The much heralded Turner Review was published by the FSA this morning. Much of it reflects ideas and proposals trailed over the past half-year by Lord Turner himself (FSA Chairman) and Hector Sants (FSA CEO), other FSA publications in recent months (such as its Business Plan and draft code of practice on remuneration policies) and the recommendations of other bodies (such as G20, the EU’s de Larosiere Group whose report was published last month, and the EU Commission itself).

Lord Turner promised “revolution not evolution” and the Review certainly reflects that – the FSA is seeking to reinvent itself for a new financial environment. There is a real risk that regulation swings from “light touch” to “heavy handed”, and wreaks more damage on the financial sector or prevents the City’s recovery as a major part of the UK economy. But financial regulation has become more politicised: the FSA has expressly accepted the risk of inhibiting economic prosperity and stifling innovation.  

Although the package of proposals described by Turner is revolutionary, many will have been hoping for more flesh on the bones of these ideas and proposals: they will be only partially satisfied. For example, the Review:

  • stops short of specific recommendations to limit mortgage lending and some of the more complex products such as credit default swaps which Turner has criticised previously;
  • merely outlines at a high level possible mechanisms to achieve macro-prudential supervision – the FSA favours a joint FSA/Bank of England decision-making body; and
  • is light in addressing Turner’s much-quoted “duck factor” 1; he seems to accept that the offshore nature of many hedge funds and SIVs allows only indirect prudential regulation unless and until international agreement is reached, even though many of the fund managers and their banks, brokers and custodians are onshore.

Despite the three-page table of actions in the introduction, the Review is as much a discussion as a blueprint for FSA or UK Government action. The first third focuses on what went wrong, and the main body of the Review looks at mainly prudential regulation (macro and micro) and FSA supervision, but touches on other areas of proposed change – such as the institutional scope of regulation, the supervision of large, complex and/or cross-border banks and remuneration practice. The implementation chapter emphasises how dependent we are on international agreement being achieved, in the EU, G20 or even more broadly.

Other points of interest include:

  • emphasis on greater transparency (information and disclosure by financial institutions) – e.g. through more detailed information in banks’ published accounts or clearer explanation of deposit insurance to consumers;  
  • the FSA welcomes the new European financial regulatory and supervisory structure proposed by the de Larosiere Group, even though that would reduce the FSA’s powers in certain respects;  
  • there is little discussion of the so-called “twin peaks” approach of assigning prudential and conduct regulation to different regulators, an idea revived in last week’s Sassoon Report for the Conservative Party: but Turner extols the virtue of one regulator covering the whole range of financial institutions.
  • the Review does not propose a formal and absolute separation of commercial and investment banking 2, but prudential and other rules will in practice encourage separation of “utility” or “narrow” banking on the one hand and investment banking on the other, and severely constrain proprietary trading by banks;  
  • ironically, the notion that the provision of liquidity in non-cash financial instruments may itself be a service has become outmoded - less than two years after EU regulators sought to interpret best execution obligations on that basis;  
  • FSA’s approach to supervision is changing, to focus on business models, strategies, risk and outcomes, rather than internal systems and processes within institutions. This is a brave move and an enormous challenge; as the FSA acknowledges, this requires major cultural change, influx of expertise and skills, much more information from the regulated community and an ability and willingness to make important judgments which may subsequently prove mistaken.  

The Review repeats and develops a number of themes on which the FSA has led comment, such as:  

  • the need for national regulators to have power to limit the activities of branches of foreign banks, even within Europe; and  
  • the limited effectiveness of Colleges of Supervisors overseeing the supervison of international banks, without a stronger international legal framework.

The 100+ page wide-ranging Review is supported by a much longer Discussion Paper (DP 09/02) focused particularly on commercial and investment banking, and FSA’s new supervisory approach. The DP elaborates many of the proposals mentioned in the Review and the thinking behind those proposals, particularly in relation to prudential regulation, regulatory architecture and supervisory approach.  

The Review is open for comment until 18 June 2009.