The Regulators’ revolt


When I chaired the UK’s Financial Services Authority (FSA), in those prelapsarian days before the 2008 global financial crisis, I was regularly asked by financiers who resented our intrusions into their profitable lives: “Quis Custodiet Ipsos Custodes?” – Who guards the guards?

In the original Latin source, Juvenal was referring to corrupt sentries taking advantage of women whose morals they were supposed to protect (not a problem with which I am familiar). But the question is a handy catchphrase and debating point for those who find themselves at odds with their regulators. It is the financial equivalent of the oft-heard playground cry, ‘Not fair!’

At the time, I did not take the charge very seriously. Far from the FSA being ‘judge and jury in its own court’ – as the accusation went, its authority was hedged with constraints. The statute within which we worked was tightly drawn, and the board was predominantly made up of independent outsiders, some from the industry. Practitioner and consumer panels had rights of access, regulatory decisions could be appealed to the courts, with the potential for judicial review, and both Houses of Parliament regularly held me to account.

In the post-2008 period, when bankers were collectively sent to sit on the naughty step, the ‘quis custodiet’ question was rarely asked. But it recently re-emerged in London in a sharper form. The Conservative Government declared its intention to legislate for a public-interest intervention power, which would allow ministers – only in exceptional circumstances and with appropriate safeguards, they claimed – “to direct a regulator to make, amend or revoke rules”.

The context is a reform of the UK’s post-Brexit regulatory environment, designed to make London an even more attractive place to conduct financial business. The exercise is sometimes referred to as Big Bang 2.0, an echo of Prime Minister Margaret Thatcher’s reform of restrictive practices in the City of London in 1986, which ushered in a long period of growth for financial business, barely interrupted by the 2008 crisis, which lasted until the Brexit referendum in 2016.

The declared aim was to regain the city’s status as the world’s leading international financial centre. But the sub-plot was to demonstrate the benefits of Brexit, which the government has been seeking to explain for some time – an exercise reminiscent of the French quest for the Scarlet Pimpernel in Baroness Orczy’s novel.

The notion of empowering government to intervene in regulators’ decisions, as distinct from setting their objectives and maintaining accountability for meeting them, divided opinion sharply. How would the government use such a power? Could it be the beginning of a race to the bottom? How would it fit with international agreements? Could the government then overrule a new Basel Accord, for example?

Remarkably, the regulators themselves came out fighting in public. The Bank of England’s deputy governor responsible for banking supervision, Sam Woods, challenged the premise on which the case for it was built. “Some might think that such a power would boost competitiveness,” Woods said. “My view is that through time, it would do precisely the opposite, by undermining our international credibility and creating a system in which financial regulation blew much more with the political wind – weaker regulation under some governments, harsher regulation under others.”

Strong words – and echoed by the head of the other main regulator in London, the Financial Conduct Authority. Richard Lloyd, the authority’s interim chairman, told MPs that the proposal was “of great concern to us”.

Woods’ view regarding the competitiveness of London is supported by surveys, conducted by the consultancy Z/Yen in particular, which try to measure the attractiveness of different financial centres. Respondents typically say that in choosing their location, they seek regulatory certainty, rather than low standards. They want to be sure they are treated fairly with a minimum of political interference and no preference given to domestic firms, and to know that their counterparties are well-capitalised and well-regulated. That makes sense. Weak regulation is not a competitive advantage.

In financial firms, opinion on the proposed new power was mixed. Some, especially the insurance industry, who think the BOE has been unnecessarily restrictive in its interpretation of solvency standards, could see potential advantages. But others noted that a power drafted by a ‘deregulatory’ government could easily be used in the opposite direction by a finance minister with a different agenda. If the power were tightly defined so as to keep the politicians at arm’s length, there would be little point in it. If it could easily be used, it could just as easily be abused.

There is a sliver of a case for a power to intervene in regulation if national security – where financial regulators lack the relevant skills or information – is at issue. But that points to a very specific intervention, not a broadly defined ‘call-in’ power relating to all the regulator’s rules.

International regulators watched the debate in London nervously. If the United Kingdom, long seen as a bastion of regulatory independence, and a key global financial centre, were to shift in a political direction, other regimes might be emboldened to take a firmer grip on their central banks and regulators. That could lead to dangerous fragmentation.

With full frontal opposition to the plan from its own regulators, the government found itself in a hole. Wisely, in late November, it followed the first law of holes and stopped digging. For now, they will not proceed, and we may assume the idea is dead until the next election. The benefits of Brexit must be found elsewhere.

‘Cave quid volunt’ is not as well-known a Latin tag as ‘quis custodiet ipsos custodes’, and has no literary source. But ‘be careful what you wish for’ is often very good advice for financial firms and governments alike.

Howard Davies, a former deputy governor of the Bank of England, is Chairman of NatWest Group.

Copyright: Project Syndicate, 2022.

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