Hector Sants, just about to complete his first year as chief executive of the UK’s Financial Services Authority, has proved his mettle during these times of great difficulty for regulators everywhere. Interview by Michael Imeson and Brian Caplen.
Of all the regulators in the world struggling to cope with the financial market turmoil, perhaps none has faced more criticism than the UK’s tripartite authorities of the Treasury, Bank of England (BoE) and Financial Services Authority (FSA). For Hector Sants, appointed chief executive of the FSA on 20 July last year, it has been the archetypal baptism of fire.
Only a few weeks after getting his feet under his new desk, the US subprime crisis detonated. It sparked off the global credit crunch, which soon led to the near-collapse of UK bank Northern Rock. Mr Sants, along with chancellor Alistair Darling and BoE governor Mervyn King, may have put out the flames but they are still keeping an eye on the embers to ensure they do not reignite.
Keen to rectify the shortcomings of a regulatory and financial system highlighted by these explosive events, the tripartite authorities published a consultation document in January called Financial Stability and Depositor Protection: Strengthening the Framework. Its proposals – to be included in a banking reform bill later this year – are wide ranging. They include a ‘special resolution scheme’ to allow the tripartite authorities to intervene when a bank gets into difficulties and which includes an insolvency regime for banks; improvements to the Financial Services Compensation Scheme to facilitate faster payouts to depositors; revising the framework for the provision (and disclosure of) liquidity; and giving the Bank of England a financial stability objective.
Unhappy bankers to pacify
Bankers are unhappy with much of this, and Mr Sants is trying to pacify them. The British Bankers’ Association accepts that some reform is needed but it has spoken out against the “aggressive legislative timetable”, is worried that a knee-jerk reaction will have unintended consequences for the economy and is concerned about the complex special resolution scheme and bank-specific insolvency arrangements.
In an exclusive interview with The Banker last month at the FSA’s office in London’s Canary Wharf, Mr Sants discussed regulatory reform and the wider ramifications of the credit crisis for the FSA and the firms it regulates. On the financial industry’s worry that the government will legislate in haste, Mr Sants says he is “very sensitive to that concern”. He insists that “all relevant parties” will have an opportunity to study the proposals and respond.
“We agree with the views of the BBA that it is extremely important that adequate time is provided for proper discussions and consultation,” he says. “Indeed, the original timetable has been extended by the government.”
FSA model: still fit for purpose?
The FSA has long been regarded by many around the world as providing the regulatory model to aspire to. Is this still the case? Mr Sants says that the FSA does not promote its model as the best, but that regulatory structures should reflect the individual circumstances of the local systems they are overseeing. “We have never put forward a view that says there’s a one-size-fits-all approach to regulatory structures,” he says.
“Having said that, in relation to the FSA’s framework, we believe it’s the right approach in the UK. When I talk about the FSA’s approach, I would highlight two features: we’re a unitary regulator, and we’re principles-based.”
Being a unitary regulator entails being responsible for the conduct and prudential supervision of all financial firms – banks, securities firms, insurance companies and the like – not just those of one sector. “I don’t think there is anything stemming from the events of the past 10 months – the market crisis and the particulars of Northern Rock – that in any way undermines the relevance and the value that the unitary regulatory proposition delivers to the UK,” says Mr Sants.
“The second characteristic that people tend to associate with the FSA’s regulatory proposition is that we are primarily a principles-based regulator. We’ve never said you can operate without any rules at all. We have merely said it’s good discipline to seek to operate, wherever possible, based on principles.
“Critically, the sub-heading to our principles-based philosophy is that we are an outcomes-based regulator. When we make judgements about a firm’s or individual’s compliance with our regulations, we look at the consequences of their actions and judge whether they were reasonable actions at the time, rather than specifically asking the question, ‘Did they comply with rules 1, 2 and 3?’
“Again, if you review the events of the past 10 months, I would say unequivocally that those events strengthen the relevance of being an outcomes-based regulator,” he says.
