My speech at the FSA Principles-based Regulation Conference, 23 April 2007

  1. It is a pleasure to be here today. I would like to start by thanking the FSA and in particular John Tiner, for inviting me to speak this morning and for the leadership that Callum and John are showing as you continue developing principles-based regulation in the UK.
  2. It is not often that Government ministers are able to talk about regulation as a ‘competitive advantage’ for our economy. But over the past year, as I have seen at first-hand the strength and depth of talent that underpins our global financial services industry and how London has continued to grow and innovate to cement its place as the world’s leading financial centre, I have seen that in the wholesale financial services field this is indeed the case.
  3. The FSA’s risk-based regulatory approach is praised around the world and regularly cited as a key strength for the UK. According to the City of London Corporation our regulatory system is ranked by some margin as the best in the world, ahead of both New York and Frankfurt – and I am pleased to see so many representatives here today both from the UK and the international financial community.
  4. Indeed it was to protect our regulatory system that last year I introduced the Investment Exchanges and Clearing Houses Bill with all party support. The Act ensures that the UK’s regulatory approach cannot be threatened by any takeover of UK exchanges or clearing houses by overseas companies.
  5. But this is no time for complacency. Things are never perfect. You face new challenges. While in the retail field there is still some way to go to make principles-based regulation a reality and win the support of all sections of the industry.
  6. So I am very grateful that John has agreed to come to a special meeting of our High-Level Group meeting next week to discuss these issues with senior City practitioners.
  7. Today I want to set out some ways in which I believe the Government can support the FSA’s work on principles and risk-based regulation. And I want to highlight two areas in particular – hedge funds and Islamic finance – where I believe, by working closely together, we can strengthen further our financial services industry and support wider policy goals.

Principles-based regulation

  1. Of course, when the FSA was first created, many City figures feared that that it might prove to be not a competitive advantage but a disadvantage for the UK – a heavy-handed and inflexible regulator, stifling innovation. That those fears have not proved right is a tribute not just to the FSA but also all those who worked so hard to get the Financial Services and Markets Act legislation right and avoid these risks.

One of the features of principles-based regulation, as John has pointed out, is the flexibility that it offers senior management in firms to take the decisions that are right for their business and their customers. And flexibility is also a key element of the legislative framework in which you operate. FSMA sets out the broad regulatory framework and leaves the detail to the FSA. This is one important reason why the FSA has been able to take forward this more dynamic regulatory approach.

  1. I know that many practitioners outside the UK have studied the FSMA structure and are watching with interest the progress that you are making towards principles-based regulation. Only last month the Canadian budget set out proposals to increase regulatory efficiency by moving towards common, proportionate, principles-based securities regulation and considering a common securities regulator for Canada.
  2. I know too there is a lively debate taking place in the US about the balance of their regulation which we – and I’m sure many of you – are following closely.
  3. But while we have reason to be proud of our achievements, there is much still to be done.
  4. Following our negotiation and transposition of MiFID, for example, the FSA is undertaking a major exercise to review the conduct of business rules governing the provision of investment services. This review cuts across both the wholesale and retail sector – and looks set to result in a major simplification and reduction in the level of prescription contained in the FSA’s rulebook.
  5. In the area of money laundering too, the FSA has moved from a prescriptive approach, to one where it sets the objectives to be reached, but leaves room for the industry to determine precisely how these should be reached.
  6. These are good examples of Government and the regulator working together to make better regulation a reality in the field of financial services.
  7. Under FSMA, the Government is also responsible for setting the scope of the FSA’s regulatory perimeter. Here the challenge is one of balancing the protection of consumers and the additional burden imposed by regulation.
  8. Last year, for example, the FSA and the Treasury consulted jointly on deregulatory measures to simplify the rules on the forms of life insurance which can be sold through the FSA’s insurance conduct of business rules with a view to removing conditions on age and the term of policies. FSA and Treasury officials have considered responses to this consultation. In recent days I have written to Callum McCarthy indicating that we intend to make changes to Treasury legislation to allow the removal of the age and term conditions. I understand that the FSA Board will consider this when it meets later this week.
  9. Of course historically, getting the regulatory balance right has always been tougher in retail than in wholesale. While in wholesale a default or an investment that does not perform as hoped can be seen as just part of the rough and tumble of markets, in retail where are consumers are less able to judge risks for themselves, it is a harder balance to strike. But we must not let this be a bar to principles-based regulation or push us towards a zero failure regime – this would benefit neither firms nor consumers. This is a challenge which the FSA is facing head on – including through initiatives like the retail distribution review.
  10. John has also quite correctly highlighted the importance of improving consumers’ financial capability.
  11. A principles-based approach, focussing on whether retail firms are treating their customers fairly, needs a capability agenda – shared by both Government and the FSA – that gives consumers the tools to make more effective decisions in their own long-term interests.
  12. And to support the extensive programme of education, information and advice that is now being delivered by the FSA, the Government is now driving forward its own contribution, publishing our long-term approach to financial capability in January this year, including the launch of the Thoresen Review of Generic Advice.
  13. In the long run, it is clearly in the interests of all regulated firms to support greater financial capability – and readily available generic advice – as this is the best way to ensure a sustainable, thriving and competitive retail market.
  14. It is also important that the FSA, as an independent regulator, is properly accountable for its economy, efficiency and effectiveness. That is why, as FSMA requires, the Treasury asked the NAO to carry out a value for money review of the FSA – which they are due to report on shortly.

