A New World Order: Risk and Recovery

“Thriving in the new world order” was the theme of the Chartered Institute for Securities and Investment (CISI)’s annual conference. How can the regulators strike the right balance between managing risk and not stifling innovation – and between enforcement and prudential regulation. The challenge is bringing in regulation appropriate for the current economic environment but that also makes the UK financial industry as competitive as possible when the recovery comes. What is the best regulatory structure to achieve this?

Hector Sants, chief executive of the Financial Services Authority (FSA) examined the regulator’s role in judging financial firms’ culture and ethics. Sants said the FSA believed it was not for regulators to define culture, but rather to put the appropriate structures in place to ensure that firms were run by the right people and had the right governance framework in place to foster a culture that did not contravene regulations. “There are already many bodies with codes with broad acceptance within the community. The focus should be on what an unacceptable culture looks like.” He added that, in answer to a question on the ‘interventionist style’ of the FSA, that it would indeed be a challenge to sustain it in better times. “The city needs to realise the value of this model,” Sants said.

The conference came the day after UK Chancellor George Osborne announced a new ‘twin peaks’ structure for financial regulation in the UK, whereby the Bank of England (BoE) will take over as the prudential regulator ensuring banks, building societies and insurance firms operate safely. Meanwhile the remainder of the FSA will become the Consumer Protection and Markets Authority (CPMA), which will regulate banking and the City.

Dr Michael Taylor, adviser to the governor of the Central Bank of Bahrain, took up the theme of how the new structure would work in practice. He said that, whatever the shape of regulation, one institution needed to be in overall charge and that the BoE, with its practitioner knowledge, needed to be among the first responders. He said his preference was for a twin peaks-style structure. “Where I diverge from the FSA’s opinion is that I believe that prudential and conduct of business regulation are awkward bedfellows. Some overlap or duplication of regulation is inevitable [in this model]. We need to accept that, even though it will increase cost. But moving to the other extreme will lead to the very situation that the foundation of the bodies were meant to address.”

The funding model of the UK banks also came under scrutiny. Xavier Rolet, chief executive of the London Stock Exchange (LSE) said it was important to regulate different financial instruments differently to avoid harming the competitiveness of the UK financial services industry. He highlighted the growth of the US derivatives market compared with that of the UK in the years immediately preceding the financial crisis. He said that wider attitudes to debt and equity in the UK had also had a ‘pernicious’ effect on the markets. “Now is the time, especially in the context of the budget review, to address the way the UK fiscal system favours debt and penalises equity, such as stamp duty. This clearly has an effect on the markets.” He added that the competition introduced into the marketplace from the entrance of other exchanges had been beneficial as it made the incumbents consider their business models, but that it had caused the macroeconomic picture to become fragmented.

Barbara Ridpath, chief executive of the International Centre for Financial Regulation (ICFR) looked at the best methods of improving corporate governance in the financial sector. She questioned whether regulation could make up for management failures, in light of the changing role of the shareholder. “I would put the onus on the corporate rather than the shareholder. It is easier to sell shares than engage in the corporate governance of an organisation you don’t agree with.” She said the many governance initiatives in the UK and Europe put the region ahead of the US, where the chairman and the chief executive are often the same person. Ridpath highlighted outstanding issues still to be addressed by regulators, including the problem of compliance in multiple jurisdictions from companies acting globally, the issue of remuneration on unrealised gains for bankers, and the tax implications of ‘living wills’. She said she believed that it was too soon to see how the proposed changes would affect the banking system: “We need to keep testing to see if the changes being made at the moment result in more consistent performance and the alignment of staff and management on risk appetite.”

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