The future of financial regulation in Europe
Speech by John Tiner, CEO, FSA
French Chamber of Commerce Lunch
25 November 2005
It is a great pleasure to be with you today and I should like to thank the French Chamber of Commerce in London for giving me the opportunity to say a few words about how I see the future of financial regulation in Europe. Of course, being a regulator, this is a subject dear to my heart. But I am sure that as many of you here today are the regulated having businesses throughout the European Union, you too are quite interested in this issue. I imagine you would like to see a regulatory system which is sensible, proportionate, avoids or minimises duplication and is cost effective in the context of the benefits regulation brings for markets and consumers.
I would like to touch on three key issues: the regulatory philosophy, the Commission's approach and the high level principles which should govern the future shape of financial services regulation in Europe.
Regulatory philosophy
Regulation of the financial services industry exists because of the potential economic and social effects of major financial instability, the desirability of maintaining markets which are efficient, orderly and fair and the need to protect retail consumers in their dealings with the financial services industry. I do not ever hear arguments against the existence of regulation in these contexts. But I do hear extensive debate about how regulation is conducted.
The FSA has a clear view on this. We believe it is managements' job to organise, manage and control their businesses in a way which meets a set of high level principles determined by the regulator necessary to safeguard the interest of customers and secure the safety and fairness of markets. Sometimes, it makes sense to underpin those principles with detailed rules or guidance, but it should not be the regulators job to tell management how to run their business.
The FSA operates a hybrid system of high level principles and an extensive book of detailed rules, which have come about partly as a legacy of the former fragmented regulatory structure in the UK and partly from the implementation of EU directives. I aim to change this balance so we look more to the principles and less to detailed bureaucratic prescription on what exactly regulated firms have to do. This change will be gradual and will take time to execute. However, I must immediately hedge my remarks since, as new highly prescriptive legislation emerges from Brussels which takes us in the other direction, such as the Markets in Financial Instruments Directive, then our hands are tied. Other directives such as the Capital Requirements Directive for banks will I hope create much more alignment between how the management view the economics and risks of their business and the regulatory capital needed to support that business. I also hope very much, that the Solvency 2 directive for all EU insurers will follow a similar pattern. So I would like to see greater alignment between the basis on which balance sheets are assessed by regulators, the metrics by which management take decisions and the accounting standards used for public reporting.
I also think that in a principle based system of regulation, regulators can use their influence (as opposed to their formal powers) in a more effective way. In the UK we are increasingly looking to the financial services industry to solve market failure problems. We use our influence to bring the industry to the table, the industry owns the solution and we keep the big stick of rule making in our back pocket in case it becomes necessary to use it. This approach seems to be working well in solving issues related to conflicts of interest, unbundling of research costs from the costs of trade execution, contract certainty in the insurance industry and Treating Customers Fairly in the retail market.
I know that some member states have concerns that without the detail of regulation being the same in each member state, regulation will not foster the emergence of a single market in financial services. Why I can understand the theoretical basis of this argument, I believe that regulation must be sympathetic to the particular characteristics of different markets and in that respect there should be appropriate member state latitude in implementing measures in a way which makes sense for the local market as well as for Europe as a whole. I would also argue, that in the retail financial services market, issues of taxation, social security systems, pensions mobility, language and culture are all more important factors in preventing the operation of a single market than regulation. So let us not be lulled into believing that regulation alone can facilitate the emergence of a single market for the retail customer.
My final point on regulatory philosophy concerns how regulators go about supervising individual firms. It seems to me that in order for regulation to be cost effective and proportionate, that resources must be constrained and therefore regulators must make choices about how it prioritises the resource at its disposal. This means regulators must take a risk based approach, so that their scarce resources are focussed on the firms and the issues which pose the greatest risk to regulatory objectives. This may mean some firms never see the regulator. I very much hope we will see converging practice around this important principle across the European Union.
The Commission's future approach
In May of this year the Commission published a green paper on financial services setting out its priorities for the next five years. A white paper is due imminently.
