Britain’s experience
in creating its own super-regulator shows that a cataclysmic Big Bang is probably required in Canada to make such a fundamental overhaul of the financial system ever happen here.

The rapid creation of Britain’s Financial Services Authority provides a model for those who aspire to similar change in Canada. While Britain didn’t have the challenge of pulling together a variety of regional authorities, as would have to happen in Canada, its task was in some ways more onerous. It had to combine prudential and market conduct regulation, self-regulation, direct regulation and the supervision of different investments, such as securities, insurance and other sorts of financial products.

Merging 13 Canadian securities regulators is one thing, but they’re at least all basically fulfilling the same role. Britain’s move required a more fundamental shift, yet the experiment appears to be working rather well for a number of reasons: the policy decision came out of sweeping political change, the FSA was given authority to get the job done with a minimum of political interference and the reform is fundamentally sound because it mimics the evolution underway in the underlying industry rather than imposing a new model upon it.

The FSA was born out of a tidal change in British politics. After 18 years of Tory rule, Tony Blair’s rejuvenated Labour Party swept to power in May 1997. This was not old, socialist Labour but a leftist party that had undergone a religious conversion to business-friendly, market-based solutions to public problems. The new look won voters’ approval, and they gave Labour a stunning majority in the ’97 election.

One of the Blair government’s first moves was to make monetary policy independent of the government, by giving the job to the Bank of England. In return, the government took the task of prudential regulation away from the bank, marrying that function with all of the various market and product regulators that covered different aspects of the financial industry.

Robin Gordon-Walker, press officer at the FSA, recalls that the decision came as quite as surprise. There was no debate about it, no consultation papers were issued and no royal commissions formed. Instead, the government made an executive decision, and gave the various players involved a tight timeline to get it done. The announcement was made in May 1997, the FSA was formed in October of that year and, by the following June, it had subsumed all of the various banking and securities regulators. It added insurance regulators the next year, and the listing authority from the London Stock Exchange a year later.

The nature of the decision and the aggressive deadline helped ensure that the employees of the various groups that wanted to be part of the new organization were all on board, says Gordon-Walker.
Government employees that objected were offered lateral position moves, and regulators’ employees outside the government had to like it or lump it.

The result was that relatively little intra-organizational strife ensued — remarkable, given the difficulty of merging 10 organizations in the private sector, let alone combining assorted government groups and self-regulators. For example, Gordon-Walker notes, in the midst of the merger, before the FSA had acquired its full authority (legislation didn’t pass until June 2000), co-operation of the boards of the various merging groups was required to get new rules passed and, for the most part, that happened.

Not only was the new body given a strong mandate, but it also received impressive rule-making authority. Unlike Canadian regulators, its rule proposals do not require government approval. The structure preserves its independence, and eliminates a special-interest lobbying opportunity. The FSA is still answerable to the government and to departments such as the Office of Fair Trading, but the government’s direct influence is largely limited to “nuclear options” — such as taking a proposed rule to judicial review or turfing out the entire board if it finds that the FSA isn’t fulfilling its statutory objective. The structure insulates the regulator from both government and industry pressure.

By contrast, the Canadian debate over regulatory reform has dragged on for decades. The imperative to govern by consensus rather than in pursuit of a vision may be the safer approach, but such timidity has also stifled progress.

The latest efforts are no exception. In the most recent federal budget, the government pledged to get a solution to the fragmented regulatory system by the end of the year. The first step was to be a meeting of the key provincial officials in March. It managed merely a conference call.

@page_break@In the meantime, the provinces are running in their own directions. In late May, a group of provinces released a proposed rule that would see them adopt a passport system.
However, Ontario is refusing to go along, and British Columbia may not either. With those provinces staying out of it, the option seems unlikely to represent a meaningful improvement.

Ontario is sticking to its demand for a national regulator. In February, it struck a committee to be headed by Ron Daniels, professor at the University of Toronto, to conjure up yet another plan for a single regulator. It was supposed to report June 30 but Daniels has since taken a job in the U.S.
So the government has turned once again to Purdy Crawford, who headed up the five-year review of Ontario’s securities law, to take over the task.

The latest committee will essentially duplicate the work of the federal wise persons committee in designing a model for a single regulator. It is already following the WPC’s example by going through the motions of building a national consensus by assembling a committee comprising representatives from Ontario, B.C., Alberta, Quebec and Nova Scotia. It will report by the end of October.

However, with little interest in Ontario’s plans in the other provinces and a minority federal government that’s clinging by a thread, it’s hard to imagine that the same sort of decisive action that brought about the FSA is imminent here.

