The UK’s Financial Services Authority has set the template for regulation around the world but it has recently come in for criticism from politicians and market players for overdoing the red tape. How justified are the claims? asks Nick Kochan.

When the UK Prime Minister Tony Blair criticised the Financial Services Authority (FSA) last month for being overprescriptive, FSA chairman Sir Callum McCarthy reacted strongly. He replied that the allegations were “damaging to our influence and our abilities” and demanded evidence from the prime minister to substantiate his assertions. This quick and sensitive reaction showed not merely that Mr Blair had touched a raw nerve when he accused the regulator of burdening business with red tape; it was also embarrassing. The FSA represents itself as the agent of the British government when it seeks to sell its message and its institution to the world – criticism from its sponsor does not help its cause.

The FSA also presents itself as the latest example of the “privatisation phenomenon”, where the UK has shown how it can produce pioneering ideas in financial services. Now it is paying a price for its very public success, becoming the stage for the latest round in the domestic skirmish between the prime minister and Chancellor Gordon Brown. The FSA is so confident of its claim to have found the most efficient regulatory model it has even set up a committee to sell the merits of its procedures, approach and benefits to countries round the world.

Spotlight on UK

UK regulation has been in the spotlight since the chancellor merged 10 agencies into a single entity in 1997. That produced the model for a single regulator, hailed worldwide as the efficient route for controlling firms and interests in a sector encumbered with special interests and rulebooks.

Many countries’ regulatory structures have been transformed along guidelines set by the UK’s private and state sectors. The FSA model has been exported to Germany, Japan, Singapore, Scandinavia, Belgium and the Netherlands, while others have used the FSA to fine-tune existing regulators.

Regulators have many critics, and the prime minister is only the latest. One critic is Angela Knight, chief executive of the Association of Private Client Investment Managers, who accused the FSA of “cookie-cutting” in its bid to fit complex firms into crude moulds.

“The FSA has a desire to put things into wholesale or retail compartments,” she says. “We all know what wholesale is, it is institutional broking and investment banking. In retail there is retail banking and independent financial advisers. But the wealth management community is anomalous. It deals with its individual clients under the normal business rules and so is retail. But this sector also amalgamates its deals and addresses the market in its institutional capacity and so is wholesale.

“I was given the choice of being a retail intermediary or a fund manager. I opted to join the fund managers because we have a greater relationship with portfolio management and fund management, even though our people are intermediaries. We handle $260bn and yet we had to decide, do we want to be an intermediary or a fund manager? It is the wrong choice. I think there ought to be much more cost benefit analysis of regulation.” Ms Knight argues that the FSA forces the market to conform to its rigid templates, rather than “doing what a commercial entity does, and conform to the market”.

The FSA’s chief executive John Tiner disputes this claim, saying: “We have a very effective matrix that ensures that wholesale players in retail get the same sort of touch as retail players who are in wholesale. There were some fears about that when we set up the structure. But I am not aware of any problems.”

Relationship with Treasury

The FSA combined 10 specialist organisations, each focused on a sector of the market and each armed with a narrow rulebook. These were collated into one massive document running to 8000 pages. A single piece of legislation, passed in 2000, empowered the new organisation, which would be entirely funded by the industry it supervises. The FSA has a formal relationship with the UK Treasury – its managers face an annual grilling from the House of Commons Treasury Select Committee – but the FSA’s management, which is appointed by the Treasury, increasingly seeks to involve the financial sector in its management.

Hence Mr Tiner was brought in from Arthur Andersen in September 2003 to head up the FSA, succeeding the civil servant Sir Howard Davies. Mr Tiner had been head of Andersen’s worldwide financial services industry practice and led the Bank of England review of UK banking supervision in 1996.

Unified regulation

The principle of unified regulation has no stronger advocate than Mr Tiner, who says: “As risk moves round the market, we can see where it is moving and we can understand it. There are real benefits of scale, of intellectual capital and of simplicity when the markets have one regulator. Some people say that integrating prudential and market conduct poses a conflict of interest because there comes a time when you are so worried about market confidence that you take actions that, in the short term, are detrimental to the consumer’s interest. But [the end result] may be better for long-term stability.”

