Regulatory Complexity

REGULATORY COMPLEXITY is an increasing challenge facing legal systems around the world. In September 2020, the Australian Commonwealth Attorney-General asked the Australian Law Reform Commission (ALRC) to consider how the legislative framework governing corporations and financial services regulation could be simplified and rationalised, how legislative complexity could be appropriately managed over time, and how the legislative framework could be made clearer, more coherent and more effective. The ALRC inquiry was partly in response to a Royal Commission into misconduct in the banking and financial services sector (for a discussion about Royal Commissions, see China Business Law Journal, volume 10, issue 5: Commissions of inquiry).

The Royal Commission issued its final report in 2019 and made the following recommendation:

As far as possible, legislation governing financial services entities should identify expressly what fundamental norms of behaviour are being pursued when particular and detailed rules are made about a particular subject matter.

The final report further stated that, “by drawing explicit connections in the legislation between the particular rules that are made and the fundamental norms to which those rules give effect, the regulated community and the public more generally will better understand what the rules are directed to achieving”. In this way, it will be easier to achieve and enforce meaningful compliance within the intent of the law.

This column considers the challenge of regulatory complexity in Australia with reference to the legislative framework for corporations and financial services regulation. It finishes with a brief reference to the position in mainland China.

The challenge of regulatory complexity

Regulatory complexity can be broadly understood to mean not just the legal framework within which activities and participants are regulated, but also the design of primary and delegated legislation.

Legislative complexity has frequently been identified as a problem with the regulatory framework. The Oxford Dictionary defines the term “complex” as “the state of being formed of many parts; the state of being difficult to understand”. One outcome of complex systems is they become unpredictable.

The concept of predictability has been used to distinguish between complex systems and complicated systems. Often used as a synonym for complexity, the adjective “complicated” in English has been defined by the Oxford Dictionary as being “made of many different things or parts that are connected; difficult to understand”.

In a colloquial sense, the terms “complex” and “complicated” are often used interchangeably. In a general legislative context, however, a distinction is often drawn between the two terms on the basis that a complicated system is predictable, whereas a complex system is often unpredictable.

If there is a difference between “complex” legislation and “complicated” legislation, it probably lies in the notion that, although both terms convey the state of having many interconnected parts or elements, the term “complex” conveys the state of having many dynamic parts, the effects of which differ depending on the circumstances to which legislation is applied. Complexity increases the risk of incoherence as it makes it difficult to ascertain how all the parts should interrelate or fit together.

In its current inquiry into the legislative framework governing corporations and financial services regulation, the ALRC has suggested: “A key objective when designing legislation should be to ensure that it is as easy to navigate and understand as possible, consistent with the policy objectives being pursued by the legislation.” This objective is embodied within the term “coherence”, which has been defined by the ALRC as meaning “logical and well organised; easy to understand and clear”.

The ALRC has further suggested a legislative framework is coherent “if it hangs or fits together, if its parts are mutually supportive, if it is intelligible, if it flows from or expresses a single unified viewpoint”.

Conversely, incoherent law is “unintelligible, inconsistent, ad hoc, fragmented, disjointed, or contains thoughts that are unrelated to and do not support one another”. As a result, the ALRC concludes, “coherence needs to be assessed by reference to both the individual components of legislation and to legislation as a whole”.

Accordingly, the task confronting law reform is not to avoid complexity altogether, but to avoid unnecessary complexity. A parallel in this regard could be drawn with the principles of contract drafting, where a distinction is often recognised between “vagueness” and “ambiguity” (for a discussion about contract drafting, see China Business Law Journal, volume 9, issue 7: Contract drafting).

The term “vagueness” reflects the realities about the inherent vagueness of language and describes the situation where the meaning of a piece of text is clear, but the way in which it is interpreted is open to question. The term “ambiguity”, on the other hand, describes the situation where a piece of text may have two completely different meanings.

Not surprisingly, best practice is to reduce vagueness where possible and avoid ambiguity at all costs. When translated into the legislative design context, best practice would be to reduce complicatedness where possible and avoid unnecessary complexity at all costs to reduce the risk of that unnecessary complexity having an adverse impact on coherence.

It is relevant to note that complexity can be as much a product of poor legislative design as a product of policy complexity.

Corporations and financial services regulation

In Australia, the primary legislation for corporations and financial services regulation is the Corporations Act. This piece of legislation is highly prescriptive, with yet further prescriptive detail dispersed across delegated legislation made by the minister responsible for financial services and by the regulator, the Australian Securities and Investments Commission (ASIC). The analysis by the ALRC suggests the prescription is both a cause and a symptom of complexity. This is particularly clear in respect of chapter 7 of the Corporations Act, which regulates financial services.

Complexity is also exacerbated by the length of the Corporations Act, which is the second-longest Commonwealth act in Australia. Chapter 7 alone makes up 28% of that length. The ALRC’s data analysis indicates that if chapter 7 were a standalone act, it would be the 11th-longest Commonwealth act.

More problematic than the length of delegated legislation is the way delegated legislation is used. Both regulations and other legislative instruments made pursuant to the Corporations Act are used to create complex conditional exemptions and “notional amendments”. Also known as “modifications”, notional amendments effectively change the wording of legislation but do not appear on the face of the legislation itself.

It is therefore often impossible to determine from reading the text of the primary legislation whether it applies “as written” or is notionally amended by regulations and other legislative instruments. Anecdotal evidence suggests that even experienced practitioners are concerned about missing something when advising on chapter 7 of the Corporations Act.

A key reform proposed by the ALRC is the adoption of a new legislative model to determine where the law is located as between primary legislation and delegated legislation. Importantly, this proposed model would remove the need for extensive notional amendments. The ALRC has proposed the use of metrics to measure the complexity of the legislative framework and to distinguish between “necessary” complexity and “unnecessary” complexity.

It is important to recognise that problems with legislative design can create a high level of unnecessary complexity. This reminds us of the importance of structuring and framing the legislative framework in an appropriate manner. It also reminds us that good legislative design is not only a question of simplification, where appropriate, but also a question of rationalisation; namely, removing unnecessary parts or elements to avoid duplication and inconsistencies.

The position in mainland China

It is interesting to note that article 7 of China’s Legislation Law provides as follows:

The requirement for legal norms to be clear, specific, targeted and enforceable reflects many of the objectives of the current law reform process in Australia.

Since September 2020, the author has been assisting the Australian Law Reform Commission with its inquiry into the simplification of the legislative framework for corporations and financial services regulation.

Andrew Godwin is currently a member of a World Bank team that is advising a central bank in Asia on potential reforms to its mandate. He previously practised as a foreign lawyer in Shanghai (1996-2006) before returning to his alma mater, Melbourne Law School in Australia, to teach and research law (2006-2021). Andrew is currently Principal Fellow (Honorary) at the Asian Law Centre, Melbourne Law School, and a consultant to various organisations, including Linklaters, the Australian Law Reform Commission and the World Bank.