Regulator’s Speech Highlights Market Turmoil; Advantages of UK Regime

June 11, 2008

In a recent address Callum McCarthy, the Chairman of the UK’s Financial Services Authority, took stock of the current regulatory regime for financial services in the UK.

“The turbulence in financial markets – what the ECB’s [European Central Bank] President Trichet accurately describes as ‘the ongoing reappraisal of risk in financial markets’ – has led to a review round the world of regulatory policies and practices,” McCarthy stated.

He then reviewed U.S. proposals for “quite fundamental changes to the fragmented pattern of US regulation,” and the growing support in Europe for a “single European regulator of financial services.”

McCarthy noted that in the UK “the problems which had long been recognized of gaps in the UK legal and regulatory arrangements for how to deal with a failing bank, and which were being addressed before the present problems in finance crystallized, are being tackled by the establishment of new legislation to be introduced later this year, which was described in a consultation paper published by the Tripartite Authorities in January, and where a further consultation paper will be published this month.” He also described additional “proposals to make structural changes to the regulatory framework.”

While McCarthy’s address, delivered at the British Banking Association’s annual conference, mainly discussed the problems in the financial/banking sector, it also took a broader approach to regulation in general, including the insurance industry.

McCarthy cited the U.S. Sarbanes-Oxley law, passed in haste after the Enron scandal, as an example. While it was well intentioned, it has nonetheless produced “inappropriate responses.” In comparison to the UK’s regulatory system it has become an increasing burden for many businesses. “I would simply remind you that a series of US reports have identified the principles which inform UK regulation as conferring substantial advantages to the UK,” he noted.

Addressing EU calls for regulatory reform, McCarthy reminded his audience: “The principles which have underpinned the regulatory framework in the UK for the last decade remain good principles, which we would depart from at our peril and to our cost. The principles which informed the structure of regulation were the need to avoid duplication between the roles assigned to each of the Tripartite Authorities (FSA, Bank of England and Treasury); to achieve clarity of responsibility and of decision making; and to have a structure flexible enough to respond to an increasingly complex, increasingly global and increasingly integrated financial services marketplace. The principles which inform the practice of regulation are a risk-based approach, based on a balance between general principles and specific rules.”

As a member of the EU, the UK is subject to the laws and rules the community enacts. McCarthy feels strongly that the potential effects of some of the proposals haven’t been clearly worked out. He pointed out that in “a world where a transaction entered into by a bank, a security firm or an insurance company can have the same economic impact, I see great disadvantage in supervision organized on sectoral grounds – i.e. split between banks, securities houses and insurance firms – both in terms of danger of regulatory arbitrage and inconsistency; and in terms of the cost – financial and managerial – of subjecting a complex financial organization to multiple regulators. I know from conversations with both policy makers and practitioners in the US how keenly they feel that the UK system, in this respect at least, provides a model to be emulated.”

In overall terms the UK’s “risk-based’ approach has been more or less adopted as the preferred method for financial regulators to follow. This is especially true of the ongoing formation of the Solvency II regulations for the insurance industry (See related article).

The full text of McCarthy’s address may be obtained on the FSA web site at: http://www.fsa.gov.uk.

Source: Financial Services Authority

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