Europe and international

  1. I would also like to highlight the importance of working together on European and international regulatory issues.
  2. It is all very well championing better regulation at home, but we can only achieve real outcomes if we also influence decisions in Brussels – on whether to legislate; and if so, to legislate in a targeted way that opens up European markets without at the same time putting in place an overly prescriptive and harmonised legislative framework that acts as a straightjacket, and stifles innovation in our markets.
  3. Step by step, I believe we are winning the argument. The success of the co-operation between the industry, the FSA, the Bank of England and the Government was reflected in the better regulation focus of the Commission’s White Paper on Financial Services of December 2005. I know that many of you in industry worked hard to persuade the Commission that this was the right way forward.
  4. A further example of our co-operation working was seen in the Commission’s decision to take a non-regulatory approach on clearing and settlement, opting instead for an industry-led code of conduct.
  5. And this approach has been apparent too in the degree of consultation and analysis that the Commission is undertaking in bringing forward its Solvency II proposal.
  6. Of course, there will continue to be difficult issues that arise. That is why together the Government and the FSA will continue to advocate a principles and risk-based approach to supervision of European markets.
  7. And just as we face challenges in establishing the right legislative framework in the EU, we need to get supervision of these markets right too. Consolidation within Europe is a reality, as we saw with Santander and Abbey, and we can expect this consolidation to increase. The UK played a leading role in putting in place the framework for the cooperation amongst supervisors – the Lamfalussy arrangements.
  8. Within that framework it’s the responsibility of regulators to make the practical decisions, in co-operation, on how best to supervise cross-border firms prudentially and in the conduct of their business. What matters is that supervision follows the economic and managerial reality of such firms, and that where there is more than one regulator, there are effective arrangements for them to work together.
  9. Internationally, too, we are increasingly looking to break down barriers to trade in financial services – both transatlantic and also with other established and emerging economies. For this to work, authorities on both sides need to trust the regulatory regimes in place – and we need to make the case for a principles-based approach at the global level too.
  10. Again we are making progress – for example, the roadmap recently agreed by Commissioner McCreevy and Commissioner Cox that accounting standards should be sufficiently converged by 2009 that reconciliation is no longer necessary for companies listed in both European and US markets. This should reduce costs significantly for companies.
  11. And there’s important work underway in both the G7, and separately in the Merkel initiative aimed at removing other barriers to investment across international borders.
  12. But let me turn now to two particular issues where I think we need to deepen our co-operation further.

Hedge funds

  1. First, the regulation of hedge funds – an issue which is a current hot topic of debate amongst the international community, including this weekend with European Finance Ministers in Berlin.
  2. The first thing to stress is the consensus over the positive role that hedge funds play – providing liquidity, helping markets price assets more accurately and driving financial innovation.
  3. Secondly, hedge funds are only one part of the broader range of issues that we are focussing on to properly understand the new risks to financial stability – alongside the strong growth in use of derivative products, the pricing of credit, and whether estimations of risk are correct. Hedge funds are part of this nexus of issues, but an excessive focus on them alone would risk missing the underlying issue of substance that authorities need to consider.
  4. Nevertheless it is right that authorities should be vigilant regarding any of the potential risks posed by hedge funds. As the location for around 90% of the EU’s hedge fund management business, the UK – and in particular the FSA – has thought hard about getting the regulatory approach to hedge funds right.
  5. We should be clear that this is not an unregulated sector. The FSA regulates hedge fund managers directly, with heightened scrutiny of the largest managers. And as Commissioner McCreevy has pointed out, there is a range of EU legislation – such as the transparency directive and the market abuse directive – which governs aspects of hedge funds’ activities.
  6. But from a prudential perspective, the key focus for regulatory scrutiny is hedge fund counterparties – their banks and other prime brokers. As Callum McCarthy has made clear, the FSA focuses on prime brokers, because that is where that the greatest potential risks to financial stability lie, rather than with the hedge funds themselves.
  7. This approach – the so-called indirect approach – received widespread support amongst European Finance Ministers at their meeting in Berlin this weekend.
  8. It is right that we should be vigilant and continually ask ourselves if there are any regulatory gaps in our approach. We also need to assess carefully what role greater transparency can play in protecting investors and promoting financial stability.
  9. You will all know that in the UK, direct retail access to hedge funds is aggressively and effectively restricted. The FSA is currently consulting on a regime for authorised funds of unregulated schemes that would include hedge funds. Where this involved access for retail investors it is of course likely that transparency would be integral to the regulatory regime governing this market.
  10. And we also believe that appropriate transparency between the hedge fund and investors is desirable – on fees, on valuation procedures, and on redemption policy. Already where concerns have emerged – for example over side letters for redemption – the FSA has acted.
  11. Some observers have urged us to go further and proposed disclosure in hedge fund portfolio positions to regulators in some sort of register. Like Callum McCarthy, I strongly believe this would be counterproductive.
  12. First, it is not clear what regulators could usefully do with that information. Second it risks giving the false impression that supervisors are overseeing specific investment decisions, creating risk of moral hazard.
  13. And were such information to be made public, as some have suggested, it could seriously compromise the working of the market, raising risks to financial stability.
  14. We should be clear: banks have a clear responsibility to manage risk in their lending and institutional investors a corresponding duty to be diligent in their investments. It is not the job of regulators to do that for them.
  15. But given the international nature of hedge funds activity, I do believe there is a role for international monitoring and, where appropriate, action. Of course we need to ensure that any steps we take are proportionate, risk-based, evidence-based, and properly designed so that they achieve the outcomes we set out to achieve.
  16. In that respect we await with interest the results of the work that Mario Draghi is undertaking in the Financial Stability Forum which may provide pointers for the way forward. And we fully support the IOSCO work on operational issues such as valuation.
  17. There is, however, one step forward that I discussed with European Finance Ministers at the weekend, and propose publicly today.
  18. Currently the FSA conducts a six monthly survey collecting data on banks’ exposures to hedge funds through derivatives, secured financing and prime brokerage. Following discussion with the FSA, we believe that the quality of prudential supervision of hedge fund activity would be enhanced if there were greater co-operation between the key regulators in monitoring the main counterparties’ exposures to hedge funds – pooling that information. One option would be to broaden the six monthly enquiries that the FSA currently carries out to other major regulators, and to all major counterparties. We will be discussing this proposal with our international colleagues further in the coming weeks in the run-up to the G8 Finance Ministers meeting in Potsdam and I hope that those countries which are especially concerned about these issues will be able to support this proposal.

