Financial Services: Regulatory Approaches and Paradigm Shift From

Shaun Elder 28/09/2010 Working Paper: Please do not cite without permission.

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Financial Services: Regulatory Approaches and Paradigm Shift

From an Irish Perspective with EU, UK and US Comparators

Author: Shaun Elder

PHD candidate, University of Limerick,

Plassey Campus, Limerick, Ireland

Contact email: [email protected]

Conference:

"The Financial Crisis, EMU and the Stability of Currencies and the Financial

System"

held at the University of Victoria (UVic), B.C. Canada

30 September-2 October 2010

(Please do not quote without author’s permission)

mailto:[email protected]


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Financial Services: Regulatory Approaches and Paradigm Shift

From an Irish Perspective with EU, UK and US Comparators

Abstract

Institutionalised regulatory control of financial services has been accepted

worldwide, and is based on domestic legal structure and practice. Regulatory

approach sets the tone for regulators including the enforcement sub-set. In

Ireland pre-crisis a „soft touch‟ principles-based approach was `adopted. It

failed. Government sponsored reports found „capture‟, supervisory failures and

resource gaps. A „retreatist‟ enforcement style was evident. Ireland‟s economy

post crisis is in turmoil. The new, assertive Irish regulator has adopted a mixed

principles/rules-based approach with a risk-based emphasis. Internationally too

reforms were mooted. The EU proposed new supranational structures dealing

with systemic risk. The US Paulson report advocated an „objectives-based‟

approach, while Dodd-Frank placed greater responsibility upon regulators. The

newly elected UK coalition government announced the abolition of the FSA

which operated a hybrid approach. Many „newcomer‟ reform proposals were

advocated to „risk‟, the definition of which is context specific. This paper, part

of a wider multi-disciplinary study, examines and analyses the approaches and

concludes that there is a confusing array of opinion internationally as to

regulatory approach, for Ireland there is a paradigm shift but its

implementation still awaits, while elsewhere there is much flux and uncertainty

with regulatory liberalism abounding. No institutionalised global regulatory

structure exists. Regulatory „outsourcing‟ to ad hoc international bodies is

evident. No single jurisdiction has assumed the lead in regulatory change.

Internationally, paradigm shift has converged towards risk. The EU has

approached issues on a piece-meal basis. The US has embarked upon the

mammoth Dodd-Frank institutional, rules and tools overhaul which will take

time to assimilate. The UK awaits further political input. Regulation of financial

services, as Black asserted, continues full of “contingency, complexity, dynamic

adaptability, and unpredictability”.


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Introduction

Financial rmarkets, according to La Porta et al (2000: 24), need protection for investors,

whether by government agency, courts or market participants, while the nature of financial

regulation, “....is deeply rooted in the legal structure of each country and the origins of its

laws”. Helm (2006) argued that institutional design is critical to regulatory quality and

extent, and controversially that most regulation followed the command-and-control pattern,

the latter an argument not borne out by this review.

Financial regulation is impacted by both international and domestic dimensions. Even pre-

crisis for instance, the Committee of European Securities Regulators (CESR) was producing

interpretative recommendations, common standards, peer reviews, and comparisons of

regulatory practice (van Leeuwen and Demarigny 2004). Domestically regulation is often a

creature of statute which may set the national model, while underlying such model is the

regulatory approach, often itself impacted by statutory objectives and interested party

consultation. There is no one model or approach and within the available spectrum there is a

continuum running from hard to soft (Ahern 2010:5). The international reform agenda is

expected to drive much future Irish regulation (Elderfield 09-06-10), with regulatory

liberalism the dominant ideology (Gamble 2009: 153-156).

From the early 1990‟s, as Regling and Watson (2010: 17) highlighted, academic and policy

debate focused upon regulatory adjustment in the face of increasing complexity of financial

products and institutions, and increasingly adaptive and innovative markets. Some countries

established separate regulators, others regulated through central banks, while in Ireland due to

a policy compromise a hybrid central bank and regulator experiment was implemented

(Regling & Watson 2010: 36; Westrup 2007: 14; McDowell Report 1999). Some moved

towards principles-based regulation which de-emphasised specific rules which could be side-

stepped. Some, like Ireland, went further and adopted a „light touch‟ version which was less

intrusive, a „flexibility‟ model (see below), but it was discredited.

While not alone due to regulatory failures, the Irish economy found itself in turmoil: property

and credit bubbles burst; banks were nationalised; the Anglo Irish Bank bail-out will cost

taxpayers between €22-25 billion at best estimates; an Irish agency called NAMA was

established to enable taxpayer purchase of „toxic‟ development and related property loans

with a book value of €90 billion; Irish bond market spreads in mid-August 2010 were more

than double those of Germany with risk premiums 300 basis points above German, and the

ECB stepped in to purchase government bonds; 13.7% unemployment was on an upward

curve in August 2010; 35,000 homeowners had mortgage arrears with many more in a

shadow cohort paying interest only; huge swaths of unfinished or unoccupied „ghost‟ estates

littered both urban and rural Ireland; large numbers of Irish homeowners were in negative

equity; emigration was on the rise; the much-vaunted „Celtic Tiger‟ economy was long dead

and buried.


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According to the new Irish Head of Financial Regulation, Matthew Elderfield (29-03-2010)

there are three main regulatory approaches applicable to Ireland post crisis: The principles-

led approach, the rules-based approach, and the risk-based approach. These may be inter-

mixed. In March 2010, Elderfield explained:

“Rather than making the artificial distinction between rules-based or principles-based

regulation, it‟s clear we need to have a mixture of both and take an approach rooted in a

clear understanding of risk. This will involve developing a regulatory model that allows for

the intensity of our regulatory framework and level of supervisory engagement to be

calibrated to the inherent risk and impact of a particular firm or sector”.

One example of differing national regulatory models, which sit above the regulator‟s own

approach, emerged from the work of Gadinis and Jackson (2007) in relation to global

securities markets regulation. Black (2010: 43) summarised the three different model types

(underlining added):

“......a „government-led‟ model, that preserves significant authority for central government

control .... albeit with a relatively limited enforcement apparatus (France, Germany,

Japan); a „flexibility‟ model that grants significant leeway to market participants.... but

relies on government agencies to set general policies and maintain some enforcement

capacity (UK, Hong Kong, Australia); and a „cooperation model‟ that assigns a broad

range of power to market participants in almost all aspects ....but also maintains strong

and overlapping oversight of market activity through well-endowed governmental agencies

with more robust enforcement traditions (US, Canada)”.

At the effective commencement of the modern era of banking regulation, Braithwaite and

Drahos (2000: 93) highlighted that by the end of the 1930‟s there was one overriding

principle, the relative independence of central banks from government, but two dominant

regulatory models. The first British, found within a highly concentrated market structure with

one powerful regulator which operated in a close-knit, exclusive community relying upon

understandings, convention, trust and tradition; and the second characterised by the US

Federal Reserve, with a highly decentralised market structure, and fragmented regulators both

federal and state, where regulation was more rule-bound, formal and bureaucratic. They

wrote that, “One of these two systems was generally used by other states as they began to

develop national systems of banking supervision” (2000: 93). Ireland followed the British

model, the Irish Central Bank was statutorily established in 1942, the hybrid Central Bank

and Financial Regulator in 2003, and the post crisis Banking Commission in 2010. While the

EU, grounded in civil law, and the over-riding „framework‟ Treaty of Rome where general

principles guidelines are set out (McMahon & Murphy 1989: 3-12), is a prime example of the

„sit-above‟ government-led model, where it is not a hands-on regulator but instead a

regulatory legislator for member states which regulate beneath it.

Contrastingly, the by now somewhat dated comparative work of Gunningham (1991) in

relation to the Hong Kong, Chicago, and Sydney futures markets, a form of private regulation

or even self-regulation grounded in the de-regulation era and with significant „efficient

market‟ undertones, was described by Black (2010: 43) as incorporating, “informal methods


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of social control [which] were more critical to maintaining order and preventing market

abuses than the formal rules either of government or the exchanges”. Black explained the

rationale thus: “Peer group pressures; fears of being ostracised, the leverage of large

institutional clients, and the transparency of market dealings all affected the definition,

motivations, and opportunities for abuse”.

When pondering the overriding supranational or national model therefore, or the underlying

domestic financial regulator‟s approach, Black‟s (2010: 48) warning as to research results of

the efficacy of the relationship between law and regulation and the markets themselves must

be considered:

“.....decades of research into markets, behaviour, regulatory dynamics, and policy-making

shows us that formal, linear, and absolute understandings of behaviour and of the

relationships between law and markets are bound to be wrong. What we have instead is

contingency, complexity, dynamic adaptability, and unpredictability. Any models of

financial markets or of behaviour and any policy prescriptions as to how to regulate either

which are not based on the acceptance of these assumptions are bound to fail”.

Paper Overview

First, we look at the principles-led approach operated in Ireland prior to and during the 07/09

financial crisis, contrast it with the rules-based approach, contemplate the hybrid proposal,

and then examine the risk-based approach. Then we look at the reform proposals of current

regulator Matthew Elderfield announced in his speech on the 29th

March, 2010 and assess

what they mean for Ireland. For completeness Paulson‟s (2008) Objectives-based approach

publicised mid-crisis is outlined. International comparators emerge from the text as do the

conclusions.

Regulatory Objectives

Whichever approach is adopted, and Murphy (2010) identified principles-based regulation as

“a big issue going forward”, for Ireland, Cain (2010) highlighted that regulation for the

public benefit must meet three objectives: (1) Set boundaries; (2) be a deterrent; and, (3) set

precedents for others to use as a benchmark.

Principles-Based Approach

In general terms explained Smith (2008: 481), principles-based approaches, “seek to focus

financial institutions on regulatory goals and outcomes and to transfer from regulators to

financial institutions (to a greater or lesser extent) the task of devising the particular

strategies that the financial institution should adopt to achieve those goals or outcomes – or

at least mitigate the risks of not doing so”.


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For Ford (2008: 5), Canadian securities regulation viewpointed a principles-led approach, “as

a New Governance regime-one that uses innovative, pragmatic, information based, iterative,

and dialogic mechanisms to gather, distil, and leverage industry learning in the service of

a...... more effective and less burdensome, public regulatory mandate”.

Black (2008: 3) extolled that, “For firms, principles-based regulation can provide flexibility,

facilitate innovation and so enhance competitiveness......[while] for regulators.... it can

provide ..... flexibility; facilitate regulatory innovation in the methods of supervision adopted;

enable the regulatory regime to have some durability in a rapidly changing market

environment; and enhance regulatory competitiveness”.

