Wednesday, 23 September 2009

Regulating The City

At last, some sensible comment on moving forward with regulation of the UK financial services sector.

The FT has at last pointed up where we should be heading in terms of regulating banking in the UK without the usual baying for blood that seems to accompany every other article or speech made by those who feel that they must be "seen to be doing something".

The FSA was established in 1997 by the then Chancellor of The Exchequer (Gordon Brown) with four statutory objectives:

•Market confidence: maintaining confidence in the financial system;
•Public awareness: promoting public understanding of the financial system;
•Consumer protection: securing the appropriate degree of protection for consumers;
•The reduction of financial crime: reducing the extent to which it is possible for a business to be used for a purpose connected with financial crime.

Recent events suggest that the first, second and third need more focus. Focus seems to have been mainly on the last in the wake of 9/11.

So why is it difficult to change at the FSA? The answer lies in the FSA's own website where, if you look closely, they state that their senior management are government appointees and that they are "accountable" to Treasury Ministers and to Parliament (i.e. to those who appointed them) but in the next sentence, they state that they are "operationally independent". They are "independent" in that their funding derives from those whom they regulate, rather than from the government but if they are government appointees, this will inevitably drive their actions. Equally, if the heads of the FSA were to be critiqued too much by their government masters, it would be tantamount to said masters admitting that they had got it wrong - something politically difficult to do.

On Friday 13th February (ironically), the FSA announced salary increases and bonuses, and yet there seemed to be little or no fuss made about this, in comparison to the hysteria that has surrounded compensation to the bankers who (single-handedly and without interference, connivance or encouragement from government, central banks, regulators or an over-spending public) caused this mess in the first place. In the past, when the FSA attempted to sound a warning, they were ignored by their masters as times were good, the boat shouldn't be rocked.

Lord Turner has suggested Tobin taxes on banks' transactions and caps on compensation to senior bankers as a means of regulating excessive behaviour. That there is a link between taking excessive risk and the "telephone-figure" bonuses of top bankers seems to be in little doubt. The "fiduciary" duty to banks' customers was swallowed by an avalanche of sales culture which demanded exponential yearly revenue increases across the board to satisfy shareholders and analysts. Credit was cheap, risk was lower, the chancellor had claimed to have "abolished boom and bust" so more risk was taken until...

So where do we start? As the Financial Times suggests, we recognise that the UK has both a domestic and foreign element to the financial system. The risks associated with domestic institutions' management of public funds, lending and payments are borne by the UK public and it is up to the FSA to ensure that those risks are properly managed. They have not been, and this is the fault both of bank management and those who regulated them (i.e. the FSA).

With regard to the "foreign" element of the UK financial sector, the FSA's role should be to ensure that foreign institutions operating here abide by international and UK rules, that any failure do do so should not harm the UK and that appropriate penalties are levied.

In short, the FSA's job is to represent and safeguard the public interest. To do this, it needs to understand the products/risks, devise rules to manage these, monitor their implementation, review their effectiveness and penalise transgressors (as recently happended with Barclays). It also needs to be taken seriously; it has notbeen in the past and this must change.

The FSA's role is not to make pronouncements on compensation or taxation, these being the purview of the market and of the Chancellor respectively. There are signs that bankers have woken up (belatedly) to the fact that high bonuses are politically unacceptable at the moment. Whether this will result in lower bonuses is for the market to decide. The fact is that "clever" people employed by the banks (who can afford to pay them) will devise ways around any restrictions that are imposed - so the compensation consultants, lawyers and accountants stand to do well as banks scramble to retain their top performers.

The FSA's regulatory tools are: to ensure that banks maintain suitable capital in relation to the risks undertaken, that suitable regulations are in place and enforced and that transgressions are penalised. The FSA is not here to be popular. It is here to protect the public.

This means that the FSA charges appropriately for banks to operate in the UK and if this means charges rise, so be it. Call it the cost of financial security. Those who take the higher risks should pay more for supervision than those who don't. Equally, those who are seen as riskier due to inherent lack of adequate controls or management weakness should also pay more.

The UK needs to remain competitive and a world leader in financial services. Has the recent crisis had a serious impact on our reputation as a quality financial services centre? Yes, it should have. Our bankers, regulators, government and the general public have all fallen down on the job. The lessons of excess must now be learnt.



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