He says that this proved to be case during the market meltdown of 2003 when institutional programme selling of shares into a falling market was averted due to FSA interventions. “Having market and prudential interests under one roof enables you to discuss issues in a very pragmatic and private way before you release information on to the market. If you have two organisations making lines in the sand, you can spook the market when it is under pressure.”

Concerns about market stability still preoccupy the FSA, even though the crisis is over. Mr Tiner says he is definitely worried about issues of market stability and market confidence. “We are also worried about wholesale market products being packaged and sold into the retail market.” The FSA bases its standards for compliance on a set of “high-level principles”, in particular transparency, honesty, open communication and customer protection, and these are the FSA’s bulwark for protecting the London market from abuse. “The City has really liked the distinctive focus on the principles-based system. This has been very good for maintaining market confidence in the City, and promoting high standards,” says Mr Tiner. These principles could then be translated into practice by the provision of detailed rules of behaviour.

Transferral of risk

However, Mr Tiner is sceptical of his ability to impose detailed rules in a complex financial environment. So he is seeking to transfer the risk to the regulated sector, and requires them to devise ways to meet his high standards. “We like to challenge the industry to come up with their own solution when a problem arises. The risks of unintended consequences are less and they have ownership of the solution,” he says.

This is the context for the FSA decision to involve the wholesale banking and investment industry in establishing a set of procedures to govern the relationships between investment managers, analysts and brokers. So called ‘softing and bundling’ of commissions and services was considered by many as detrimental to investors. The FSA consultation paper on the topic received an unprecedented response from the industry.

“Because we were dealing with wholesale markets, with institutional fund managers, with pension fund trustees, who were ultimately acting on behalf of the public, we felt we should challenge the industry to come up with their own solution. We basically said ‘you have till the end of 2004 to come up with an industry solution’,” says Mr Tiner.

Industry groups involved in research, broking and investment were brought together under the auspices of the FSA, and in due course provided a solution that satisfied the FSA. Mr Tiner states: “That seems a very good way to use the regulatory authority which you have, in addition to using the rulebook.”

A similar process has begun in the wholesale insurance sector. The FSA has told firms, who were taking from six months to four years to deliver a note, to smarten up their act by the end of 2006. “Can you imagine doing a one-year forward foreign exchange deal where the confirmation comes in six months’ time? It wouldn’t be acceptable,” says Mr Tiner.

“We have challenged the insurance market to find a solution for what we have called contract certainty. We will give them until end 2006, otherwise the rulebook will have to come out. We are going to monitor progress. If we didn’t have the rulebook in our back pocket, the industry might say ‘that’s very interesting and thank you’. We are not frightened to use it if we have to.”

Documentation of credit derivative deals is likewise being tightened up at the FSA’s behest. Mr Tiner shows the iron fist inside the management consultant’s velvet glove, when he says: “The market should want to remove the operational risk and to invest in getting rid of it. We are inviting them to get on with that. We find that when the FSA invites them to get on with it, the response is quite positive.”

Credit derivatives fan

While the FSA seeks to tighten up back-office administration in the credit derivatives market, its chief executive – who was a derivatives trader earlier in his career – remains a fan of the sector. “Credit derivatives bring speculators and hedgers into the derivatives market, and that means they bring information into the market. I think this makes markets more transparent and that must be good for all players.

“There has been concern that a lot of this credit risk has moved from banking to insurance, from those that know how to manage credit to those that don’t, and they have been stuffed with a whole load of paper that they don’t really want. There is not really any evidence to support that,” he says.

He takes a similarly laissez-faire approach to hedge funds, arguing they “diversify markets and serve a particular market appetite”. He speaks approvingly of hedge funds who are more active in challenging company shareholders. But he accepts: “There are risks out there. There are questions, will there be another Long-Term Capital Management? If so, what are its consequences? The level of gearing in the hedge fund industry is not something that should spook us too much. The [more important] issues are to do with how transparent it is; how robust are its procedures? Hedge funds are not regulated, although the managers are. Hedge funds build up strategic stakes and that is one reason why making them readily available to the public market is never going to be easy because that would demand full transparency.