The regulatory philosophy adopted in Ireland pre-crisis was inherited from the best practice

at the Irish Central Bank asserted Honohan (2010: 59), and before that the British model

(Braithwaite & Drahos 2000: 93). Former Irish financial regulator Patrick Neary (05-03-

2008) described the then Irish principles-based approach as „open and collaborative‟. Being

found at the softer end of the spectrum it was known as „soft touch‟ and had found some EU

approval (Black 2008: 2 footnote 3). It was geared towards nine un-codified principles first

unveiled in 2006, which included sound governance, transparency and accountability,

prudence and integrity, risk control, oversight and reporting, sufficiency of financial

resources, and timely information production (Honohan 2010: 46). Neary (05-03-2008)

defined it in the following terms:

“Responsibility for the proper management and control of a firm, and the integrity of its

systems, rests squarely on the board of directors and its senior management. This in turn

requires appropriate governance, ethical behaviour and transparency in business

dealings.”

Numerous statements and restatements of the Irish regulatory view were published according

to Honohan (2010: 45-46), including one in 2004 by Liam O‟Reilly, former CEO of the

Financial Regulator, when he stated that the approach would be achieved by boards and top

management committing fully to, “a culture of integrity, competence and best practice”, the

expectation being that they would, “ensure that this culture flows throughout all levels of

their organisations”. Organisations would require, “compliance systems, controls, and

internal audit departments that have the standing and the powers to meet”, expected

standards of behaviour. “We set out those standards: they must invest in the system and staff

to ensure those standards are met”, O‟Reilly concluded.

Cain (2010) expressed his lawyer view that the Dublin IFSC as a unit regarded principles-

based regulation as cheaper and business friendly. The major constituents of the principles-

based approach for him were that the complete responsibility, even beyond the business

model, rested with the management of the firm or company itself with the regulator operating

a hands-off, light-touch approach (Cain 2010). In this approach, compliance risk should be

more however than the risk of internal firm regulatory breach and sanction, and involve proof

of risk assessment and interaction with external regulatory outcomes, within a context of an


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analysis of risk to the firm‟s customers, an exogenous goal and benchmark (Smith 2008:

485). Honohan (2010: 47) concluded that Irish “principles-based regulation referred not just

to the principles but also to the various rules, codes and regulations that underpin financial

regulation”.

From a pre-crisis UK insurance world perspective, Sklaroff (2006: 39-40) outlined an

alternative principles-based model. He argued that there was a need for the right set of

overriding high-level principles, with unambiguously permissive supplementary guidance,

enabling the financial services sector to devise their own methods of compliance, in either

self-regulatory initiatives or industry-led compliance advice. He envisaged a genuine

partnership between regulator and regulated (2006: 41). Teuten (2007: 36) explained the UK

FSA principles-based approach thus:

“The objective is to focus on the desired outcomes (the principles) and evaluate how well a

company manages the risks associated with those principles. Individual companies decide

how to meet these principles, and avoid or mitigate risks that will negatively impact them”.

Cain (2010) argued that for Ireland neither a rules-based nor principles-based approach was

effective, or would have been effective, in mitigating the 07/09 financial crisis, a view shared

by Murphy (2010) and Regling and Watson (2010: 17). Comparatively for example, Cain

argued, in the UK the FSA operated a principles-based approach and they encountered

problems with Northern Rock, and Bradford and Bingley; while in the USA where a rules-

based approach was applied, problems arose amongst others, with Lehman Brothers, Bear

Stearns, Bernie Madoff, and in 2010 Goldman Sachs.

As legal commentators, Connery and Hodnett (2009:90) clarified the Irish banking

experience: “Deregulation and light touch regulation would appear not to have worked for

certain aspects of the banking sector, rather they led to a lack of transparency and a lack of

prudence in relation to risk taking”. From the perspective of international bankers in Ireland,

Ward (2010: 11) as FIBI chairman stated: “......a light touch regulatory regime.....has not

served us well and has left a legacy of reputational damage in the domestic and international

arena”. Honohan (2010: 59-60) criticised in more particular terms that the Irish regulatory

approach was „deferential‟, that attempts to strengthen the approach had limited effect, that

key governance architecture elements were not put in place, that sanctioning was only

reluctantly applied to micro-prudential functions, and that the nine regulatory principles were

never codified. Further emphasising the apparent „capture‟, the academic critique by

professor Gregory Connor (2010) of NUI Maynooth, was that the Irish political establishment

created a, “regulatory system that was.....very lax, very secretive, and very accommodating,

and it was done deliberately”. Valencia (2010: 3) concluded: “The idea that markets can be

left to police themselves turned out to be the world‟s most expensive mistake”.

Cain (2010) contrastingly argued that Ireland was subject to a great deal of rules sourced

abroad, and in his opinion was “heavily regulated”, for instance, by the Basel Accords

capital requirements. In Cain‟s view while some institutions in Ireland took unacceptable

actions, these may have followed from poor business models rather than inadequate


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regulation. He concluded that the: “...quality and nature of supervision [was] the key, not the

approach”.

Murphy (2010), relying upon his experience as group Legal Advisor to the Bank of Ireland,

stated that he never liked principles-based regulation, and that while he could understand how

it developed in the UK, its application was never thought out or debated in Ireland. The real

regime objective, according to him, was a choice between firm rule or flexible principle,

while in Ireland the more flexible principles-based approach led to confusion and not clarity.

Enforcement he argued was the difference between the UK and Irish principles systems, a

point the Honohan report bears up, while Cain (2010) lamented “the quality and nature of the

supervision”, in Ireland. For Sklaroff (2006;41) UK supervisors must be trained, managed

and remunerated sufficient to encourage initiative and independent judgement, while the

preferably single regulator must resist political and media pressure.

This issue of supervision loomed very large in the post-crisis, government-sponsored,

Honohan report (2010: 63,75) when resource volumes, inadequate skill mixes, lack of

expertise, recruitment issues and especially salary, a pattern of inconclusive engagement

with regulatees, and lack of decisive follow through were pointedly criticised. Regling and

Watson (2010: 37-41) in their government-sponsored report, described Irish supervision as

the opposite of „hands-on‟ or pre-emptive in relation to increased macro-financial banking

risks or governance, lamented information deficits, and highlighted a socio-political context

un-conducive to pricking the Irish property bubble. Such a description sits comfortably

within McAllister‟s (2010) „retreatist‟ enforcement style. One essential element identified by

Honohan (2010: 48-49, 53) was the establishment of a governance architecture to include

directors‟ compliance statements, fit and proper standards of qualification and behaviour, and

a corporate governance code as a core requirement, while in two of these areas he found Irish

regulatory default. Post crisis Elderfield (09-06-10) told the Irish funds industry that

supervisors must have open and frank dialogue with senior management and must insist their

prudential judgement replaced the firm‟s commercial view where necessary.

Some of the identified pros and cons of the general principles-based approach, as opposed to

the „Irish soft touch‟ approach, were highlighted by Murphy (2010) as set out in the following

table:

In Favour Against

Engage senior management Legal obstacles

Develop more strategic view Lack of certainty

Offer flexibility Proliferation of guidance – it multiplies

Enhance speed of response Regulatory creep


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Harder to manipulate principles Accountability issues

Eliminate handbook Over-zealous enforcement

Reduce complexity Overlap with other legal requirements

Offer a dialogue basis with regulator

Murphy (2010) criticised regulatory overlap concluding that in Ireland there was duplication,

confusion, uncertainty and expense. Breslin (2010) argued that in the UK that they used a

principles and rules hybrid system, which he described as „attractive‟. Sklaroff (2006:39-40)

outlined three advantages to his UK model: (1) deeper and more rapid industry buy-in; (2)

easier alteration of informal guidance; and (3) an unfettered regulator who may add further

prescription as required.

In Ireland there was a need for proper remedies, Breslin (2010) asserted. For instance, he

pointed out that the Financial Ombudsman operated a ready and cheap scheme but that there

was a monetary limit for private investors. Large claims were problematic; Section 117 of the

Central Bank Act 1979 provided a civil sanction but some observers took the view that

private suit was excluded, while the code itself maintained that it was not intended to give a

private right of action. Furthermore, in criminal cases there was no mechanism for restitution.

Regling and Watson (2010: 43) concluded:

“In an adaptive financial system there is a case for principles-based supervision, in

conjunction with clear rules. But the “light touch” approach to supervision has been

discredited: it sent wrong signals to banks and left supervisors poorly informed about

banks‟ management and governance, potentially impairing crisis response capacity also”.

Rules-Based Approach

In 2005 Liam O‟Reilly, as then CEO of the Irish financial regulator, outlined his conception

of a contrasting rules-based approach (Honohan 2010: 47):

“....detailed rules across the whole range of regulatory powers are set out. The rules set

out clearly what must be done, and importantly, what will happen in the event that

something is not done. This method implies a very legalistic approach. It suggests doing

things right rather than doing the right thing. It allows no scope for interpretation. It is

slow to react to change. It punishes the compliant equally with the non-compliant”.

Here the regulator relies on supervision and detailed analysis in a prescriptive way; detailed

rules are established in a tick-the-box approach with little qualitative data; supervision may


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include dedicated teams embedded in the larger organisations, as the SEC require in the USA

and the FSA in the UK, where teams are put into investment banks; and the approach is more

inflexible and demanding than that of the principles-based approach (Cain 2010; Teuten

2007). For many years the USA has adopted a rules-based approach with regulators using

guidelines and rule books, but Teuten (2007: 36) criticised, “Companies pass the SEC‟s tests

yet corporate malfeasance persists rendering rules-based compliance an ineffective means

for managing risk”.

One method applied by the US SEC is compliance audits or monitorships, where as part of an

enforcement action on foot of a settlement agreement, a monitor or compliance auditor is

taken on by the acknowledged guilty, regulated, corporation at their own expense, for a

period up to 3years, to oversee compliance improvement so as to avert future violations, and

to report back to the agency (Ford and Hess 2009; Black 2010: 45). Originating from the

court appointed receivership process commenced by the SEC in the 1960‟s to preserve assets,

monitorships gradually evolved to ensure future corporate compliance with securities law

(Ford and Hess 2009: 684). Bathed in controversy surrounding whether or not the

enforcement technique is sufficiently punitive, monitors deep or shallow diving into

corporate culture, and conflicts of interest around monitor selection, Black (2010: 45)

synopsised the Ford and Hess research as finding a coalescing of incentives and motivations,

where corporations want a report just rigorous enough, monitors want to preserve reputation,

and the regulator only wants sufficient to close the file and move on.

