More self-regulatory models should be applied to financial services, says new IEA report


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The financial crash triggered a new age of increased regulation and state intervention in financial services. This was a knee-jerk reaction that assumed all regulation must come from the state, ignoring hundreds of years of successful self-regulation in the market, according to a new report from the Institute of Economic Affairs.

The report, ‘Regulation without the state: the example of financial markets’, examines the growth of state regulation, sets out modern and historical examples of how private alternatives can work, and asserts that the process of competition in regulatory services is necessary to discover the best approach to regulation.

Politicians and economists often discuss whether there should be regulation, but rarely discuss who is best placed to regulate – whether that be the state or private regulatory institutions. This new report, authored by Professor Philip Booth, makes the case that more self-regulatory models should be applied, as they often provide better outcomes for consumers and market participants.

State regulation in financial services:

  • The Financial Services Act [FSA] 1986 marked the beginning of state control over who could – and could not – conduct financial business.

  • This brought previously independent professions into state regulatory systems.

  • The complexity of regulation also increased at this time – in 2011 the UK financial regulator issued regulation, consultations or guidance totalling 4.3 million words (five times the number of words in the Bible).

Overreaching powers of the FCA today

  • The FCA can determine its own burden of proof, levy fines, and prevent people from working in any area of financial markets.

  • The FCA has wide-ranging enforcement powers equivalent to those adjudicated in civil and criminal courts with none of the accountability or guarantee of due process that exist in proper courts.

  • In 2015, the FCA levied nearly £1 billion of fines, all without the competition that would come from multiple different regulatory systems.

How market-led regulation works:

  • Until relatively recently, most regulation of financial services was developed within markets to deal with commonly acknowledged problems.

  • Institutions including independent professions; intermediaries; exchanges; trustee bodies; and firms with special corporate governance arrangements (such as customer-owned firms) developed as part of the entrepreneurial process to regulate behaviour.

  • Such bodies – along with brand recognition – helped customers and counterparties recognise good and bad firms, as well as promoting competition between different methods of regulation.

  • Exchanges operated on a club-basis, setting standards and expected practices for members and in return enhancing the reputation of members.

  • Unlike modern state monopoly regulators, self-regulatory bodies did not prevent non-members from practising so long as they did not claim to have the ‘badge of approval’ that came with being a member of a profession or exchange.

The case for more self-regulation:

  • Government regulators cannot accumulate information on the efficacy of its regulations as effectively as a private regulator

    • This renders state regulation less adaptable and more prone to creating regulation which restricts the market rather than broadens access to new firms and reduces choice for consumers.

  • Government regulation can be captured by the regulated firms or by the political or bureaucratic process.

  • Private regulation exists outside financial services and is well-received.

    • For example: Uber – a platform which regulates the behaviour of its drivers and to some extent, its customers. Uber competes with government-regulated transport through TfL (the regulator of black cabs). The competition between regulators increases choice for customers.

  • Where still permitted, private regulatory bodies have remained successful in the financial sector – examples include the International Swaps and Derivatives Association.

  • State regulators should be very careful before restricting the activities of private regulators on competition grounds. The market should be defined widely to avoid this.

    • For example, Uber may have a virtual monopoly in its very specific product field in some countries, but it competes with taxis, private hire cars, buses, tubes and private cars.

Commenting on the report, author and IEA Senior Academic Fellow Professor Philip Booth, said:

“There is a long history of regulation being provided within markets. We should dismiss the argument that state regulation is required because of market failure. Markets are able to provide regulatory services because they are valued by market participants. As a minimum, it is vital that the Competition and Markets Authority regularly investigate whether state regulators are inhibiting competition”.

Notes to editors:

For media enquiries please contact Emma Revell, Communications Manager, 07931 698 246.

To download the IEA’s report ‘Regulation without the state: The example of financial services’ click here.

The mission of the Institute of Economic Affairs is to improve understanding of the fundamental institutions of a free society by analysing and expounding the role of markets in solving economic and social problems and seeks to provide analysis in order to improve the public understanding of economics.

The IEA is a registered educational charity and independent of all political parties.