The threat of regulation can be regulation in itself

Henry Kaufman’s article in Wednesday’s FT, ‘The principles of sound regulation’, was an interesting read with its consideration of eight precepts of sound financial regulation and conclusion that while many financial institutions resist new constraints on their autonomy, central bankers will need to make financial supervision a much higher priority in their deliberations.  And I have to say that I agree.

The deregulation and reform of the London financial market under Margaret Thatcher’s government in 1986 was monumental and had the dramatic effect of strengthening London’s position as the capital of European finance which at the time was lagging behind New York and facing stiff competition from other European cities such as Paris.

At the time there were plenty who thought this evolution would spell disaster but for the past two decades London, as a financial centre, has been a massive contributor to the economic growth of both the UK and Europe.  While the financial regulatory structure has certainly had to be fine-tuned none would claim that the ‘Big Bang’ has not worked.

There are plenty of examples where regulatory change has been cumbersome, complicated and costly, however there are also many examples of regulation facilitating efficiency and growth.  Regulation does not always equal hindrance and if regulatory change is approached in the right way can be harnessed for the greater good.

This battle between regulation and de-regulation is an ongoing one.  In Europe, one of the problems we have is the number of ongoing initiatives aimed at building efficiencies in the European trading landscape – as a market we are almost swamped with regulations focused on specific areas of the financial markets rather than addressing the more macro issues.

As suggested by Kaufman, new systems of financial regulation should pay less attention to minor matters and more to broad systematic weaknesses – a theory which has been successful in the OTC derivatives space in the US. In this case the threat of regulation in the derivatives processing was enough to make market participants pull their socks up enough so that regulation wasn’t needed – the threat of regulation was more successful than regulation itself.

Having an unregulated market acting as if it is regulated shows there can be a happy medium between regulation and deregulation.