In March 2007, immediately pre-crisis, Hank Paulson, then chairman of the Federal Reserve,

acknowledged that principles-based regulation was superior to a rules-based model, at a time

when US companies complained of annually paying $6 billion to comply with Sarbanes-

Oxley and north American firms paid out almost $30 billion annually for compliance

(Teuten 2007: 38; Ford 2008: 2; Black 2008: 2). Taking the matter further was stymied by the

crisis itself, although Ford (2008: 2) has highlighted that while internationally the US SEC

has been regarded as a “rules-oriented and prescriptive securities regulator” moves have

been made towards a principles-led approach, Black (2008: 2) highlighting their

„formalisation‟ concerning capital markets in the Paulson Report (2008: 11-12).

Despite the heavy rules emphasis in the US, nonetheless failure at the principal-agent level

and poor governance, argued Lang & Jagtiani (2010: 125), were prime causes of the risk

management breaches revealed in the sub-prime mortgage crisis for two reasons: (a) a lack of

incentive to worry about „fat tail‟ risk; and (b) internal controls and risk management were

inhibited by weak governance and principal-agent conflict issues.

Mixed Principles/Rules Hybrid

The UK operated a hybrid principles/rules based system (Breslin 2010), and this mixture was

the preferred post crisis option of Irish regulator Matthew Elderfield, appointed in January,


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2010, and formerly the regulator in Bermuda, when he envisaged a risk component being

added. Honohan (2010: 48) stated, “There must be principles to back up the rule book. Any

sensible model has both rules and principles”. However, one Australian study upon the use

of standard-compliant general purpose financial reports has highlighted conflicts between

principles and principle-based rules (Walker 2007). In the US system of fragmented and

institutionalised regulators, the CFTC has utilised a principles-based approach for the futures

industry (Paulson 2008: 11), while the SEC has favoured a rules-based philosophy.

Ford (2008: 6- 11) extensively reviewed the relevant authorities concerning the relationship

between rules – regulator determines factual issues based on pre-determination of permissible

conduct – and principles – regulator determines both permissible conduct and factual issues –

and found they are both points on a continuum, there is a good deal of overlap and

convergence, and that no statutory scheme is a pure type instead oscillating such continuum.

She stated: “Rules still admit of considerable discretion and interpretation. Principles, in the

fullness of context, may congeal around a particular meaning”.

One example, vectoring investor protection, disclosure, and regulatory responses may assist

in exploring the hybrid conceptualisation (Linsley & Shrives 2005). Disclosure of financial

information about sophisticated products especially, where findings of inability by initiates

and innocents alike to read, understand or act upon such disclosure, Black (2010: 40) argued,

have led to calls for simplification of disclosure, increased regulation of complex derivatives,

and product purchase restrictions. For instance, advisors throughout the EU and UK must

now focus upon the suitability of the particular product as well as investors‟ attitude to risk.

Black (2010: 41) goes on to argue that absent research, regulators themselves are filing the

gaps, and particularly in the UK, Canada and Australia, are researching and learning investor

decision-making rationales, risk perception and information understanding and usage. Since

the year 2000 the UK FSA for instance, have been „road-testing‟ disclosure documents with

consumer focus groups, a trend followed in Canada in 2006, and announced as pending by

the EU in 2008.

The UK FSA in 2006 announced retention of its Key Features Document (KFD) category for

disclosure, rebranding it a „keyfacts‟ document, in line with survey results which determined

consumer preference for shorter more focused material (FSA 2007). Each regulated firm

determined document content which had to include key headings outlining product, aims,

investors‟ commitment, risks, general questions and answers, and charges. The FSA outlined

that their new rules were less prescriptive, in line with a move towards a more principles-

based approach, although they declared finding only 15% of their two hundred document

sample as complying with their own standards.

In a general critical commentary of the European disclosure paradigm, designed to meet the

four objectives of remedying market failure, disciplining market actors, improving

investor/consumer choice, and preventing abuse, Avgouleas (2009) argued that the crisis

exposed the failings of disclosure as an effective regulatory tool in financial markets.

Avgouleas highlighted that the market failed to control both disastrous bank risk-taking and

bank reliance upon implicit government guarantees, despite most of those risks being fully

disclosed to the market, because they were not sufficiently understandable to market players,

due to product complexity and socio-psychological factors. It remains to be seen whether or

not the US Dodd-Frank disclosure reforms are successful.


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In 2009, Hector Sants, then UK chief executive of the FSA, who resigned in the wake of the

May, 2010 British election results, in a step up to McAllister‟s (2010) „legalistic‟

enforcement style, warned the UK financial industry of the introduction of an “intensive

supervisory model”, a statement followed by a new enforcement model of “credible

deterrence”, designed to garner maximum media headlines for punitive action (The

Economist 27-03-10: 73). Figures for fines revealed a big turnaround of over 650% in two

years:

2007 2008 2009

Stg£5.3 million £22.7 m £34.9 m

Adapted from: The Economist, 27-03-10, p73.

March, 2010 was a very busy month for the FSA for example:- on the 11th

a former

stockbroker at Cazanove was jailed for insider trading; on the 16th

a former Merrill Lynch

interest-rate trader was banned from London‟s financial markets for at least five years for

covering up losses; on the 23rd

in its biggest investigation into insider trading to that date,

police and FSA officers raided sixteen premises, and arrested six people, with a seventh to

follow next day (The Economist 27-03-10: 73). Despite this increased enforcement activity,

on the 16th

June, 2010, the new British Chancellor of the Exchequer, George Osborne

announced the abolition of the FSA effective 2012.

For 2010, the FSA projected recruitment of 460 extra staff, plans mirrored in Ireland also,the

increase of its budget by 10%, and the promise of increasingly more obtrusive inspection.

The largest UK banks were targeted to each have fifteen permanently stationed officials at

their headquarters, an increase from six each pre-crisis (The Economist 27-03-10: 73).

Contrast this with the pre-crisis Irish approach where there was no embedding, and three

supervisors were responsible for Anglo Irish Bank and the Bank of Ireland, while two

supervisors dealt with Allied Irish Banks and Irish Life and Permanent (Carswell 10-06-10:

8; Honohan 2010: 64).

Risk-Based Approach

Analysis and understanding of the risk-based approach, just as for other approaches, hinges

upon the individual commentators viewpoint or bias. Non-market public interest academic

comment includes Fisher (2003) who argued that risk was the new buzzword, one of the

central tasks of the UK executive state, and was such an overarching concept that we are


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witnessing the rise of a risk commonwealth. Black (2005: 512) asserted that UK internal risk

management and risk-based regulation together formed a „new public risk management‟. In

later research Black (2006: 1) added that risk based frameworks were an attempt to define

acceptable/unacceptable „failures‟ and thus to define the parameters of blame, although her

view may fail the systemic risk test. She added (2006: 1,2) that risk-based frameworks, a

„newcomer‟ to the risk and regulation lexicon, and possibly pouring old wine into new

bottles, are themselves not risk-free, and in seeking to manage risks they inevitably introduce

their own. She concluded (2006: 2) that, “The aura of “risk-based regulation”.... combines a

sense of strategy and control in the face of uncertainty in a way that is politically

compelling”.

This time from the regulatory viewpoint, for Black (2005: 514) the rationales for a risk-based

regulatory approach included political and organisational pressures within regulatory

agencies, coupled with government efficiency demands, and especially cost-effective

regulatory implementation and resource deployment. She later explained (2006: 1) that risk-

regulation involved, “the development of decision-making frameworks and procedures to

prioritize regulatory activities, organized around an assessment of the risks that regulated

firms and others pose to the regulator‟s objectives”. She went on to describe this regulation

as „flexible‟, a move away from standardised rules to a form of targeted or tailored standard

setting to fit particular risks (2006: 4)..

Academic commentary geared towards the public interest concerning market failure includes

the pre-crisis Barth et al (2009: 27) categorisation of bankers as higher risk takers gaining on

the up and protected by limited liability on the downside. Gamble (2009:37) who warned that

in economic booms that both the calculation of risk changed, and that actors become

complacent and careless, coming to believe the boom will be endless. And post crisis,

Reinhart and Rogoff (2009: xxv, 171-172) who nailed the lie of man‟s inflated claims of

financially engineered tamed risk, or no risk, market control, and highlighted the necessity to

balance the risk and opportunities of debt.

The pure market view, which pre-dates all „newcomer‟ regulatory „risk‟ control, is

exemplified by Mallaby (2010: 77) who conceptualised financial markets as “...mechanisms

for matching people who want to avoid risk with people who get paid to take it on”; while

Foy (1998: xvii) expressed more conservatively, “finance is fundamentally a question of

analysing risk; and reducing risk”. This risk momentum pre-crisis was clearly financial

market led, resulting in the politically popular regulatory response, also partly market led.

New Risk Paradigm: Market Focus

Pre-crisis, Braithwaite and Drahos (2000: 102-103) highlighted from a market focus, the

growth of risk protection through the creation of derivatives which are effectively collateral

hedging contracts, purposed to protect the risk of currency fluctuation, share market fall or

price risk, and also the securitisation of loans otherwise known as the „contractualisation‟ of

risk, purposed to identify, separate and transfer risk to those in the best position to bear it,

both of which created tradable markets in risk.


14

In the decade after 1996 the financial industry entered a new risk paradigm, with low interest

rates, low volatility and high returns (Valencia 2010: 3). This new paradigm, Valencia (2010:

3) argued, hinged mainly upon three closely linked developments, the first two already

identified by Braithwaite and Drahos: 1) a huge growth in derivatives; 2) the decomposition

and distribution of credit risk through securitisation; and, 3) increasing risk management

reliance upon risk modelling based upon the combined power of mathematics and computer

technology.

Risk Modelling

Risk models, designed to ensure financial stability, are common to financial markets, while

regulators have followed the market lead in bank or credit agency securitised risk modelling

(Black 2010: 34). Credit, liquidity and operational risk are used to benchmark performance

(Simpson & Evans 2005). One of the most widely known models relates to capital adequacy

requirements for banks as set out in the Basel II Accords, where relying heavily upon banks‟

internal models „efficiency‟ was the focus, while in later Basel III reforms less reliance was

placed upon banks‟ own risk models and the focus was „robustness‟ (Valencia 2010: 3, 13).

In the EU the Capital Directive (CAD III) effectuated the Basel II reforms, which were

directed at operational risk, and widened them to include all credit institutions and investment

firms (Lastra 2004; Sheen 2005).

