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The Supervisory Landscape: A Discussion from 'Our man in Madrid'

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leaning bust asymptotixI believe that it would be a great mistake, irrespective of the outcome of 6/5 (UK Election date) to switch regulatory control of the market to a central bank function as these are two distinct mechanisms which perform entirely different functions. One is necessary to manage and control money supply and macroeconomic control mechanisms such as interest rates, exchange rates and inflation in relation to deficit and GDP, and also manage issues such as quantitive easing and its corresponding effect upon exchange rates as we have seen in the deleveraging of Stirlings value as money supply was increased but in times of illiquidity within the wider economy; and the other is to implement and manage compliance with effective regulatory controls over the financial sector. These are in essence macroscopic and microscopic functions and therefore incompatible under the management of one body. The BoE is not geared to be a regulator and does not have the structure in place to do so. The FSA does and with its increase of quadrupling the number of inspectors, tightening the rules and protocols, and effectively enforcing compliance through fines in a manner whereby it is less expensive to comply than it is not to do so and audit protocols and resources send a message of control. I have always maintained it is about effective regulation, audit and compliance if we want a system which works rather than purely exists. This is what is necessary to restore confidence in the City, which like all other leading financial centres were caught by surprise with the velocity and extent of the volatility in the meltdown which was in itself a result of inadequate regulatory audit and control when times were better.

The solution to avoid the need for massive state intervention in the future is not more taxation which is a blunt sword and will have no effect other than to raise revenue - it will not reduce risk; it is effective regulation, audit, monitoring and a compliance regime which is applied and enforced and the ideal mechanism to achieve this is an independent regulator (FSA) adequately resourced and independent of the central bank function which is money supply control and not regulatory compliance orientated. Let the BoE manage macroeconomics with the government and let the FSA manage regulation and compliance within the sector.


Extending this to the USA we have precisely the same issues and I do not consider the current response is the correct one. Glass Steagall is not the answer and will simply force the powerhouse which is Wall Street to move its investment operations to Asia at a time when the country is facing unprecedented budget deficits and public expenditure growth, and what is required is that the SEC independent from the Fed as a central bank function is allowed to effectively introduce measures to ensure as the FSA are doing that compliance is compulsory and not an option. Risk is a part of all banking and asset management is no different. The key issue is that it should be conducted in a responsible manner with due regard to risk and compliance. The best people to manage investment risk are those expert in it and these are the banks, but it has to be done within a controlled structure with risk effectively managed and a regulatory framework which is not only present, but applied effectively.


This should also extend to ratings agencies. They are selling professional services and have a duty of diligence to ensure that products are effectively and fairly rated responsible. This failed also, and therefore it should be a part of the regulators remit to audit the ratings agencies and impose heavy fines in the case that products are inaccurately rated or that the procedures to assess and categorise ratings are not effective or managed correctly. If the ratings issued are misleading, and based upon these ratings investment managers are taking risk based decisions, then a part of regulatory policy must be to audit and ensure that investment managers can rely upon the ratings they are purchasing and that investors know this to be the case and can therefore properly assess risk and return ratios when making investment decisions. It is ultimately all about being able to measure risk and this is only possible if the data upon which you are making such decisions is reliable. All involved in this process from issuers of securities, ratings agencies and asset managers have to be sure that each party in the overall investment process is working with reliable information within a controlled framework of effective regulation and compliance and therefore is not being mislead about real risk levels when making investment decisions. It is as critical for the City as it is for Wall Street that this house is put in order. The way for this to be achieved is via effective regulation and mechanisms to control quality and compliance, and an effective audit process and punitive regime to guarantee standards. It has to be more expensive not to comply than to comply and this only functions when audit procedures guarantee that non compliance will be detected. It is in effect self funding if done properly via the application of non compliance a fines and the surpluses return to the central purse.  It is not only required, it is effective and affordable and will restore investor confidence and the prestige of the financial centres concerned.


With the pressures from the EU to transfer to Paris and Frankfurt 60% of the control management of the FSA, it is difficult to see how the transfer of such regulatory controls would benefit the City and therefore it would be illogical to transfer the FSA's management function to the Bank of England at a time when it is clear that the FSA is becoming one of the most effective regulators globally who is bringing order to a lack of structure and can operate outside macroeconomic management and focus on microeconomic regulation and compliance in a well ordered system with effective checks and balances. In fact; it will have precisely the opposite effect and further weaken the City. Ergo; the policy is correct and it is as important for the City as it is for Wall Street to show leadership in regulation, management and compliance and this will allow the economic powerhouses that both economies require to continue to not only deliver this aim, but also contribute to the need to get the public budget deficits under control and therefore cost the social programmes that political will and society wishes to see introduced. Social politics are very noble but requires a funding mechanism in order to finance these ideals.


I therefore conclude that the solutions lies as much for the City as for Wall Street that the answer is neither taxation nor a return to Glass Steagall. Let the asset management institutions do what they do far better than government does, but require them to do so in a responsible manner managing risk effectively in a well controlled regulatory panorama by a regulator independent from central bank macroeconomic functions and focus on the eliminate of misrepresentation and a lack of effective regulation which was the root of the crisis as we all now understand, and restore investor confidence in being able to take investment decisions correctly appraising risk return ratios which are honestly represented by all in the sector.



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