I very much welcome Benjamin Wrench’s paper. An assumption seems to have passed into all discourse about financial regulation that we have deregulated finance and we simply do not regulate it enough. The reality is that, in the UK, regulation has been increasing dramatically. Much of the responsibility for that increase in regulation can be laid at the door of the European Union and the listing of specific threats from Brussels in the Appendix of the paper is particularly useful.
First, let me lay the “deregulation myth” to rest with a few examples. Worldwide, in 2011, there were 14,200 new financial regulations. Within the UK, one of the two main bodies responsible for financial regulation – the Financial Conduct Authority – has written, it has been calculated, 4,000,000 words of financial regulation.
And this is not a trend that began with the financial crisis. Bank of England Chief Economist Andrew Haldane has noted: “In 1980, there was one UK regulator for roughly every 11,000 people employed in the UK financial sector. By 2011, there was one regulator for every 300 people employed in finance.”
Indeed, if the number of people working in finance and the number of financial regulators in the UK is projected forward from 2011 for another 60 years, by then there will be more financial regulators than people working in finance – and this excludes compliance officers and others working on regulatory issues within financial firms themselves.
If you look at the Basel Accord, which is the international agreement on bank capital, the first Accord of 1988 was just 30 pages long. Its successor, Basel II, was 347 pages. This longer, more complex set of regulations clearly did not avert the financial crisis; indeed, they probably contributed to it. Basel III was agreed in 2010 following the crisis and weighed in at 616 pages – twenty times the length of Basel I.
Turning to consumer-facing regulation we see a similar pattern. Mortgages in the UK were entirely unregulated until 2004 – except lightly by the Consumer Credit Act. No problems of any significance were seen in the market. In 2004 they were brought under the remit of the FSA regulation. We now see whole groups of people (self-employed and partially retired, for example) excluded from the market because of actions taken by regulators following the 583 page Mortgage Market Review by the Financial Services Authority (now the FCA). We also now have the Bank of England using so-called “macro-prudential regulation” to influence the allocation of credit, the first time any such policies have been used since the days of Dennis Healey.
And then we have had the hugely increased regulation of defined benefit pension funds. There are many reasons why defined benefit pension schemes have wound up. However, one contributory factor was the increased level of regulation from 1995 onwards. This regulation tried to remove all risks facing members, but ended up actually increasing risk and then undermining the schemes altogether. In other words the pursuit of the perfect (risk-free top quality pensions) was the enemy of the good (a decent income in retirement subject to a moderate degree of risk).
When it comes to the regulation of consumer markets, we have replaced a “caveat emptor” market with a “caveat vendor” market in which sellers of financial products can be penalised decades after the event for actions that they had no idea at the time might be wrong. The consumer is no longer asked to take responsibility.
There will always be risks in finance. The danger of regulation is that we raise the costs of financial services, but also make the risks more systemic by encouraging financial services companies to behave in more similar ways.
So, without question, I am on the side of the author of this paper. But, the question I would like to pose is to what extent is this an EU problem and to what extent is it home grown?
Many of the international regulatory arrangements that we join, such as the Basel Accord, the International Organization of Securities Commissions (IOSC) and the International Association of Insurance Supervisors (IAIS) have little to do with the EU and we would probably co-ordinate regulation through them in the absence of the EU. Such bodies may be a bad thing, but they are not the product of the European Union.
It is true that there have been some terrible things that have come out of the EU – regulations in relation to bankers’ bonuses, for example, and the Alternative Investment Fund Managers Directive, as well as a host of other things listed in the Appendix of Benjamin Wrench’s paper. However, we have also become a factory of financial regulation right here at home.
Indeed, the UK has sometimes led the way in promoting over-regulation in Europe. Until we adopted EU insurance law at the beginning of the 1970s, the 1870 Insurance Companies Act had governed insurance regulation in the UK. This Act simply required that insurance companies published actuarial information to the market and published the basis upon which that actuarial information was calculated. It was the markets’ responsibility to discipline companies. This worked. Only two life insurance companies were wound up for reasons of insolvency in the 100 years after the act and in neither case did policyholders suffer.
Now, of course, we have the EU’s Solvency II agenda. You cannot judge regulation only by its length, but it is worth noting that the 1870 Insurance Companies Act which, in effect, lasted 100 years was shorter than the list of typographical errors alone in one tiny part of the EU’s Solvency II regulations entitled “the technical specifications for the preparatory phase” of Solvency II. But, whilst this is an EU project, it is the UK that has been promoting it within the EU. We would not have less insurance regulation in the absence of the EU, but it is possible that the EU would have less insurance regulation in the absence of the UK.
So, if we believe that leaving the EU will be a solution to the over-regulation of finance, we are deluding ourselves. Both in the UK and the US the so-called Anglo Saxon common law model has been jettisoned – certainly in those markets that are consumer-facing and also in insurance markets – in favour of exactly the kind of approach to financial regulation that we for so long criticised. And this regulation has done nothing to make the financial system safer.
From what I have said so far, you may think that I am a Europhile who will vote to remain in the referendum. In fact, I have no idea how I will vote. But, one thing that influences me is the political dynamics. It is true that there are some movements towards liberalisation in the EU as a whole. The harmonisation of regulation in many areas – especially in securities markets – is forcing some countries to liberalise. I call this process “liberalisation through centralisation” which, as you can probably tell is intended to be a back-handed compliment. In other areas, though, the direction of travel is in the opposite direction. And there is a real danger that the euro zone will evolve into a single voting bloc and impose some pretty nasty – and potentially protectionist – legislation on the rest of the EU.
And the real difficulty with EU regulation is that once you have got it you are more or less stuck with it. The political structures of the EU make it very difficult to go into reverse. Furthermore, the incredibly high levels of regulation create barriers to entry, centralise risk and inhibit competition.
At least when regulation is home grown there is a possibility that it can be reversed – though that possibility looks very remote at the moment.
The essential problem is that we have come to believe that uniformity of regulation is essential for free trade. It is not. It would be much better if we had international trading arrangements – including within the EU, but on a wider basis too – whereby we decided to unify or make our regulations consistent by consensual agreement and rather than using a centralised process to create enforced uniformity. Of course, it would be better still if the UK returned to a situation whereby contract law and institutions that evolve within the market itself where the only regulators.
So, at the moment, when it comes to the referendum, I face a choice between Britain in an over-regulated European Union or an over-regulated Britain outside the European Union. I sympathise with everything that it is in Benjamin Wrench’s paper. I only wish that through a single vote in June we could return to the late nineteenth century ideal. Unfortunately, that is not on offer.
Prof Philip Booth is the IEA’s Academic and Research Director, and Professor of Finance, Public Policy and Ethics at St. Mary’s University, Twickenham.