affairs to be perpetually attained provided that and to the extent in which the regulator is effective in communicating the meaning of the regulatory requirements to the regulated population.

57 It is noteworthy that financial firms in Australia (insurance industry companies are but one example) are faced with similar problems in their attempt to make sense of the applicable regulatory provisions and that the growing dissatisfaction with the design of the normative framework of the Australian financial regulation has led recently to a number of initiatives that aim to improve it. However, one should abstain from drawing lessons from the reform of the Australian financial regulation with the view of applying them directly to the UK, not least because these two regulatory regimes differ considerably in terms of their institutional structure: Taskforce on Reducing Regulatory Burdens on Firms Rethinking Regulation Report of the Taskforce on Reducing Regulatory Burdens on Firms (January 2006) pp 100–101; Gengatharen, R and Barton, G, ‘The regulation of financial advisers in Australia’ (2006) 21(10) Journal of International Banking Law and Regulation 580 Google Scholar; . On the different institutional structure of the Australian and the UK regulatory authorities, see Hadjiemmanuil, above n 11.

58. FSA Implementation of the Distance Marketing Directive: Proposed Rules and Guidance FSA Consultation Paper 196 (September, 2003); Office of Fair Trading A Guide for Business on Distance Selling: Summary of the Responses to the Consultation Paper (September 2006), available at http://www.oft.gov.uk.

59. For a detailed account of the recent developments that intend to improve FSA business capability and capacity, see FSA FSA Business Plan 2006/2007.

60. These limitations are discussed below in a separate subsection.

61. Indicative of the FSA's dissatisfaction with getting this right is the fact that ever since the FSA Handbook was brought into being, the balance between high-level principles and detailed rules has been the subject of constant review: McCarthy, above n 21. I discuss this point further below when I explore some of the weaknesses associated with the purposive nature of the FSA's policy of rule use.

62. One might object that there are benchmarks to make sure that FSA gets the balance between high-level principles and detailed prescriptive rules right, pointing out that the present regulatory authority is held accountable on the basis of the four statutory objectives and principles of good regulation, which, inter alia, require the use of cost–benefit analysis and a risk-based approach to financial regulation. This argument, however, does not impose a serious challenge to my claim, given that the content of the statutory objectives, the principles of good regulation and the implications of findings of empirical research are subject to interpretation and the FSA is the ultimate arbitrator of their meaning and implications in terms of public policy. After all there are concerns that the FSA cost–benefit methodology has its own flaws. In a recent report, the National Audit Office suggested that the FSA ‘needs to enhance its grip on information on the cost of its activities’: National Audit Office NAO Report HC 500, 2006–2007: The Financial Services Authority, Executive Summary (London: NAO, April 2007).

63. C Briault The Rationale for a Single National Financial Regulator FSA Occasional Paper (1999) pp 18–19.

64. On the FSA accountability regime, see R Lastra and H Shams ‘Public accountability in the financial sector’ in Ferran and Goodhart, above n 11, ch 12; E Lomnicka ‘Making the Financial Services Authority accountable’ [2000] Journal of Business Law 65.Google Scholar

65. Wilson, above n 31.

66. Waters, above n 39; AC Fawcett ‘Examining the objectives of financial regulation: will the new regime succeed? A practitioner's view’ in Ferran and Goodhart, above n 11, ch 4, p 48.

67. See the discussion in the relevant subsections below.

68. The EU Reinsurance Directive came into force on 10 December 2005 and it will be implemented across all Member States by the end of 2007.

69. FSA Implementing the Reinsurance Directive FSA Consultation Paper 06/12 (June 2006) para 4.4.

70. This is the so-called ‘financial prudence’ principle. See Principles for Business, FSA Handbook PRIN.2.1.1.

71. The recent Handbook release on glossary definitions seems to suggest that the FSA tried to accommodate the industry's demand for a definition of financial reinsurance, since it contains definitions of terms such as ‘reinsurance intermediary’, ‘reinsurance undertaking’ and ‘reinsurance contract’: FSA Handbook Release 64: Glossary Definitions (23 April 2007).

72. On the industry's reaction, see National Audit Office, above n 62; Wilson, above n 31; Waters, above n 39; Fawcett, above n 66 and Tiner, above n 23, p 3.

73. For a criticism of Fawcett's claims above, see Georgosouli, above n 15, pp 36–37.

74. Black, above n 20, p 27.

75. Ibid, p 26.

76. All those features of the FSA policy of rule use that can be described as ‘conversational elements’ are examples of mechanisms that aid the regulator in making informed choices providing, at the same time, an additional layer of public scrutiny.

77. The risk-based approach to regulation as it finds expression in the ARROW II framework is the standard example to evoke in this connection.

78. Black, above n 20, pp 42–44.

79. Ibid, p 42.

80 The purposive character of the FSA's policy of rule use may be evoked in support of this view as it clearly indicates an emphasis on meta-regulation. In this connection, see Tiner's comments on the rationale for a principles-based approach to regulation and the FSA's enthusiasm to encourage and embrace market-based solutions to market failure in Better Regulation: Objective or Oxymoron? FSA Speech (9 May 2006). On meta-regulation, see Parker, C The Open Corporation: Effective Self-Regulation and Democracy (Cambridge: Cambridge University Press, 2002)CrossRefGoogle Scholar and .

81. Black, J Proceduralizing regulation part Ii’ (2001) 21 Oxford Journal of Legal Studies 33 CrossRefGoogle Scholar.

82. In elucidating the pathology of the conversational aspects of the FSA's policy of rule use, I am only concerned with a question of fact: ‘Is the FSA capable of performing this role?’ The corollary question of principle, namely whether the regulator should perform this role, falls outside the scope of my inquiry.

83. Black, above n 81, at 48.

84. Ibid, at 51–52.

85. March, J and Olsen, J The new institutionalism: organisational factors in political life’ (1984) 78 American Political Science Review 734 CrossRefGoogle Scholar and .

86. Waters, above n 39.

87. Black, above n 47, at 531.

88. Ibid.

89. On the phenomenon of ‘process-induced myopia’, see ibid, at 543.

90. Regulators are further discouraged to do so in light of the new politics of accountability that the introduction of risk-based regulation brought with it: ibid, at 545–546.

91. Wilson, above n 31.

92 On the new politics of accountability, see Black, above n 47, at 545–546. On the lack of incentives to adopt an imaginative approach to regulation, see, more generally, Sparrow, M The Regulatory Craft (Washington DC: Brookings Institution, 2000) p 310 Google Scholar; and .

93. McCarthy, above n 21.

94. Wilson, above n 31; Braithwaite, above n 80.

95 On ‘meta-regulation’, see Black, J Managing regulatory risks and defining the parameters of blame. a focus on the Australian prudential regulation authority’ (2006) 28 Law and Policy 1 CrossRefGoogle Scholar at 22.

96. For a more general discussion, see Baldwin, above n 3, at 505.

97. Black, above n 20, ch 3.