Two different modelling approaches, which originated from different sources, have been

adopted according to Black (2010: 34). Firstly, a statistical technique known as „Value at

Risk‟ (VAR) assessments, which assess the risk to the bank‟s proprietary trading portfolio,

and amount to an estimate of the worst possible monetary loss from a financial investment

over a future time period (Sollis 2009:1). They were developed by JP Morgan as a response

to the 1987 Stock Market crash, and nine years later added to the Basel Accords. Valencia

(2010: 3,5) asserted that this kind of modelling had its roots in academic work of the mid-

twentieth century, and especially in the mid-1970‟s when some in the Chicago „options pits‟

began using Fisher Black‟s model, while soon derivatives exchanges progressed to the Black-

Scholes model which used share and bond prices to calculate value; that the banks hired

phalanxes of highly educated „quants‟ to fine tune ever more complex models; and that the

increasing calibration of risk led many to turn debt into securities. Valencia described a false

sense of security which led on to ruin: “Regulators accepted this, arguing that the „great

moderation‟ had subdued macroeconomic dangers and that securitisation had chopped up

individual firm‟s risk into manageable lumps”. Unfortunately many VAR models, especially

standard ones, underestimated financial risk, especially rare or extreme event risk (Nielsson

2009; Sollis 2009).

Secondly, stress testing, which was primarily originated by regulators in the wake of the

LTCM hedge fund debacle in 1998, and which required banks to test their own models

against varied adverse market scenarios, and especially the statistically described „fat tail‟

rare occurrences, known to market insiders as (Nassim Nicholas) Taleb‟s Black Swans

(Black 2010: 34). Valencia (2010: 5-6) recorded critics describing default-probability models


15

as „the formula that killed Wall Street‟, and Taleb accusing that they increased risk exposure

rather than limited it; and then, while accepting that interest rates and foreign exchange

versions performed as required, the critics denounced pre-crisis debt market models as

abjectly failing to take account of low-probability but high-impact events such as huge falls

in house prices. Additional bad features included both heavy model dependence which

changed the very markets they were reading in a process known as counter-performativity,

and the similarity of risk models which negated diversification because too many others held

similar positions (Valencia 2010: 6).

Black (2010: 34) argued that banks were modelling uncertainty which by its nature was an

impossible task, such stress tests subject to the limitations of the modellers‟ imaginative

skills, experiences and quantitative skills limitations, as well as the potential chain of events,

and their impacts upon correlations between portfolio component values and different risk

„baskets‟ (credit, market, liquidity). In addition, she highlighted deficiencies which emerged

before and during the 07/09 crisis including „herding‟ where followers disastrously ape the

model of a perceived better, failing to adhere to maximised statistical confidence levels in

scenario analysis, excluding a sufficiently full range of potential events, and significant

incentive problems including moral hazard, all of which led to under-pricing risk. Goodhart

(2009:9) argued that Central Banks and international institutions prior to mid-2007 were

pointing to a serious under-pricing of risk, as financial institutions in the low interest market

sought to increase yield by moving into increasingly risky assets.

In Haldane‟s (2009) view stress testing didn‟t manage risks, it managed regulators. A good

example is unfortunately found in Ireland when former Irish Central Bank governor, John

Hurley, stated on the 11th

of October, 2007 (re-iterated as late as the 28th

February, 2008)

that,“ ...stress-testing of the banking system and....extensive financial stability analysis

indicates that Irish banks are solidly profitable and well-capitalised” (Carswell 26-05-10:

14). Rebonato of the Royal Bank of Scotland, as quoted by Valencia (2010: 6) explained that

stress tests were not a predictive tool but instead a means of considering possible outcomes to

prompt nimble reaction to unexpected developments, a rapid reaction also sadly lacking in

Ireland pre-crisis.

Bank Risk Modelling Responses

Banks post crisis have responded in a number of ways to these modelling problems (Valencia

2010: 6-7), and particularly by:

Introducing new and extra elements into VAR calculations, some expanding to

COVAR under the urging of regulators, capturing spill-over effects in troubled

markets such as losses due to the distress of others, or like Morgan Stanley moving to

their own „Stress‟ VAR which factors in very tight liquidity constraints.

Introducing „Reverse‟ Stress Testing: Some regulators, and in the UK it became

mandatory for banks, building societies and insurers to submit them as and from the

14th

December, 2010 , require banks to introduce „reverse‟ stress testing, which

requires the bank to assume a hypothetical collapse and then work backwards to

determine the culprit causes or vulnerabilities.

Removing or upgrading technology legacy systems that prevent or slow

communication.


16

Considering self-insurance by holding, as does JPMorgan Chase, a „model-

uncertainty reserve‟, in other words making provision in the good times for bad maths

mishaps.

UK and International Risk-Based Approach

In the UK, the FSA was formed in 1997, received full statutory power in 2001, was the

amalgamation of nine predecessors including the regulatory functions of the Bank of England

all of which utilised risk-based regulation, and was one of the first integrated regulators in the

world (Black 2005: 523). In 2001, as updated in 2003, the FSA in conjunction with its hybrid

approach, and updating the outmoded precedents as Black (2005: 523) has fully set out,

adopted an annually reviewed risk-based operating framework, known otherwise as risk-

based regulation. This used a set of strategic aims targeting achievement of statutory

objectives, designed to drive prioritisation and resource allocation for regulatory response at

four levels, the firm, consumer products, the market, and the wider industry, with financial

crime reduction and financial understanding especial contexts (Stewart 2005: 43-44; Black

2005: 528). Stewart (2005: 46) explained that the approach must, “identify the key risks and

ensure appropriate controls are adopted”, the key element being, “making the risk

assessment process transparent”.

The FSA, for instance, sought to protect consumers specifically in four risk areas (Gobert and

Punch 2003:313):-

Prudential Risk (investment failure due to bad management/financial collapse – the

focus is solvency, safety and soundness);

Bad Faith Risk ( fraud, misrepresentation etc);

Complexity/Unsuitability Risk (investment unsuited to needs/circumstances);

Performance Risk ( investment does not produce expected return).

Teuten (2007: 36) viewed the FSA approach as principles-based with risk as its key tenet, the

principles such as business integrity, fair treatment for consumers and adequate financial

resources, being objectives to be flexibly met by firms which may customise and innovate in

the most cost effective manner aligned to their own business strategy. He explained: “The

ultimate goal is to embed best risk management and compliance practices into the day-to-day

operation of the business in order to uphold the principles”.

Regulatory ideology moved compliance towards risk management practices not least because

Basel II defined legal risk as operational risk (Smith 2008: 484). The Basel Committee

incorporated into Basel II cross-border capital adequacy requirements supplemented by risk-

based supervision, early intervention and market discipline, as well as specifically

encouraging regulators to adopt a risk-based approach (Stewart 2005: 44). Similarly, EU

directive-based capital adequacy requirements, introduced by the Investment Services

Directive, were extended by the Markets in Financial Instruments Directive which became


17

effective on the 1st November, 2007 in relation to investment banks, portfolio managers,

stockbrokers and broker dealers, corporate finance firms, and some futures, options and

commodities firms; while the Solvency II directive 2009/138/EC, introduced quantitative

capital requirements for the insurance industry, in force 6th

January, 2010, and to be

implemented by 31st October, 2012 (Carney 2010).

New Irish Risk-Based Approach and Influences

Filling in the back-story, Honohan (2010: 64,66) revealed that in 2005 a formal risk-based

framework was adopted in Ireland, the system evaluating risk using factors such as

supervisory complexity, corporate governance, and business and reputational risk, based on

regular statistical reports supplied by regulatees. The rationale was to have a single cohesive

approach across all sectors. The framework was used to draw up a list of on-site inspections,

which however only amounted to once a year for large institutions, bi-annually for the next

level, and as resources permitted for the rest, due to „thin‟ staffing levels.

Post crisis, Elderfield, in March 2010, made it clear that, in his view that Ireland needed to

have a mixture of both principles-based and rules-based regulation, and to take an approach

rooted in a clear understanding of risk, “to be calibrated to the inherent risk and impact of a

particular firm or sector”. Cain (2010), referring to Elderfield‟s speech, described it as

„assertive risk-based regulation‟, which is more intrusive in the face of higher risk, needs a

credible method of enforcement, and has a strong emphasis on supervision.

Unfortunately as Ross and Hannan (2007) highlight in relation to money-laundering: “Risk is

sometimes referred to as a property that is inherent in places, people or products, sometimes

as an outcome of financial activity, and sometimes as a property of the regulatory regime

itself. Rarely, if ever, does legislation attempt to provide a definition of risk, and regulatory

agencies provide few explicit criteria that can be used to differentiate high risk from low

risk”. The definition of „risk‟ therefore is context specific.

Elderfield (29-03-10) himself highlighted the need, “to take a sceptical and challenging view

of a firm‟s internal risk management practices, including the use of internal models”, and

indicated that his staff under the new risk-based approach would, “be more challenging and

assertive where this is required”. This new rigour was amply demonstrated in relation to

Quinn Insurance when in March 2010, an application was successfully made to the Irish High

Court for the appointment of examiners, due to a deficiency in the insurer‟s solvency margin

which had been ongoing for over two years.

All of this amply demonstrates Black‟s (2010: 44) view that, “regulators are active in

constructing their own perception of their role, and their appropriate institutional position

vis a vis other actors in the regulatory system; not just firms, but other state and non-state

regulators”.

With reforming zeal for Ireland, regulatory supervision must be analytically linked to asset

and liability risk, including legal links between connected borrowers, economic links between

connected assets which may decline in value simultaneously, and funding short-fall risks


18

triggered by asset problems, argued Regling & Watson (2010: 43). A credit register, financial

stability analysis strongly integrated into supervision, a more confrontational risk analysis

culture especially at inter-agency level, and more intense and operational supervision at an

EU level are all tools recommended (Regling and Watson 2010: 43-44).

In the UK, where regulator resources were directed at the major risks and opportunities

(Sergeant 2002), the effectiveness of the system depended upon agreement with the regulator

about identifying risks to control, and the manner of such control, while the key need for

those regulated was to ascertain and understand the regulator‟s risk assessment of their

individual firm (Stewart 2005: 45). For example, the overriding consideration for the FSA in

any enforcement decision concerning alleged money laundering, where preventive effort

must be proportionate to the risk, was whether a firm had implemented an effective control

structure that identified and mitigated its own particular money laundering risk (Proctor 2005:

14; Ross & Hannan 2007). In addition, in terms of capital allocation to identified risk for

instance, the monitoring was on a real-time basis, the rationale being that risk is constantly

changing (Teuten 2007: 37).

