CFTC Chair Heath P. Tarbert compared the benefits of using a principles-based approach with those of a rules-based approach to regulation.

Benefits of Principles-Based Approach

In remarks delivered at the 2019 Annual Robert Glauber Lecture at Harvard University's Institute of Politics, Mr. Tarbert stated that a principals-based approach (i) reduces complexity, (ii) eliminates "over and under inclusion," (iii) dissuades "loophole behavior" (i.e., complying with the literal terms of a rule but not with the rule's purpose), (iv) allows regulators to keep in close contact with regulated firms and (v) facilitates international cooperation.

Chair Tarbert explained that a rule-based approach (i) brings greater clarity and more consistency to the markets, which allows market participants to know in advance where the line is between legal and illegal conduct, (ii) clarifies "best practices" standards for market participants, and (iii) potentially protects firms against private lawsuits.

Mr. Tarbert recommended a principles-based approach if:

  • the regulatory objective is (i) prudential supervision, (ii) setting standards or providing guidelines for market behavior, or (iii) achievable through multiple channels;
  • the "nature of the market" is (i) subject to frequent rule updates, (ii) a nascent industry (e.g., technology) or (iii) already subject to a self-regulatory organization that provides regulatory regimes; or
  • the regulator and regulated entity frequently interact, providing there is a "high level of trust."

Benefits of Rules-Based Approach

Mr. Tarbert said a rules-based approach is preferable if:

  • the regulatory objective (i) is market conduct or disclosure, or (ii) targets behavior that is generally considered malum in se (e.g., enforcement regulations);
  • the "nature of the market" would be convoluted by a principles-based approach;
  • regulations would not need to be updated often;
  • regulators must coordinate regimes with multiple domestic regulators; or
  • the market is domestic.


Bob Zwirb

While Mr. Tarbert described the merits of both approaches - even noting that in certain instances regulators will use both or even a hybrid form of the two approaches - he underscored that "there's a general censuses that we've had a little bit of an information overload in terms of rules," and highlighted the advantages of the principles-based approach:

"Principles-based regulation has a high level of generality. It's flexible and can be applied broadly. It focuses on outcomes, not specific conduct. It's also generally qualitative rather than quantitative. It's also susceptible to elaboration. So when you have very specific rules, they become ossified. They become frozen in time to some extent, whereas a principles-based approach can be allowed to evolve over time as markets and behaviors change."

Steven Lofchie

Chair Tarbert provides a helpful discussion of two different regulatory approaches. Mr. Tarbert's conceptual framework is useful in explaining why one approach or the other may be preferable in a particular situation.

One "advantage" or "disadvantage," depending on one's perspective, of the principles-based approach is that it may give regulators very wide latitude to determine that specific conduct was impermissible. This broad latitude is particularly problematic where the underlying principles are not themselves clear.

By way of example, one might look at the CFTC's Interpretive Guidance regarding its jurisdiction over cross-border swaps. See 78 Fed. Reg. 45291 (July 26, 2013). In explaining how it would apply its authority, the CFTC uses the word "circumstances" 89 times. In many cases, it was neither clear what circumstances mattered nor what policy was at issue. The CFTC itself acknowledged market participants' confusion over the CFTC's proposed interpretation of the term "U.S. person." 78 Fed. Reg. at 45303. So, to Mr. Tarbert's analysis, one should add that where a regulator relies on a principles-based approach to regulation, the regulator should bear the burden of being very clear as to the end result that it wishes to achieve and why it wants to achieve that end.

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