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The UK’s approach to European, Global and Domestic Financial Regulation
Thank you for your warm welcome and thank you especially to our friends here at Bruegel for hosting this event. I’m an admirer of many of this group’s thought-pieces and it’s a great pleasure to be with you today.
I am here as a member of the new British Government, we are less than a month old. Thanks to an election that resulted in no one party with an overall majority, we are a coalition Government. This makes us a Government with more in common with many of our European counterparts than any in recent British history.
For anyone from Germany, Italy or Poland coalition government may seem unremarkable. But in Britain we have known nothing but one party for several decades.
There were fears in the UK that joining with another party would lead to weakness and indecision but even at this early stage it is clear that the new experience of forming a coalition has taught us that you can work together, remain distinctive, find common ground and end up stronger for it.
And this strength will be needed. Amongst the many issues facing Europe today, one of the most pressing is the reform of financial services. As Bruegel’s own Nicolas Veron, said in a recent piece
banking reform has become as urgent as fiscal adjustment, and as important for stability as enhancing Europe’s growth potential.
And we have already demonstrated our commitment to addressing the fiscal position in the UK. The strength of our coalition was demonstrated when, less than two weeks after taking office, we took immediate action on our budget deficit, reducing public spending for this year by over £6 billion. This will be followed by a full Budget later this month and a review of public spending later this year.
And in the interests of transparency George Osborne, the Chancellor of the UK Exchequer, has taken the bold decision to pass control of government economic forecasts to an independent body - the ‘Office of Budget Responsibility’. It will be distinct from Government, tasked with producing the fiscal forecasts that underpin Budgets, and importantly, holding the Government to account over progress towards its fiscal goals. This independent check and balance ensures the accountability of our new Government to domestic, European and global stakeholders.
Tonight I want to flesh out our approach to the reform of financial regulation at home and abroad. Our agenda is framed by the fact that London is one of the world’s leading financial centres so reform has to be guided by both the sector’s global nature and its domestic impact. I want to explain how reforms in the UK link to those being debated in the European Union and the G20.
We back global and European reforms that strengthen markets, promote confidence and transparency and produce better results for businesses and households. This means working together, but we must never lose sight of the lesson of the last three years that it is taxpayers that pick up the bill when one of our banks fails. Some decisions must be taken at home. The British Government will never shirk the difficult choices needed to reform banking and financial regulation and, if we have to, we are prepared to go further and be tougher than our international partners to safeguard our economy.
The first challenge we face is to strike the right balance in our regulatory response. Whilst we recognise the power of free markets to serve the real economy, we equally recognise that the self-serving nature of these markets - if left unchecked - can leave households and businesses bearing the cost of high-risk strategies.
Hindsight shows us with 20:20 clarity that the system was skewed in favour of excessive risk taking, we will bring this back into balance, towards the people and businesses these markets are ultimately supposed to serve.
But we will be doing the real economy no service whatsoever if we stifle innovation and lending through overly prescriptive regulation. Businesses and consumers get the best outcomes from financial services if markets are competitive and properly regulated. Disproportionate or overbearing regulation imposes costs on firms that are passed on to users either through higher charges and lower returns or through a reduction in choice and competition. This is a delicate balance, but one we are committed to getting right both at home and abroad.
In the UK there is a tension between our domestic responsibilities and the global role that businesses in London play. Whilst geography might tell us that Britain is an island, in terms of financial services we are inseparably joined to world markets, not least to European markets. The UK has extensive experience of the benefits that opening up domestic markets to competition can bring. If you walk down a high street in Britain you are as likely to walk into your local branch of Santander as you are to walk into Lloyd’s or Barclays.
In the City, Deutsche Bank and BNP Paribas jostle for business alongside Barclays Capital, Citi, Nomura, JP Morgan and HSBC.
This is not new - Lombard Street in the heart of the City, traditionally where UK banks had their headquarters, is a reminder of the links with continental Europe going back to the 14th century.
But have been reminded throughout this crisis that banks are ‘global in life, but local in death’ a lesson we have learned the hard way in the UK.
We need regulatory frameworks at global, regional and national levels that respond to the challenges that an interconnected financial system presents. And we see the UK playing a major part in shaping the global response working through the EU and the G20.
So let no one be in any doubt of the importantance of the international regulatory architecture to the United Kingdom but this is a Government that wants to lead, not follow in its redesign.
Lessons from the crisis
Our exposure to global financial markets meant that the economic crisis in the United Kingdom was severe. We were one of the first major economies to go into recession and the last G20 country to emerge. Having just experienced the longest and deepest recession since the 1930’s, the financial crisis has made us sit up and ask where we went wrong and what we need to change. The United Kingdom has to learn the lessons from the banking crisis.
They were expensive lessons for all of us, and we want to learn not only from our own experience, but from each other. That is why I am here today; not to defend the old way of doing things, but in the spirit of our new Coalition Government, to work together to engage, listen and contribute.
