From light-touch to hard line

The newly operational Financial Conduct Authority has a more prescribed remit to toughen standards governing market participants but will a hard line approach attract greater investment?

By None

The dissolution of the UK's Financial Services Authority was an election pledge of the Conservative Party, but will a new regulator necessarily be a tougher one?

Under the new system of UK financial regulation, the Financial Services Authority will largely morph into the Financial Conduct Authority (FCA) and concentrate on the regulation of individual firms, including asset managers and brokers. The newly created Prudential Regulatory Authority (PRA) will focus on broader issues facing the UK financial system and will operate as an arm of the Bank of England (BoE). This 'twin peaks' structure will be reinforced by the Financial Policy Committee (FPC), also within the Bank, which will have direct input from the FCA and PRA.

These changes, first voiced four years ago as the Conservatives sought their mandate, were a response to the failings of HM Treasury, the BoE and the FSA in coordinating operations to avoid large-scale issues such as the failure of Northern Rock, and have been strengthened by subsequent problems regarding the handling of Royal Bank of Scotland (RBS) and HBOS. Under the new structure, the BoE will widen its aims and take responsibility for identifying systemic risk within financial markets, which will potentially lead to a tougher, more active stance on City regulation.

New structures are all very well but will the FCA be materially different from the FSA?

The FCA's statutory objective is to ensure markets work safely and efficiently, and regulate the firms not beholden to the PRA. On its website the authority states: "The FCA is accountable to HM Treasury and Parliament. The FPC will be able to give the FCA and PRA directions, using its macro-prudential tools for the purpose of protecting and enhancing financial stability."

It also has more powers. For example, it can ban misleading financial promotions immediately from the market.

Speaking on the direction and remit the new regulator will adopt, Martin Wheatley, CEO of the FCA, said it would strive to robustly regulate financial markets.

"Firms should expect to deal with FCA in areas that regulators have not historically looked at. This may be in parts of securities markets where participants have traditionally believed the regulator will let them get on with it - either because they believe we are not interested, or because they believe they are big enough and sophisticated enough to look after themselves," Wheatley said in November.

The choice of Wheatley is itself significant. As head of Hong Kong's Securities and Futures Commission he established a tough reputation. Specifically he was active and successful in aggressively chasing non-HK firms if they had broken the authority's securities law, and more broadly bolstered Hong Kong's standing as a well-governed financial centre in Asia. The fact that Singapore has subsequently toughened up some of its financial codes of conduct to compete more effectively with Hong Kong suggests a strong regulatory stance can attract business.

Q: But is there a danger that hard line regulation will damage an already weakened City?

A mass of regulatory change will hit the City over coming years as the reaction to structural weaknesses linked to the financial crisis takes legislative shape. This has already begun to pile pressure on market participants, but it is necessary and a middle path must crystalise. Too tough regulation can thwart innovation, but too lax and too much risk is taken on as poor practice become commonplace.

If a location becomes associated with scandals, investors will stay away. London was the centre of the AIG's problematic credit derivatives activities before the crisis and since then has seen RBS, HBOS and Northern Rock fall, with the Libor, UBS' Delta One desk and London Whale scandals also occurring within the City. For investors, financial hubs with high corporate governance standards are most appealing -a recent example is how Brazil's Nova Mercado attracted new equity market investors by imposing tougher standards on issuers.

Tough, clear and fair regulation is a necessity and there should be no contradiction between that and the defence of the City against legislative changes that are seen as damaging to end investors, such as a pan-European financial transaction tax.