Perhaps if one of the Opposition parties transforms itself from a regional, or marginal, concern into a convincing alternative, presents a new vision and receives a significant electoral mandate, the same sort of Big Bang change could follow.
As long as the Canadian government remains weak, and the rest of Parliament is simply fractious, it’s hard to imagine similarly resolute action.

That’s unfortunate, because creating a financial services super-regulator may not only make sense purely to cut duplication and enhance efficiency but it also provides an opportunity to rethink regulation from first principles, which may be the more compelling long-term return from such a fundamental reorganization.

The argument for Canadian federal securities regulation made sense simply on efficiency grounds back in the 1960s. Since then, the financial industry has changed immensely — product pillars have crumbled, the industry has gone global and technology has accelerated those changes even further. In many ways, the regulatory system is built for a bygone era. Efforts to rethink the goals, intent and function of regulation have occurred in Canada in the past few years, such as the B.C. model and the Ontario Securities Commission’s fair dealing model, but yet both initiatives remain hamstrung by the fragmented regulatory system.

In Britain, the dawning of the FSA gave regulators the opportunity to reconsider the purpose of regulation, says Gordon-Walker. The result is an effort to reduce the amount of regulation, particularly on the institutional side, where it prefers to let market enforcement take care of things as much as possible and only intervenes if there’s a real market failure. “In a way, we’d like people to carry on as if we didn’t exist, with us in the role of monitor,” he says.

The marriage of prudential and market conduct regulation also gives the FSA a novel perspective. In some sense, Gordon-Walker says, conduct and prudential regulation have diametrically opposite goals. Prudential regulators don’t much care if customers are being taken advantage of, as long as profits are boosted as a result and firms are kept well-capitalized. Conduct regulators are concerned with fairness, profits be damned. Regulators are always trying to find a balance between these competing priorities. The question is whether that balance is best found within a single organization or among different bodies.

In Canada, the two imperatives have traditionally been separate, although the idea of merging them has been kicked around, albeit not nearly as exhaustively as the notion of merging market conduct regulators. In an interview with Investment Executive in March, chief prudential regulator Nick Le Pan, superintendent at the Office of the Superintendent of Financial Institutions, pooh-poohed the idea of such a merger in Canada, suggesting that there are few potential synergies.

Yet, OSFI has implicitly acknowledged the growing overlap between the interests of prudential and market conduct regulators in a recent notice that advises firms to pay more attention to managing reputational risks. Bad conduct may boost short-term profits, but it can also do fatal long-term damage to a firm’s franchise.

Gordon-Walker insists that the FSA’s experience has been that the industry does benefit from the convergence of the two types of regulation. For example, he says, its response to the shuttering of Wall Street in September 2001 was made much easier and faster by the fact that the regulatory authority is all in one group. He says that the day-to-day regulation of global financial conglomerates is simplified, and says its response to potential firm failures is also more sophisticated as a result of the both imperatives residing under the same roof.

The FSA’s efforts to minimize regulation are supported by the fact that the regulator must answer to the Office of Fair Trading, which has the power to challenge any rule the FSA makes that the office believes hinders competition. The British government also recently reiterated its preference for fewer rules when Chancellor of the Exchequer Gordon Brown announced a new action plan that aims to cut regulation and inspections for all sorts of businesses.

It hopes to cut regulatory inspections by one-third, and the amount of filling out of forms that firms must do by one-quarter.
Brown says that the goal is to “break down the barriers” that restrain business. It aims “not just a light touch but a limited touch.
[This] moves us a million miles away from the old assumption that business — unregulated — will invariably act irresponsibly.”

As much as the FSA says it would like to have fewer rules, Gordon-Walker says that the fact of Britain’s membership in the European Union is pushing it the opposite way. He estimates that about 70% of the rule changes it makes are in response to directives from the EU. Indeed, one of the great attractions of Britain’s small-cap market, the lightly regulated Alternative Investment Market, is that it’s not subject to EU directives. The flurry of EU directives runs contrary to the sort of low-intensity regulation that the FSA has sought to develop. In that sense, the passport model doesn’t appear to be delivering for Europe, and it serves as a cautionary tale for Canada.

To be sure, the FSA is far from perfect. It has been accused of being too powerful.Its enforcement process is in the midst of a review in response to that charge. However , one indication of whether the British government believes the FSA merger has worked is the fact that it has recently given it more responsibility. It added the supervision of mortgages in October 2004, and of general (property & casualty) insurance in January 2005, rather than trimming its brief.

Score one for ideas and vision over the paralysis of seeking
consensus. IE