Monday, 22 September 2008

Principles vs Rules

I have just been watching Newsnight and heard Jeremy Paxman discussing how the UK is changing to a rules based accounting format from our current principles based approach. The implication is that the American system of rules is better and will prevent the kind collapse we have been witnessing recently.

Put simply a principles based means obeying a spirit while a rules based approach means obeying a law. If we take the theme of independence we can see how this works in practice. Under a rules based approach, you need to ensure you comply with a checklist to make sure you are independent, with the onus being on the authorities to make sure rules are up to date. While with principles the onus is on you to ensure you meet the key principle of being "independent in mind and appearance". A simpler system which is less open to fraud and abuse, due to the professional bodies enforcing these behaviours

I see four major faults with Paxman's assertion.

1, The US is moving away from a rules based approach to principles. If this approach is so good why are the Americans changing?

2, Rules can be got round by clever legal minds as was evidenced by Enron and Worldcom.

3, Principles makes compliance the duty of the company, while rules makes it the duty of the regulator to ensure they are complying.

4, Rules cannot cover every eventuality an in a market as varied and complex as finance the principles based approach allows companies to be more flexible in assessing risk.

Frankly this idea is silly and will be a knee jerk reaction to increase regulation.
Regulation is not what the market needs. What the finance section needs is confidence and that will not come with a change of rules

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