In a world where people, capital and businesses are highly mobile, we cannot pretend that either the United Kingdom or the European Union can tackle these problems in isolation. Decisions that we take will determine where international businesses locate - this debate is not about London, Paris or Frankfurt but about Europe, the US or Asia.
Some might say that the easy option is to force these businesses out of Europe, but the interconnectedness of financial services means that problems in one country or region ripple through others too.
So our practical response to the financial crisis is rooted in our understanding of the strengths and weaknesses of global markets; a recognition of the benefits of global and European co-operation but a realisation that the distinctive nature of the UK’s financial services sector presents a set of challenges which is the prime responsibility of our Government. The supervision of individual firms is intrinsically linked to, potentially large fiscal impacts for individual member states. Some decisions will always need to be taken by national authorities.
Informing the European response
The previous Government took three important steps with cross-party support to move towards this:
- Stress-testing bank balance sheets to improve market confidence and supporting G20 agreements to raise regulatory standards in the long-term;
- Leading the international debate on living wills, or recovery and resolution plans, so that we know what banks have to do in the event of a crisis; and
- Establishing new resolution tools when an institution has failed.
Let me say a little about each of these.
UK banks have been subjected to rigorous stress tests using transparent assumptions applied in a consistent manner. Now in any exercise such as this you have to be prepared for the fact that you might not like what you find, but in this instance ignorance is far from bliss. If problems exist they must be identified if they are to be solved. To push concerns to the back of your mind risks storing up bigger problems for later and a fundamental undermining of confidence.
It is clear that doubts remain over the solvency of some European banks. The extraordinary interventions we have seen in recent weeks by Governments and the ECB were in large part due to severe strains in the banking system. A genuine, rigorous stress testing exercise is urgently needed to answer questions around solvency in severe market conditions. The tests should be transparent both with respect to their results, but also the methods used. Urgent action should be taken with respect to any institution failing the stress test. Only this way can we restore true stability and confidence to this sector in the near-term.
As the German Finance Minister, Wolfgang Schauble recently said: “Given the complexity of modern technology, the individual needs a chance to judge what he is doing…..We need transparency for all market participants.” For banks, this means much more detailed and granular public disclosures of risk positions, business models, capital structures, funding profiles and sources and remuneration practices. Supervisors and investors need more and better information to hold banks to account.
So these reforms will help address the fundamental drivers of failure. But we are not naive enough to think we can remove the risk entirely - so what if the worst happens?
We have led the debate internationally on Recovery and Resolution Plans. RRPs are a diagnostic tool that help authorities assess the ease with which banks can recover from stress, or be resolved, and to identify obstacles to effective resolution.
As agreed by the G20, all cross-border financial institutions will have internationally-consistent RRPs drawn up by the end of this year. These will increase regulators’ understanding of firms, improve transparency, and enhance resolvability during crises.
The UK stands ready to share the outputs and lessons learnt from the initial phase of our domestic RRPs pilot, which will continue to evolve during the year. And European Union competition authorities have a key role to play here before and after resolution in ensuring discipline and avoiding moral hazard, as ultimately any resolution plan has to be implemented in line with state aid.
And these supervisory tools must be complemented by legislation to back them up. The Special Resolution Regime, established by the Banking Act 2009, is the UK’s statutory toolkit for resolving failing banks and building societies. It includes resolution tools to stabilise and restructure a failing bank, and provisions to ensure speedy redress for consumers through our deposit guarantee scheme.
We will be consulting further on a special administration regime for investment banks and insurers. Together these tools should allow for the orderly failure of any financial institution. We hope a similarly ambitious approach can be adopted across Member States, with far reaching reforms to deposit guarantee, insurance and investor compensation schemes to ensure consumer confidence and rapid payouts in the event of a failure along with a wider set of crisis management tools.
But the new Government wants to go further, the package of reforms introduced by the last Government seeks to tackle what happens when something goes wrong - the cure - we want to focus on prevention.
We must challenge current assumptions about the structure of the UK banking model are launching a commission to look at its impact on businesses and households, as well as the taxpayer. We are concerned that because three out of the four principal UK banks are universal banks, we have a particular set of risks that we need to tackle. Our independent commission will rigorously examine the existing business models for UK banks to see if there is a better and safer way to meet the needs of businesses and households.
And to improve the regulation and supervision of the sector we will give control of macro prudential regulation, with oversight powers of micro decisions, to the Bank of England. This will enable better monitoring of systemic risk and more effective regulatory interventions with an eye to not just individual firms, but sectors and markets as a whole.
We believe that this package of reforms will increase confidence in the banking sector in the UK. It demonstrates our willingness to take difficult decisions on regulation where we believe they strengthen markets and outcomes.
Shaping the global response
As well as informing national level solutions, Britain will remain at the forefront of shaping international reforms.
