At first glance, the City appears to be accepting with equanimity the government’s plans for a super regulator of financial services. Even though the proposed organisation has ballooned – acquiring the moniker Fat Controller – and the journey to the statute book looks like a helter-skelter, practitioners have kept their counsel.
Many claim discussion is redundant. The momentum behind the scheme, they say, and the inevitability of its imposition by the Labour party through its huge parliamentary majority seem to make any criticism futile. As one banker commented last week: ‘Why stick your head above the parapet when Labour has such a big majority and can do what it likes?’ But the Chancellor Gordon Brown’s decision to create a regulatory behemoth deserves to be challenged.
Just before the election, Brown and opposition chief secretary Alastair Darling were arguing that some coherence should be brought to the regulation of securities houses, investment businesses and financial advisers. This argument was widely accepted. After all, it involved simply wrapping up the Securities & Futures Authority (SFA), Investment Management Regulatory Organisation (IMRO) and the Personal Investment Authority (PIA) into the Securities and Investment Board (SIB).
Three weeks later, with the election won, the Treasury heavyweights were forced to eat their words. They had forgotten that independence for the Bank of England meant it needed to dump banking supervision. To cover their embarrassment, according to some Labour sources, the idea of a super regulator was born, which, like The Emperor’s New Clothes, the Treasury claimed it had wanted all along. A fortnight ago, after two months of discussion among the regulators, and with Treasury input, the SIB said the job of the New Regulatory Organisation (NewRO) should take in nine regulators rather than the original three.
The government has argued, so far, that a radical shake-up of regulation is needed to supervise the big financial combines more effectively. But experts in the field of financial regulation are beginning to question whether a solution devised in only two months can really be credible.
Michael Taylor, the newly appointed professor of financial services at Reading University’s Centre for Education & Research in Securities Markets, believes the SIB’s report to Brown last month missed an opportunity. ‘I have sympathy for the people charged with coming up with a solution. They have not been given any time to work with. Consequently, there is little change. In fact, it looks like they have taken the standard self-regulatory organisation (SRO) and fed it on steroids.’
John Hitchins, a banking expert at Price Waterhouse, agrees: ‘It looks and smells very much like the existing system with an umbrella on top.
They all have a policy unit, a unit for authorisation, supervision, investigations and a group dealing with complaints. They are not new.’
Taylor rose to prominence last year following the publication of his ‘Twin Peaks’ model for regulation of UK financial services. This scheme contained one body charged with consumer protection and overseeing the retail markets, while a second concentrates on prudential supervision of wholesale markets. It allowed the regulators to concentrate on two distinct sections of the industry, he says. At the same time, this construction would end the years of conflict between investors and suppliers that is internalised in the current system.
The model does support Labour’s belief that multidisciplinary banks bring with them a need to integrate supervision. Banks deal in most financial products and other institutions – insurers like the Prudential – are catching up. But Taylor, who has just finished the first critique of NewRO in a book entitled Regulatory Leviathan: Will Super SIB Work? (CTA Publishing), believes the structure outlined by the SIB attempts to squeeze too many functions into one body. ‘The current SROs have a similar set up, except they have a more heterogeneous group of firms to supervise,’ he says.
The NewRO board will need to understand and check on a diverse range of areas from commodities and derivatives to PEPs and pensions. But the SIB report argues the burden on the NewRO board can be eased if policy and decision-making is pushed down the chain to the supervisory units.
John Tattersall, head of the financial services team at Coopers & Lybrand, supports the move to a devolved structure. His concern is that a super regulator has a higher risk of losing credibility. ‘If a big bank fails then the entire board loses credibility because a member firm has gone under.’ He thinks the NewRO should isolate responsibilities, so only parts, not the whole, are tainted. ‘With the current structure,’ he says, ‘only the Bank of England suffers.’
But we have seen recently how a government agency like the Crown Prosecution Service, which allowed decisions on police prosecutions to be taken by middle-ranking staff, was pilloried for abdicating responsibility for alleged mistakes made lower down the chain. A NewRO board, which will number between 10 and 15, will be faced with the same dilemma. All the major decisions previously thrashed out by nine boards will need to fit on to the agenda of the single NewRO board.
It will also need to cope with inconsistencies. The SIB report argues that supervision should be rationalised across the industry. In the same breath, it argues that different cultures and ways of doing things will need to be recognised.
The point, says Taylor, is that the NewRO board will find the organisation unmanageable. Only Denmark, Norway, Sweden, Malta and Austria have combined banking and securities regulation along the lines of the NewRO, yet they are tiny organisations by comparison. Denmark has the largest with a budget of $14m (u8.8m) and 120 staff, whereas the NewRO will pull together 2,099 staff and operate with a budget of about $185m (u117m). Although this doesn’t make it the largest regulator in the world – the Securities & Exchange Commission (SEC) in New York employs 3,100 staff and operates on a budget of $342m (u216m) – it will easily be the most complex. The SEC, after all, only deals with one area of financial services.
