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Chapter 1
Introduction
âRegulationââŚa simple term, but one which so quickly posits itself â often with a certain tinge of imposed immediacy â into some format of a conflictual mode. Possibly, some of the more beneficially inclined amongst us do not perceive it in such manner. But the nub is that many look upon regulation as an âinterferenceâ of some sort in the activity being regulated. The whole of the activity being regulated, and often also the total environment around it, has to be governed, ruled, altered, controlled, guided, in some way impacted upon, i.e. indeed, regulated.
The reference to immediacy needs to be contemplated. This regulator vis-Ă -vis, or indeed versus, the regulated (or regulate) scenario, implied in a conflict mode paradigm, has evolved in our times with a methodology which, even if, potentially and beneficially, one might see as moving away from conflict, and into a paradigm of ongoing processor relationship, it is in fact regulation occurring over, or at different, points in time. Hence, rather than just saying âregulationâ, we should perhaps be more concerned with the means, or methods, of regulation and over what period. In such a context the means of regulation do not need to be rules, laws, directives, regulations, or even indeed soft law. Regulation can conceptually also be studied in a pure context of incentives, as opposed to sanctions which so often go with most of the conventional rule-like regulation.
So we are here clearly and immediately positing criticism of the definitional attempt which views regulation as a process, or structure, imposing rules, directives, or laws, by means of authoritative direction. Where situations are normal, the two sides involved in any regulation process (the regulators and the regulated), plus even others in the market or environment, or certain related stakeholders, all easily come over as accepting the regulatory process, in the fulfilling of which is laid down a pattern that is, at the minimum, claimed to be correct, ordinary, usual, formal and stable.
So perhaps it is never quite just âregulationâ, but âa regulatory contextâ, or environment, that warrants being discussed. To which the sceptic might reply: if it is such we speak of, then why have it at all? Here of course the answer may easily come over as simple. Total absence of regulationâŚor of a regulatory environment or contextâŚis perhaps the hallmark of the uncivilized society. Total non-regulation, or total absence of the regulatory context, is as close to operational anarchy as one can get. All civilized societies have regulation, or are regulated in this or that function.
Not to do so, within any modern societal context, is to border on what some describe, as said, to anarchy. In its simplest definitions, anarchy is absence (indeed a cruel one!) of governance (or its âownerâ, government), or, in milder terms, simply disorder and confusion. The counter-position to this is to see regulation as in fact, in its manifold forms, the central process of contemporary governance (central as opposed to corporate governance) as it seeks to blend the dynamism of market economies with responsiveness to political and normative demands for fairer financial services, more equitable and just health, safety, environmental protection and fairness generally. 1 In positing this approach, Kagan and Bardach (1982) had to, inevitably and with much reason and validity, submit that understanding regulation's varieties, vulnerabilities, virtues and processes has become a significant focus of academic research and theory.
Regulation â and nowadays what is so much its very close concomitant, âriskâ â is clearly present in a process of constant reconceptualization. Braithwaite holds that a main cause of this process, and restructuring, stems from the roles of institutional and national economic crises. He is part of a class of analysts that sees regulatory policy as complex and paradoxical, in ways that require us â as academics, students, practitioners, or even mere market participants â to attend to the substance and the politics of specific regulatory regimes (Braithwaite, 2002). I will be returning to the big issue of the paradox of regulation, and what it can, and what it cannot, do, later.
Regulation is on the rise across the world as the state continues to step back from public ownership of economic activities. Indeed the process of privatization may be described as having run out of its own subject matters: what, and where, is left to privatize? When the Central and Eastern European Countries (CEECs) were going through their variegated processes of privatizing â inter alia their financial services sectors â they did indeed offer to the detached, but simultaneously keen, analyst a plethora of examples of how regulatory vacua, as former Communist regimes went to ground, would hamper progress into the much desired but clearly unknown new worlds of reasoned new formal regulatory structures (vide e.g. Consiglio, 2006). But the way, and the style adopted, for political delegation to be passed on to regulatory authorities did not follow a uniform pattern. Administrative traditions, different attributes of institutional endowment, market structures and business cultures, legal and soft-law structures, these and other factors, all influenced the creation of regulatory authorities and implementation styles. 2
In a different approach, Michael Moran's seminal 1986 study also concerned itself with the big issue of discretion. It is worrying that since Moran wrote we still have the situation where the rules governing the behavior of both regulators and regulated vary greatly across world markets in scope and detail, and consequently the extents to which discretion is confined do also vary considerably. By, hypothetically speaking, detaching regulation from the exercise of state power, it also constantly creates new complex problems. Common sense distinctions between private regulation (or self-regulation, as it is commonly described) and public (state) regulation are immensely difficult to maintain. Much state regulation depends for its effectiveness on private cooperation; much self-regulation is effective only because it is underwritten by state power; and, yes, unusual hybrids of public and private regulations are constantly evolving. Indeed Moran rises above this important issue of discretion by positing all regulation theory into four clearly distinct groups: a teleological (or public interest) theories grouping, an instrumental theories grouping, culture theories and administrative theories groups (Moran, 1986).
