Why regulators find it so hard to regulate

I hosted a fascinating dinner last night which built upon the comments made yesterday about regulators being unable to regulate.

The theme was around how to make the G20 supervisory framework work with regulators, compliance heads, bank directors and a CIO in attendnace. All in all a nice crowd, and a convivial conversation.

However, I did note a few comments such as:

“Europe is run by the Council of ministers”
“European regulations are overly prescriptive”
“Greed is the biggest desire and how do you regulate that?”
“I’m amazed by the financial regulator’s lack of teeth”
“The French make the laws as complex as possible and then don’t follow them” …

and more.

Oh yes, nothing like being a London-based European is there?

Now this may sound like a disaffected group, but it isn’t. It is more a case that you can create as many rules and laws as you like but if they are unclear, unworkable or inappropriate, then you cannot enforce them.

This is the frustration of the regulators as much as the regulated, and there is no simple answer.

We then talked about principles- versus rules- based regulation, with three-quarters of the room saying that principles-based regulation is still far more appropriate than rules-based. Although rules are easier to follow, they can be too constraining.

Then the conversation was pulled up by the statement that principles-based regulation no longer works and we should focus upon outcomes-based regulation.

Interesting, especially as we have a lengthy process of new outcomes-based regulation coming through, such as the FSA’s Consultation Paper entitled 'Strengthening liquidity standards 2: Liquidity reporting' (CP09/13) released yesterday.

I haven’t had time to read the document but PJ Di Giammarino, who chairs the Financial Services Club’s Capital Markets Chamber**, posted a commentary as follows:

“After a rapid review of the 174-page CP09/13 response on liquidity reporting, we think the FSA is essentially saying ‘We appreciate it is going to be hard but get on with it, because we are serious’.

“Despite many of the 98 respondents to the 15 questions in CP 08/22 (the first consultation paper released last December) highlighting the practical issues associated in delivering new reports, the FSA has decided that liquidity problems need to be monitored daily. And for banks this means exactly what it says on the tin.

“The FSA recognises that reporting requirements may be costly to implement but believes the data concerned would normally be utilised by most firms during the normal course of business.

“In an important nod to the recent G20 meeting, it is also clear that the FSA is engaged in international efforts to align other regulators to its data-intensive approach – and then use this as the basis of cross-border benchmarks.

“Firms should expect the new rules and guidance to be in effect in the fourth quarter of this year with new FSA reporting arrangements going live in Q1 2010. It goes without saying that there’s a huge amount of work to be done across the industry to get this right.

“Our discussions with practitioners in banks lead us to conclude that, whilst much of this makes good business sense, it has the consequence of asking banks to rethink their infrastructures from the bottom up. The good news is that investment firms now have a clear and certain regulatory target to aim at.”

This also builds on the De Larosière report and other rulings as discussed previously, and my take on PJ’s comments is that the FSA has placed stringent rules in play which will force banks to report daily based upon strong liquidity data analysis.

Sounds like a prescriptive regulation if you ask me, and promotes the idea that outcomes-based regulation is not going to be based on principles but will be based upon strong controls, enforceable through prescriptive data reporting structures.

A-ha … and hopefully with teeth and co-ordination for a consistent approach across geographies.

But even if it isn’t, it does not matter as the key here is to have a transparent regulatory environment which ensures a robust marketplace, and the more robust the marketplace the more market players.

It honestly doesn’t matter what the UK, France, Germany, Spain, Italy or others implement in their interpretation of EU Directives, it just matters that each creates a strong and robust marketplace which attracts liquidity and has some form of consistency, even if not quite 100% the same.

This is why the FSA always jumps in first, because they want the UK market to be the most robust and well regulated, to encourage participation in that market over others. 

And there's the rub.  Who can create the market that has great regulations, which are easy to work with and robust, whilst avoiding constraints and rules which might deter business and liquidity.

And one, of course, that averts a disaster anything like the one we’ve just experienced in this crisis, e.g. from Paul Kedrosky’s Infectious Greed yesterday:

Anyways, back to the dinner and the comment that resonated the loudest around the room was the one that asked: “where’s the customer’s voice?”

In all the dialogue about regulations and regulating, the focus appears to have been to lock the horse back in the barn after its bolted whilst the fact is that the farm still needs looking after.

In other words, are we focusing too much upon the crisis and its issues, or should we be focusing back on what is good for corporations and citizens, and then apply this to the banks?

I guess we’re trying to do both: to plug the holes in our existing legislation that allowed the credit bubble to balloon and burst, whilst protecting corporations and customers from past, current and potential future misdemeanours.

No wonder the regulators have such a hard time.

** Next meeting of the Capital Markets Chamber is 23rd April with the debate theme: "This House believes banks can't count high enough to measure their UK carbon reduction commitment ... but their regulators can!"  If you would like to attend, please register.