Before the election, the SEC was often raised as a model for the UK securities industry. One of the key responsibilities envied by some regulators in the UK allows the SEC to control what companies disclose in their company accounts. Others drool at the investigatory and prosecution powers granted the to US body.
The powers given to NewRO are likely to be restricted. Instead, it will concentrate on promoting ‘fairness, transparency and orderly conduct in financial markets, looking in the first instance to the markets and market participants to set and enforce high standards in this area’. There will be an investigatory unit. But the City, which will continue to be the paymaster, is unlikely to fund the kind of organisation that kicks down doors to get what it wants. There will also be a consumer relations unit and a consumer panel to advise the main board. But Taylor describes these groups as outside the main structure looking in.
On a more basic level, there hasn’t been enough time to rethink the relationship between the various trading exchanges and the NewRO. All we know is that supervision of scandal-hit institutions, such as the London Metals Exchange and others, will continue, but at arm’s length. Also, any developments in areas like corporate governance are likely to be left to ad-hoc committees such as Hampel. And how newcomers to the market – like Tesco Bank and Virgin Bank – will be regulated is still unclear.
Hitchins argues that there is still much to play for in the style of regulation adopted by the NewRO. The extent to which auditors are used by the new body will be an important question over the next six months when the objectives and regulatory approach must be agreed.
At the moment, much of banking supervision is sub-contracted out to reporting accountants. They produce the Section 39 reports which detail how well a client bank has implemented controls laid down by the Bank of England.
By contrast, auditors in the insurance industry produce reams of numbers for the Department of Trade & Industry, but place little emphasis on controls.
Tattersall would prefer a more widespread adoption of Section 39 reports.
Companies can then crunch numbers for the benefit of their business rather than for the regulator, which is more interested in risk-based controls.
The likelihood is that accountants will be used more extensively in the risk-management process by the NewRO. Expertise, if nothing else, is hard to come by and the Big Six firms, in particular, are already building large specialist practices to meet the growing demand from their clients, let alone the regulators.
Whether they will prevent another Barings or pensions mis-selling scandal is unclear. It is probably more important for investors – the ultimate beneficiaries of the financial industry’s success – to know how the Fat Controller will handle a crisis when it comes. If Taylor is right, he could be looking in the other direction.
THE PROFESSION ANTICIPATES THE NEW SUPER REGULATOR
Sir Andrew Large’s report last week on the structure of the NewRO has done nothing to dispel the confusion surrounding the accountancy profession’s role within the new super regulator, writes Hooman Bassirian.
In the 23-page document, Large fails to mention how the recognised professional bodies (RPBs) – the English and Scots ICAs and ACCA (and the Law Society) – will operate alongside the other divisions of the NewRO. And, despite recent assurances from the Treasury that it has no plans to strip the accountancy bodies of their right to regulate their members under the Financial Services Act, the uncertainty further fuels doubts about the RPBs’ role.
More alarmingly, it also raises fresh questions about the government’s commitment to self-regulation for accountants and the long-term viability of the Review Board, the profession’s embryonic watchdog. Modelled on the US Public Oversight Board, last month the new body cleared a crucial barrier to its creation by winning the support of its harshest critic, CIMA.
A detailed framework for the board is now being drafted by a cross-institute working party. Its report will be presented to the Department of Trade & Industry in September for approval before the watchdog comes into existence in the New Year. However, such is the English ICA’s concern that it is setting up a taskforce to work out a strategy for dealing with the NewRO.
The taskforce has yet to meet, but one of its first jobs will be to lobby the government to produce ‘greater clarity in the existing (financial services) legislation,’ says Raymond Fear, head of the institute’s practice regulation directorate.
Meanwhile, ACCA is taking a more sanguine view. Anthony Booth, its director of professional standards, believes the RPBs will escape being sucked into a new structure under the NewRO. ‘The Super-SIB has some very important fish to fry and that’s why references to RPBs are non-existent (in Sir Andrew Large’s report),’ says Booth. He expects the RPBs to continue as they are for the next two years, until the absorption of the regulatory bodies, such as the Securities & Futures Authority and IMRO, into the new organisation is completed. According to Booth, the profession should now focus its attention on lobbying the government to ease the regulatory pressures on accountants in the new Financial Services Act, which is expected in 1999.
‘It would be much better if things alluding to investment business that are part of the accountant’s normal work should be excluded (from financial services regulation),’ adds Booth.