FSA Report Promises a ‘Very British Revolution’ in Regulation

March 18 (Bloomberg) -- Financial Services Authority Chairman Adair Turner has promised to start a “revolution” in financial regulation with new rules for banks and hedge funds to address the worst economic crisis in 80 years.

The U.K. regulator said last month that a report to be issued today will discuss liquidity and capital rules, compensation, accounting, and how the FSA and the Bank of England can monitor risks to the financial system.

“This will be a very polite revolution,” said Simon Gleeson, a regulatory lawyer at London-based Clifford Chance LLP. “It’ll be a very British revolution, where not much is going to happen and everyone will be nice to each other.”

The FSA has come under fire for not doing enough to spot warning signs of the global financial crisis, which has led to the nationalization of Northern Rock Plc and Bradford & Bingley Plc, the takeover of a third bank, and the government holding majority stakes in two others.

The FSA report is one of several from regulatory agencies before the Group of 20 Nations’ summit in April in London, when lawmakers from around the world will try to redesign financial regulation. U.K. Prime Minister Gordon Brown asked Turner to lead the U.K.’s position on the global response to the crisis. The report’s themes, apart from the oversight of system-wide risk, are ones all regulators must discuss ahead of the summit.

No Coincidence

“There’s no coincidence at all in the timing,” said Bob Penn, a regulatory lawyer at Allen & Overy LLP. “This is a clear play to demonstrate thought-leadership, and is a plea for international consensus.”

The FSA said as early as June that it would press ahead with reforming liquidity rules even if other countries lag behind, and has published proposals for banks to hold more Treasury bonds. Similarly, it has published a draft code on compensation; and told banks that they should plan to move to conserve capital in the good times to draw on during the bad.

Different regulators moving at different speeds is the main hurdle to Turner’s proposals: financial regulation is dictated by directives from the European Union, and rules on capital are overseen by an international committee in Basel, Switzerland.

“What is needed is a revolution in Europe and a revolution in the United States,” said Jonathan McMahon, a former FSA supervisor now advising companies on regulation at Promontory Financial Group.

Catch Up With U.K.

There is an international consensus that hedge funds need greater supervision. The FSA already regulates hedge-fund managers and Hector Sants, the FSA’s chief executive officer, told the select committee last month that it would be a good idea for the rest of the world “to catch up” with the U.K.

The FSA said last month if hedge funds posed a risk to the economy if they failed, it would introduce capital and liquidity rules. An obstacle is that the funds are often based overseas, beyond the jurisdiction of the FSA, said McMahon.

At a parliamentary committee hearing last month, Turner also said there would be proposals to increase by “several times” the amount of capital banks hold against risks on their proprietary trading books. Proprietary trading is when a financial company trades securities and other financial instruments with its own money rather than for its customers.

Banks have “been able to trade in pretty much whatever market they choose in whatever instrument they like,” said McMahon. “It is certainly putting the brakes on some of the changes that have occurred over the last 20 years.”

Perhaps the biggest change will be in the way the FSA regulates. Turner told lawmakers that political pressure to use a “light touch” stopped the FSA from asking too many questions.

Scary Sants

The opposition Conservatives suggested last week that should they win the next general election, they may hand supervision of capital back to the Bank of England. The FSA was created by Gordon Brown in 1997 as one of his first acts as then-Chancellor of the Exchequer.

Sants said last week that “people should be frightened” of the FSA. He signaled a move away from principles-based regulation, where companies abide by 11 over-arching themes such as treating customers fairly.

He said the FSA will question the business models of financial companies, become involved in appointing senior executives -- and hold them to account when things go wrong.

“That will be heightening the risk for the FSA,” said Arnondo Chakrabarti, a regulatory lawyer at Allen & Overy. “People can say: ‘You were involved in those business decisions’ if things go wrong.”