This story sheds light on one reason why laws and regulations, especially in finance, seem to be getting longer and more complicated. Rules can start out simple (OK, tax laws rarely do), but soon someone very smart (or very stupid) will do something that triggers an explicit new ban or policy. In the wake of the ‘cum-ex’ scandal, a rule was added on who can issue certificates of withholding tax on dividend payments(1).
People in finance and beyond yearn for a simpler world, free from over-complicated language, conditionality, sub-clauses, exceptions and esoteric references. But that’s wishful thinking. Our complex world must be kept in check by a multitude of standards, laws and regulations. We can—actually should—focus on incentives to get people to do the right things, but even sensible actions can lead to bad outcomes.
Financial regulation has indeed increased enormously. 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 the earlier Basel 2 rules. 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 hard to read as a Thomas Hardy novel – and I’m reading The Mayor of Casterbridge for GCSE English; it was boring enough.
But simpler rules have done harm in the past. Basel 3 became so lengthy and difficult because of the flaws in the global and national regulations that formed the basis of the 2008 financial crisis. The UK took a lighter, principles-based approach to regulation, while the US set capital requirements for banks as a simple percentage of total assets, whatever the assets. Both approaches failed by allowing banks to chase profits in ultimately dangerous ways.
This is not just the fault of regulators or bankers. It is the result of the long-dominant intellectual movement that said individuals and companies that maximize their own returns achieve the best outcome for society as a whole. Many people, doing what was then considered generally rational, have contributed to systemic financial crises, harmful pollution, and climate change—more than just bad actors can be blamed for.
So it’s not just individual behavior that regulators need to address—they need to find solutions to the less predictable outcomes of entire social systems. Doing both is difficult, doing both is Herculean work. Hence the complexity.
Additional complications arise from trying to create common standards so people can do business across countries. In the UK, the selling point of Brexit has been a dream of escaping Europe’s Byzantine rules on finance, trade and human rights. Six years after the vote, things look more confusing than ever. (This isn’t just a financial matter. For example, try reading hygiene standards for cheesemakers, who have to set rules befitting huge industrial plants, and artisans who age their products in ancient French caves.)
None of this means that we should accept complexity unconditionally. Humans have a natural tendency to contribute to sluggish processes when solving challenges, rather than thinking about how things could be made more efficient. Complexity can also be used as a tool of obfuscation and obfuscation, as any good tax attorney will tell you.
But not all complexity is created equal. Although a study of restaurants found that complex rules are more likely to be broken, repeat violations were more likely for rules that referenced many other rules (as opposed to simple long and detailed rules). This is surprisingly a small plus point for Basel 3: according to the Bank of England study, each rule in Basel 2 contains, on average, more references to other rules than those in the later book.
Financial regulation is highly technical, detailed and difficult to understand – reflecting the wide variety of things finance does and the motivations of those who make it all work. You wouldn’t expect nuclear physicists or molecular biologists to just speak plain language to guide their work with power plants or genetically engineered foods or drugs.
The question is how to cope with the complex?
Ongoing engagement between well-resourced regulators, financial actors and society is one response to how rules can be kept as functional and efficient as possible. Although that in itself is a laborious process. Technical rules can also work alongside simpler, more obvious principles; but if companies want people to comply, they need to provide healthy, constructive incentives and clear, relevant education about where the lines are and why (and what it costs to cross them).
This kind of cultural healing is one of Swiss bank Credit Suisse Group AG’s key responses to its long list of recent problems. The bank pledged to increase personal accountability across the bank and make everyone a risk manager.
Christine Lagarde, President of the European Central Bank, gave a different answer in a recent interview. She said part of the world seems so complex is because “everyone is increasingly focused on their own area of expertise.” She seeks out art and culture to keep her own mind pliable, even with her sons – one sends her messages about telescopes and space architecture, the other, who runs two restaurants, tells her about his problems with company accounts and human resource management.
In other words, make a virtue of seeking different ideas and experiences within and well beyond your normal realm. That might help put the complexity in some perspective. You never know, it may even help you find ways to make some things easier.
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• Cancel private jets? Here’s a better idea: Chris Bryant
• Not abandoning small businesses in the energy crisis: Javier Blas
• Liz Truss is about to get her hands on Brexit dynamite: Therese Raphael
(1) The new regulation said that only the custodian bank that has distributed dividend payments can also withhold taxes and issue tax certificates. This would ensure that tax certificates, essentially receipts for taxes paid, are issued only once. Some experts argue that this still hasn’t really closed the loophole,
This column does not necessarily represent the opinion of the editors or of Bloomberg LP and its owners.
Paul J. Davies is a Bloomberg Opinion columnist covering banking and finance. He was previously a reporter for the Wall Street Journal and the Financial Times.
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