In introducing the green paper, Commissioner Charlie McCreevy emphasised that the plans essentially amounted to a programme of consolidation. After the experience of the elaboration and negotiation of the 42 measures in the Commission's Financial Services Action Plan, the collective sigh of relief from regulators and industry alike was clearly audible.
The FSA has welcomed the direction set out in the green paper and we very much hope that this will be carried forward into the white paper. There are still some key pieces of European legislation to be put into place, such as Solvency 2, but the focus should now shift to effective implementation of legislation across the EU and, as I just mentioned, greater convergence of member state's supervision.
The Commission has said that it will only embark on new legislative initiatives where there is robust evidence of market failure and that the failure can be addressed cost effectively through regulation. I am very strongly supportive of this approach as it is one we are required by law to follow in the UK. But to clarify, I believe the Commission's impact assessments for new legislation should cover not only the original proposals but also amendments from either Ministers in the council or the European Parliament, as these can substantially affect the outcome.
We diverge from the Commission's thinking on the extent to which regulation can be justified on the basis of facilitating cross border business. This is perhaps the case in the wholesale markets where business and capital are mobile, but as I mentioned a moment ago, where the barriers are factors other than regulation, new costly regulations should not be justified on the basis that they facilitate the creation of the single market.
Future structure of financial services regulation in Europe
So what is the optimal structure of financial regulation in Europe. Well this has become a hotly debated topic, particularly among Government and Commission officials, regulators and the leaders of major financial enterprises with operations across Europe. Once again, the FSA's view is clear on this matter. We strongly support the current framework proposed by the committee of wise men led by Baron Lamfalussy. For the banking and insurance sectors, the application of this framework is still in its infancy and we need to give it a chance to show that it can work. More generally, it should be recognised that there are limitations to what CESR, CEBS and CEIOPS can achieve.
We, of course, frequently hear proposals for a more radical restructuring of regulation in Europe, including calls for a single regulator. The debate should not in our view be about institutional realignment for the sake of it, but should be about better regulation – that is would any proposal provide more efficient and effective regulation than the current structure.
In order to inform this debate and to achieve some consistency in analysing different proposals, we have determined a set of criteria against which to consider any proposal. Time does not permit me to cover each of these in detail, but to give you a flavour I would mention the following:
- The regulator must have clear and explicit objectives and be able to undertake the full range of activities necessary to achieve them.
- The regulator must have a clear and unambiguous legal basis. It must be independent of Government and operate within a clear accountability framework.
- The activities of the regulator must align with other key bodies with responsibility for consumer protection and financial stability and be based on common reporting and information flows.
- The regulator must operate on the basis of established good practice in the formulation of regulatory standards and in carrying out its regulatory functions. Its activities must be risk-based.
- There must be reasonable scope for detailed rule making and day to day supervision to take account of specific conditions in national markets and infrastructure.
- The creation of any single EU structure must lead to demonstrable and permanent compliance savings in the EU financial sector on a scale which offsets the transitional and other costs of moving to the new structure. These would need to be accompanied by measurable efficiency savings within the regulatory structure itself.
- There would need to be a broadly consistent allocation of resources for the regulation of domestically focussed firms or activities with comparable risk profiles. This would need to be based on an agreed common view of risk, risk appetite and the effectiveness of regulatory resources.
- It must be possible to demonstrate that any single regulatory structure would be capable of delivering more effective regulatory processes than a well functioning network.
Currently, we have not seen any new proposal which meets these criteria and neither is any likely to do so in the near future. So let us get on and make the current structure work by achieving better co-ordination among the three level three Lamfalussy committees, pushing forward enhanced cooperation arrangements on homehost issues with other supervisors and promoting the use of meaningful peer review.
Madames et Monsieurs I am very grateful for the opportunity to set out some thoughts on the important topic of financial regulation in Europe. I believe that Europe has a great opportunity to get it right by doing what makes sense for business, while securing the fairness of markets, protecting the interest of consumers and achieving the Lisbon objectives of stimulating economic activity in Europe.
Thank you.