Modern financial risk management must be rooted in three concepts, argued Lang and

Jagtiani (2010: 132). Firms must:

Account for unexpected losses as well as accurately measuring expected losses;

View risk from a portfolio perspective, taking into account correlations among assets,

implying concerns for concentrated exposures to common risk factors , a view shared

by Regling and Watson (2010: 43);

Develop measures of tail risk for assessing capital needs (as already identified).

Elderfield confirmed and fleshed out his vision for Ireland, when warning in May, 2010, of resource

gaps in the regulators office before promoting new limits on the number of directorships which

bank and insurance board members may hold, and the prevention of CEO‟s becoming board

chairpersons (Carswell 11-05-10). In addition on the following day, new rigorous proposals to set

standards for insurers selling variable pension annuities which paid guaranteed returns over

extended periods were outlined by Elderfield‟s assistant, as well as proposals for new public

disclosure regulations to force insurers to be open, frank and up front in describing their

business, and their risks, performance and financial position (Carswell 11-05-10). Two days

later, on the 13th

May,2010, Elderfield himself informed a Joint Oireachtas Committee that he

proposed, “clear and enforceable” stringent new rules curbing lending by banks and building

societies to directors, senior managers, related parties and shareholders, designed to prevent

abuse and conflict of interest (Carswell 14-05-10). Within a month Elderfield (09-06-10)

speaking to the funds industry, highlighted that risk management standards and controls had

eroded on the watch of unvigilant boards, but advocated a „proportionate‟ approach to

corporate governance standards, eschewing a „one-size-fits-all‟ model, and applying different


19

criteria to the different risk profiles as between banking/insurance and funds. In the case of

funds the industry itself was invited to propose its own corporate governance code.

Two weeks later, in a major clarification, a new strategy upon banking supervision was

announced, which clearly reflects Black‟s (2006) flexible move to targeting, when four in-

depth review actions upon „supervisory themes‟ were planned, the results of which were to be

published at different future target dates, the themes being: (i) governance and risk

management at major retail banks; (ii) lending standards; (iii) the quality of banks‟ strategies;

and, (iv) remuneration practices (McMahon 21-06-10). Simultaneous to this announcement

the Regulator‟s office clarified that its risk model was the engine of its supervisory strategy

and that institutions of highest risk would primarily be targeted (Brady 21-06-10). In a speech

to the industry, assistant director general for policy and risk Patrick Brady (21-06-10)

outlined, mirroring the UK FSA approach (Black 2005: 533): “Risk will be assessed on a

number of parameters. For example, impact, inherent risk, probability. Within a risk

framework, companies will be assessed as high risk, medium high, medium low and low”. A

scorecard, which would be shared with each regulatee, was to be kept with „behaviour‟ a

significant part of the calculation. It was planned to capture a range of quantitative and

qualitative aspects, the quantitative indicators including, “level and quality of capital,

funding, liquidity, size of deposits, the nature, scope and extent of lending and so on”; while

the qualitative included, “corporate and internal governance, quality and experience of staff,

business strategies, remuneration policies etc.”. It is unclear as yet to what extent, if any, the

approach will amount to „meta-regulation‟ i.e. relying upon internal controls. The qualitative

additions are a step beyond the Black (2005) identified FSA practice. Brady (21-06-10)

concluded, “In relation to risk, what we need assurance on is that, at board level and

throughout your organisations, risk is identified, monitored, managed and mitigated.

Business decisions must be properly assessed and informed”. This approach appears firm-

and-industry-centric and, thus open to the criticism that trends may not be spotted (Black

2005), or may possibly fail the new systemic risk „buzz-concept‟. In a very clear statement of

regulatory approach, far from the former „retreatist‟ enforcement style, and harking back to

Smith‟s principles-led definition, Brady announced, “a paradigm shift in our regulatory

approach. Our supervisory strategy will be outcome focused, demanding decisive follow-

through by both supervisory staff and supervised institutions”.

And again within days in June, 2010, the Irish regulator‟s office proposed new rules to force

financial advisors and sales staff to undertake 15 hours of professional development training

annually (and to keep reporting records of it), and also proposed rules to phase out

„grandfathering‟ were announced (Carswell 01-07-10: 21). A new assertive Irish regulator

had clearly arrived, and seemingly grounded in a new political will.

On the Irish political front, also on the 13th May, 2010, and presaging some of the above

announcements, Irish Taoiseach Brian Cowen TD stated:

“There is a need for much more intensive and risk-based supervision of financial

institutions ......There is also a need for a radical change in culture in Irish banks.

Regulation, and legislation underpinned by the gardai and other regulatory agencies,

must effectively police this on an ongoing basis (Cowen 2010).


20

This latter theme was taken up by the Irish DPP James Hamilton who was reported six days

later, to have stated that a regime of serious financial regulation must include the ability to

prosecute those infringing (Coulter 19-05-10). It is unknown how the gardai reacted to being

categorised as a ‟regulatory‟ agency by the Taoiseach!

Concerning risk-based approaches generally, and equally applicable to the new Irish

approach at least operationally, Black (2005: 542-543) identified a „four risks to the risks‟

paradox: (1) implementation risk; (2) model or design risk; (3) cultural or perception risk; (4)

„process-induced myopia‟. It remains to be seen if any, or to what degree if any, prove

relevant to the new Irish experience.

For the UK specifically even pre-crisis, identified risk-based approach drawbacks included:

public perception of its performance at both retail and governmental level, a possible failure

to identify and/or control a significant risk, and potential resource allocation gaps (Stewart

2005: 45). To counter problems the FSA emphasised both transparency and making the

process public for instance, by regular updates, the publication of its risk-rating process for

individual firms, the individual provision of a risk assessment, and the supply of a risk

mitigation programme (Stewart 2005: 46; Smith 2008: 486). On the micro level, financial

firms must have effective internal controls, accurate and timely financial and risk reporting

procedures to the correct management level, and a corporate-wide view of risk or an

enterprise-wide risk management programme argued Lang & Jagtiani (2010: 141).

Wider afield, and an area Ireland may not be big enough to influence heavily, Valencia

(2010: 5) asserted that regulators generally were inching towards a more „systemic‟ risk

approach discussed more fully below, that banks must find a better balance between the

mathematical numbers and „gut feeling‟, and additionally that, “rules will have to be both

tightened and better enforced to avoid future crises – but that all the reforms in the world will

never guarantee total safety”.

In a general survey in February, 2010, Bloomberg were quoted as counting fifty bills and

other serious proposals for financial reform in the US and Europe alone (Valencia2010: 15).

Regulators were recognised as having both blind spots and vulnerabilities to those they

police, as evidenced by the asset-backed mortgage fiasco. One suggestion for „players‟ was

new rules combating incentives for excessive risk taking in the private sector, since human

behaviour required more focus than financial instruments. Short-term pay incentives required

longer term alignment and no relation to leverage, while in securitisation originators must be

more transparent and disclose more detail about loan pools and also hold a slice of the

product risk (Valencia 2010: 15-16). Risk around credit rating agencies is a matter for

discussion elsewhere, but was addressed by both the EU and Dodd-Frank (see below), while

regulatory default has been highlighted throughout.

Valencia (2010: 16) concluded with a warning: “Post-crisis regulation has a long history of

unintended consequences.......Another danger is the pricing of risk by regulation, not

markets......After every crisis bankers and investors tend to forget that it is their duty to be

sceptical, not optimistic. In finance the gods will always find a way to strike back”.


21

General Bank Risk Reforms

The Economist (13-02-10: 11-12) asserted that in the financial industry the balance of power

had shifted back to those who police risk takers. The highly influential magazine suggests

that chief risk officers must be appointed, or where so appointed, must be fully empowered;

traders must prove their case if they disagree with risk managers; boards must monitor risk

better, have more experience and expertise, be slimmed down in numbers, and directors must

attend more meetings; bank bosses must set a corporate risk tone or culture that encourages

flagging potential problems; and, approved a healthy scepticism of mathematical risk models

and metrics which should be supplemented by stress tests and scenario planning.

Valencia (2010: 9-10) identified a number of other practical and important bank reforms

which affect risk management:

Combine market and credit risk groups as HSBC did in 2009;

Change the culture by instilling a tradition of asking and repeating questions until

clarity emerges;

Establish new independent risk committees as UBS has done;

Boards must define the parameters of risk oversight and better police risk adjustment

in allocating capital internally;

Re-think pay structures for investment bankers and top executives, an issue upon

which a number of governments intervened, even if only temporarily.

In May, 2010 new EU Commission governance reform plans were announced, including the

restriction of the right of bank directors to sit on the boards of other companies, limitations on

the time any individual may spend on a board, and the reining in of pay structures which

reward excessive risk taking (Beesley 29-05-10).

Regulators‟ Risk Reforms

Apart from the stress testing reforms already mentioned, ECB president Jean-Claude Trichet

in November, 2009 highlighted three connected response areas for global regulators

(Valencia 2010: 11) :-

1. Firms regarded as Too-Big-to-Fail:

The focus here is to reduce the risk to market stability. Systemically important giant

institutions are the main risk, and during the 07/09 crisis forced government intervention.

Some of the stop-gap steps made the situation worse by shot-gun conglomeration takeovers

of sickly rivals, for instance, the Bear Stearns takeover. To illustrate this point, The

Economist special report on financial risk, published 13th

February, 2010 on page 13,

depicted the top five global banks in graph form post crisis as increasing their assets as a

percentage of the industry total by approximately 33%!


22

Problem solving centres either on reducing size, for instance, by shrinking the giants or by

erecting internal barriers or firewalls, or else by focusing on potential failures by increasing

capital adequacy requirements or making special provision to wind down the „collapsers‟.

In July 2009 the EU Commission laid down a number of principles to govern the

restructuring of banks left struggling by the credit crisis and these included measures to limit

distortions on competition ( Hennessy 6-11-09 : 5).

Mervyn King, Governor of the Bank of England, on the 20th

of October 2009 called for banks

to be split into separate utility companies and risky ventures saying it was a delusion to think

tougher regulation would prevent future financial crises (21-10-09: 19). He was also

reported as stating that regulation is not enough to keep banks from becoming too important

to fail, that moral hazard is endemic and that banks should be split up (24-10-09: 41).

