In the last 6 months since the FSA published its Business Plan for 2010/11, the UK has seen its first formal coalition government since the Second World War, there are proposed changes to the financial regulatory infrastructure, the new Basel III rules have been published and there have been proposals to tighten the regulations in relation to derivatives. The theme - a global obsessive compulsion to regulate and control the financial markets based perhaps on an over-anxious reaction to control? Understandable perhaps bearing in mind the extent of the financial crisis but are these the right conclusions?
In June 2010, the UK’s coalition government announced plans to abolish the FSA (and, therefore, dismantle the tripartite system) and hand back supervisory functions to the Bank of England and related agencies. The Chancellor of the Exchequer took the view that the FSA “failed spectacularly” in relation to the recent financial crisis. One of the new measures is the creation of the Financial Policy Committee tasked with monitoring and dealing with the ‘big picture’ issues in relation to any risks to financial stability. However, even before the deadline (18 October 2010) for comments on the Treasury’s paper on regulation, commentators have criticised the change. The focus should not be on the ‘architecture’ of the regulatory structure but on employing the right people with the appropriate skills to effectively prevent bankers from taking inordinate risks. The British Bankers' Association believes that the new structure will lack accountability due to the significant amount of control that the Bank of England will now have.
In addition, to these new domestic rules, Basel III rules will require banks to retain more capital by requiring a bank to have its core tier-one capital ratio (a specific measurement of a bank’s financial strength) at 4.5% by 2015. Further, banks will have to maintain a further conservation buffer of 2.5% by 2019. The penalty for not maintaining the buffer will be that banks will be restricted from paying dividends and bonuses etc. There will be a quality control on the type of capital with a significant amount of Tier 1 capital having to be common equity and retained earnings. Some banks will to have raise billions of funds to meet these requirements, but UK banks such as RBS, Lloyds and Barclays are already above these thresholds. They do however have 8 years to meet these requirements.
But the extra regulation does not end there. On 15 September 2010, the European Commission published its intention to regulate the derivatives market (a market worth around £384 trillion) to increase transparency and decrease risk associated with these financial instruments. Measures include requiring disclosure to the regulator of short positions of over 0.2% of issued share capital of the company and disclosure to the market where it is over 0.5%. The EC want to empower national regulators to ban short-selling in certain circumstances and to include transparency by routing most derivative trades through centralised houses. However, these are just proposals at the moment with a view to them being implemented by 2012.
The Independent Commission on Banking will publish its report at the end of September 2011 making recommendations about the relationship between utility and casino divisions of universal banks. The conclusions may go some way to indicate how banks will be structured in the future.
Questions will be raised as to whether these regulations are effective in their aim to avoid another financial crisis or whether this is merely change for change's sake. The introduction of the Basel III rules improving the quality of capital should be widely welcomed though attempts to put the regulator into the bank board room should be resisted. Separation of banking institutions into commercial banking and investment banking may have merit, but to label parts of banking institutions as the “casino” is to misunderstand the importance of investment banking to the economy.
We applaud the efforts to implement structures and controls to avoid future financial troubles but we remain sceptical that the replacement of one regulator with another is the right solution. To blame the failings of the regulator for the troubles seems a rather simplistic conclusion and certainly overlooks the role of others connected to the crisis.