It seems blindingly obvious: Banks should not trade shares to help investors claim rebates for taxes they have not paid. Yet, in Germany it took a court ruling just last year to confirm this was illegal a decade after the practice was banned. A string of international lenders are still being investigated; last week, German prosecutors raided JPMorgan Chase & Co.’s Frankfurt offices as part of their probe into the scandal — known as “Cum-Ex” — that’s estimated to have cost taxpayers upwards of 10 billion euro ($10 billion).
This story illuminates one reason why laws and regulations, especially for finance, seem to be getting ever longer and more complicated. Rules can start out simple (OK, tax codes rarely do), but soon someone very smart (or very stupid) will do something that triggers an explicit new prohibition or guideline. With the “Cum-Ex” scandal, this involved adding a stipulation for who could issue certificates for taxes withheld on dividend payments
People in finance and beyond pine for a simpler world stripped of overcomplicated language, conditionality, sub-clauses, exceptions and esoteric references. But this is wishful thinking. Our complex world has to be kept in check by an array of standards, laws and regulations. We can — in fact, should — focus on incentives to get people to do the right things, but even reasonable actions can add up to bad outcomes.
Financial regulation has indeed grown vast. 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 previous 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 nearly twice as difficult to read as a Thomas Hardy novel — and I read “The Mayor of Casterbridge” for GCSE English; it was tedious enough.
But simpler rules have done damage in the past. Basel 3 became so long and difficult because of the shortcomings in global and national rules that were the seedbed for the 2008 financial crisis. The UK had a lighter principles-based approach to regulation, while the US set bank capital requirements as a simple proportion of total assets regardless of what those assets were. Both approaches failed by allowing banks to chase profits in ultimately dangerous ways.
This isn’t just the fault of regulators or bankers. It is the result of the long-dominant intellectual movement that said individuals and companies maximizing their own returns produce the best outcome for society as a whole. Many people doing what was agreed at the time to be generally rational have contributed to systemic financial crises, damaging pollution and climate change — more than can be blamed on bad actors alone.
So it’s not just individual behavior that regulators have to worry about — they have to solve for the less predictable outcomes of entire social systems. Doing either is hard, doing both is Herculean. Ergo, the complexity.
Added complication comes from trying to create common standards so that people can do business across countries. In the UK, the selling point of Brexit was a dream of escape from Europe’s byzantine rules on finance, trade and human rights. Six years on from the vote, and things look more confusing than ever. (This isn’t just a finance thing. For example, try reading hygiene standards for cheesemakers, which have to set rules fit for giant industrial facilities as well as artisans who mature their products in ancient French caves.)
None of this means we should accept complexity unquestioningly. Humans have a natural tendency to add to jerry-rigged processes when overcoming challenges, rather than think about how things could be more efficient. Complexity can also be abused as a tool of obfuscation and disguise, as any good tax lawyer will tell you.
But not all complexity is the same. Although one study of restaurants found that complex rules were more likely to be broken, repeat offenses were more likely for rules that referenced lots of other rules (as opposed to simply long and detailed rules). That, surprisingly, is one small positive of Basel 3: On average, each rule in Basel 2 makes more references to other rules than those in the later book, according to the Bank of England study.
Financial regulation is very technical, detailed and difficult to understand — that reflects the vast multiplicity of things that finance does and the motivations of those making it all work. You would not expect nuclear physicists or molecular biologists to speak only in plain English to guide their work with power stations or genetically modified food or medicines.
The question is how to cope with the complex?
Constant engagement between well-resourced regulators, financial actors and society is one answer for how to keep rules as functional and efficient as possible. Although that in itself is an elaborate process. Technical rules can work alongside simpler, more obvious principles, too; but if companies want people to abide by them, then they have to set healthy, constructive incentives and offer clear, pertinent education about where the lines are and why (and the costs of straying outside them).
This kind of cultural cure is one of Swiss bank Credit Suisse Group AG’s main responses to its long list of recent troubles. The bank promised to reinforce personal accountability throughout the bank and make everyone a risk manager.
Christine Lagarde, the European Central Bank president, gave another answer in a recent interview. She said the world seems so complex in part because “everyone is increasingly focused on their own field of expertise.” She looks to art and culture to keep her own mind supple as well to her sons — one sends her messages about telescopes and space architecture, the other, who runs two restaurants, tells her his problems with operating statements and managing staff.
In other words, make a virtue out of seeking different ideas and experiences within and far beyond your normal realm. That could help put complexity into some perspective. You never know, it may even help you find ways to make some things simpler.
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