Professor Nouriel Roubini, aka „Dr Doom‟, of New York University, echoing the King

viewpoint, stated at the inaugural International Financial Services Summit in Dublin on the

5th

of November, 2009, that if a financial institution is too big to fail, it is too big, and if it is

too big it should be broken up ( Kavanagh 06-11-09: 2 ). He also warned that bigger banking

„monsters‟ had been created through the crisis management mergers as already illustrated,

thus worsening the problem. He advocated the disassociation of public utility banking

(commercial banking) from investment banking.

Mallaby (2010) argued both for a concerted effort to drive financial risk into institutions that

impose fewer costs on taxpayers by encouraging the proliferation of firms that are not too-

big-to-fail, and by favouring institutions where incentives to control risk are relatively strong

and perhaps where regulatory scrutiny assumes less of the burden. He asserted that the “key

question about the future of finance” was “How can governments promote small-enough-to-

fail institutions that manage risk well?” and answered, “Governments must encourage hedge

funds” (2010: 380).

Early examples of action occurred in November 2009, when then EU competition

commissioner Nellie Kroes insisted that Royal Bank of Scotland and Lloyds sell assets,

effectively to part with its Churchill and Direct Line insurance unit, while the UK Financial

Services Authority (FSA) indicated they must in future hold nearly 10% of tier one capital

namely four times what was required before the global crash (Hennessy 06-11-09: 5). Also,

under EU pressure Dutch bank ING agreed both to divide its banking and insurance

businesses by selling online bank ING Direct, and to pay the Dutch Government extra fees

(Hennessy 06-11-09: 5).

US President Barack Obama, during the tortuous Dodd-Frank wrangling, in January, 2010,

unveiled two initiatives:

(a) A Tobin type tax on bank activities. The late economist James Tobin first mooted his levy or

tax idea in 1972 in relation to currency exchange, as a way of making short-term speculative

trading less profitable. The concept had been taken up in September, 2009 by Lord Turner


23

head of the FSA, and advocated by former UK Prime Minister, Gordon Brown, while

European leaders such as Sarkozy and Merkel and US economic adviser Larry Summers

were also early supporters (Gibbons 2009); while on the 26th

May, 2010 the EU Commission

also proposed a new bank levy joining the IMF and governments in Europe and America

(The Economist, 29-05-10: 77). However, as a result of successful lobbying, at the last minute the

$19 billion levy on large banks provision was stripped out of the Dodd-Frank Wall Street Reform and

Consumer Protection Act 2010 when passed in July 2010 (The Economist 3-07-10: 61).

And,

(b) The „Volcker Rule‟, subsequently watered down in the Dodd-Frank reform, which proposed

limiting bank size and activities, by banning deposit-takers from proprietary trading in capital

markets and from investing in hedge funds and private equity, and which plan received a

cautious welcome from the Basel-based Financial Stability Board (FSB) on the basis it would

be combined with tougher capital standards and other measures (Valencia 2010: 12-13).

These other measures must include the treatment of lenders, depositors, bond-holders and

taxpayers, all matters of great interest in Ireland especially in the wake of NAMA, the Irish

bad bank.

Counter-party trading exposures, which normally if uncollateralised are at the bottom of the

creditors pay-out pile, and which in the US received favourable treatment in the troubled

banks and AIG in 2008, and which have been protected to date by credit-default-swap

buying which were state underwritten, however remained undealt with (Valencia 2010: 13).

For the US, the Volcker Plan was seen as supplementing other proposals, the most important

of which was improved „resolution‟ mechanisms for failed giants, because standard

bankruptcy rules were too slow for financial firms where value evaporates rapidly (Valencia

2010: 13). The US approach was for regulators to seize and wind down the failures, although

obvious down-sides included both convincing the markets that these measures were not

another form of life-support, and the absence of an international agreement on handling

cross-border firms, for instance Lehman Brothers, which had almost 3,000 legal entities in

dozens of countries (Valencia 2010: 13).

2. Overhauling Capital Requirements:

The focus here is to ensure that banks have adequate capital cushions against losses. In a

graph re-published in The Economist special report on financial risk, of the 13th

February,

2010 at page 14, Haldane and Alessandri of the Bank for International Settlements, showed in

a comparison between the USA and Britain that the cushion became more „threadbare‟ over

th period of a century, from an approximate high in 1880 for the US of 24% and Britain 17%,

dropping through two world wars and intervening events to 1995, for the US 7.5% and

Britain 4%. Pre-crisis, banks held mainly common equity of as little as 2% of risk-weighted

assets, with markets post crisis demanding that banks hold four or five times such levels,

while regulators encouraged the introduction of convertible capital in the form of „contingent‟

bonds that automatically convert into common shares at times of stress (Valencia 2010: 13).


24

Strengthening capital buffers, which are at the heart of reconciling the pull between cheap

and efficient credit and bank stability, may take different forms. Different national

approaches include a punitive capital surcharge, sectoral variations may enable regulators to

influence marginal costs of lending to riskier segments, or be related to the individual

lender‟s contribution to systemic risk based upon its size, complexity and the extent of

connections to other financial firms (Valencia 2010: 13). Contrasting examples include

Switzerland where the cash and equivalents cushion is 45% of deposits, and the UK where up

to 8% of banks‟ assets could be tied up in cash and guilts. In addition, the composition of

liquidity cushions has caused controversy with some desiring to restrict these to government

debt, deposits with central banks and the like, while others like the Basel Committee wanted

to include high-grade corporate bonds (Valencia 2010: 11). The Economist asserted that it

was vital that banks carried bigger safety buffers of capital and liquid assets and highlighted

that the job of ensuring this had been „outsourced‟ to the Basel club of regulators (The

Economist 29-05-10: 11).

Upon the global level, the Basel Committee of central banks and supervisors from twenty-

seven countries in December, 2009 proposed a two component global liquidity standard for

internationally active banks, effective 2012-2013, dubbed Basel III, which predictably

garnered feisty bank opposition (Valencia 2010: 11, 13-14; The Economist 29-05-10):-

(a) A „coverage‟ ratio, designed to cover a one month period of acute stress like a sharp ratings

downgrade and a wave of collateral calls, by having a large enough pool of high quality

liquid assets; and,

(b) A „net stable funding‟ ratio, designed to cover a year or more, and aimed at promoting

longer-term financing of assets with a view to limiting maturity mismatches. One

commentator, Credit Suisse was quoted as reckoning that this proposal would require

European banks alone to raise €1.3 trillion of long-term funding (The Economist 29-05-10).

In June, 2010 the G-20 group of countries meeting in Busan, South Korea, as represented by

their finance ministers and central bank governors, was reported as having „big differences‟

in relation to implementing Basel III reforms regarding the capital, leverage and liquidity

reforms which had been agreed in 2009, and which were due for implementation in

November, 2010. Disagreements were reported over the scale, scope and timing of increases

in capital and liquidity requirements for banks, as well as leverage allowable (Reuters 05-06-

10).

3. Improving Macro-prudential Regulation:

The focus is a system-wide approach in terms of overhauling day-to-day supervision in

conjunction with taking account of collective financial behaviour and contagion effects, while

in the US and Europe regulators have introduced pay comparisons, stepped up lending

standards, and introduced peer review (Valencia 2010: 14). The US SEC established a new

risk division with new oversight duties to include the scanning of derivatives markets, hedge

funds and the like for any emerging threats to stability (Valencia 2010: 14). The Dodd-Frank

reform inter alia provided for regulation of advisers to hedge funds, as already mentioned

limited bank involvement with hedge funds and proprietary trading under the Volcker rule,

imposed counter-cyclical institutional capital requirements, regulated OTC swaps markets,


25

empowered the SEC to impose „point-of-sale‟ disclosure rules, imposed obligations regarding

executive remuneration and corporate governance, and allowed for regulation of credit

ratings agencies. Directly applicable EU Regulation1060/2009, effective 7th

December, 2010,

stipulated licensing of such ratings agencies, which must be IOSCO rule compliant, on the

„passport‟ system, with the CESR facilitating co-operation and co-ordination among member

states.

However, there is no global agreement as to how systemic regulation will or should work, or

who the regulator(s) should be. While central banks are mooted by some, there are political

obstacles particularly in the US, with international co-ordination equally tricky, the already

mentioned FSB recommending colleges of supervisors to regulate thirty of the largest banks

and insurers for cross-border scrutiny (Valencia 2010: 14). The EU has its own systemic-risk

council (see below), while private sector groups are vocally active. In the US Dodd-Frank

provided for a Financial Stability Oversight Council comprising ten voting members charged,

inter alia, with identifying risks to US financial stability, promoting market discipline, and

responding to emerging financial threats.

Some critique that the creation of an official global systemic regulator may only provide false

comfort, and suggest an independent body staffed by economic expertise to provide

institutional memory of past crises, with a brief beyond reactively setting rules post event

(Valencia 2010: 15). Such a body may deal with cross border capital flows, co-ordinate

regulation, and assist in dealing with political pressures where the looming next election may

stall corrective intervention (Reinhart & Rogoff 2009: 282). Some recommend the IMF as

international watchdog but highlight impartiality and governance reform issues (Gros et al

2009). This of course, will prove more problematic in the wake of many governments

themselves becoming market „players‟ as well as referees (Valencia 2010: 15).

Another very tricky task is how to deal with asset-priced bubbles. Pre-crisis the US under

Greenspan adopted a wait-and –see approach where the focus was aftermath clean-up,

whereas the Bernanke post crisis view was geared more towards intervention via regulation

or even by the use of monetary policy, Valencia argued (2010: 14). Noises from Ireland

made it quite clear that previous regulators regret not intervening in the growing Irish bubble

(Carswell 26-05-10). Valencia (2010: 14) quoted former US Federal Reserve governor

Mishkin, now of Columbia University, who, contrasting the more dangerous credit-boom

bubbles with irrational stock-market exuberance, suggested that in the former that pre-

emptive action is more warranted because the bubble is accompanied by a cycle of leveraging

against rising asset values. One possible approach is for regulatory action where credit and

asset prices grow above average rates (Valencia 2010: 15), but not alone does this penalise

flexibility, it means the intervention can only occur at national economic level, an occurrence

likely to be heavily influenced by domestic political issues.

In Ireland the institutional reform approach has been legislative change with the first of three

bills introduced in April 2010, the establishment of a new Banking Commission, and the

separate Financial Regulator has been restored to the aegis of the Central Bank, while the

Minister for Finance, claiming both international and market approval declared, “..... the new

fully integrated structure”, will upon further legislative change, “enhance the powers and

functions of the new restructured Central Bank in relation to: the prudential supervision of


26

individual financial institutions; the conduct of business, including the protection of

consumer interest and the overall stability of the financial system”( O‟Halloran 21-04-10).

