Tighter supervision is on the way but will the EC be a help or a hindrance?

Published on Saturday 26 September 2009 16:17

AS HE stood to deliver his speech at London's Mansion House on Tuesday, Lord Turner would have known his words would not go down well with swathes of his City audience. Despite feasting on fillet of beef and Duchesse potatoes – washed down with Château Moulin à Vent 2005 – the financial giants were still hungry to hear what the chairman of the Financial Services Authority (FSA) had to say.

But Adair Turner's comments on tighter regulation and lower bonuses proved hard to swallow.

In his opening remarks, he joked about being "regarded as somewhat of a heretic in certain quarters of the City" – but branding the financial services sector as "swollen" and parts of banking as "socially useless" did not endear the watchdog to guests.

His remarks sparked indignation, with at least one former fund manager heckling the speaker, the first instance of this in living memory at a City banquet.

Turner told diners that taxpayers would have to foot the bill for a banking crisis "cooked up in trading rooms where not just a few but many people earned annual bonuses equal to a lifetime's earnings of some of those now suffering the consequences".

But Godfrey Bloom – the UK Independence Party MEP for Yorkshire and North Lincolnshire and a former fund manager – shouted: "Just like the FSA."

After the dinner, he added: "The FSA paid bonuses for the biggest failure in regulation."

Turner rammed home his view that heavier regulation and more supervision is on the way for the financial services sector. He endorsed plans by the new international Financial Stability Board (FSB) – made up of regulators and central bankers – to link limits on bankers' pay to higher capital requirements.

But with the FSB, the European Union and the FSA all touting new regulations and increased supervision, who will emerge as top dog among the financial service watchdogs?

Owen Kelly, chief executive of Scottish Financial Enterprise (SFE), the trade body representing the sector north of the Border, was less scathing in his criticism of Turner but the Mansion House comments certainly ruffled feathers.

"I think he's describing – in a very colourful way – what most people know already, which is that there has to be significant change," says Kelly. "I don't think he's right to question the value of our industry to the economy – a successful and thriving City of London is very important."

Away from the bluster of "swollen" financial services firms and "socially useless" banks, Kelly is keeping an eye on the draft legislation unveiled by the European Commission last week. Under its proposals, a new European System of Financial Supervisors – consisting of national supervisors and three "European Supervisory Authorities" – would replace the existing "fragmented" regulatory framework covering the European Union.

The trio of supervisory authorities – the European Banking Authority (EBA), European Insurance and Occupational Pensions Authority (EIOPA) and European Securities and Markets Authority (ESMA) – will work alongside a network of national financial supervisors, such as the FSA. Each will supervise individual financial institutions and will take over the duties of the Committee of European Banking Supervisors (CEBS), Committee of European Insurance and Occupational Pensions Committee (CEIOPS) and the Committee of European Securities Regulators (CESR).

While the proliferation of acronyms may border on the comical, the new bodies will have a very serious role to play and one that experts warn will have repercussions for how the FSA works in the UK. On top of regulating individual companies, the three supervisory authorities will also develop proposals for technical standards and resolve "cases of disagreement between national supervisors, where legislation requires them to co-operate or to agree".

Patrick Brandt, a partner in the financial services regulation team at law firm Dundas & Wilson, said Turner's review of financial services opened the door to a pan-European body taking on such a role.

Brandt said: "It's not obvious how having three new bodies is going to change the style of regulation. There is going to be a change in the way the UK regulators approach the financial services industry – it's just a question of how radical those changes are likely to be. As a matter of law, if a European directive is made then it has to be implemented into UK law, but the UK may still have some say in relation to areas where they have discretion."

If the FSA does lose power to one or more of the new pan-European bodies then Brandt thinks UK regulators will want to have a bigger say in forming policy as part of the FSB or those new EU authorities.

One man who may well fill that role is Mervyn King, Governor of the Bank of England, who is in the running to be deputy chairman of the European Systemic Risk Board (ESRB), a further watchdog being proposed by the European Commission.

While the three authorities would deal with micro-regulation, the ESRB would work on a macro scale, monitoring trends across the continent and warning of future financial crises.

The ESRB would apply "moral pressure" to get member states to adjust policies if needed but would not have the powers to enforce any changes, leading some commentators to brand it as a watchdog without teeth. "At the EU level, the proposals on supervision are to be welcomed because they could reinforce and strengthen the single market," says Kelly. "But the devil will be in the detail. If the new provisions are too burdensome then that objective that we all support – of enhancing the single market – could be undermined.

"A systemic risk board is a sensible idea, as long as it's properly connected to what's going on in the rest of the world. In terms of the national regulator, one possible outcome of these proposals is that individual companies may have to deal with a number of regulators, or a 'college' of regulators. Making sure that those requirements are balanced against the need to maintain an open single market will be a challenge as we go through the implementation – if you've got several regulators to deal with then that's fine if it's going to increase the stability and reliability of the regulatory process but you can't allow it to stifle trade."

While experts await more details on the EU plans, Brandt warned that there are bound to be disagreements within the framework of three proposed authorities.

"If you have regulators pursuing different objectives – will the French and German objective be the same as the UK's? – you're going to have disagreements among national regulators and that will have to be played out within each group," he says.

Differing national opinions have already begun to emerge.

Last week, German finance minister Peer Steinbrueck accused the UK of "doing its best" to block stricter regulations in an attempt to protect the City of London's "competitive advantage". His comments, when coupled with the EC's proposals to overrule national bodies with pan-European regulators, sent both conspiracy theorists and Euro-sceptics into overdrive.

But with Germany going to the polls this weekend, Steinbrueck's accusations illustrate the massive role that politics still has to play in banking regulation. How much of the current proposals makes it into law is reliant on politicians following through.

"The question becomes about political will, because if the will is there to have global or EU standards then that will eventually happen," says Brandt. "But what may happen is that, as the crisis subsides, the impetus and the necessity of having a one-size-fits-all approach for the western world may actually subside with it."