Wednesday, 9 August 2017

Regulatory Budgets in Perspective: The Bank of England Issues Yet Another Warning over Brexit

In today’s financial news, the Deputy Governor of the Bank of England – Sam Woods – said that the Bank would see its regulatory capability stretched in the wake of the U.K.’s secession from the E.U. to a point that would demonstrate a ‘material risk to [the Prudential Regulation Authority]’s objectives’. The basis for Woods’ suggestion is that the potential loss of financial ‘passporting’ in the wake of Brexit would both result in dispersed regulatory entities, and also an influx in companies needing to be regulated due to the removal of the ability to essentially outsource the regulation of an entity to another ‘competent authority’. Whilst this point is worth assessing, and this post will briefly do that, it is also worth taking a broader look at the state of the U.K.’s regulatory framework in terms of its capability.

Sam Woods’ comments regarding the ability of the Prudential Regulation Authority (PRA), the regulatory arm of the Bank of England, were extremely direct. Woods further emphasised that ‘we may have to make some difficult prioritisation decisions’ in the wake of the differing dynamic created by Brexit, which comes as a stark warning if we consider that it is those changing dynamics that may (or, more likely, will) encourage speculation, a reduction in quality controls, and so on. The nature of Woods’ warning is based on the increased risks that would accompany the diversification of financial service providers across Europe (we have spoken before here in Financial Regulation Matters about the movement of sectors of financial service provision across a number of countries) in terms of the reduced ability to hedge risks, but also on the increased confusion that will emanate from contractual confusion, as well as the ‘extra burden’ that may come from the repatriation of a number of companies who are regulated by other financial regulators across Europe. However, one onlooker has described how ‘the only encouraging news’ is that the Bank has requested only an extra £5.4 million for its ‘Annual Funding Requirement’ – as the PRA is funded by the regulated entities – which would take its total funding for 2017/18 to £268.4 million. Yet, a question that could be asked is does this news really count as encouraging?

If we begin by looking at the operating budgets of the other financial regulators in the U.K., it will be possible to obtain an understanding of the tools available for regulators with regards to their mandates to regulate and maintain order in the marketplace. Starting with the Financial Reporting Council (FRC), whose role it is to set standards for auditing firms and also help develop the U.K.’s Corporate Governance Code, the news is hardly ‘encouraging’. The FRC is tasked with regulating the accounting industry, amongst other things, which means that it must aim to insert its dominance in a market that is dominated by four firms that are serial offenders; as of 2015, the FRC faced an oligopoly that had a combined income of over £8.5 billion which, when combined with the pressure of providing regulation for seven major bodies responsible for registration and education standards, and conducting well over 1,000 visits per year, the operating budget for the FRC of £36 million for 2017/18 does not add up.

The Financial Conduct Authority (FCA), which as a regulator is tasked with regulating over 56,000 businesses, 18,000 of which count the FCA as their prudential regulator, has a defined aim of protecting consumers, financial markets, and also to promote competition. Yet, for this vitally important regulator who have a massive task ahead of them, their proposed budget for 2017/18 stands at £475.3 million, representing just a rise of £5 million from the previous year. The Serious Fraud Office, although not technically a ‘financial regulator’ – though, as we know here in Financial Regulation Matters, are an extremely competent body despite the aims of Theresa May – currently has a budget of £54 million, despite garnering over £460 million in fines since 2014. The details of all of these budgetary breakdowns are available through the links provided, and it is worth noting that most of these budgets come from levies on the regulated entities. Yet, there is a glowing issue that seems to be ignored more generally.

These regulators, just in regards to the U.K. alone, are tasked with regulating a marketplace that operates in the billions, if not trillions, of pounds. They are tasked with preventing the pervasive and unethical culture that struck in 2007 from happening again, and must balance this task in relation to a wider picture that is defined by an economic downturn that perseveres over the years (the credit bubble is an excellent example of something ‘external’ that these regulators must account for). They do all of this with a combined budget of just over £800 million a year which, when considered in these aggregated terms, is ludicrous. It is ludicrous because we know, beyond doubt, that markets left to themselves will wreak havoc. It is ludicrous because the effect of lax regulation is in front of us every day when we see the increased use of food banks, increased poverty, illness, and depravity. Yet, the small increase in funding required by one of the most influential regulators in the country is ‘encouraging news’ – it is not. What is required is one of two things, and either will suffice. Firstly, and this option is the most righteous, regulated firms should see the amount they have to contribute increased substantially, and should see this increase enforced by legislation. It is not acceptable to have the companies’ contribution limited whilst the public’s contribution is unlimited. However, the alternative to this is that the public, via government spending, substantially increase the operating budgets of the regulators. Whilst this may sound distasteful, it is a social hazard to have financial regulators underfunded, and the cost of providing this extra funding is far less than the cost of rectifying the damage caused by underfunding - the haphazard bonanza we saw in 2008 is a testament to that. Ultimately, there needs to be a societal shift away from the altar of economics. This discipline is extremely useful to society, but at its heart it discounts the effect of the economy – the detachment involved in theories like ‘the economic man’ is fundamentally constraining societal development, and only when that mode of thinking changes shall we see a reduction in the social harm associated with modern finance. 

Keywords - "Financial Regulation", "Financial Conduct Authority", "Prudential Regulation Authority", "Serious Fraud Office", "Politics, Economics", "Financial Regulation Matters", #finregmatters

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