US Reforms

Objectives-based Approach

Mid-crisis, Henry „Hank‟ Paulson recommended a fourth regulatory approach, the

„Objectives-Based‟ approach, which resonating heavily with the risk-based approach already

discussed, and reflecting Smith‟s (2008: 481) view of the principles-led approach where

goals and outcomes are central, and Ford‟s (2008: 3) „outcome-oriented‟ Canadian regulatory

practice, advocated the use of three distinct regulators, and eschewed a specific industry

focus (The Paulson Report 2008: 13-14). The US Department of the Treasury report or

„blueprint‟stated the objectives-based approach was particularly focused on potential market

failures and incorporated three key goals:

• Market stability regulation to address overall conditions of financial market stability that

could impact the real economy. A second US view this time post-crisis, and outside the

report, from Acharya et al b (2009:283) complained that, “Current financial regulations seek

to limit each institution‟s risk (for example, market and credit risk) seen in isolation; they are

not sufficiently focused on systemic risk”. In Europe the De Larosiere Report was

commissioned with a view to examining the nature and magnitude of systemic risks, and how

a co-ordinating authority with prudential regulation and emergency powers could counteract

them (Donnolly 2010), and it was recommended that an additional constitutional layer, a

supranational systemic early warning council be established to deal with identified

decentralisation and fragmentation problems. Dodd-Frank reforms along similar lines have

already been and will be further highlighted below.

• Prudential financial regulation to address issues of limited market discipline caused by

government guarantees; and

• Business conduct regulation (linked to consumer protection regulation) to address standards

for business practices. Interestingly Goodhart (2009: 56) from the UK perspective opined that

the bulk of the work of a primarily supervisory body like the FSA, involved conduct of

business issues, with the dominant staff professions being lawyers and accountants.

Highlighting regulatory fragmentation in the US, the Paulson report claimed that a major

advantage of objectives-based regulation was that regulatory responsibilities were

consolidated in single regulatory areas where natural synergies take place, as opposed to

dividing them among individual regulators. Other advantages included: being better able to

adjust to changes in the financial landscape; providing a clearer focus on particular goals; and

establishing the greatest levels of market discipline by clearly targeting institutions by type.

However, when the proposal is investigated it reveals similar fragmentation minus overlap. In

addition to the three distinct regulators, each covering one of the key goal areas, the report

claimed that two other key authorities, a federal insurance guarantor and a corporate finance


27

regulator, would be required. In addition a structure apparently rationalising the „chartering‟

of financial institutions was advocated with the establishment of three separate institutions.

Dodd-Frank opted for many new regulators for specific areas as detailed below, continuing

the US fragmentation model identified post-Depression by Braithwaite and Drahos.

Dodd-Frank

The US Dodd-Frank Wall Street Reform and Consumer Protection Act 2010 which was

passed in July 2010 after enduring a twenty-two month, separate and then joint, Senate and

Congress rite of passage, may be characterised as a legislative leviathan comprising a series

of sub-topic pieces of legislation synergised into one great whole. Described as the most

sweeping change to US financial regulation since the Depression and a paradigm shift

affecting all financial regulatory agencies, it made changes in four key areas: (a) regulatory

oversight, establishing many new agencies; (b) derivatives, and especially accountability and

transparency; (c) dealing with troubled banks felt too big to fail, focused upon no more

taxpayer bail-outs; and (d) consumer protection. The impact of the legislation will largely

depend upon the way the regulators, namely the Federal Reserve and the newly established

consumer agency, enforce its provisions The Economist asserted (03-07-10: 10).

Regarded as too American to be a good template for elsewhere, Dodd-Frank is riddled with

“messy compromises”, the new law handing a great deal of discretion to regulators with

much of the text a mere template, while capital rule-making has been outsourced to

international bodies, The Economist critiqued (The Economist 03-07-10: 62, 64). One leading

US law firm, Davis Polk & Wardwell, estimated that the 2,300 page act required regulators to

enact 243 new rules, conduct 67 studies, and issue 22 periodic reports. Altering existing

regulatory structure, in addition to removing or merging some agencies, many new

institutional regulatory agencies and innovations were introduced – effectively, an

institutions, rules and tools reform- including (The Economist 03-07-10: 62):-

Establishing the Bureau of Consumer Financial Protection with broad powers to write

rules and ban financial products;

Establishing a resolution authority which extends to non-bank financial firms;

The resolution mechanism extends regulators‟ powers to force losses on creditors as

well as shareholders and requires healthy financial firms to cover the cost of winding

up collapsed rivals;

„Standardised‟ derivatives must be routed through clearing houses and traded on

exchanges, with higher capital charges for customised contracts;

Hedge funds and private equity funds overseeing $150 million or more in capital must

register with the SEC and give information about their trades and portfolios;

Establishing the already mentioned systemic-risk oversight council, comprising the

US Treasury, federal regulatory agencies and an independent member;

Establishing the office of the Director of Financial Research, charged to report

annually only to Senate and Congress, about inter alia potential emerging financial

threats;


28

Establishing the Office of the Investor Advocate, an advisory committee, and an

ombudsman, all aimed at stifling regulator „capture‟;

Expanding FDIC powers to wind up bankrupt financial companies;

Establishing within the Department of the Treasury a Federal Insurance Office to

monitor the insurance industry;

Providing for rules obliging asset-backed securitisers to retain an economic interest in

the credit risk, and inter alia to meet disclosure requirements;

Requiring every three years for shareholder approval of executive remuneration in

public companies.

Paradigm: Changes and Shift

Different jurisdictions have taken the regulatory change lead from time to time. For instance,

Ireland followed the UK hybrid approach, and the disclosure of individual firm risk

evaluations to regulatees; the UK first mooted the Tobin tax, the EU led the US on regulating

credit rating agencies and the systemic risk council, while the US led on hedge funds as the

EU lagged.

When reviewing the Irish regulatory paradigm shift, the shift stretches the old British model

towards the new principles/rules/risk hybrid which the UK attained pre-crisis. The US shift

amounts to an institutional shift, with new rules and tools, where their eighty year old rules-

based model has moved towards a rules, principles and risk based approach. Accordingly

across the Irish, UK, and US regulatory approaches, and even the EU „sit-above‟ government

model, there is a convergence towards risk. This is conceptualised in the figure below.

Figure: Regulatory Approaches: Pre to Post Crisis Paradigm Shift Conceptualisation (Elder 2010)

Sources include Braithwaite & Drahos (2000); Gadinis & Jackson (2007); Ford (2008); Black (2008).

1930’s British Converge Risk 1930’s USA

Rules

Hybrid

Pr Risk Ru

Soft Hard

Principles

Hard Soft

EU Govt Model: shift Pr to Rk

UK Hybrid

USA (Canada) shift to Pr and Rk

IRL Pr shift to hybrid


29

Conclusion

The new Irish financial regulatory paradigm which awaits implementation, continues to be

institutionalised although in a changed format, is principled in that it still relies partly upon

principles which are still however non-statutory and un-codified, is rules attentive, and

especially flexibly targeted risk-centric, is legally underpinned institutionally by legislation

both EU and domestic, while impactors such as the move to regulatory liberalism, a newly

appointed uncaptured and assertive regulator, and new regulatory issues are lurking at

paradigm margins or influencing the birth into strategy. Regulatory approach continues to be

key to regulation, monitoring and supervision, including the enforcement sub-set. Worldwide,

this paper reveals a fragmented, disjointed and confusing array of opinion as to regulatory

approaches, and an equally bewildering array of reform proposals especially tailored toward

„risk‟, the definition of which is context specific No institutionalised global regulatory

structure exists. Regulatory „outsourcing‟ is evident. No single jurisdiction has taken the

outright regulatory change lead. The EU has approached issues on a piece-meal basis. The

US, continuing their fragmentation model, has embarked upon a mammoth institutional, rules

and tools overhaul which will take time to assimilate. The UK position awaits further

political input. The regulation of financial services remains, indeed, as Black asserted, full of

“contingency, complexity, dynamic adaptability, and unpredictability”.

Addenda

1. Bank stress tests carried out May/June 2010 and see results in July 2010?

See computer file Irish times extracts, EU, bank stress tests.

2. NESC report July 2010 released August 2010. Recognised need for

enhanced domestic, EU and global financial regulation.

3. Herman Van Rompuy task force established March 2010 by the European

Council ECOFIN to examine EU economic governance; exploring for the

Euro area improvement of economic policy surveillance and co-

ordination; waiting for report. Report due out October 2010.

4. The European Commission’s Communication of 12 May 2010, ‘Reinforcing Economic Policy Co-ordination’; further development of these proposals is provided in a subsequent European Commission Communication of 30 June 2010. It was agreed to strengthen the rules on budgetary discipline. From 2011 onwards,

Stability/Convergence Programmes16 will be presented in spring. This will include advance

presentation of key budgetary parameters for the next budget, „taking account of national budgetary

procedures‟ (European Council, 2010: 5)17. It was also agreed to review the sanctions in the SGP

(stability and growth pact) and to ensure that all member states have budgetary rules and medium

term budgetary frameworks in line with the SGP. Broader macroeconomic surveillance (beyond


30

budgetary matters) is to be improved. A new scorecard is to be developed to this end, with a view to

early detection of unsustainable trends along with an effective surveillance framework.

5. On the 26th August 2010 the US CFTC sought comment upon rules for OTC derivatives. It

acknowledged that it had identified under Dodd-Frank 30 areas in which rule-making will be

necessary. This included three enforcement areas: whistle-blowing, anti-manipulation, and

disruptive trading practises. See the sanctions file CFTC sub-file for more info.

6. Re page 3 and Irish economy. Late August 2010 Irish ten-year bond spread increased to 347

basis points over German rate; on 7th September it was 375 basis points above. 347 figure

occurred after S&P again downgraded Ireland. (17-09-10 interest rate rose to a record 6.3% at

day‟s end...spread probably about 4000 basis points above Germany!). Also as of 2/9/10 the

Irish Times was recording Irish unemployment at 13.7% end of July 2010 and 13.8% end of

August 2010, with 455,000 on the live register, with Dan O‟Brien suggesting Irish economic

data point to stagnation see Irish Economy paper file).

7. On 2nd

September 2010 (see Euractiv file) following on from proposals made as far back as

June 2009, the EU (reps from Council, Parliament and Commission) established a new

financial architecture. Three new watchdogs (EBA-banking based in London, EIOPA-

insurance & occupational pensions based in Frankfurt, and ESMA-securities & markets based

in Paris) supplement the European Systemic Risk Board ( ESRB) which will be chaired by

the ECB President, with powers to over-rule national bodies under three scenarios: (i) when

the national supervisor is in breach of EU law, (ii) when there is a disagreement between two

or more national supervisors and (iii) when an emergency has been called by member states(

Council define „emergency‟). Final approval will come from finance ministers on 7th Sept 10

and by the Parliament during plenary sessions on 20-23 Sept 10.