With all of the above as a general background, it therefore comes as no surprise that the discipline of regulation is indeed complex. Over time the attentive student of regulation would inevitably have noted the plethora of attributes or adjectives that have become almost inseparable from the topic: inefficient regulation, innovative regulation, under-regulation, over-regulation, better regulation, deregulation, re-regulation, âsmartâ regulation, âproportionateâ regulation, prudential regulation, business conduct regulation, transparent regulation, knee-jerk or ad hoc regulation, the list is indeed endless. Similarly the tools and methodologies of the discipline.
In such a context, it comes as no surprise that many see too much ad hocism revolving around specific regulatory situations. This, considering the inseparability (within precisely the above-mentioned âanarchyâ context) of regulation from the daily, monthly, constant grind of life and events, makes any attempt at writing âa history of regulationâ as, if not impossible, certainly a herculean task. The sociologist may hold that regulation has always been here in some format or other with mankind. At the other end, the contemporary historian might, with some justification, differently hold that we even only first started to utter the word in the post-Lehman crisis world of September 2008 (Fig. 1.1).
Fig. 1.1. What They Were Saying to Defend Themselves!
Source: Carfang (2018).
One possible consequence or result from this contemporary viewpoint of regulation is a realization of the truth that at the time of the mess of 2008â2010 (see box for front row seat of the industry's self-defence) the finance industry was more concerned with sorting itself out, than with following up what the realities of financial technology â fintech â could contribute to itself. Artificial intelligence, distributed ledger technology, robotic advisory and technology, and other fintech developments were still far away from the mindset that by a decade later was coming round to accepting that data are the facts of this twenty-first century: by which time, however, the ever more forward-thinking amongst us are most certainly already realizing that data and its technologies both have their own product life cycle. The more realistic will hopefully look upon fintech (including what are so much some of its taken-for-granted ATMs, Internet banking, mobile banking, etc.) as an opportunity, not a challenge. Not for the first time in history, the finance industry practitioner too is called upon to be considerate of the truth that knowledge (true or false) and wisdom (right or wrong) are not always freely interchangeable.
So one could even argue, yes, that 2008â2010 was indeed the time when the world, or at least big parts of it, âdiscoveredâ, or woke up to, regulation. The international post-September 2008 financial crisis was not an even one across the whole world. But the Western world economy was indeed badly hit, and financial communities and sectors in many countries found themselves in what may be described as battle modes, clamouring for sense, sensibility, calm, leadership, and generally a modicum of reassuring financial environments. Bankers in London were living particularly anxious times. When, with the crisis raging high, the European Union appointed a new financial sector chief at the end of 2009, Michel Barnier, a Frenchman, he quickly sought to reassure London's bankers that new regulation introduced in the wake of the crisis would be both âsmartâ and âproportionateâ.
In Britain, that appointment raised fears of greater regulation from Brussels. In March 2010, Barnier told the British Bankers' Association (BBA) that Britain's institutions would continue to play an important part in assuring continuance of their business. The bankers in London, at that time home to 80% of Europe's financial services funds, were arguing and insisting that proposed new EU-wide rules would make it more difficult to lend, which would slow economic recovery. When Barnier was seeking to reassure the City's bankers, he articulated his objectives in very ambitious terms: âAn efficient and innovative financial sector will provide the engine to power our companiesâ. âTo restore confidence we need regulation. And much better supervision. But [also] smart, effective, and proportionate regulationâŚwell supervised institutions, well capitalized institutions, and responsible institutionsâ.