“The hedge fund industry is at a very interesting point of development. The [US] Securities & Exchange Commission has announced that they are going to start licensing hedge funds, and it will be interesting to see how that plays through. What influence will that have on the hedge fund industry, when a lot of companies are offshore, well beyond the jurisdiction of the FSA and the SEC?” he asks. In mid-June, the FSA opened the door for the entry of hedge funds into the UK’s private investment sector, subject to further research and industry scrutiny.

Industry gripes

But not everything the FSA does meets with market approval. Its enthusiasm to involve itself in as many areas of financial services as possible comes at an increasingly intolerable price for the regulated sector, says Simon Gleeson, a partner at law firm Allen & Overy. “The FSA is a very strange regulator because it is exclusively interested in the service and completely disregards the price for the industry involved. It works on the basis that the more regulation it hands out, the better off everyone will be.”

One former legal officer at the FSA says it is aware of the general cost burden but unable to find a way to price it. “The cost/benefit side of things is not working properly,” he says. “The analysis under the Financial Services and Markets Act is perfunctory. I would like to see an attempt to price the system more generally.” He says that the FSA has had two attempts at pricing UK regulation, but both have ended in “whinges rather science”.

Mr Tiner answers this by saying that the organisation is poised for a third attempt at pricing of regulation. This will use an academic argument that the cost of regulation can only be accurately assessed if you measure the effect on firms, markets and consumers if regulation were completely removed. He calls the approach “counter-factional” and he is set to appoint a firm of consultants to implement it.

He suggests this approach may show regulation to be less of a burden than the industry claims. “What would Barclays do if there were no regulation? They would still have capital, because the ratings agencies would tell them to and the capital markets would tell them to. They would still try hard to look after their customers well because that’s good for business. So the real cost is the incremental element over and above the counter-factual. That is the theory which is very difficult to establish.”

Support for deregulation

Allen & Overy’s Mr Gleeson says much regulation is not only financial burdensome but also unnecessary. “Regulation increases until it hits the weight of the heaviest existing burden of regulation. Everybody is in favour of deregulation in general and regulation in specific cases. You won’t get universal opposition to any particular regulation because all existing regulations have economic beneficiaries who can be guaranteed to oppose the removal of the regulation concerned,” he says. “Somebody will always argue that the repeal of a regulation will reduce the protection of consumers and nobody in this political environment is going to say, I am in favour of fewer rights for consumers. So a lot of regulation confers absolutely no benefit on anybody, but is strongly supported by the industry because it creates barriers to entry.

“There is not a lot of difference between the FSA’s views on regulation for regulated firms, and modern views of corporate governance. You could get rid of the FSA rules and insert a one-liner that says that regulated firms should adhere to good standards of corporate governance. That’s it,” he adds.

Criticism from financial and political quarters is pushing the FSA to clarify its stance on regulation, as Mr Tiner has endeavoured to do. If the FSA model is to become the world model, further selling of the concept probably needs to be done and Tony Blair’s comments are mostly unhelpful. The FSA needs to respond to its critics but the debate needs to be a more enlightened one.

In the end, however, regulators are never going to be universally popular with the markets. But as long as the FSA can demonstrate that its model is superior to others, the prospects of another great British intellectual export becoming the global model – along with privatisation and central bank independence – are more likely than not.


All fields are mandatory

The Banker is a service from the Financial Times. The Financial Times Ltd takes your privacy seriously.

Choose how you want us to contact you.

Invites and Offers from The Banker

Receive exclusive personalised event invitations, carefully curated offers and promotions from The Banker

For more information about how we use your data, please refer to our privacy and cookie policies.

Terms and conditions

Top 1000 2023

Request a demonstration to The Banker Database

Join our community

The Banker on Twitter