The financial crash triggered a new age of increased regulation, a knee-jerk reaction that assumed all financial regulation must come from the state, ignoring hundreds of years of successful self-regulation in the market, according to a new report from UK free-market think tank the Institute of Economic Affairs (IEA).
The report, ‘Regulation without the state: the example of financial markets’, examines the growth of state regulation, sets out modern and historical examples of how private alternatives can work, and asserts that the process of competition in regulatory services is necessary to discover the best approach to regulation.
The report says politicians and economists often discuss whether there should be regulation, but rarely discuss who is best placed to regulate – whether that be the state or private regulatory institutions.
The new report, authored by Philip Booth, a senior academic fellow at the IEA and professor of finance, public policy and ethics at St Mary’s University, Twickenham, makes the case that more self-regulatory models should be applied, as they often provide better outcomes for market participants.
Tracing regulation in financial services, the report put the Financial Services Act [FSA] 1986 as marking the beginning of state control over who could – and could not – conduct financial business. In turn, this brought previously independent professions into state regulatory systems. The complexity of regulation also increased over time: In 2011 alone, the report notes that the UK financial regulator issued regulation, consultations or guidance totaling 4.3 mn words – ‘five times the number of words in the Bible’.
Today, the powers of the Financial Conduct Authority (FCA) are overreaching, argues the report, as the FCA can determine its own burden of proof, levy fines and prevent people from working in any area of financial markets.
The FCA has wide-ranging enforcement powers equivalent to those adjudicated in civil and criminal courts with none of the accountability or guarantee of due process that exist in proper courts.
In 2015, the FCA levied nearly £1 bn ($1.3 bn) of fines, all without the competition that would come from multiple different regulatory systems.
But, the report notes, until relatively recently, most regulation of financial services was developed within markets to deal with commonly acknowledged problems.
Institutions including intermediaries, exchanges, trustee bodies and firms with special corporate governance arrangements – such as customer-owned firms – developed as part of the entrepreneurial process to regulate behavior.
Such bodies – along with brand recognition – helped customers and counterparties recognize good and bad firms, as well as promoting competition between different methods of regulation.
Exchanges operated on a club basis, setting standards and expected practices for members and in return enhancing the reputation of members, notes the report. Unlike modern state regulators, self-regulatory bodies did not prevent non-members from practicing so long as they did not claim to have the ‘badge of approval’ that came with being a member of a profession or exchange.
Therefore, putting forward the case for more self-regulation, the report states government regulators cannot accumulate information on the efficacy of its regulations as effectively as a private regulator.
This renders state regulation less adaptable and more prone to creating regulation, which in turn restricts the market rather than broadens access to new firms and reduces choice for consumers, argues the report.
Private regulation exists outside financial services and is ‘well-received’, it adds. Where still permitted, private regulatory bodies have remained successful in the financial sector – an example given is the International Swaps and Derivatives Association.
In the same way, state regulators should be very careful before restricting the activities of private regulators on competition grounds. The market should be defined widely to avoid this, says the report.
Commenting on the report, Booth, says in a statement: ‘There is a long history of regulation being provided within markets. We should dismiss the argument that state regulation is required because of market failure.
‘Markets are able to provide regulatory services because they are valued by market participants. As a minimum, it is vital that the Competition and Markets Authority regularly investigate whether state regulators are inhibiting competition.’