Barnier was also the EU's Commissioner for the internal market. Significantly, his views on the new regulatory structures being introduced were broad-based, and internationalist almost to an extreme. His seeking to engage with vital players in Britain was impressive: the British Bankers' Association, the British Chancellor of the Exchequer, the finance spokesman of the British Conservative Party George Osborne, the Bank of England's governor Mervyn King, the Head of the Financial Services Authority (the nation's main FS regulator) Adair Turner. But not only: he urged âOur American friends and other global partners to work together to introduce a new financial rulebookâ. 3
One could argue that what Barnier saw as his mission, for Britain and for other countries of the EU, was really tackling, in diagrammatic terms, the outer circle of the problem. But, arguably, the core of problems in the world financial crisis was centred in the United States. There the various government agencies regulating the finance industry (indeed some 20 bodies, all fiercely jealous of their patches, see box), with their varying missions, rules and standards, ironically led in fact to certain entities not being regulated at all, with others subject to less oversight than their peer financial firms organized under different charters. 4 The DoddâFrank Act of 2010 aimed to, amongst other objectives, overhaul their existing agency oversight system. 5 Indeed, no less than five new agency creations came into the new picture in its wake (Fig. 1.2):
- Creation of a Financial Stability Oversight Council (FSOC);
- Creation of the Office of Financial Research (OFR) within the US Treasury to support the FSOC;
- Creation of an independent Bureau of Consumer Financial Protection (BCFP) within the national Federal Reserve Bank (the nation's central bank);
- Creation of the Office of National Insurance (ONI) within the Treasury;
- Creation of the Office of Credit Rating Agencies (OCRA) within the then already existing Securities and Exchange Commission (SEC).
Fig. 1.2. Financial Regulatory Authorities and Supervisory Agencies in the United States.
For the United States, the DoddâFrank Wall Street Reform and Consumer Protection Act â better known as the DoddâFrank Act â enacted the most comprehensive financial regulation reform measure taken after the great Depression of the 1930s. It is too generic to simply state that it had its roots in the fact that a nationally calamitous financial crisis had occurred. The real rationale of the crisis's roots was deeper. Despite, on the mere face of things, having all the right processes in place, in the United States it became clear as the crisis unfolded that consumer protection regulators had not been delving deep enough into the substance of service providers' abuse against consumers. The regulators came over as functioning and operating as seemingly more concentrated on legal niceties which the market simply allowed them to exploit to the hilt in their own favour. One example was significant mis-selling, especially of products which were at the core of rampant securitization processes. When the poor retail public awoke, it was far too late. It had received a really bad deal from investment services providers (including some highly reputable names), and when the regulatory agencies reacted to the disaster it was evident to the unbiased observer that they had been caught doing too little, too late, only after public pressure, and next to nothing was ever resulting in terms of effective compensation being made to victims. Delays in appropriate regulatory action being taken resulted in millions of life savings of the retail public going up in smithereens.
The security markets were not the only arena disastrously tainted by the demise of Lehman Brothers and, later, the near-default of AIG and Bear Stearns. In 2011, a commission of international regulators recommended that all trade in over-the-counter (OTC) derivatives be made more transparent to curb financial market instability. Whilst, at the popular or populistic levels, in the formerly mentioned part of the big market arena, transactions were mainly of a nature concerning selling to small (or possibly even not so small) investors who were in the full eye of the maelstrom, at the conceivably higher business levels where use was habitually made of these OTC instruments, the reality was one where a big lack of adequate information on the exposures involved in such tools was in fact exacerbating a big number of corporate distress situations in the crisis.
On 24 August 2011, a commission made up of representatives of the Bank for International Settlements (BIS), the International Organization of Securities Commissions (IOSCO), and the European Commission (EC), following a request made by the Group of 20 (G20) international leaders who had met in Pittsburgh two years earlier in September 2009 â and thus only one year from the fatidical year of 2008 â presented their recommendations for OTC derivatives to be made more transparent to curb financial market instability. The G20 wanted transparency rules on these types of potentially very opaque transactions, often valued at thousands of billions of dollars. The recommendations dealt with various types of derivatives, i...
