Regulating for Growth
Since becoming Chancellor, Reeves has gone out of her way to emphasise the need for growth and how important it is that the City plays its part. Not just those working there but the regulators.
The FCA has certainly got the message. In July 2024, it proposed relaxing the current rules so that directors of listed companies who make misleading profit projections in prospectuses will not be liable if they have only been negligent rather than reckless or deliberately dishonest. Predictably, those advising companies have welcomed the proposal whereas those advising investors are more sceptical. Such a proposal might well make it easier for smaller companies to raise capital, as intended. But even ostensibly worthwhile changes can have adverse consequences or end up as loopholes abused by bad actors. How will this be guarded against? What are the chances that in a few years this change will be pointed to as one of the reasons some future wrongdoer got away with fleecing investors?
In August 2024 she announced her determination to put pressure on financial regulators to fulfill their new secondary objective – to “facilitate the international competitiveness of the UK economy …. and its medium to long-term growth.” She wants regulators to carry out a “financial services review to go through the rulebook and tear up rules that are unnecessary or duplicative.”
Facilitating competitiveness and medium to long-term growth are much needed. But there are some assumptions in this view about the City and regulations which need examining.
– First, that it is the City which facilitates the growth of the economy. It might well do but how? Or does it suck resources away from other sectors? Does it unbalance the economy? And which aspects of the City do this? Private equity, for instance, has not always had a glorious history or beneficial effects.
– Second, is that growth fairly shared across the economy?
– Third, how does she propose to avoid the risk identified by the Parliamentary Commission on Banking Standards some eleven years ago?
“…. being a global financial centre with a medium-sized wider economy also poses risks…. It is essential that the risks posed by having a large financial centre do not mean that taxpayers or the wider economy are held to ransom.”
The Commission went on:
“Banking history is littered with examples of manipulative conduct driven by misaligned incentives, of bank failures born of reckless, hubristic expansion and of unsustainable asset price bubbles cheered on by a consensus of self-interest or self-delusion. An important lesson of history is that bankers, regulators and politicians alike repeatedly fail to learn the lessons of history: this time, they say, it is different.”
In an interview just after the General Election, the former Lord Mayor of the City, Sir Nicholas Lyons, pleaded for the City to be allowed to take risks again after a period when, because of what happened in 2008, “we’ve tried to eliminate risk”, something he says damages the economy as “you can’t make returns without taking risk”. (Given his experience at Salomon Brothers and Lehmans, a cynic might not be surprised at his call to “unleash” the City. A close look at the history and fall of both these entities might lead to the response “Hmmm …..”)
It is perfectly true that profits come from taking a risk. But it is a false dichotomy to say that the choice is between taking risks to make money and eliminating risk but damaging the economy. All finance is about managing risk as it is never possible to eliminate risk. The issue is not about taking or not taking risks. It is about understanding the risks you are taking, making sure you are taking them for the right reasons, being transparent and ensuring that, if they go wrong, the fall-out is contained and not borne by those least able to bear them.
The reasons why we have laws, rules, and regulations – and should have effective enforcement of them – is that they are an attempt to correct the imbalance of power, of knowledge between between consumers and companies, between the weak and vulnerable and the strong. Laws, rules, regulations, codes of conduct, enforcement of minimum standards of training, qualifications, licensing, and authorisations are an attempt to redress that imbalance, to make matters fairer. It is one of the fundamental duties of the state
What we have had instead during the past few decades have been a plethora of often incomprehensible or poorly designed regulations ineffectively enforced – as if the state’s duty ends with the passing of laws and the creation of regulators rather than with ensuring they are properly understood and effectively enforced. The burdens of regulation without its benefits. Little wonder voters look at governments’ favoured tools: privatisation, the use of private sector consultants, self-regulation, deregulation, outsourcing or delegation to arm’s length bodies, inadequate resourcing, a revolving door between regulators and those they regulate, monies spent on bonuses and fines rather than remediation and see little more than a giant, well-rewarded racket paying little regard to the state’s obligations to the defenceless and the vulnerable.
The fundamental problem too often seems to be that politicians talk in mantras: “privatisation”, “deregulation,” “regulation”, “light touch”, “arm’s length”, “robust”, “red tape”, “one in, two out”, a “bonfire of regulations” etc without ever explaining clearly what they mean or thinking through and explaining the consequences. Or indeed without any realisation that all such changes will have adverse consequences which either need to be mitigated or explained why they do not matter or must be lived with. The Chesterton’s Fence principle – understand the reasoning behind the status quo before changing it – is forgotten. It is not an argument against change; it is a plea to understand why the rules or requirements you are intent on removing are needed before removing them. If the need still exists, how is it going to be met if the rules are removed or changed?
This tension between protecting consumers and facilitating competitiveness, the proper relationship between regulation and growth, the trade-offs between allowing more risk and more “things going wrong” were discussed by the FCA before the Treasury Select Committee on 10 December. The FCA was concerned that (a) it would be blamed when something went wrong because politicians wouldn’t back it; (b) there would be pressure to make the taxpayer pay; and (c) the public would not understand that this was a consequence of placing a greater value on growth and risk rather than the latter’s elimination and total protection for voters. If politicians such as Reeves want regulators to promote growth, those regulators will want to be certain that politicians will have their backs when this leads to problems. The public need to understand and be happy with the risks they are taking (is financial literacy and education good enough to permit this?) and everyone needs to trust that no-one will break ranks from this hard-headed position. The way some politicians jumped on the WASPI bandwagon and, even now are justifying the right decision for the wrong reasons in a way which has reduced rather than enhanced trust in them does not give a great deal of confidence that this last will happen. In her letter to the FCA, Reeves wrote about the “difficult trade-offs” needed to enable “informed and responsible risk-taking by firms and customers” and said “I commit to the Government supporting you in this.” How bankable is that promise? Not just now or in the next 5 years but in 10 years when the next financial scandal is all over the press?
And if it is, will this just make voters feel – even more than they already do – that the system is stacked against them?
An economist with a major bank wrote this: “I don’t think we are going to see any more scandals on a very large scale; I think people have learnt their lesson.”
Reeves is basing her policy in part on a belief that this is true, small scale scandals will be acceptable as the price for growth and that people really have learnt their lesson. So, who wrote this and when? It was Ian Harwood, Chief Economist at SG Warburg – in June 1987. The scandals on a large scale and for many years were about to begin.
But this time people have learnt their lesson. This time it’s going to be different. Yes?
Cyclefree