Howard Davies: Rule Braker

Financial regulation, said Davies – who dislikes being called ‘Sir Howard’ and banishes such references from all FSA documentation – should be ‘appropriate and proportionate and sensitive to the needs of the markets’.

But because of the current political environment, regulatory bandwagons are now rolling in the US, Europe and even Japan – and the UK isn’t immune, either. Of the Sarbanes-Oxley Act, Davies said at the Mansion House, ‘With their usual generosity of spirit the Americans have ensured that a number of its provisions apply to overseas companies as well as to their own.’

Of the list of Brussels regulations being considered, Davies observed: ‘It’s easy to make fun of European directives. Indeed, it’s almost impossible not to make fun of them.’ And on Japanese initiatives to regulate short-selling: ‘Good luck to them.’

In a speech last June he argued that the UK’s tough regime had attracted capital rather than repelled it – but he tells us he is frankly amazed at the tendency of some elements of the national press to refer to the FSA as ‘draconian’: ‘I wonder if any of the writers on the Financial Times actually know anything about Draco [an Athenian lawmaker who penalised even trivial crimes with death] – but the similarities between us and Draco are not great, actually. We put out some extremely modest proposals on possible controls on analysts, for which I’ve actually been criticised by a number of companies for being feeble, and the first paragraph of the FT story said, “FSA proposes draconian new rules for investment bank analysts.”‘

When we asked Davies to say which is the most significant recent development in the world of financial regulation, we were surprised that he choseone over which the FSA has no authority: the introduction of international accounting standards for European listed companies in 2005.

‘This will create for the first time a genuinely global basis for company reporting and valuation which will create the reality of global capital markets,’ Davies says. As IASs make it easier for companies from one jurisdiction to raise capital in another, then there will follow ‘a degree of harmonisation of international regulatory practice’, he says, and regulators will become ‘quite interested in knowing that those accounts are meaningful and that they have been audited by genuinely independent auditors’. There will be an inevitable knock-on effect and ‘a lot of pressure for raising the standards of regulation around the world’.

He adds that the Committee of European Securities Regulators has two bodies, CESR-Fin and CESR-Pol, which are both ‘designed to ensure that there’s cross-border enforcement of accounting standards’ – and that the SEC, unlike the FSA, has ultimate oversight of accountancy issues.

Creating standards isn’t necessarily the same thing as raising standards, however. Quite the opposite, in fact. Davies has warned repeatedly in the past that the EU’s proposed prospectus directive is a ‘one-size-fits-all’ approach that would ‘dismantle a well-functioning feature of our corporate governance’.

The problem is that this is a ‘maximum harmonisation’ directive, meaning that member states must all introduce the same sort of listing rules but are not allowed to impose additional rules – ‘super-equivalent provisions’ – on top.

Such UK features as compliance with corporate governance codes would not be permissible as additional London listing rules.

Brussels appears to be intent on introducing yet more rules as ‘maximum harmonisation’ directives. If that’s the case, then there may be no other choice but to change UK company law, giving legal effect to London’s rules and codes. ‘So far the Commission are thinking about it,’ Davies says.

Using the law to retain key listing rules isn’t an attractive option, however. Parliamentary time is scarce – ‘Company law bills come by once every generation, really, so it’s quite an inflexible tool to use,’ he says – and he is not convinced that it would be easy to differentiate between listed and unlisted companies.

US legislation in the form of Sarbanes-Oxley seemed almost to have come out of nowhere – and there are a few rough edges as a result. ‘Rapid agreement was suddenly reached in Congress such that it seemed like a good idea to get something through and then work on the details a bit later,’ Davies explains.

‘The thing that has concerned people the most is the extra-territoriality of it’ – but it’s creating more of a problem for other European companies than for the UK, he says, because UK corporate governance – company structures, audit committees, independent directors and so on – much more easily meets US requirements.

‘So although Sarbanes-Oxley has not been welcome to UK companies, the anxiety is not as great as it is in general.’

