Policing in good times and bad

Regulatory spotlight on financial services may dim as the economic climate brightens

Andrew Wass

The Libor scandal has inflamed the debate in financial services about the relationship between market practice, the law and the regulatory regime. ‘Market practice’ in this context is the manner in which a market and its participants operate. Its importance lies in ensuring the efficiency and freedom of that market.

Free marketeers argue that markets should be left to police themselves, but the events of 2008 have changed attitudes among policymakers and the public.

Recent events have put the spotlight back on the regulators. The EU Commission plans to criminalise some of the practices that led to market abuse and the Government’s white paper on banking regulation has adopted most of the recommendations of the independent commission. However, with implementation deadlines set for 2014 and 2019 respectively the public appetite for an immediate response may be far from satisfied, begging the question – will the desire for reform have subsided by the time regulators act? And what, if anything, does this mean for the future of ‘market practice’?

Certain wholesale financial markets remain unregulated. These include foreign exchange and the interbank money market. Prior to 2007-08 politicians were advocating less, not more regulation. The FSA’s approach was (and still is) to regulate the participants (traders, brokers), rather than the market.

Even for heavily regulated markets, the English courts can (and occasionally do) ignore market practice and apply the law prescriptively. This can have peculiar consequences. Sometimes, the written contractual terms do not accord with accepted practice because experienced market participants deal with transactions in the way that is most efficacious, knowing their counterparty expects this or is doing the same thing.

But it would be difficult to persuade a court that the course of dealing should be looked at in place of the written terms to establish the implied terms of the contract. In tort, the difficulty lies in not only proving liability against market manipulators but also in establishing that loss that was caused by manipulation that was reasonably forseeable.

There have been a number of reforms implemented since the financial crisis, designed to curtail the bad behaviour of market participants, perhaps most importantly in how individuals are remunerated. Rules set out in the FSA’s remuneration code are designed to prevent staff from being incentivised to take excessive risks. The code has been in force for some 2,500 firms for over a year now, with the top 25 banks and building societies having been covered by the precursor arrangement since 2010.

So far it is not apparent that the code has changed behaviour. It may take a generation of bankers growing up under the new framework before there is a change in culture, and by that time the global economy will hopefully have recovered.

Will politicians of the future be strong and prudent enough to maintain regulatory restrictions in better economic climes in the face of severe pressure from banks that will be complaining about the need to compete internationally?