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Mitchell, Arthur "Creating a Regional Compliance Strategy" [2006] ADBLPRes 1 (15 March 2006)

Creating a Regional Compliance Strategy

Remarks
of
Arthur M. Mitchell*
General Counsel
Asian Development Bank

At the Asia-Pacific In-House Counsel Summit, 2006

InterContinental Hotel, Hong Kong
March 15-16, 2006

Distinguished guests, ladies and gentlemen. It is both a pleasure and an honor to welcome you to this session on “Creating a Regional Compliance Strategy.” This topic is particularly relevant today, almost a decade after the Asian Financial Crisis.

Regulatory reform as a response to the Asian Financial Crisis

The Crisis was caused by a confluence of many factors, and not by a single event. Broadly, these factors include mismanaged Asian economies; foreign investors’ financial panic and the resulting capital flight; and inadequately administered financial liberalization that created fragile domestic financial markets. It has been observed that prior to the Crisis, “all East Asian economies implemented financial reform without first establishing a comprehensive regulatory and supervisory framework.”¹ These weak and poorly regulated financial markets were at the root of the financial contagion that plagued the region.

In retrospect, it may be that the Asian Financial Crisis was a brief but painful interruption in the trend toward increasing regional integration in trade, foreign direct investment (FDI) and financial flows. In order to avoid the contagion that can result from increasing economic integration, it is important to recognize that regulatory failure in one country places the entire region at risk.² It is not surprising to learn, therefore, that there has been a gradual but increasing level of coordination among regulators on policy, supervision and enforcement issues.

Compliance challenges to today’s enterprises

Despite increasing coordination among regulators both within and outside the region, the reality is that there is great diversity in “hard” regulation—laws and administrative regulations—and “soft” regulation—rules, standards, models, codes, methodologies, and routine practices—of various sectors, industries, and professions. Today, enterprises are obliged to comply with local and national regulations as well as national and international standards.

Such complexity poses serious challenges for global enterprises. Overregulation can hinder economic development. For example, the existence of different national and local energy regulations in Indonesia has been identified as a factor that hindered FDI growth in the power sector.³ Japan’s financial sector was similarly criticized for being “overregulated” in 1997, and this was seen as a factor contributing to its lackluster economic performance in the past 15 years.

Compliance itself has become costly. The very nature of cross-border outsourcing, trade and investment, and capital flows has caused management to rethink their business models. Multinational enterprises now rely on a complex matrix management configuration, which needs to incorporate compliance with layered, overlapping, and sometimes conflicting regulations. In the manufacturing sector, a single business enterprise may be required to comply with regulations concerning the product itself; regulations involving the disclosure of information about the product; and regulations governing the sale of the product to consumers. Each set of regulations have a corresponding effect on the cost of production.

On the other hand, non-compliance may prove to be even more expensive. A compliance problem in a global organization’s subsidiary can catch the attention of a home-country regulator and result in the payment of fines and cause major reputational damage. Moreover, non-compliance often translates into failed investments. They incur significant costs caused by misunderstandings, regulatory disputes and contentious political actions, all of which have the net effect of making the environment for investment more hostile. In the worst case, non-compliance can result in the equivalent of a corporate death penalty, such as the revocation of a license to do business or even bankruptcy.

Addressing challenges to compliance through regional integration

How do we address the phenomenon of increasingly complex, overlapping and costly regulations? One strategy that we can adopt is to work toward converging regional regulatory frameworks. Such frameworks can reduce the transaction costs resulting from overlapping and contradictory regulations.

Regulatory convergence has proven to be possible, and has enhanced economic development in Asia, notwithstanding the region’s diversity. ADB is engaged in a number of endeavors that have enabled it to watch and encourage the process of regulatory integration up close. Allow me to describe three models that appear to be at work in Asia:

• the contractual model,
• the harmonization model, and
• the institutional model.
⁴

The contractual model

Countries that wish to engage in interregional trade may agree on the creation of arrangements that will define the rules and regulations governing their trading relations and the product traded. One such agreement currently being formulated is the Regional Power Trade Operating Agreement (RPTOA) in the Greater Mekong Sub-Region (GMS).⁵ The purpose of the agreement is to “create transparent rules and a regulatory framework for cross-border trade in electric power.” ⁶

