One of the few winners from the financial crash should have been the financial regulator. After years of being seen as the financial equivalent of the Maytag repairman – a mechanic made idle by the good running of the machines – the watchdogs found themselves the focus of attention.
The raft of measures aimed at tightening financial regulation that were demanded by the G20 three years ago will mean a higher workload for the world’s leading regulatory agencies in Europe, and specifically the giant financial centre of London, and the US.
Yet at the same time regulators were singled out for blame for causing the crisis. They were accused of relying too much on economic theories and models that put a lot of weight on the markets’ ability to resolve any bubbles, and banks’ ability to regulate themselves.
Governments have responded by embarking on radical shake-ups of their domestic regulatory systems and investing heavily in these new bodies.
However sceptics question whether regulators have the resources to implement the huge weight of rules being handed to them. “People say we need more regulation, but I know of these people with PhDs in physics from MIT working on Wall Street,” says Bill Sharpe, a professor at Columbia University.
“These people are a lot smarter, they get paid a lot more, they are a lot quicker and a lot less restrained, and they can think up the most amazing ways of conforming to a regulation in principle but not in substance.”
The best response, according to market purists, is to employ financial incentives. “While there are dedicated people in the regulatory bodies, it is clear that the problem is to rely on this ‘giving to the state’ as the way to attract the best,” says Myron Scholes, professor emeritus at Stanford University and a director of the failed hedge fund Long-Term Capital Management. “If you are going to have a complicated financial system then the regulatory system has to have the pay to attract those persons.”
Marrying the need for a larger regulatory workforce and tight public spending limits makes that a hard task. In the UK for instance, the Financial Services Authority (FSA), currently the lead regulator, took on more than 1,000 people in the year to April 2011 yet imposed a pay freeze for general staff for the second successive year.
An added problem is that the focus on regulators has been accompanied by zeal from politicians to stamp their work on the new framework. This has led to an alphabet soup of new agencies.
In the UK, radical reform has seen overarching responsibility for financial stability pass back to the Bank of England through the creation of the Financial Policy Committee, 14 years after it was stripped of the powers.
The FSA, which was created in 1997 as part of that shake-up, will disappear in 2013 when a new structure becomes effective. Firm level supervision will be split, with the Prudential Regulation Authority, a Bank of England subsidiary, providing prudential oversight of banks and insurers.
The oversight of conduct and markets, along with the prudential regulation of other financial firms, will be delivered by a new independent regulator, the Financial Conduct Authority (FCA).
In the US the Dodd-Frank legislation created new bodies, notably the Consumer Financial Protection Bureau to protect consumers of financial products, and a Consumer Protection Agency to protect consumers from abusive lending practices, and placing the Federal Reserve in charge of all the nation’s largest and most interconnected financial institutions.
But the creation of these new bodies has been hampered by partisan battles between Republicans and Democrats in Congress over how powerful they should be. Republicans have used their powers to block key presidential appointments.
Meanwhile a new Financial Stability Oversight Council is to take a bird’s eye view of risks in and around the financial sector, including oversight of the “too big to fail” issue and of capital requirements for systemically important banks.
In the EU, archaic colleges of national supervisors have been replaced by more powerful bodies including the European Banking Authority (EBA), the European Insurance and Occupational Pensions Authority (EIOPA) and the European Securities and Markets Authority (ESMA). Overarching these is a European Systemic Risk Board responsible for the macro-prudential oversight of the union’s financial system.
“The number of regulators and regulations has increased dramatically, but there is little accountability in the system,” says Scholes. “And there’s very little regulatory knowledge within these bodies.”
While the latter point might seem unfair, some in the market are worried that some regulators may be sacrificing long-term effectiveness for short-term influence.
Referring to the regulation of Europe’s giant asset management industry overseen ultimately by ESMA, Guy Sears, director of wholesale at the UK’s Investment Management Association, says asset managers are “struggling” under the weight of regulations. “There is no meta-narrative: they can see individual icebergs but can’t see how it joins together,” he says.
Karel Lannoo, CEO of the Centre for European Policy Studies, says European regulators have a “huge workload”. On top of the headline functions, they will have to oversee licensing of third-country hedge funds, credit rating agency and eligibility of derivate instruments. “It’s an enormous task, and that’s why they will have to hire a lot of capable people.”
As Columbia University’s Sharpe puts it: “However smart and dedicated the regulators can be, it’s not a fair battle and that’s the problem.”