8. Beesley, Arthur, “EU continues quest for deal to strengthen economic system”, Irish Times, 6th Septmber, 2010: May 2010 due to sovereign debt crisis in Greece, the creation of a €750 billion EU/IMF rescue net for struggling euro zone members eased the sovereign debt crisis in the single currency area; Van Rompuy has been trying to get agreement upon tougher rules in the EU re national budgets, as Merkel wants member states in default of EU budget rules to be denied voting rights; most EU governments favour sanctions ( eg not receive structural funds; automatic/discretionary imposition) to help relieve the revealed systemic weakness in the Euro, and Van Rompuy is to make proposals while the EU economics commissioner Olli Rehn is set to produce a definitive set of proposals on sanctions on September 29th, 2010.

9. Irish Times 6th Septmber, 2010, editorial: THE NUMBER of residential mortgage holders who are more than 90 days in arrears on their loan repayments continues to rise. Figures from the Central Bank and the Financial Regulator for the second quarter to June 2010 show that one in every 20 mortgages are in some difficulty: 36,348 were in arrears out of the 789,814 mortgage loans outstanding. The Central Bank data may well understate the problem as the collection of mortgage arrears statistics only began a year ago (2009).

10. USA Dodd-Frank signed 21st July 2010 and by 20

th August 2010 the CFTC was holding a

roundtable discussion concerning rules re derivatives. See computer file re CFTC and look for

drop-down from their website August 2010.


31

11. EU governance model note re the Helm quote p1 : Moloney (2008: 37) described EU

securities regulation as, “the zenith of the Community method....the triumph of the

command-and-control model for intervention”.

Source: Moloney, Niamh, EC Securities Regulation, 2nd

edition, 2008, Oxford

University Press.

12. Source: Konzelmann Sue, Wilkinson, Frank, Forargue-Davies, Marc, and Sankey,

Duncan, “Governance, regulation and financial market instability: the implications for

policy”, Cambridge Journal of Economics, 34(5), September, 2010, p929-952.

“Both Wall Street and London‟s Square Mile acquired and built their

influence as a result of „light touch‟ regulation-resulting in what is known

in The City as the „Wimbledon Effect‟: a great British tradition but

almost all the players are foreign. Initially attracted by the lack of

regulation, they would be likely to move on, should London tighten

regulation independently. The same would also apply to New York or any

other financial centre. Regulatory arbitrage thus necessitates a globally

enforceable set of rules. The over-reliance of post-industrial economies,

such as Britain and America, on the financial sector underscores the

imperative of such a system and the ineffectuality of independent national regulation”. (p 952)

13. Basle II reforms announced 12th

September 2010. See Irish Times 13th

Sept 2010 “Banks must bolster reserves”.

The reform package, known as Basel III, includes a new minimum core tier one ratio

for banks worldwide. This vital measure of bank safety compares a bank‟s equity plus

retained earnings with assets, adjusted by their riskiness. The current minimum is 2

per cent.

Banks in Europe are most likely to need to raise funds, notable in Germany, Spain and

other weak spots.

The Basel group, which announced details of the deal late yesterday, has set the new

minimum at 4.5 per cent and added, for the first time, an additional buffer of 2.5 per cent,

making the total 7 per cent. Banks within the buffer zone will face restrictions on their

ability to pay dividends and discretionary bonuses.

Although a solid group of countries agreed on the 7 per cent figure at a preliminary

meeting earlier in the week, some countries had wanted minimums as low as 4 per cent

and others as high as 10 per cent.


32

The Basel group also announced that the new rules should be gradually implemented from

2013 to the end of 2018.

The reform package not only requires more capital but also tightens the definition of what

counts toward core tier one capital.

The Irish Times 14th

Sept 2010 article” Top bankers braced for tougher capital

requirements” by BROOKE MASTERS, JENNIFER HUGHES and NIKKI TAIT contained the

following:

LEADING BANKERS in Britain, the US and Switzerland are prepared for national

regulators to impose tougher capital requirements than those required by last Sunday‟s global

agreement, even as investors bid up bank shares on relief that the standards were not more

rigorous.

The 27 member countries of the Basel Committee on Banking Supervision agreed on Sunday

that banks will in effect be required to triple core tier one capital ratios from 2 per cent to 7

per cent by 2019. This ratio measures the buffer of highest-quality assets that banks hold

against future losses. The agreement was hailed by regulators and industry groups as a vital

step that would go a long way towards preventing a repeat of the fiscal crisis without

endangering the nascent recovery.

14. Beesley, Arthur of Irish Times “Temporary ban on short-selling proposed”, 16th

September 2010 reported that EU Internal markets Commissioner Michel Barnier

unveiled far-reaching plans to curtail short-selling and regulate derivatives trading.

The legal measures, which Mr Barnier hopes to put on the statute book by 2012,

would provide for a temporary ban on short-selling while radically increasing

oversight of the derivatives market.

“No financial market can afford to remain a Wild West territory,” said Mr Barnier. “We have

to limit risks of hyper-speculation.”

Mr Barnier said he wanted to address the absence of transparency in these markets, the risk of

negative price spirals and the risk of settlement failure in “naked short-selling” trades.

The proposals will have to be agreed by member states and the European Parliament before

they become law.

The commission said it was including credit default swaps in the proposal because they could

be used to secure a position economically equivalent to a short position in the underlying

bonds.

One proposal would give oversight of short-selling trades to the new EU markets regulator,

giving it the power to impose a three-month ban on such deals or unilateral national bans

such as controversial measures introduced by Germany earlier this year.


33

In the case of “naked short-selling”, regulators would be able to demand that sellers

demonstrate their capacity to complete the deal. In essence this means that investors would

have to have borrowed an instrument or have pledged to do so before entering such a

transaction.

The EU executive wants information on over-the-counter derivative contracts to be reported

to trade repositories and be accessible to supervisory authorities.

It also wants standard over-the-counter derivative contracts cleared through central

counterparties to reduce the risk that one party to the deal defaults.

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and Compliance, 2009, 17(2), p156.

Ross, Stuart and Hannan, Michelle, “Money laudering regulation and risk-based decision

making”, Journal of Money Laundering Control, 2007, 10(1), p 106.

Sergeant, Carol, “Risk-based regulation in the Financial Services Authority”, Journal of

Financial Regulation and Compliance, 2002,10(4), p329.

Sheen, Andrew, “Implementing the EU Capital Requirement Directive – key operational risk

elements”, Journal of Financial Regulation and Compliance, 2005, 13(4), p313.

Simpson, John l., and Evans, John, “ Benchmarking and crosschecking international banking

economic and regulatory capital”, Journal of Financial Regulation and Compliance, 2005,

13(1), p65.

Sklaroff, S, “Regulation in an untrusting world”, Journal of Economic Affairs, 2006 26(2), p

37.

Smith, Herbert,“Legal and compliance risk in financial institutions”, Law and Financial

Markets Review, November, 2008, p 481.

Sollis, Robert, “Value at risk: a critical overview”, Journal of Financial Regulation and

Compliance, 2009, 17(4), p 398.

Stewart, Sam, “Coping with the FSA‟s risk-based approach”, Journal of Financial

Regulation and Compliance, 2005, Vol 13 No 1, p 43.

Teuten, Peter, “Regulation: the principle of the thing”, Risk Management magazine, July

2007, p 34.

Van Leeuwen, Arthur, Docters, and Demarigny, Fabrice, “Europe‟s securities regulators

working together under the new EU regulatory framework”, Journal of Financial Regulation

and Compliance, 2004, 12(3), p206.


38

Walker, RG, “Reporting entity concept: a case study of the failure of principles based

regulation”, Abacus (Australia), Mar 2007, 43(1), p49.

Ward, Neil, “The IFSC: Charting a Course to Future Success”, About Banking, May 2010, p

10.

Westrup, Jonathan, “Regulatory Governance”, 12 November 2007, UCD GEARY

INSTITUTE DISCUSSION PAPER SERIES.

Newspapers and Magazines:

Beesley, Arthur, “EU plans new measures to restrict bank directors”, Irish Times, 29th

May,

2010, p16.

Carswell, Simon, “Elderfield criticises „spectacular failures of corporate governance‟”, Irish

Times, 11th

May, 2010 p 20.

Carswell, Simon, “Warning on varying rules for insurers”, Irish Times, 12th

May, 2010 p 18.

Carswell, Simon, “Stringent new rules to curb bank lending”, Irish Times, Business This

Week, 14th

May, 2010 p 1.

Carswell, Simon,“Central Bank sent out wrong message on crisis”, Irish Times, 26th

May,

2010, p 14.

Carswell, Simon, “Regulators showed „unduly deferential approach‟ to banks”, Irish Times,

10th

June, 2010, p8.

Carswell, Simon,“Stricter rules on financial staff training”, Irish Times, 01-07-10, p21.

Coulter, Carol,“DPP outlines challenges for justice system of strict financial regulation”,

Irish Times, 19th

May, 2010, p5.

Gibbons, John, “Tax on speculative trading a great way to raise billions”, Irish Times, 5th

November, 2009, p15.

Hennessy, Mark,“British banks bow to commission”, Irish Times, Business this Week, 6th

of

November 2009, p 5.

Kavanagh, Brian, “Summit hears call for global regulation”, Irish Times Business this Week,

6th

of November 2009, p 2.

King, Mervyn, “Split risky financial ventures, says bank governor”, Irish Times, 21st October,

2009, p19, as reproduced from the Financial Times; and Economist, “Splitting up banks Too

big to bail out”, 24th

of October 2009, p 41.


39

O‟Halloran, Marie,“Bill to merge regulator with Central Bank introduced”, Irish Times, 21st

April, 2010, p8.

Reuters report, as published in the Irish Times, entitled “Divisions in G20 on tougher banking

rules”, 5th

June, 2010 p 16.

The Economist, “Bar-knuckle in Basel”, 29th

May, 2010, p 11, and “The banks battle back”,

p77.

The Economist “Financial reform in America A decent start” 3rd

July 2010, p10.

The Economist “Not all on the same page”, 3rd

July 2010, p61-64.

TV interviews:

Connor, Gregory, RTE Prime Time, RTE 1 TV, broadcast 10th

June, 2010.