Islamic finance

  1. Let me end by talking briefly about Islamic finance – a further area where I believe that greater co-operation between the Government, the FSA and industry can further enhance the UK’s competitive position in the global financial markets – and serve the needs of British Muslim businesses and savers.
  2. The Islamic Finance market has grown dramatically over recent years with Islamic finance assets worldwide estimated to be worth over $USD 250 billion and the number of Islamic financial institutions rising from just one in 1975 to over 300 today in more than 75 countries.
  3. London is already seizing these new opportunities. In the last couple of months alone we have made important strides – sukuk has become listed on the London Stock Exchange and we are seeing a growing secondary market. At the same time the FSA has started regulating Islamic home financing, a market estimated to be worth £1/2 a billion pounds and one UK high street bank is now offering Shariah-compliant business accounts.
  4. We are determined to do everything we can to deliver greater opportunities for British Muslims – and also to entrench London as a leading centre for Islamic finance in the world. We have already made considerable strides in reforms to taxation and regulatory policy in the last few years, including further reforms in Budget 2007.
  5. And last Monday we invited over twenty experts in the retail and wholesale Islamic financial markets, as well as key figures in the Muslim community, to an Islamic Finance Summit at No 11 to discuss the next steps with the Treasury and the FSA. At that meeting, we announced that we are establishing a new consultative forum, the ‘Islamic Finance Experts Group’ to act as an industry sounding board for the Government and the FSA on Islamic finance issues going forward.
  6. I have listened carefully to a range of views, including those voiced at the Summit last week, on what additional steps the Government could take. One suggestion that has been put forward is for the Government itself to issue sukuk bonds in its own name. There is clearly a strong demand for Islamic financial services and transactions and many issuers have already accessed this market including sovereign issuers of sukuk bonds such as Bahrain, Malaysia, Qatar and Saxony-Anhalt in Germany.
  7. I believe there are great potential advantages for the UK Government issuing Shariah-compliant debt. So I can announce today that I have asked the Debt Management Office and HM Treasury to carry out a feasibility study into opportunities for the Government issuing Islamic financial instruments in the wholesale sterling market, consulting with our new Experts Group and reporting at the time of the Pre-Budget Report.
  8. The working group will examine the wider benefits from the issuance of sukuk bonds for the development of London as a centre for Islamic finance in the context of our debt management policy objective of minimising long-term cost, taking into account risk, and examining the implications for gilt market structure and management.
  9. And because we are also keen to promote new ways for British Muslims to save, I have asked National Savings and Investment to look at the feasibility of the Government becoming an issuer of retail Islamic products as part of the implementation of it’s new five year strategy. This review will be complete by spring 2008.


  1. So in conclusion, I am encouraged that the Government and the FSA are working increasingly closely together to make sure consumers are properly protected, that our wider financial stability is maintained and to ensure that the UK financial services sector can continue to thrive, take advantage of new opportunities and win new markets round the world.
  2. And I look forward to further close cooperation in the months ahead to ensure our regulatory approach remains a competitive advantage for Britain.
  3. Thank you.
Posted November 26th, 2015 by admin