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Plans by the Financial Services Authority to reform the way the financial services sector is regulated need to forestall future crises, not simply focus on past failings in the system, says ACCA (the Association of Chartered Certified Accountants). Banks’ current risk aversion owes much to the economic climate and is likely to prove temporary. This gives governments and regulators a short but important breathing space in which to introduce a sustainable and robust regulatory regime.   

In welcoming the Turner Review and the Discussion Paper, ACCA says that the need to look forward makes it essential that a new regulatory regime is thoroughly thought through, is consistent with G-20 deliberations and includes a robust early warning system.

Dr Steve Priddy, ACCA’s Director of Technical, Policy and Research, said: “In future we need a system where sound regulation, supervision and good corporate governance reinforce each other.  The UK and its citizens will benefit from a profitable and more stable financial services sector which supports long term economic well being for itself and its stakeholders. While we prefer a market solution rather than a regulatory answer to the other contributory factors, ACCA urges regulators to consider the problem as a whole.”

“It is essential that published accounts help contribute to financial stability. Lord Turner’s analysis of the challenge posed by the need for accounts, which are both meaningful at an individual level and at a macro level, appears to be sound. His proposal for an Economic Cycle Reserve is both interesting and worthy of debate. ACCA will be pleased to help facilitate such debate.”

ACCA agrees with the International Monetary Fund’s (IMF) recent assessment of the regulatory causes of the market failure – which highlighted financial regulation which could not identify risk concentrations and flawed incentives; macroeconomic policies which did not take systemic risks in the financial system and the housing markets into account and a fragmented global surveillance system. 

However there are other factors, particularly failings in corporate governance, which have contributed to the current crisis.

ACCA will be preparing a fuller response to the Review proposals and Discussion Paper, including suggestions for the effective interaction of regulation with good corporate governance. Meanwhile, we consider that the following points could be taken into account in the process of developing the new approach to regulations:

 

1. Be clear on the purpose of regulation
The purpose of regulation is to facilitate legitimate and competitive business activity while providing safeguards for the interests of stakeholders.

That regulation should be flexible and principles-based, with a strong emphasis on ethical codes and practices, should recognise the complexity of trading in global markets, but also be grounded in simplicity.

There should also be a separation of policy-making (rules and regulations) and compliance (monitoring and enforcement). There should be public oversight of the system with 'heavyweight' industry experts to conduct monitoring, with legal and regulatory teeth to pursue issues identified.

While identified areas of abuse need to be addressed in any new approach to regulation, we need to ensure that it is sufficiently principles-based and flexible to be relevant and applicable to a fast changing business environment.

2. Co-ordinated national action
It is vital that governments pursue coordinated national action for the regulation of financial markets.

3. Complexity
The complexity and opacity of some investment products contributed to the crisis.  Neither regulators nor bank boards appear to have sufficiently understood or controlled their use. Effective regulatory control at any level requires both transparency and comprehensibility; regulation should encourage greater clarity and understanding and, where necessary, demand proper explanation of opaque financial instruments. 

At consumer level, regulation should seek to enable individuals to understand what they are buying. Financial literacy programmes should be encouraged.

It is also crucial that regulation, at both national and international level, is characterised by simplicity to the extent that both regulators and the regulated understand what is expected of participants.

4. Segmented regulation
Some banks are perceived to have become too big and interconnected to be allowed to fail; more importantly, many have become too complex to manage and, therefore, to regulate. This is unsatisfactory and a lasting solution needs to be found. Combining retail and investment activities increases complexity considerably. Although a return to the Glass Steagall separation of retail and investment activities may no longer be practicable regulators need to pay much more attention to complexity as well as materiality.

Following the Hampton principle of proportionality, regulators in the banking sector should adopt a risk-based approach to concentrate regulatory efforts on those institutions which wield disproportionate market influence and whose failure would pose the greatest threat to the financial system.

Firms themselves should be expected to satisfy the authorities on an ongoing basis that they are managing risk actively and competently in the particular circumstances of their business.  Regulators need to be acutely aware of responding correctly to those firms which have fundamentally changed their business model.

5. Capital adequacy: encourage stability not pro-cyclicality.
Basel 2 capital requirements added to pro-cyclicality in the business cycle. The accord requires banks to increase their capital ratios when they face greater risks. Unfortunately, this may require them to lend less during a recession or a credit crunch, which could aggravate the downturn. Regulation should act as a shock absorber and limit the worst effects of pro-cyclicality to ensure a smoother ride for the economy. Consideration should be given to designing a series of indicators to help regulators assess risk; such indicators might include trends in trade deficits
for economies and levels of leverage and indebtedness at country, firm and individual level.

Capital requirements should be cyclically adjusted and increase when the economy recovers from the current situation.

6. Supervision
It has been argued that many of the present problems arise from poor supervision of existing regulation rather than insufficient regulation. The nature of the reforms proposed will place additional demands of supervisors. They will almost certainly need additional resources and skills to meet what will be needed of them.

Further, an effective approach to regulation should encourage learning and continuous improvement based on strong ethical principles ad practices.

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Notes to Editors
1.  ACCA is the global body for professional accountants. We aim to offer business-relevant, first-choice qualifications to people of application, ability and ambition around the world who seek a rewarding career in accountancy, finance and management. We have 362,000 students and 131,500 members in 170 countries worldwide.

2.  ACCA has worked with governments, national organisations and development agencies in emerging economies- for over 20 years- promoting the accounting profession, to create value for the communities, businesses and individuals it serves.

3.  ACCA believes that globalisation of business means that one set of reporting standards is essential. We favour the principles-based IFRS.

4.  ACCA understands the real issues facing small businesses as 63,000 of our members work in SMEs or small partnerships worldwide.

 

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For further information please contact:

Colin Davis, ACCA Newsroom +44 (0)20 7059 5738 +44 (0)7720 347713 colin.davis@accaglobal.com