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The Imperative and Benefits of Introducing Outcome Based Privatized Co-Regulation

Recent turmoil in the financial markets can be explained by the science of governance used by engineers to design the regulatory systems of devices operating in unknown, dynamic environments. Turmoil is the result of insufficient supplementary co-regulators. The laws of governance "absolutely prohibits any direct and simple magnification but does not prohibit supplementation" of regulation. This law creates an imperative for regulators to require that their regulatees establish a requisite variety of co-regulators. It is the stakeholders of regulatees that can provide the requisite variety of co-regulation required to avoid regulatory failure. Many stakeholders would typically include those individuals or organizations that government regulators are created to protect. The introduction of bottom up outcome based co-regulation by relevant stakeholders would result in the partial privatization of regulation. The resulting flexibility would allow regulatees to reduce compliance costs and obtain operating and competitive advantages. The paper identifies how bottom up private sector co-regulation by stakeholders could be introduced on an incremental basis. An example is presented on how a company efficiently raised new equity through changes in its constitution that also allowed the regulator to exempt it from the compliance processes and costs of changing auditors. A requirement for stakeholders to be effective co-regulators to reduce elements of public sector regulation is that they obtain the: (i) information, (ii) will and (iii) capability to act independently of regulatees to protect their own interests and that of the financial system as may be relevant. The role of government and its regulators would change from defining practices and processes to defining outcomes of the stakeholder and system protection required. An outcome based regime would introduce flexibility for regulatees to develop the most efficient and effective practices and process in their particular business to achieve the desired outcomes. A co-regulatory strategy would also reduce the cost to government as stakeholders complemented the monitoring role of regulators and reduced the need for regulators and the courts to take corrective action.