The rise of the single peak regulator

In setting out the history of the UK insurance regulation we have seen that until 1986 the UK regulatory system was one of self-regulation.

The Lloyd’s market, for example, was self-regulated by the Committee of Lloyd’s and later by the Council of Lloyd’s. The London Stock Exchange was regulated by the London Stock Exchange and so on. Regulation existed as it was through the Rule of Law.

The rule of law

For example laws required insurers to maintain a specified solvency margin and to publish annual financial statements.

The relationship between insurer and insured was governed by the law of contract and enforced via the courts - the Lockeian Framework. This started to change with the passing of the 1986 Financial Services Act (FSA) which cannot be attributed to any specific event or failure.

There were issues of concern such as the London Stock Exchange being accused of having restrictive practices which it agreed to abolish and did so with the Big Bang.

There were also the two asset managers which collapsed – this was an investment and not insurance issue. Then there was the Guinness Distillers saga involving manipulating of share prices.

Rearranging a sinking ship

The FSA created the UK’s first bureaucratic regulatory system and also started the march to market conduct regulation. Each industry was supposed to establish its own regulator, a Self-Regulatory Organisation (SRO) all to be co-ordinated by the Securities and Investment Board (SIB). The new system did not work and did not last.

This article looks at the demise of that system and the system which replaced it – the Single Peak Regulator. It is the first failed regulatory system and the failures continued.

That is why it can be said that each new regulatory system is merely rearranging the deckchairs on a sinking ship. A new bureaucratic system is installed with much acclaim, reflecting best international practice. An event happens demonstrating the system to be a failure. Another new system is installed again with much acclaim. Yet another event happens, demonstrating the new system to a failure and so it goes on. The deckchairs are simply being rearranged having no influence over the fact that the ship is sinking.

A single regulator model

The event which occurred in 1995 was the collapse of Barings Bank which had been founded in 1762. The collapse of Barings Bank was caused by a single individual, Nick Leeson, Head Derivatives Trader, trading futures contracts in Singapore. Before the collapse he was generating 10% of the bank’s profits.

The collapse of the Baring Bank made it clear that the complex system created by the FSA of 1986 was a failure.

The Labour party won the 1997 General Election and decided that the collapse of a bank demonstrated that the Bank of England was not the suitable institution to regulate banks so bank regulation had to be moved from the Bank of England, but where to? It also decided there were too many regulators, at the time at least nine of them.

In 1996 Michael Taylor had suggested a Twin Peaks model which would result in essentially two regulators in place of the fragmented nine regulator system, one for prudential regulation and the other for market conduct.

The Labour Government however, opted for the single regulator system. A single regulator, it was argued, was in line with best international practice. After all Norway introduced the Single Regulator in 1986, Denmark in 1998, Sweden in 1991, Japan in 1998, Korea in 1998 and Iceland in 1999.

Other countries were considering a Single regulator system including Canada, Germany, Singapore, Switzerland, Luxembourg, Ireland, Mexico and then also South Africa. And so in May 1997 Gordon Brown, Chancellor of the Exchequer, announced the UK would introduce the single regulator model.

This brand new regulator would have clearly defined objectives and a set of coherent functions and powers. Since it would consolidate nine existing regulators it was argued it would be more cost effective and would solve the regulatory issues.

The regulation of banks would of course be taken away from the Bank of England and transferred to the single regulator. It would work, so it was argued since it was after all in line with best international practice. It did not work. It would be the second failure.

Does one size fit all?

In 1997 the SIB morphed into the FSA. The Financial Services and Markets Act (FSMA) of 2000 was passed, creating the single regulator. The SIB-FSA revoked recognition of the various generally unsuccessful SROs.

Conceptually from 2000 onwards there was one thing being regulated - a financial market. Technically, thereafter, it was incorrect to consider the insurance market as being regulated. To the extent it is regulated it is merely incidental as being part of the financial market.

A single peak regulation system becomes a one size fits all model; banks, insurers and intermediaries are now all the same thing, collectively called the financial market.

There is no distinction between a bank and an insurer. There is no distinction between an intermediary and an insurer. There is no distinction between a prudential problem and a market conduct problem.

If a distinction is made between these different markets; stock markets, short-term insurers, long-term insurers, unit trusts and pensions this results in multiple regulators existing within the single regulator. Then all that has happened is an additional layer of bureaucracy is installed.

With the single market, worst of all, the original problem is ignored. With the 2008 finacial crisis it was not that the single peak regulator, the FSA, took its eye off the ball regulating banks, it did not even know the ball existed.

The FSMA had nice sounding objectives:

a) Maintaining confidence in the financial system;
b) Promoting public understanding of the financial system;
c) Securing the appropriate degree of protection for consumers; and
d) The reduction of financial crime by regulated persons and by those who are carrying on regulated activity in contravention of the General Prohibition in Section 21.

A better suited system

Laws are supposed to be clear instructions, commands to be obeyed and not generalised fine sounding words, dreams. As we have seen in the past, when a problem occurred and legislation was passed, the legislation did exactly what it was supposed to do.

It issued clear commands and very clear laws addressing identified problems. The weakness of the FSA 1986 system was made clear by the collapse of the Bearings Bank. What commands did the new legislation make which would address the bank failure problem, none. It failed to identify the problem and take steps to address the identified problem. All it does is create another failed bureaucratic organisations i.e. the system introduced by the FSA.

That failed system was then replaced by an equally aimless and pointless Single Peak Regulator. That too failed.

However, the nature of the FSA became clear. It was a self-contained, self-funded, centralised bureaucratic managerial regulatory system. It was not the historical regulator operating via the rule of law within the constraints of the separation of powers. It was not operating within the Lockeian Framework.

This system is better suited for communist type governments with their belief in centralised planning and control. It is odd to see this in Western countries. Paul Samuelson, Nobel Laurate in economics was once asked what the difference between capitalism and communism is. He replied the one is the oppression of man by man; the other is the other way round. In the end unless a conscious effort is taken, the one morphs into the other.