Chapter 5. The case of the Dutch Authority for Financial Markets
5.4 Testing the second principle – acting ethically
According to the requirements of the second principle a government’s decision to delegate authority to an NMI can only be justified if for its task performance the passing of ethical judgments is minimized as much as possible. This means that the AFM should predominantly rely on empirical judgments for its task performance within the scope of the “appropriate” operational territory of NMIs. To demonstrate the practical application and importance of the second principle an example is given of how the AFM passes ethical judgment far beyond what is minimally unavoidable or required.
5.4.1 The derivatives file
In January 2012 the Vestia-scandal is uncovered. Many major Dutch banks sold derivatives worth billions of Euros to the housing corporation Vestia. These derivates became “submersed” as interest rates had dropped. Vestia had to make additional payments of two billion Euros to prevent going into bankruptcy (de Volkskrant, 2012). A derivative is a type of insurance an organization can purchase to protect itself from increasing interest rates on long-term loans. When interest rates drop the principle works conversely, additional payments have to be made when the contract is ended (Het Financieele Dagblad, 2015a). Banks also sold these derivatives to many small and middle-sized businesses. These financial products had serious negative consequences for the businesses involved. Business owners were unaware of the risks due to the products’ complicated nature and deceptive marketing techniques used by banks (Idem).
The Dutch Authority for Financial Markets (AFM) has been trying to settle the matter ever since it was uncovered. After investigating the facts closely the AFM decides in 2014 that banks will have to reevaluate the contracts they closed with their “non-commercial” clients. The AFM allows banks to reevaluate their own products and does not require external independent accountants to do so. The AFM states that this saves the banks significant costs. The banks themselves would have been held responsible for the cost in case external auditing was mandatory (Het Financieele Dagblad, 2015b).
The entire process takes a turn when an internal investigation of the AFM, sparked by a random sample of its own work, shows that neither the banks nor the AFM have been successful in handling the derivatives file. The banks did not reevaluate their products fairly. They did not take the consumer interest sufficiently at hand nor did they obey the existing legal framework. And the AFM’s was not capable of accurately judging the evaluations of the banks. The AFM discovered that its own rapports contained inaccuracies, omissions, and that the quality varied greatly (Website AFM, 2015). What is even more worrying is that this problem was not identified during prior sample checks.
The derivatives file illustrates how the AFM forms an epistemic community with the institutions that it overlooks. The financial interests of the banks are taken into account when deciding which measures to take. The banks are put in charge of their own reevaluation to save costs, despite the fact that their deceptive sales techniques have gotten many small and medium business owners into trouble.
In deciding how to act in the derivates file the AFM functioned as a “closed world”. This “closed world” was inaccessible to the general public who had a clear interest in solving the matter at hand as quickly as possible and holding the banks responsible for the mistakes that they made. The AFM decided differently and instead dragged out the process over many years, only to discover that neither the banks nor the AFM was capable of handling the matter. The way the derivatives file is handled shows that the AFM engages in passing ethical judgments beyond what is minimally required. In this particular instance they decided to act on the basis of their own ethical judgments. Instead, given the ethical nature of the matter at hand this decision should have been made by a democratic institution.
The way the AFM acted in handling the derivatives file supports the argument that those who are “wise” are not necessarily wiser rulers. Ethical judgments should not be deferred to the AFM based on the idea that this institution is better capable of passing ethical judgments. After all, the proposed approach by the AFM failed on three accounts: 1) the AFM was not capable of monitoring the reevaluations of the banks, 2) it was not capable of monitoring its own process, and 3) to date the derivates file has not been settled and those affected are still duped. This is not to say that knowledge does not play a role in promoting wise rule. It merely illustrates how the electorate, or their representatives, should not be put in a position in which they have to defer their ethical judgment to a different agency under the pretense that this agency is better capable of making ethical judgments.
5.4.2 Meeting the requirements of the second principle
To conclude, the requirements of the second principle are not met. The arguments provided in the example of the derivates file show that the AFM has engaged in passing ethical judgments beyond what is minimally required. It underscores the problematic nature of delegation when society is affected by the ethical judgments that the AFM passes. Through application of the normative framework the risks of epistemic communities, epistocratic government, and deferring ethical judgments, have been demonstrated.
This means that the government’s decision to delegate authority to the AFM with regards to the second principle is not justified. The current delegatory arrangement does not provide for a situation in which passing ethical judgments is minimized as much as possible2. This does not mean that there is no epistemic value
in granting the “wise” ruling power. This epistemic value is, however, limited to instances when the passing of ethical judgments is minimized as much as possible. The potential benefits of delegation only occur when the delegated task relies on passing empirical judgments.
Using the phrase “minimized as much as possible” in the formulation of the second principle leaves some room for interpretation. Therefore it is possible that
2What a delegatory arrangement should look like that does meet the requirements of the second principle
lies outside of the scope of this thesis. Though it is possible to identify several ways in which the government could have restrained the AFM’s “ethical maneuver space”. For instance, the government could have opted for a different institutional design, a narrower task description, a more constricting mandate, or a different accountability structure.
others applying the framework might reach a different conclusion as to whether or not the requirements of the second principle are met. Nevertheless, at a minimum, the government should have paid more attention to the ethical judgments required for the task performance of the AFM upon deciding whether or not to delegate authority. Application of the second principle to the AFM results in adopting a more critical stance towards the practice of delegation.