Details have still to emerge but Davies believes that the oversight board that will be created in the US may use ‘exemptive authority’, enabling it to recognise equivalent regulation in other jurisdictions, if it decides that it’s appropriate to do so.

‘My hope and optimistic expectation is that there will be use made of this exemptive authority and that the degree of this extra-territoriality of Sarbanes-Oxley will be mitigated in due course,’ Davies says. ‘But for the moment there isn’t really anybody to talk to about it because there isn’t a public oversight board in place yet.’

But even if UK companies eventually are exempted from complying with large parts of the new US law, Davies agrees that Sarbanes may well become the de facto benchmark against which good corporate governance practices are measured ‘and I think in some respects it might be a good idea if it was,’ he insists.

‘The irony from a UK point of view is that, until Sarbanes-Oxley, we had a more rigorous regime of auditor oversight than the Americans had. [Former SEC chairman] Arthur Levitt used to frequently say they needed to learn from the way the UK responded to the accounting problems in the early 1990s when we had our Maxwells and other things which caused us to want to overall audit regulation.

‘Now the Americans have gone round on the outside and have ended up with something which is actually more rigorous. But the reality is that if you want access to the US capital markets then other countries will have to show that they have at least broadly equivalent regimes. I think the issue will be, how far the US is prepared to accept that a broadly equivalent regime doesn’t have to be one that is exactly the same in all particulars. And I think they ought to accept that.’

The US act also requires the SEC to introduce rules governing investment analysts’ conflict of interests by 30 June 2003. At the same time, the Financial Services Authority has a consultation paper on the subject which is open for comment until 30 October 2002. (Also underway is a review of the listing regime which covers a number of the points discussed above, on which comments are welcome up to 15 October.) In it, the FSA notes that analysts’ buy recommendations vastly outnumber the sells – and that a sell tag on a company that is a corporate client of the relevant investment bank is almost unheard of.

This isn’t exactly a new phenomenon, however: it certainly dates back more than 20 years. Of course, since then, Big Bang and the rise of integrated investment banks have further confused the relationship between companies and brokers.

‘You may say that investors can aim off of that but then that’s quite hard work: how do you know which have been more influenced than the others’ You don’t know if they’ve got a monster long position in this stock that they can’t get rid of or if it’s just that they are a house broker who do a little bit of business from time to time.’

Terminological inexactitudes don’t help, either, such as when ‘accumulate’ is used as a weaker form of ‘buy’ but actually means ‘dump the stock!’ ‘You might think that it’s slightly silly but I can’t help thinking that anything where you obfuscate with the language is not usually very helpful,’ Davies says.

A number of ideas are being considered to find ways of ‘insulating’ analysts from the rest of the bank. Davies is considering some ‘obvious no-brainers’ such as addressing the way that analysts are remunerated, delinking their rewards from the short-term success of the investment bank, and perhaps preventing analysts going on sales pitches.

FDs have a role to play, too, and the FSA paper acknowledges that directors are known for sometimes favouring bullish analysts over bears – not so much on mandates but by not inviting bears along to the next analysts’ meeting or barring them from conference calls. ‘I suspect that you only gain an extremely short-term advantage thereby,’ Davies believes. ‘If you’ve got something to hide and somebody is on to you, just stopping them getting on the conference call is not going to help you for more than a week or two, I think.’

With the mass of regulatory change under way and being considered, Davies says that FDs need to become more involved. ‘We’ve found until recently that we got far less feedback from finance directors than we expected or certainly than we wanted, In the early stages of setting up the FSA we got almost no response, even though we felt a lot of what we were doing was of direct interest to them.

‘We had to stimulate some interest in the prospectus directive – and then people went, ‘Oh, we don’t like the look of this!’ and started to write in to Brussels about it. But it wasn’t until we stirred the pot that people took any notice. So I would say to FDs, keep checking our website.’ It’s at

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