Transition to the bureaucratic regulatory system

We have been plotting the history of UK insurance regulation since the inception of the insurance market during the reign of Elizabeth I. We now come to 1986, the year in which the Financial Services Act was passed.

During this entire period the regulatory system essentially operated via law and the rule of law.

Micro-managed system

Specific laws were passed, to address identified problems, which had to be complied with. Insurers, for example, had a defined solvency level. They had to publish annual financial statements compiled increasingly in accordance with generally accepted accounting standards which were also sent to the Registrar.

There was hardly a need for a regulator. There was a registrar whose job was basically to maintain a statutory register.

All of that started to change in 1986 into the expensive system which can be described as a centralised bureaucratic managerial regulatory system; a micro-managed system. The question however is why and how did this happen?

The answer is very simple. It’s all because of the one man Gower Committee. Although the insurance industry is greatly affected by this system, it had nothing to do with insurance. This problem continues to this day. Massive expensive systems are imposed on the insurance industry for no rational reason. Insurance is just sucked into the system.

What event brought this all about? Nothing, there was no event. It is now alleged that the market had been deregulated; the light touch and this caused the problems of 2008. The market up to 1986 had never been regulated as currently understood.

Protecting own interests

The focal point of Gower was the London Stock Exchange. Lord Acton, an eminent historian, noted that power expands until stopped by a more superior power. People left to their own devices will tend to devise systems which protect their own interests. That is to be expected. What is necessary is to dismantle these so the market can operate.

Prior to 1983, it was recognised that the voluntary rules of the London Stock Exchange were restrictive, protecting largely the interests of the members of the exchange. These probably ran fowl of the Restrictive Trade Practices Act. Some felt these were anti-competitive. The 500 page rule book was laboriously examined to determine if it was unduly anti-competitive.

After many negotiations the exchange decided to abolish much of what appeared to be restrictive practices within the rules. The question was if the changes would take place slowly or all at once.

Removing restrictive practices

The all at once approach was adopted, famously dubbed as the “Big Bang” of 27 October 1986. Interestingly, the Johannesburg Stock Exchange (JSE) followed the London Stock Exchange example. The LSE was “deregulated”.

So the so-called deregulation had nothing to do with regulation or insurance. It had to do with removing restrictive practices contained in private rules. The outcome was astounding. Virtually all private stock broking firms disappeared virtually overnight as these were taken over by the banks.

The famous Open Cry system disappeared as remote screen trading became the order of the day. The Stock Exchange ceased being a club operating in terms of its unregistered Deed of Settlement and was registered as a limited company. The UK system began to rapidly resemble the US system.

The proposed system

In 1981, at about the same time the Big Bang was evolving, something else unrelated to the Big Bang happened. Two major investment firms, known today as asset managers, collapsed. Once again, investment firms had nothing to do with insurance.

Increasingly the UK financial market was beginning to resemble the American market. Gower, even before he started, was of the view that what the UK needed was an American styled Securities Exchange Commission (SEC). The SEC was established in 1934. A self-standing commission was, in his view, the answer. However, since the UK market had never had a regulator per se, he did not believe the UK establishment and public would accept it. And so he set about designing a complex system.

On the face of it, the self-regulatory characteristic would continue. His plan was that various industries would form voluntary Self-Regulatory Organisations (SROs) each of which would regulate their own industry. So in theory, insurance brokers could form a SRO to regulate brokers and short-term insurers could form a SRO to regulate short-term insurers.

Gower was of course quite oblivious that the short-term industry had been doing that since the 1860s through Tariff Committees, discussed previously. It was never clear what a SRO was supposed to be and how many of these should exist. Some oversight mechanism was needed to manage the SROs. In the end all these ideas were set out in a White Paper published in 1985 which described the proposed system as “self-regulation within a statutory framework.”

How the SROs were to be coordinated did not appear until section 114 of the White Paper was reached. The system would be under the surveillance of a self-standing Commission. A foot was in the door to establish an American styled Commission and the formed surveillance body was called the Securities and Investments Board (SIB). The proposals passed though the legislative process to become the Financial Services Act 1986 - a mammoth 212 sections, 17 schedules and 289 pages.

Gower got close to getting his SEC. When he started he did not think he would succeed in convincing the City Establishment to accept the idea of a Commission. When he was finished the idea and reality of a Commission was accepted. On the face of it, the system continued to be a self-regulatory system but that was rather illusionary. As Gower noted the self-regulatory element was relatively slight.

The sole purpose of the Act

It does not appear as if the system was ever a success. However, for the first time ever the UK had a regulatory system. It was basically the American system which was imposed on the UK.. The SIB was poised to become the centralised regulator.

Essentially the system covered all financial services other than banks. The structure for a centralised bureaucratic managerial regulatory system had been created and the main instrument through which it was to function was the rules. Each SRO would be able to draw up its own rules subject to the scrutiny of the SIB.

Therefore, the United Kingdom moved from regulation by law to regulation by bureaucracy. At the beginning of this series it was pointed out that laws are traditionally passed to deal with specific problems.

For example when the Albert collapsed, it was realised there was no money to pay policy holders so a law was passed; a deposit of £20 000 had to be lodged with the government. It was realised that policyholders may not know the true financial position of companies so a law was passed; audited financial statements had to be published and lodged with the registrar.

The mammoth Financial Services Act had none of this. The de-regulation of the Stock Exchange had taken place without the Act. Two asset managers had collapsed but the Act never addressed any of these issues. For the first time the legislation had no defined purpose. The bureaucracy itself became the sole purpose of the Act.

This continues to this day.