DealBook: Responding to Financial Crisis, Britain Overhauls Its Regulators

Hazel Thompson for The New York TimesMartin Wheatley will lead Britain’s Financial Conduct Authority.

LONDON — After the financial crisis, countries like the United States adopted wide-ranging changes to their banking regulation.

Yet Britain was the only major economic power to go a step further by completely overhauling its regulators.

Taking the place of the current watchdog, the Financial Services Authority, will be two new bodies created to oversee the country’s banks, hedge funds and other financial institutions. The Prudential Regulation Authority will monitor Britain’s largest banks, while the Financial Conduct Authority will be responsible for consumer protection and market abuse. They will take over in April.

“Britain has gone for a complete overhaul,” said James Smethurst, a regulatory partner at the law firm Freshfields Bruckhaus Deringer in London. “It’s a big task to ensure everything will work the way it should.”

By splitting the duties of the Financial Services Authority, policy makers hope to separate the daily monitoring of banks’ financial health from the policing of illegal activity like insider trading. The goal is to allow the separated regulators to focus on their own areas, instead of trying to cover everything from banks’ capital buffers to market abuse.

It is the second time since the late 1990s that Britain has done a major regulatory revamping. In response to the growing complexity in the financial industry, the Financial Services Authority was created starting in 1997 by progressively combining nine smaller agencies. The authority also assumed control of banking regulation from the Bank of England.

Yet as the financial crisis left Britain’s banks on a knife-edge, politicians began to doubt whether the sole regulator could keep on top of the wide-ranging problems facing the country’s financial institutions.

“When a system of regulation fails so spectacularly, people are going to ask what replaces it,” George Osborne, the chancellor of the Exchequer, said in a 2010 speech announcing the most recent major overhaul.

The task awaiting the new regulatory bodies will not be easy.

A series of recent scandals has tarnished London’s reputation as a global financial center. The wrongdoing raised questions about why regulators had failed to spot a glut of risky lending by British banks, money laundering for drug cartels and other illicit activity that has cost consumers around the world billions of dollars.

Further scandals, including a $2.3 billion loss from illegal activity in London by a former UBS trader, Kweku M. Adoboli, and a $6 billion trading loss at a London-based unit of JPMorgan Chase, have heaped further pressure on British regulators.

“When we look back, last year will be seen as the low point,” said Martin Wheatley, who will take control of the Financial Conduct Authority after six years with the Securities and Futures Commission, the regulator in Hong Kong. “The time is right; we can rebuild from here.”

This is the toughest job of Mr. Wheatley’s career. After earning a philosophy and English degree from the University of York, Mr. Wheatley, 54, worked for the London Stock Exchange for almost two decades before becoming a regulator. Over 6 feet tall, he comes off as relaxed and laid-back — traits that will inevitably be tested by future financial crises.

His counterpart at the Prudential Regulation Authority will be Andrew Bailey, a Cambridge-educated economist, whose sometimes rambling comments would not be out of place at a university lecture hall.

Mr. Bailey, 53, who has spent more than 25 years working at the Bank of England, will oversee 1,300 regulators based in a building in London’s historic financial district, just around the corner from the British central bank. “We are holding institutions to higher standards than before the crisis,” he said.

In an odd twist, the regulators will work from the desks formerly used by one of the banks they regulate — JPMorgan Chase. The authority leased the building when JPMorgan moved its staff to Canary Wharf last year and bought much of the furniture in the building.

Canary Wharf, London’s newer financial hub, will also be home to the Financial Conduct Authority and its staff of 2,600.

Not everyone believes the two new bodies will have an impact.

While the regulatory structure has changed, the enforcement powers remain essentially unchanged. London’s financial community is awash with skeptics who question how dividing regulatory powers into two new bodies will safeguard against future abuses.

“Regulators never had a lack of powers — they had an unwillingness to use them,” said Bob Penn, a regulatory partner at the law firm Allen Overy in London. “Regulators failed, not the regulatory structure.”

Both Mr. Bailey and Mr. Wheatley admit the new regulatory structure may not have stopped the recent failures that have blackened London’s reputation as a financial hub.

At the Prudential Regulation Authority, which will focus on banks’ governance and capital reserves, regulators will be expected to take a more aggressive stance on how firms price risk. That will include questioning boards on risky trading activity that may leave banks underfinanced, as well as subjecting senior management to greater scrutiny over how they run their businesses.

The efforts to change banking culture follow widespread criticism of Barclays’ senior executives after the bank announced it would pay a $450 million fine to settle claims by American and British authorities related to manipulation of the London interbank offered rate, or Libor. In testimony to British politicians, Mr. Bailey accused the bank of having a “culture of gaming” the regulatory system.

“You can’t regulate culture,” Mr. Bailey said. “We expect standards that put more emphasis on the public interest.”

For its part, the Financial Conduct Authority plans to place a priority on industrywide investigations over those that take aim at individual firms.

In late January, British regulators demanded that local lenders review the sale of certain interest-rate hedging products to small businesses after 90 percent of a sample of the instruments was found to have been sold improperly. The case, which already has forced banks to set aside more than $1 billion in potential payouts, resulted from a yearlong investigation that showed the misconduct was endemic across the country’s banking industry.

British regulators and their United States and international counterparts also continue to investigate several global banks over the manipulation of important global benchmark rates like Libor. So far, the abuses have been limited mostly to low-ranking traders and managers, though authorities will hold senior executives accountable if they are implicated.

“In most cases, a direct line to the top management hasn’t been there,” Mr. Wheatley said. “If we see a clear guiding hand from boards, we would take a stronger line.”

In the countdown to the regulatory changeover in early April, some analysts fear that the pending changes will lead to turf wars between the two new bodies.

Many of the country’s largest institutions will be policed by both institutions, though the separate authorities have different priorities.

The focus of the Prudential Regulation Authority, for example, is on banks’ financial well-being, while the Financial Conduct Authority will emphasize consumer protection. Sometimes, regulatory experts say, these different goals will lead to contradictory rulings with little clarity over who will act as referee between the two agencies.

For Britain to regain its reputation as a global financial center, a lot is riding on how Mr. Bailey and Mr. Wheatley will work with each other. Both men have put in all-nighters together dealing with scandals like the implosion of MF Global, and each will sit on the other institution’s management board, though potential conflicts — particularly at times of financial crisis — are almost inevitable.

“We have to make it work,” Mr. Bailey said. “The system won’t succeed if we don’t work together.”

Article source: http://dealbook.nytimes.com/2013/03/11/responding-to-financial-crisis-britain-overhauls-its-regulators/?partner=rss&emc=rss