Evaluating the UK regulatory framework

This report argues that the balance between stability and risk in UK regulation has swung too far over the past decade and that the regulatory framework has been a significant factor in the decline in many areas of activity across UK banking, finance, and capital markets compared with other countries. It analyses the main challenges in the structure and remit of UK regulation, outlines the context in which regulators have been operating, and outlines some ambitious but achievable ways to reset this balance.

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The election of a new government focused on growth is a good time to take stock of the first decade of the UK regulatory framework since the Financial Conduct Authority and Prudential Regulation Authority were launched in 2013. This report explores how the framework and regulators have performed, and analyses whether the remit, structure, and political framework of regulation over the past 10 years are appropriate for the coming decade.

We think it’s important to evaluate this performance in the context of the sort of market outcomes you might hope for under a well-designed, robust and flexible framework. The starting point for this report is our analysis of market outcomes in the UK over the past decade across nearly 60 metrics of activity in different sectors of banking, finance, and capital markets. Unfortunately, in most cases these outcomes have not turned out as well as you might have hoped: activity has fallen in just over half of the metrics in real terms and in two thirds of them relative to GDP. In 80% of the metrics we looked at, growth in activity has been lower than in the US.

It would be unfair to blame regulators specifically for these outcomes: there are many other factors at play, and delivering these outcomes was deliberately not part of the objectives that were set for them in the wake of the financial crisis. But we think the UK framework has contributed to these outcomes and that the framework does not have the right balance between stability, risk, and growth.

The balance between risk and stability

The new government has picked up the baton from the previous administration in exploring how banking, finance, and capital markets can help enable and support more investment, innovation, and growth. 

But investment and innovation inevitably involve a degree of risk, and the financial system in the UK is operating under a framework that was deliberately designed to reduce risk after the financial crisis when everyone agreed that we needed to do so. This has led to a culture of risk aversion from the top down that is only slowly beginning to change. Fast forward more than a decade and the problem today is that we need more - not less - risk.

Having outsourced more power to regulators than perhaps they appreciated, parliament and government cannot just pull a lever to make things change. Political tension has increased as the gap has widened between what government wants regulation to do and what regulators think it should do under the remit and powers they have been given.

It is important to frame this debate in the right context. From this project it is clear that (most of) the industry thinks that regulators have broadly done a good job in near impossible circumstances over the past decade. This project has also been like operating on a live patient: the regulatory framework is changing and there is a growing recognition among regulators at a senior level that the balance of risk needs to be reset although it is not yet clear how embedded this shift in mindset is further down the organisation.

Here is a short summary of the report:

1. A 10-year performance review: this report evaluates the performance of the UK regulatory framework in the context of market outcomes over the first full decade since the creation of the FCA and PRA. It argues that the sensible reduction in risk in the wake of the financial crisis has gone too far and morphed into a culture of risk aversion that has spilled over into the wider economy in the form of lower investment, innovation, and growth.

   
   

2. Market outcomes: the starting point is our analysis of market outcomes over the past decade across nearly 60 metrics of activity in different sectors of UK banking, finance, and capital markets. In most cases, the sort of outcomes you might hope for have not materialised: activity has fallen in just over half of the metrics in real terms and in two thirds of them relative to GDP. In 80% of the metrics, growth in activity has been lower than in the US. 

   
   

3. The balance of risk: the UK economy needs more and not less risk in the system. ‘More risk’ is a scary concept for many people but it is a natural corollary of more investment, dynamism, and innovation. The paradox is that in seeking to reduce risk regulators have created bigger and longer term risks elsewhere. Enabling investors and market participants to take a little more risk could help create a virtuous circle of investment and growth.

   
   

4. A clear and consistent vision: one of the biggest challenges in UK regulation over the past decade is that there has not always been a clear and consistent vision for the industry from the government, politicians, and regulators themselves that has been matched by underlying policy. This creates confusion, uncertainty, and unpredictability in the regulatory framework that raises costs and further disincentivises risk. 

   
   

5. Structure and complexity: the post-crisis redesign of UK regulation has created a hugely complex system marked by overlaps and duplication. This is reflected in the high volume of regulatory reforms (an average of two consultations per week, every week, for eleven years…), the increased complexity of the rules themselves, and sometimes inefficient processes and operations.

   
   

6. The wider context: the report outlines the constraints under which regulators have been operating over the past decade (such as a 25% decline in average pay in real terms) and the fact that many of the criticisms directed at them might more accurately be directed at politicians for layering additional remits and on top of the existing objectives for regulators. Government and parliament have delegated more power than perhaps they initially appreciated to regulators, which has increased political tension between them.

   
   

7. Operating on a live patient: the UK regulatory framework is already changing and there has been a shift in the mindset of senior regulators. As with many banks after the financial crisis, any cultural shift will take time to filter down. The FCA and PRA have embraced their new secondary objective on competitiveness and growth with mixed enthusiasm and it has not yet been fully reflected in their work.

   
   

8. Refocus on growth: the report outlines a series of broad directional reforms, including a clear reset and greater clarity in expectations, refocusing the secondary objective on growth, setting regulatory goals in terms of specific market outcomes, and improving the metrics against which regulators and the wider framework should be measured including a regular ‘warts and all’ dashboard to monitor progress.

   
   

9. Governance and structural reform: while structural reform is tempting (such as carving out separate consumer protection and wholesale markets regulators) it is likely to be more disruptive and cosmetic than it is worth. We recommend internal structural and governance changes at UK regulators to clarify their roles and accountability. A spring clean of the additional remits they have accumulated over the past decade would reduce complexity.

   
   

10. Improved accountability: there is a fine line between political accountability (good) and political interference (not so much). A more structured process for political accountability focused on systems and processes would deliver better outcomes than episodic political interventions on high-profile issues. More structured engagement and dialogue between government, regulators, and the industry would improve cooperation and help rebuild trust between them after a bruising few years.