13.2 Financial regulation in the uk

13.2.1Regulatory changes in the 1980s

The problem of regulation of the City of London came strongly to public atten-

tion as a result of a number of cases in 1986 and 1987 relating to breaches of the

City code on takeovers and mergers and of various types of insider dealing (where

information gained in one part of a rm’s activities is used to advantage in another

part of the rm’s business). The fear was that such cases, along with other areas

of doubtful practice, for example problems experienced over several years in the

Lloyd’s of London insurance market, would sully the reputation of the City and dis-

courage investors at a time when the government was seeking to encourage investor

participation.

As we saw in Chapter 6, the Big Bang reforms in securities markets, most notably

the acceptance of the dual capacity system that allowed a rm to act as both broker

and market-maker, together with the change in stock exchange rules permitting

100 per cent outside ownership of member rms, led to a series of takeovers among

City rms and the growth of large nancial conglomerates. To remove the possibil-

ity of insider dealing, rms were required to keep their different activities entirely

separate from each other. This became known as establishing ‘Chinese walls’

between the different types of business: for example, between corporate nance and

market-making or fund management, or between market-making and stockbroking

research.

It became clear fairly rapidly, however, that it was extremely difcult to police

all of the Chinese walls and that the costs to large rms of trying to do so were

burdensome. In the early years following Big Bang, a number of insider dealing

cases arose. The only comfort was that the new computerised dealing services that

accompanied Big Bang allowed insider dealing and market manipulation to be

tracked down more efciently. Nonetheless, the problem itself remained and had

threatened to damage the reputation of the markets and to undermine investor

condence in them.

In the light of these concerns, the Financial Services Act of 1986, which came

into force in April 1988, was seen as crucial for the City as well as for the protection

of the investor. The aim of the Act was to create a exible system of regulation that

inspired condence in both market practitioners and investors based upon the

notion that the best form of regulation was self-regulation. It established a new prin-

cipal regulatory authority to supervise the affairs of the City of London. This body,

the Securities and Investments Board (SIB), recognised a number of self-regulatory

organisations (SROs), formed of investment practitioners, to supervise their markets.

In addition it recognised a group of professional bodies that attempted to main-

tain the standards of lawyers, accountants, insurance brokers and actuaries who

participated in the market and a number of exchanges in which trading occurred.

The SROs, then, were separate from the recognised exchanges in which they

operated. Prior to the Act, membership of the Stock Exchange had carried with it

the exclusive right to use the trading facilities of the market: the exchange and its

regulatory body, in other words, were one and the same, enabling outsiders to be

kept out. Members of some SROs now operated in more than one exchange.

369

....

FINM_C13.qxd 1/18/07 11:39 AM Page 370

Chapter 13

• The regulation of nancial markets The principal arguments made for self-regulation were that:

l	a self-regulatory body would be able to react to changing circumstances more quickly than a statutory body;

l	the involvement of practitioners in formulating and enforcing rules and in encour- aging high standards of conduct would ensure more effective regulation;

l	practitioners were better able to spot breaches of rules than a statutory body;
l	self-regulatory bodies could be set up more quickly;

l	government would be kept at arm’s length from the day-to-day regulation of the markets.

This was all very well but problems soon arose. The complexity of the various

elements of the industry meant that the regulatory needs of the various activities

were different. This was the reason for the establishment of a number of SROs, each

dealing with a particular segment of the industry. However, the classication of

the industry for the purpose of dening membership of the SROs was far from

easy because of the overlapping of activities following the functional integration

of nancial services rms. This allowed a single rm to be engaged in banking,

insurance and securities business. For example, life assurance rms not only provide

insurance but also run pension funds, have an interest in housing nance, engage

in fund management, provide investment advice, and have entered the world of

banking. Under these circumstances, there was bound to be overlap among the SROs,

giving rms a choice as to which organisation to join.

This led to the separate SROs competing among themselves for members, intro-

ducing the possibility of competitive laxity with the regulating authorities who tried

to maintain high standards, losing out to those who chose to lower standards and

reduce the burden of regulation on their members.

Competitive laxity:Organisations that are meant to control markets and ensure high

standards compete for members among producers by failing to enforce and/or lowering

standards.

The SROs were in danger of acting as trade associations, looking after the interests

of their members and underplaying the role of consumer protection. Some regulators

attempted to maximise membership by keeping subscriptions low, reducing their

ability to supervise the behaviour of members. For example, FIMBRA (the Financial

Intermediaries, Managers and Brokers Regulatory Association), one of the original

SROs set up by the Financial Services Act, kept its subscriptions low and soon ran

into nancial problems. It then had to be rescued by loans from its larger members,

causing it to be heavily dependent on a small number of members who could

transfer to other associations if the actions of FIMBRA did not suit them. One of the

consequences of this weakening of the regulatory system was the Maxwell pension

fund scandal set out in Box 13.3.

370

....

FINM_C13.qxd 1/18/07 11:39 AM Page 371