UK Financial Regulation Reflecting Back

UK Financial Regulation

Reflecting back on the last three years the global economy stood on the precipice of a major catastrophe. Only through the concerted and coordinated efforts of G-20 central banks and government action was the subsequent economic downturn a severe recession rather than a second worldwide Great Depression. The economic downturn which had its roots in excess leverage and misunderstood asset risk impacted the global financial services sector to a greater degree than other sectors. "The UK financial system, which is one of the most open, globalized and successful in the world, was impacted by these factors as much as, if not more than, any other" (HM Treasury. July 2010. P. 7.). Restoring the health of the global financial services sector is accomplished through coordinated efforts of the Basel Group, G-20, IMF, and European Union. However, equally important is the action of individual governments to reform and strengthen their financial service sector, ensuring that the best defense against a repeat of the economic turmoil which began in summer 2007 is in place. It is in this context that the following summation of the key aspects of UK financial regulatory reform is presented.

Addressing Critical Issues of Reform

The UK reform package is for all practical purposes contained and explicated in three reference submissions from Her Majesty's Treasury. In crafting the regulatory package the focus was on tackling several key problems which the existing regime could not adequately handle. "Identify the problems that were building up in the financial system, take steps to mitigate them before they led to significant instability in financial

Markets; and deal adequately with the crisis when it did break, especially during the first part of the crisis in the summer of 2007" (HM Treasury. July 2010. P.8.). The inability of the existing regime to address these issues stemmed from first

"a monolithic financial regulator, the Financial Services Authority (FSA), which had too broad a remit and insufficient focus to identify and tackle issues early. Second, the Bank of England (Bank) did not have the tools or levers to fulfill its responsibility for ensuring financial stability. Third, the Treasury had responsibility for maintaining the institutional framework but no clear responsibility for dealing with a crisis which put public funds at risk. Lastly, no single institution had the responsibility or authority to monitor the system as a whole, to identify risks to financial stability and act decisively to tackle them" (HM Treasury. November 2010. P.7.).

The reform package attempts to rectify these issues in large part by removing the FSA as a governing body, and placing the regulatory power in the hands of three new government agencies: the Financial Policy Committee (FPC) responsible for overall macro regulation, the Prudential Regulatory Authority (PRA) designed to manage individual financial firm risks, and the Financial Conduct Authority (FCA) which will handle consumer protection issues (HM Treasury. Feb 2011. P.8.). This new framework has its design in collaborative operations between the three bodies which have specific focus mandates rather than overarching authority to manage and regulate both macro and micro issues.

Positives and Negatives of Reform

If as Lord Tuner Chairman of the FSA indicates, the most significant issue in the former tripartite model was the "fact that no single institution has the responsibility, authority or powers to monitor the system as a whole, identify potentially destabilizing trends, and respond to them with concerted action" (HM Treasury. July 2010. P. 8.); then there is a confusing contradiction in providing the FPC with broad powers to manage and regulate systemic financial risk. As noted previously one of the existing regime's weaknesses was the FSA and its monolithic structure which had too broad a focus. How then in this context can another overarching regulator the FPC expect to manage systemic risk which is by definition a broad-based focus? Perhaps systemic risk can be in and of itself a narrowly defined mission however, this may be the biggest weakness of the reform package. Expecting another regulator to discern where the root causes of the next crisis will emanate from, and use tools to counteract them, places too much regulatory power in the hands of one large governing body.

One of the strengths of the package is its creation of the PRA and FCA to handle micro- prudential regulation and consumer financial issues. The part nationalization of Royal Bank of Scotland and Lloyd's of London in which "the government acquired a stake of around 83% in RBS and a 40.6% holding in Lloyds following huge losses at both during the credit crisis" (Gupta. S. March 16, 2011) point to the need for stronger regulation of the financial sector. The UK banking system which is one of the most successful and innovative in the world must continue to have autonomy in its operations. Over regulation will only stifle an industry which is a key to the return of a strong economy, particularly in light of the austerity measures of the coalition government which will slow government expenditures to buttress an economic recovery. A greater emphasis on firm specific activities which will encompass leverage, capital ratios, balance sheet assets and liabilities is not over regulation but rather smarter regulation.

In contemplating reform the FCA will ensure that the focus of the financial sector is on the individuals who utilize their products not the shareholders who reap the gains from profits. The FCA will make the important determinations on which financial instruments are for the benefit of the greater population while still allowing the banking firms to generate a profitable return. The FCA may be the single most important aspect of financial reform in its protection of the consumer and its limits on financial product excess.

Framing the Debate

Financial regulatory reform is not about taking action simply because something must be done; rather it is an acknowledgement that "there were real and significant failings in the UK regulatory framework. This meant that regulators failed in recognizing and responding to the problems that were emerging in the financial system" (HM Treasury. July 2010. P.7.). Lord Turner describes this problem as 'underlap', "a phenomenon whereby macro-prudential risk analysis and mitigation fell between the gaps in the UK regulatory system" (HM Treasury. July 2010. P.8.). The solution presented is to fill these gaps with the aforementioned regulatory agencies FPC, PRA, and the FCA. Additionally, these agencies will be given the tools by which to effectively manage the systemic and individual firm risks that arise. These policy levers were not at the disposal of the Bank of England, Treasury or the FSA and as such the necessary actions to prevent the crisis before it erupted were not initiated.