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John Kay: FSA’s legalistic approach is not working

by Danielle Levy on Nov 08, 2012 at 13:04

John Kay: FSA’s legalistic approach is not working

Leading economist professor John Kay has hit out at the FSA’s legalistic approach to regulation and fears it will take another financial crisis before the industry sees real reform.

The author of the recent report, Review of UK Equity Markets and Long-Term Decision-Making, advocates ‘simple structural rules’ as an alternative to the FSA’s increasingly interventionist and rules-based approach, and warned on the dangers of the burgeoning industry developing around regulation.

He said the expansion of the chain of intermediation over the past two decades has in some cases created a misalignment of incentives, which at its root has not been addressed by the regulator. 

Speaking to members of the New City Initiative, a think tank made up of independent asset management and wealth boutiques such as Stanhope and Odey, Kay explained: ‘There are two consequences – all of them [intermediaries] take something out of the cake, which gets smaller by the time it gets to the saver from when it came out of the company.

‘The other is that the more intermediaries there are, the more scope there is for misalignment of incentives between intermediaries,’ he explained.

Linked to this, Kay says there are flaws in the regulator’s approach, allowing perverse incentives to exist and then seeking to correct them with ‘detailed rules about how to behave’.

‘This has not worked well. It has led to financial services regulation, which is on the one hand extensive and intrusive and on the other rather ineffective at achieving its underlying goals, and which because of its complexity and detail is subject to regulatory capture.

‘That is the people who regulate the industry… compliance people at firms, and lawyers and consultants who intermediate between the two, [have] an interest in its expansion, which it is doing successfully.

‘I think to get outcomes the public wants from the industry, we need a different approach to regulation,’ he said.

He says the regulator should start by addressing the inherent conflicts of interests that exist within the different activities undertaken by large organisations, and argues that regulators have placed too much faith in organisations to address these conflicts. ‘Almost all institutions we deal with are conflicted in this way and people go on naively believing that conflicts of interest are managed in their interest.’

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4 comments so far. Why not have your say?

Ian Skinner

Nov 08, 2012 at 15:02

The professor is spot on about regulatory capture; especially as the FSA refuses to recruit anyone from the industry

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Nov 08, 2012 at 15:43

Bravo John Kay.

It's not just our industry, it's all forms of regulation - there has been a wholesale move away from a small professional group of those who understood the industry they were regulating to an indiscriminantly recruited army of poorly motivated box-tickers. Think CRB, think OFSTED, think NHS Inspectorate....

Large organisations feel more comfortable dealing with large organisations, so it is not wholly surprising that the FSA has made life harder for smaller firms. Nor is it surprising that they only go for large firms once those firms have 'fessed up' and the damage done.

When you consider that regulation consumes more than 10% of the turnover of the private client investment management sector, it is staggering at just how unsuccessful they have been. Never has so much been done by so many people at such enormous expense to so little effect.

However - and there's always an however - what the Prof doesn't perhaps fuly grasp is that these QUANGOs are significant employers, and no politician will have the courage to tackle them if it leads to wholesale redundancies. And so the dance continues....

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Terry Arthur

Nov 08, 2012 at 17:44

Bravo, indeed, John Kay.

Perhaps The IEA publication (Hobart Paper 169) "Does Britain need a Financial Regulator?" published in August 2010, will now receive a tad more attention.

I seem to recall that it (and the authors, one of whom was myself) were somewhat vilified on this page a year or so ago.

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Nov 09, 2012 at 14:53

I read it, Terry. A good piece, and I have been an IEA subscriber for the last twenty years.

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