The harmonization model

Countries that recognize the need to reduce cross-border transaction costs are adopting best practices of others in the region over time, but without specific agreements to do so. To facilitate cross-border trade, countries are harmonizing regulations, and are identifying and eliminating some of the most onerous and contradictory impediments to cross-border transactions. For example, the harmonization model is the strategy adopted by finance secretaries and ministries of ASEAN + 3 countries that regularly meet and discuss how to reduce transaction costs relating to cross-border financial transactions. Harmonization may also involve mutual recognition--one country’s acceptance of another country’s certification that a satisfactory regulatory standard has been met. Mutual recognition played a role in the formulation of the Greater Mekong Subregion Cross-Border Transport Agreement. It may prove to be valuable in future attempts to move toward greater regulatory integration.

The institutional model

It has been observed that Asia stands to benefit from pursuing deep and comprehensive economic integration.⁷ One possible outcome of such integration is the creation of supranational institutions that will adopt and enforce a broad range of regulations with regional application. The European Commission and European Court of Justice are some examples of institutions that characterize this integration model in the European context. It may take some years before Asia fully develops the institutional model of integration, but the other models can become important stepping stones.

Regulatory compliance: Rewards and opportunities

What is evident in all these models is that regulatory convergence expands markets, removes impediments to economic activity, lowers transaction costs, and improves overall economic efficiency.

Regulatory compliance facilitates the acquisition of similar rewards. For example, banks that achieve the higher risk management standards required under the Basel Capital Accord will be rewarded with lower capital requirements. An insurance company that complies with regulations that require the adoption of a more risk-based approach will enjoy the benefits of becoming more capital efficient.⁸ Manufacturing companies that strategically invest in flexible compliance systems are likely to succeed in integrating business functions and processes through technology, reducing costs, and improving the end product in the long run. ⁹

More importantly, a company’s proactive position on compliance can improve the industry or sector in which it invests. Compliance helps build relationships and trust between enterprises and regulators. These relationships can potentially allow regulators to understand the company’s business better, and allow regulators to follow up quickly on issues and perceived risks. Compliance may even be its own reward. Companies that are able to demonstrate consistently high standards of self-governance might expect less scrutiny from the regulators as a kind of “regulatory dividend.” ¹⁰

Compliance is necessary to ensure a global enterprise’s very survival. Investment in a business outside one’s own country involves large amounts of capital and resources, and the returns are expected over the long term. Long-term investments require building relationships not only with your customers in the region—but other stakeholders involved or affected by your company’s business. Diverse regulations are tailored to protect varied stakeholders’ interests. Failure to respond to these interests often leads to costly renegotiations of the investment contract, if not project failure.

From shareholder to stakeholder value

What is needed then is more work toward the right kind of regulation on a local, regional and global basis. For example, regulatory reforms traditionally involve the promotion of corporate governance—ensuring that management not only maximizes, but protects value that benefits a company’s shareholders. Today, best practices in corporate governance involve responding to a broader range of stakeholder interests as well. There is greater recognition of the benefits of corporate social responsibility—the private sector’s responsibility to help ensure that the social and environmental costs of their business activities do not outweigh their benefits.

In this context, the role of legal counsel today needs to be viewed more broadly than in the past. No doubt, you will continue to play a key role in protecting shareholder value through vigilant efforts to ensure compliance with existing regulations. But legal counsel is also in a unique position to spot regulatory developments and identify how new regulations can shape the business environment. The private sector must do a better job of identifying regulatory conflicts between jurisdictions that impede cross-border trade. You are in the best position to advise management on the opportunities to create positive impacts for shareholders as well as on other stakeholders who are both affected and protected by today’s evolving regulatory frameworks.

Moreover, you are in a position to create opportunities to hold dialogues with government regulators. You may wish to take advantage of various forums such as the APEC Business Advisory Council or its equivalent at the Pacific Basin Economic Council, or even create the occasion for such discussions. I hope that you will lend your support to some of the emerging regulatory trends I have described today and act as an informed voice promoting harmonization and rationalization of regulations across borders.

Thank you.