This story sheds light on one of the reasons why laws and regulations, especially for finance, seem to be getting longer and more complicated. The rules may start out simple (OK, tax codes rarely do that), but soon someone very smart (or very stupid) will do something that triggers another explicit ban or directive. With the “Cum-Ex” scandal, this meant adding a stipulation on who could issue certificates for withholding tax on dividends(1).
People in finance and beyond yearn for a simpler world stripped of overly complicated language, conditionality, sub-clauses, exceptions and esoteric references. But that’s wishful thinking. Our complex world must be mastered by a set of standards, laws and regulations. We can—in fact, we should—focus on incentives to get people to do the right things, but even reasonable actions can lead to bad results.
Financial regulation has indeed expanded. A Bank of England study last month analyzed the length and linguistic complexity of the global banking standards known as Basel 3. They found that the book is more than twice as long as previous Basel rules. 2. Somehow, according to the analysis, Basel 3 is both twice as precise and 25% more vague than its predecessor. By another metric, the rules are now almost twice as difficult to read as a Thomas Hardy novel – and I’ve read ‘The Mayor of Casterbridge’ for GCSE English; it was quite tedious.
But simpler rules have done damage in the past. Basel 3 has become so long and difficult due to gaps in global and national rules that were the breeding ground for the 2008 financial crisis. The UK had a more lighthearted approach to principle-based regulation, while the states United States set capital requirements for banks as a simple proportion of total assets, whatever those assets were. Both approaches have failed by allowing banks to chase profits in ultimately dangerous ways.
It’s not just the fault of regulators or bankers. It is the result of the long-standing dominant intellectual movement that individuals and companies that maximize their own returns produce the best results for society as a whole. Many people doing what was agreed at the time to be generally rational have contributed to systemic financial crises, pollution damage and climate change – more than can be blamed on bad actors alone.
So it’s not just individual behavior that regulators need to worry about – they need to address the less predictable outcomes of entire social systems. Doing one or the other is difficult, doing both is herculean. So the complexity.
An additional complication comes from trying to create common standards so that people can do business in all countries. In the UK, Brexit’s selling point was a dream of escaping Europe’s Byzantine rules on finance, trade and human rights. Six years after the vote, and things seem more confusing than ever. (It’s not just a question of finances. For example, try reading the hygiene standards for cheesemakers, which must establish rules suitable for giant industrial installations as well as artisans who ripen their products in old French cellars.)
None of this means we should accept complexity without question. Humans have a natural tendency to add trick processes when overcoming challenges, rather than thinking about how things could be more efficient. Complexity can also be misused as a tool of obfuscation and disguise, as any good tax attorney will tell you.
But not all complexities are the same. Although a restaurant study found that complex rules were more likely to be broken, repeat violations were more likely for rules that referenced many other rules (as opposed to simply long and detailed rules). This is, surprisingly, a small positive point of Basel 3: on average, each rule of Basel 2 makes more references to other rules than those of the last book, according to the study of the Bank of England.
Financial regulation is highly technical, detailed and difficult to understand, reflecting the vast multiplicity of activities in finance and the motivations of those who make it work. You wouldn’t expect nuclear physicists or molecular biologists to speak only plain English to guide their work with power plants or genetically modified foods or drugs.
The question is how to deal with the complex?
Constant engagement between well-resourced regulators, financial actors and society is one response to keep the rules as functional and effective as possible. Although this in itself is an elaborate process. Technical rules can also work alongside simpler, more obvious principles; but if companies want people to respect them, they need to put in place healthy, constructive incentives and provide clear, relevant education about where the lines are and why (and the costs of straying from them).
This kind of cultural remedy is one of Swiss bank Credit Suisse Group AG’s main responses to its long list of recent problems. The bank promised to strengthen personal accountability across the bank and make everyone a risk manager.
Christine Lagarde, the president of the European Central Bank, gave another answer in a recent interview. She said the world seems so complex in part because “everyone is increasingly focused on their own area of expertise”. She turns to art and culture to keep her mind flexible and with her sons – one sends her messages about telescopes and space architecture, the other, who runs two restaurants, tells her about his issues with operating states and personnel management.
In other words, make it a virtue to seek out different ideas and experiences within and far beyond your normal realm. This might help put the complexity into perspective. You never know, it may even help you find ways to simplify some things.
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(1) The new rule stipulated that only the custodian bank which distributed the dividends could also withhold taxes on them and issue tax certificates. This would ensure that tax certificates, essentially receipts for taxes paid, would only be issued once. Some experts say that still hasn’t really closed the loophole,
This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.
Paul J. Davies is a Bloomberg Opinion columnist covering banking and finance. Previously, he was a reporter for the Wall Street Journal and the Financial Times.
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