In the G20, we need to avoid reforms that have a detrimental impact on competition through seeking agreement at a global level. Protectionism and closing our borders to free movement of capital will cost us more in the long-run; now is a time for Europe to look outwards and develop a plan for dealing with a globalised economy. A co-ordinated global response minimises the risk of regulatory arbitrage as businesses adjust their business models and location to get the best possible regulatory dividend.
For example, as part of this rebalancing of the financial services sector, we support a bank levy and we are pushing for international agreement. But in tandem, we are considering detailed design and implementation of a UK only levy, drawing on the work the IMF has done to guide the international debate in the absence of an international agreement.
There is some debate as to whether the proceeds of any bank tax should go into so-called national “resolution funds” or the general budget. As the IMF has noted, this is a secondary part of the debate and we must remember that tax proceeds remain the responsibility of national parliaments.
The UK supports a bank levy but is concerned about the moral hazard implications of designated funds. Some argue that these concerns can be mitigated if a fund is not permitted to participate in bailouts. We are sceptical. It is hard to see how any tax legislation, European or otherwise, could be crafted which had a credible and legally watertight “no bailout clause” for banks. There would be a major time consistency issue. We want the focus of the discussion to be on the tools that enable institutions to fail in an orderly way.
Remuneration will also be central in this debate. The UK has already taken steps to implement the Financial Stability Board’s recommendations on remuneration into domestic law and regulatory policy. It would be beneficial if the same approach were adopted globally.
An active role in the EU response
As I said earlier, London is an open market place and we are strong believers in the European single market. Indeed, a recent report from our hosts’ honorary president, Mario Monti, highlights its importance in fostering healthy competition in all sectors to give consumers and businesses the best products and returns possible - a message we support.
So what does this mean in practice for the debate on regulation and supervision?
I welcome the work programme published this morning by Commissioner Barnier, charting a clear and ambitious set of priorities for financial services in the European Union. I also respect the efforts of many hard working parliamentarians in the European Parliament, particularly on the ECON Committee, many of whom I am meeting tomorrow.
I agree with Commissioner Barnier that connected markets need co-ordinated responses. Which is why we support common EU standards on supervision. In our view, the need is for European level bodies to oversee national regulators but not to replace them. I reiterate that day-to-day supervisory decisions have to remain local in nature.
We believe that the new supervisory architecture - a network of supervisors local complimented by strong central bodies - is the right arrangement for the EU. We would like to see these institutions up and running by 2011. The new framework has the potential to fundamentally improve the quality and consistency of supervision. If you are host to an institution headquartered in another EU jurisdiction, you want to know that it is effectively supervised as its failure could damage the host market as seriously as its home market.
Because we want the single market to work, a common rulebook underpinning key elements of that single market is important.
For example, we are keen to see new higher minimum capital levels in place and we support the work taking place in Basel and in the European Union. But we also believe that national supervisors need the discretion to respond to the challenges posed by the size and structure of their banking sectors as well as domestic economies. So whilst we support moves to improve regulation of banks’ capital, liquidity and leverage, we want CRD3 and 4 and Basel 3 to set high, minimum levels coupled with supervisory discretion to go further when domestic conditions require.
We must understand the impact, so as to phase in measures in an orderly way, but we should not allow the overall ambition of the reforms to be diluted, with each country seeking exceptions for their own institutions.
And then crucially, these rules must be followed. We have a strong compliance culture in the UK, to the point where many firms within our borders call for similar standards elsewhere. A single market means a level playing field not just in the setting of rules, but in the adherence to them. This is why we support strong ESA powers to ensure EU law is being followed and if necessary, to enforce it where this is found to be lacking.
The global nature of financial services means that good cross-border information sharing arrangements are needed. The UK plays host to a large number of financial services firms whose parents lie overseas. In order to effectively supervise these firms, and ultimately protect our taxpayers, we need to know what is happening in other member states. And we are equally aware of the corollary of this and our duty to provide information the other way. We stand willing to help make this work better.
The Commission today also published a paper on corporate governance. Just as strong corporate governance is vital for financial institutions, so the new European Supervisory Authorities must abide by the highest standards of corporate governance themselves. This means depoliticised oversight, open and meritocratic appointments and transparency in decision-making. And the new framework must be legally workable.
Reforms along these lines will promote confidence in the operation of Europe’s financial services markets: common rules properly applied with consistent standards of supervision and information sharing between regulators. We believe that ESA’s with these roles will help strengthen our markets.
There was a newspaper headline in the late 19th century that read “Fog in the Channel - Europe cut off”. Some of you might have hoped that this would characterise the approach of the new British Government to the debate on the reform of financial regulation in Europe. You will be disappointed.
We are here and we are here to stay. Not because we want to be difficult or awkward - which sometimes we will be - but because we see our vitally important financial services sector as part of a wider European and global sector. We need to get the regulatory framework right if we are to realise the sector’s full potential for the UK, European and global economy.
We won’t shirk from making difficult decisions, imposing additional regulations or challenging existing business models. But we do believe in making sure decisions are taken by the right authorities building on their strengths and recognising their limitations.