Self-regulation under attack
21 November 1995
House of Commons Select Committees have proved a useful constitutional innovation. They reveal what the Government, the Civil Service and the private sector think about a host of topical matters.
Nevertheless, select committees have an in-built majority in favour of the governing party.
What is most surprising about the Treasury Select Committee's sixth report into financial services regulation is the extent to which the committee appears to endorse strands of Labour Party policy for regulation of UK financial markets.
Labour's stated policy for City regulation consists of:
moving responsibility for
supervision of banks from the Bank of England to a new banking commission;
no British Securities and Exchange Commission, but an end to self-regulated financial services;
putting the Securities and Investments Board (SIB) on to a more explicit statutory basis with wider powers and responsibility for direct regulation of financial services and public interest representatives sitting alongside practitioners on the SIB board of directors.
The committee's report did not go as far as Labour MPs would have liked. The party's proposal that Self-Regulatory Organisations (SROs) such as the Securities & Futures Authority (SFA), the Investment Management Regulatory Organisation (IMRO) and the Personal Investment Authority (PIA) should be folded into the SIB to form one wholesale and retail securities regulator was rejected by the Conservative majority on the committee. However, with phrases such as "self-regulation is dying a natural death", the committee was not frightened to express itself.
It is 10 years since the Financial Services Bill was under consideration in Parliament. The committee's conclusions reflect the fact that the UK's financial markets have changed out of all recognition.
A number of regulators have given testimony as to the extent to which the Financial Services Act 1986 (FSA) has proved to be a flexible piece of legislation which has allowed the regulatory authorities to respond to changes in the market place.
However, the committee highlights the use of the contractual relationship between SROs and regulated firms as a means for extending regulation in ways which the Act either did not explicitly envisage or, owing to the fudge of statutory regulation and self-regulation which the 1986 Act comprises, has served the immediate, short-term interest of an SRO.
As a parliamentary committee should do, the Treasury Select Committee has made the valid point that there ought to be limits to the extent to which regulatory law should be extended in this way without resorting to changes in primary legislation.
In its report the committee omits any reference to the amendments to the FSA, including primary legislative changes through the Companies Act 1989. These changes were a response to the furore that accompanied implementation of the FSA via the detailed rulebooks of SIB and the SROs. The 1989 changes (the New Settlement) were intended to produce simpler statements of principle and core conduct of business rules at the top of the rulebook structure and to provide uniformity at that level across different SROs.
This has been successful but it took a lot of the SIB's time.
Andrew Large's report (commissioned by the Chancellor of the Exchequer from the SIB chair as a response to the roles of IMRO and SIB in the Maxwell affair), presaged the change in SIB's approach from rule writing to delivering higher standards of regulation and enforcement. The committee concludes that the SIB has done well in redirecting itself. As a result the committee suggested a range of new tasks for the SIB including:
the boards of PIA, IMRO and SFA to have a majority of public interest board members to reflect the fact that SROs are now independent regulators achieving acceptable standards of regulation;
examine the FSA regulation of chartered accountants and lawyers through their recognised professional bodies (such as the Institution of Chartered Accountants or Law Society).
There is concern that the standard of regulation is not the same as that for firms regulated by SROs and should be. What the SIB fails to understand is the regulation of Lloyd's, which should be transferred to an independent body.
However, the SIB's work on statements of principle should be the guiding light for a new Lloyd's regulator. Neither does SIB understand banking and building society supervision.
In an earlier report the committee concluded that the Bank of England could continue to be responsible for prudential supervision of banks, but in this latest report has, in the light of Barings, suggested the Treasury review the Bank of England's supervisory role. A single stand-alone supervisor of banks and building societies is suggested as a way forward.
The SIB should be pleased with this report. The Bank of England may be less happy with the criticisms of its supervisory role in relation to the securities and futures business of bank affiliates (eg Barings' derivatives problem in Singapore). The committee seems to doubt whether the Bank of England has any credible plan for acquiring securities regulatory expertise.
The committee is also critical of the Department of Trade and Industry's role in relation to some aspects of the financial markets, including Lloyd's and the insurance industry.
The committee recommends that regulatory responsibility for all financial markets be transferred to the Treasury. This is a specific point within an overall theme of the report which is that there are too many overlaps of regulation.
The committee quotes a comment made in evidence by Christopher Sharples, then chair of the SFA, that at international regulatory conferences one finds two or three people from France, Germany and the US and 10 people from the UK.
Difficulties with derivatives are highlighted as an area of regulatory confusion. The committee criticises regulators for more than simply competing for the same turf. It points out that it seems odd that risk management initiatives seem to emanate from the private sector, from trade associations or informal groupings of market participants and are not led more creatively by the regulatory authorities. However, we will have to wait for the committee's final conclusions on derivatives as it probes Barings and banking regulations.
The enforcement side of financial services regulation in the UK has been jinxed by too many agencies serving different requirements - criminal and civil and regulatory. The committee recommends a carefully formulated strategy for changes to financial markets legislation which would remove confusion over responsibilities.
The committee concludes that the ability of financial markets to turn themselves inside out in a short period of time and to break down boundaries of function and institutional groupings and cross-border operations presents a serious challenge to UK regulators and to Parliament, but the challenge has to be met. In making these points the committee members have displayed a handsome measure of wisdom.