Chapter 5. The case of the Dutch Authority for Financial Markets
5.5 Testing the third principle – Institutional reforms and functionalist arguments
According to the requirements of the third principle a government’s decision to delegate is only justified if the benefits of delegation outweigh the democratic costs of delegation. Assessing whether or not the criteria of the third principle are met requires analyzing if both the benefits and the democratic costs of delegation were represented fairly in the political debate. To demonstrate the practical application the third principle the Legal Reform note is analyzed.
The Reform Note was implemented in 2002 and it forms the basis for the institutional design of the AFM. The Reform Note is a suitable document for analysis because it captures the debate on delegating authority to the AFM in a comprehensive manner. It provides a detailed account of the political context in which delegation to the AFM is set, it provides the reasons for delegating authority to the AFM, and it justifies the institutional design choices that were made with regards to the AFM. 5.5.1Analyzing the reform note
When analyzing the Reform Note four main conclusions can be drawn. Firstly, the arguments presented for delegating authority to the AFM and the institutional design of the AFM are all functionalist in nature. Market supervision in itself needs to be effective, it should be structured in such a way that it meets publically defined goals. The content of supervision should be uniform and constitute an institutionally integrated approach to consumers. Supervision needs to be market oriented, and the institutional design of the AFM should support innovation and competitiveness in the free market. Ultimately, supervision also needs to be efficient. It should be designed in
such a way that it minimizes the financial and administrative burden of the institutions that are supervised (Reform Note, 2001: 3-4).
A second important conclusion is that little to no attention is paid to determine what the publically defined goals of the AFM’s supervision should be, let alone how one should arrive at definition of those goals. Thirdly, themes such as legitimacy and accountability, which should be a part of any institutional design discussion, are not mentioned anywhere in the Reform Note. This is remarkable given the fact that the proposed reforms constitute radical changes with the old system. Finally, the broader democratic institutional context in which financial market supervision is set is not mentioned. This means that the possible consequences of delegating authority to the AFM for democracy and its institutions are not reflected in the debate.
The benefits of delegating authority to the AFM can outweigh the potential democratic costs of delegation. The expected benefits of delegation feature prominently in the Reform Note. The authority that is being delegated to the AFM facilitates international competition and evolution in the financial market sector. This is essential for a middle-sized economy such as the Netherlands, in which the benefits of economies of scale are limited. Financial institutions profit when supervision is delegated to the AFM for this optimizes efficiency. The consumer profits from delegating supervision because this creates the possibility to make better informed choices (Reform Note, 2001:9). Overall the Reform Note provides a lot of information on the choices that were made in designing the AFM and the expected benefits that delegation would deliver. It does not include any information the consequences of this radical reform for democracy, democratic institutions or the underlying value of political equality.
5.5.2 Meeting the requirements of the third principle
The government’s decision to delegate authority to the AFM does not meet the requirements of the third principle. The Reform Note makes no mention of the democratic costs of delegation, the benefits and costs can, therefore, not be weighed accordingly seeing how one of them is not reflected in the public debate. It is not possible to draw the conclusion, solely based on the analysis of the Reform Note, that the government’s decision to delegate authority to the AFM is not justified. There are two important reasons why such a conclusion may prove invalid.
The first reason is that the democratic costs of delegation are reflected in a different part of the political debate that has not been captured by the Reform Note. Only a more extensive analysis of for instance parliamentary debates and news paper articles can validate this assertion. The second reason is that for its task performance the AFM solely relies on passing empirical judgments, which means that the potential democratic costs of delegation are insignificant and for that reason not reflected in the Reform Note.
If this second reason is true, then the situation remains that in the Reform Note, a document that lies at the heart of delegating authority to the AFM, an important aspect of the debate on delegation has been left untouched. For the sake of having a full debate the democratic costs of delegation should have been included in the Reform Note, even if these costs were minimal. The second reason, however, also does not hold on different grounds. Based on the arguments presented in the previous paragraphs it is reasonable to assume the AFM passes ethical judgments beyond what is minimally required, which means that there are potential democratic costs to delegating authority to the AFM.
Overall, it is possible to assert with relative certainty that the democratic costs of delegation were not taken into account when the government formulated a decision on delegating authority to the AFM. It may not be possible to draw a definitive conclusions based on application of the third principle that delegation to the AFM cannot be justified. It is possible to draw a preliminary conclusion that the decision to delegate authority to the AFM should have been subject to closer scrutiny, for it is very likely that it does not meet the requirements of the third principle.
5.6 Conclusion
This chapter has demonstrated the practical application of the proposed normative framework by performing a case study of the Dutch AFM. It has confined the analysis to those activities that the AFM performs that are a part of the “in-between ground”. Extending the application of the framework beyond this operational territory would result in condemning the practice of delegation all together, this would be due to the inseparable nature of empirical and ethical judgments when deciding what is “relevant” knowledge and what is an “acceptable” conclusion.
Even when analyzing the AFM within this demarcated space the decision to delegate authority to the AFM does not meet the requirements of any of the three principles in a satisfactory manner. The requirements of the first principle are not lived up to because of the potential for perverse incentives that create reasonable doubt about the possibility to separate empirical from ethical judgments. The second principle requirements are not met because there are examples of cases when the AFM has engaged in passing ethical judgments beyond what is minimally required. The requirements of the third principle are not met because in the public debate on delegating authority to the AFM the democratic costs of delegation are not included. This makes it impossible to accordingly weigh the benefits and costs of delegation.
Yet, it is not possible to establish with absolute certainty for each individual principle that the requirements are not met. For application of the normative framework is open to a degree of interpretation. By formulating the principles and the supporting arguments in a precise manner an attempt has been made to reduce the potential interpretative differences. By considering the normative framework as a whole and not merely as something that is comprised of individual components one can draw two possible conclusions.
Either, through a more strict application of the normative framework the government’s decision to delegate authority to the AFM cannot be justified. Or, if one chooses to apply the principles more loosely, the conclusion is that, though not unjustified, the decision to delegate public authority to the AFM should have at a minimum been approached with much greater care.
The fact that the AFM as an NMI is responsible for performing a task that is rather technical in nature and which has a clear legal demarcation contributes to the conclusion that delegation as practice should be subject to closer scrutiny by elected officials, legislators and citizens. If doubt can be raised about the ability to justify delegation in the case of the AFM then this is definitely possible with regards to cases when delegation has a more profound ethical component.
In conclusion, delegation as a practice, or to the AFM specifically, does have some merit. The potential benefits of delegation can be manifold and NMIs can function as important governing institutions. Application of the normative framework has, however, demonstrated that the conditions under which delegatory practices take place should be subject to closer scrutiny. For starters NMIs should only engage
in activities that fall in the appropriate operational territory that this thesis has called the “in-between ground”. It is on this ground that the NMI can potentially add value through passing empirical judgments and only engaging is passing ethical judgments that are minimally required.