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Beware of the impact assessment

Why apple pie is not always good for you

In May, European Commission Vice-President Timmermans presented his Better Regulation proposals, which aims to reduce the regulatory burden and improve the way new rules are made. Some say that Better Regulation is like apple pie – no one is against it. Then why is the subject so controversial?

Since the package was announced, more than 50 civil society organisations have formed a new network called the Better Regulation Watchdog. Its members, including Finance Watch, are worried that, in some cases, the benefits of Better Regulation could come at a wider cost to society.

The proposals include extra consultations for stakeholders and a statement from the Commission that it will fully use its right to withdraw legislative proposals, if it feels that amendments by the European Parliament or Council of Member States have changed it too much (when the horse turns into a camel, as it has been described).

One potentially worrying proposal is for more impact assessments at various stages of legislation. The Commission wants the Parliament and the Council to quantify the impact of the legislative amendments that they introduce during their scrutiny phases. Changes with a negative “impact” should no longer be allowed.

The Commission is also reviewing its own procedures, with a revamped Regulatory Scrutiny Board composed of 50% “independent” experts who will scrutinize the impact assessment of Commission proposals before they are presented.

But how to measure the impact of legislation? There is no uniform definition and participants in the debate often mix up the costs of compliance with the impact of regulation on business.

The cost of compliance is what is often referred to as “red tape”. No one is in favour of unnecessary administrative burden, and we should work together to reduce these costs to a minimum. Legislation should be easy to comply with and not introduce e.g. double or conflicting reporting requirements.

However, compliance costs are not the same as the (negative) impact of regulation on a certain business model. Often, this impact is actually the purpose of the regulation, such as when reducing the proportion of high-frequency trading or speculative activity on financial markets, to stabilize markets and make sure they serve their social purpose. By definition, this is bad news for the companies involved in this sort of business.

It is not a surprise that those being regulated are quick to point at the impact of regulation on their business. In the past six years, the EU has introduced legislation in many parts of the financial industry that were previously unregulated, such as hedge funds, short selling and money market funds. When these companies complain that regulation is hurting their business, this impact must be traded off against the societal benefits of regulation, in a proper cost-benefit analysis.

The costs of regulation are often quite easy to calculate (as protesting industry participants demonstrate), since they are easy to quantify, immediate and fall on a small defined number of players, who will shout and scream to show how much their profit has gone down compared to the pre-legislative situation.

The benefits of regulation, on the other hand, are often difficult to quantify, in the long run, and fall on a large group of actors. What is it worth to us to reduce the long-term risk that taxpayers have to finance bailouts of large systemic banks? Try to put a figure on it. Is it OK that large banks will lose hundreds of millions in potential profits, in exchange for taxpayers not paying billions to save banks?

Unfortunately, when decision-makers speak about a cost-benefit analysis, they often mean a cost assessment, and it is important to remind ourselves that there was a reason to regulate the financial sector – we have gone through the worst financial crisis in a century and this has had a significant impact on the real economy. Taxpayers had to bail out too-big-to-fail banks in many European countries, and legislation should aim to reduce the risk of this happening ever again.

That is why we are sceptical about the push for more impact assessments. It is hard to imagine how the legislative process will be improved from society’s viewpoint if every significant amendment requires a new impact assessment that looks mainly at the costs to business.

Better Regulation could have a lasting impact on the way that democratic rules are made, indeed that is its aim. There are other concerns as well as impact assessments; to find out more, visit the Better Regulation Watchdog website.

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