Northern Rock not on the radar
Critics have said that communication breakdowns between the three authorities exacerbated the problems of last summer. For example, it has been alleged that the FSA possessed information about firms that it did not pass on to the BoE.
That criticism was based on some “understandable misunderstandings outside the financial community”, says Mr Sants. “Throughout the period in question, the Bank [of England] had access to all the information the FSA had in respect to events in the marketplace.”
The FSA published a report earlier this year admitting that it made mistakes in the supervision of Northern Rock. It was congratulated for being detailed and frank about its errors. But why had the bank almost disappeared off the regulator’s radar?
“I would not characterise it as disappearing off the radar screen, but as not getting onto the radar screen. This was a building society with a simple business model that became a bank, pursed an aggressive business strategy and became relatively large pretty quickly. The FSA failed to adjust to a small institution becoming very large. We didn’t recalibrate our supervisory intensity to manage the increase in its size and importance to the UK financial system.”
If all the alarm bells had rung when Northern Rock started to falter, how much could the FSA have done about it? “It’s a very interesting question whether, even if we had been supervising it to the standards we believe we should have been, it would have made any difference to the outcome. That’s a difficult discussion to have and one that we haven’t sought to debate in the media because we didn’t wish to come across as not being willing to take responsibility for our own actions,” says Mr Sants.
International regulation
Plenty is happening on the international regulatory scene to strengthen the resilience of the banking system. The Basel Committee, for example, is rewriting parts of the Basel II framework to include, among many other steps, new standards for liquidity risk management and supervision.
The Financial Stability Forum (FSF), a group of international and national regulators of which the FSA is a member, is recommending root and branch changes to the way countries supervise their financial systems in order to improve the resilience of markets and financial institutions. The FSF wants, among many other aims, to ensure that staff bonuses are based on better risk assessments and long-term profits.
“Basel II represents a huge improvement over Basel I but, as the FSF has indicated, some lessons have been learnt which should be incorporated into Basel II,” says Mr Sants. However, he says that “there is no evidence” that the mark-to-market concept has been undermined by events. The debate, rather, is how investors interpret mark-to-market valuations when markets are damaged.
On bankers’ bonuses, Mr Sants firmly states: “It’s not the role of the regulator to determine the quantum of remuneration.” He adds: “We are not a price regulator and do not wish to become a bonus regulator... however, I believe it is legitimate for a regulator to make an appraisal of the risk that remuneration systems may pose to a bank’s ability to manage its risks appropriately. Our supervisory framework, Arrow, does allow us to make some judgement around the risks that any given remuneration structure might pose. Recent events will obviously encourage us to be more focused on this point.”
Attracting talent
The FSA has difficulty recruiting top people with market expertise because it is hard to match the City of London’s private sector salaries. “We can offer a credible and competitive proposition at the graduate level. There is no question it becomes more challenging to hire from the commercial sector when you move to the mid-career segment, when there can be quite wide discrepancies between what regulators can pay and the compensation available in the commercial marketplace,” says Mr Sants.
One solution has been to take on more part-time advisers, experienced market practitioners who are carving out a consultancy career for themselves and using a three-day-a-week contract at the FSA as the bedrock for that. “We have been very successful of late in hiring a number of very senior people from the financial community in an advisory role, mostly on a three-day week. In times of crisis they would obviously be fully engaged,” says Mr Sants.
The FSA will have a new non-executive chairman in September in the form of Lord Adair Turner, who takes over from Sir Callum McCarthy when he finishes his five-year term. Lord Turner is a former director-general of the Confederation of British Industry whose current positions include being a director of Standard Chartered.
“I am looking forward to working with him,” says Mr Sants. “We’ve already had some meetings. He has a strong track record.”
For all that is said about the FSA not being able to match the highest salaries, it must be doing something right to recruit a figure of Lord Turner’s stature.
HECTOR SANTS: CAREER HISTORY
July 2007: Chief executive, FSA.
2004: Managing director, wholesale and institutional markets, FSA.
2000: Chief executive, EMEA, CSFB.
