Brexit will remove the power of key authorities and regulators from the European Banking Authority to the European Court of Justice – or so the Prime Minister has pledged.
Whatever the details of this separation, it is clear that the City will find itself in a different regulatorylandscape.
While the potential drawbacks of losing EU membership have been
well-documented, this new regulatory landscape should be seen as an opportunity for the City to forge a new relationship with regulators – one that helps secure its position as a global financial centre and champion of innovation.
To see how this could be achieved, we should first look to what it was that gave London its pre-eminent position in the first place. Language and time-zone played their part of course, but part of the reason for its growth from the 1980s onwards has been its light-touch regulation. This in turn fostered a culture of innovation which helped fuel the growth of the London derivatives market by allowing new products and trading methods to flourish.
In short, the absence of prescriptive regulation fostered innovation.
But that “light touch” regulation – based around broad principles rather than hard and fast rules – has also been regarded as a key cause of the financial crisis and has been met with a new raft of rules, from remuneration codes to capital requirements. Now, a decade on from that crisis and with Brexit likely to reshape the regulatory framework in Britain, it is time to ask afresh whether the new rules are working, whether we have an opportunity to rethink their details, and indeed whether the current rules are in fact the best protection against future crises or scandals.
Some will argue that the rules and systems now in place are sufficient.
Take Janet Yellen, chair of the Federal Reserve, who does not believe another financial crisis will occur in her lifetime. Similarly, Steve Eisman (the man Steve Carrell’s character was based on in The Big Short) has recently stated that there are no more systemic concerns in the financial system.
Of course there is logic to this position. Undoubtedly, the financial industry is far more alert to the dangers of high risk loans. It is reassuring to see that regulators have made considerable efforts to ensure that the money banks lend is offset by more stable assets.
But there was a deeper underlying cause of the crisis, one that lies in the culture of the financial sector.
Ultimately, this was the mismatch between the rewards available from making short term profits and the longer term risks that such activity was storing up for individual institutions, and indeed the whole system.
As we reassess our regulatory framework, we should recognise that a strict, rule-based regime is unlikely to persuade the industry of the benefits of changing their short-term approach.
Rather, a return to the principles-based approach of the past would enable the City to rethink the benefits of valuing reward over risk, whilst simultaneously creating a structure that facilitates innovation.
Critics will warn that a principles-based approach allows malicious actors to exploit the system. But in fact the opposite may be true.
Narrow regulatory regimes of box-ticking can create the circumstances in which crooks find a way to tick the boxes and meet the hard and fast rules, while still breaking the spirit or principles that should lie behind them.
Another important way to adjust attitudes to risk is by preparing for black swan scenarios. Currently, risk management is too focused on analysis of immediately available data. In an era of misguided economic forecasts, it is clear that this approach has limitations. Instead, thinking about the unthinkable would allow risk managers to better prepare for crises.
Again, the fixation with hard and fast rules may be driving risk managers to look too narrowly at what risk their businesses face.
Reward the guardians
Finally, one simple way that the City can both address its attitude to risk and develop its position as an innovative financial centre is to pay regulators more. Attracting the best talent to the regulator will increase its ability to determine principles that truly encourage innovation and creativity in finance, while simultaneously reducing the chance that it stifles the new thinking that will be essential for London to maintain its status as a financial capital.
It would also in itself be a source of appeal to international finance.
After all, what better way to signal that the City is the place to do business than demonstrating that we do not simply reward those who make money regardless of the risk, but that we reward the guardians of the system that keep it stable and a secure place to carry out your business?
We have an opportunity to reassess regulation in the City and to do so in a spirit of cooperation between the regulators and the regulated.
A broader and more imaginative approach to risk assessment; a professional and well-remunerated regulatory profession; and a system guided by sound principles – that is the combination that will turn the challenge of Brexit into an opportunity for the City.