28 November 2022

Project Syndicate's Howard Davies: The Regulators’ Revolt

Britain's Conservative government recently sought a "call-in" power that would authorize it “to direct a regulator to make, amend or revoke rules.” But facing full frontal opposition to the plan from the regulators themselves, the government found itself in a hole – and wisely stopped digging.

When I chaired the UK’s Financial Services Authority (FSA), in those prelapsarian days before the 2008 global financial crisis, I was regularly asked by financiers who resented our intrusions into their profitable lives, “Quis Custodiet Ipsos Custodes?” Who guards the guards?5

In the original Latin source, Juvenal was referring to corrupt sentries taking advantage of women whose morals they were supposed to protect (not a problem with which I am familiar). But the question is a handy catchphrase and debating point for those who find themselves at odds with their regulators. It is the financial equivalent of the oft-heard playground cry, “Not fair!”

At the time, I did not take the charge very seriously. Far from the FSA being “judge and jury in its own court,” as the accusation went, its authority was hedged with constraints. The statute within which we worked was tightly drawn, and the Board was predominantly made up of independent outsiders, some from the industry. Practitioner and Consumer panels had rights of access, regulatory decisions could be appealed to the courts, with the potential for judicial review, and both Houses of Parliament regularly held me to account. In the post-2008 period, when bankers were collectively sent to sit on the naughty step, the “quis custodiet” question was rarely asked.

But it recently re-emerged in London in a sharper form. The Conservative government declared its intention to legislate for a public-interest intervention power, which would allow ministers – only in exceptional circumstances and with appropriate safeguards, they claimed – “to direct a regulator to make, amend or revoke rules.” The context is a reform of the UK’s post-Brexit regulatory environment, designed to make London an even more attractive place to conduct financial business. The exercise is sometimes referred to as Big Bang 2.0, an echo of Prime Minister Margaret Thatcher’s reform of restrictive practices in the City of London in 1986, which ushered in a long period of growth for financial business, barely interrupted by the 2008 crisis, which lasted until the Brexit referendum in 2016. The declared aim was to regain the City’s status as the world’s leading international financial center. But the sub-plot was to demonstrate the benefits of Brexit, which the government has been seeking to explain for some time, an exercise reminiscent of the French quest for the Scarlet Pimpernel in Baroness Orczy’s novel.

The notion of empowering government to intervene in regulators’ decisions, as distinct from setting their objectives and maintaining accountability for meeting them, divided opinion sharply. How would the government use such a power? Could it be the beginning of a race to the bottom? How would it fit with international agreements? Could the government then overrule a new Basel Accord, for example?

Remarkably, the regulators themselves came out fighting in public. The Bank of England’s deputy governor responsible for banking supervision, Sam Woods, challenged the premise on which the case for it was built. “Some might think that such a power would boost competitiveness,” Woods said. “My view is that through time it would do precisely the opposite, by undermining our international credibility and creating a system in which financial regulation blew much more with the political wind – weaker regulation under some governments, harsher regulation under others.”

Strong words – and echoed by the head of the other main regulator in London, the Financial Conduct Authority. Richard Lloyd, the authority’s interim chairman, told MPs that the proposal was “of great concern to us.” Woods’ view regarding the competitiveness of London is supported by surveys, conducted by the consultancy Z/Yen in particular, which try to measure the attractiveness of different financial centers. Respondents typically say that in choosing their location, they seek regulatory certainty, rather than low standards. They want to be sure they are treated fairly, with a minimum of political interference and no preference given to domestic firms, and to know that their counterparties are well capitalized and well regulated. That makes sense. Weak regulation is not a competitive advantage...

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