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Top 400: Finance and regulation

Financial regulators primarily aim to serve consumers and the wider public interest. The finance industry attends mainly to the private interests of shareholders. This tension influences much of the interaction between the two. 

Regulators emphasise investor protection and issues of fairness as worthy goals. In response, the industry rallies around a call for efficiency and the freedom to innovate to serve the consumers the regulator wishes to protect. Given these divergent priorities, there is much suspicion. Regulators might wonder how many of the industry’s complaints about regulation are based on self-interest. Similarly, the industry fears regulatory overreach, perhaps exacerbated by an insufficient understanding of the dynamics of the marketplace. While each has a healthy respect for the other, how can these bedfellows be better reconciled?

The various finance and investment professions could provide the necessary bridge between the two. A profession exists to serve the broader interests of society at large, in line with the objectives of regulators. It should not pander to commercial interests, thereby providing for an independence and objectivity that should be prized by regulators and consumers. A profession aims to raise the ethical and competency standards of its members. In so doing, it provides a warranty of trust to users of financial services who consult professionals. 

At the same time, a profession is an association of expert practitioners who understand much about the complex nature of markets, products, processes, incentives and behaviours that combine to provide both useful services and safeguards. Such practical knowledge is essential when formulating prescriptive regulatory rules. These professionals make their living within the finance industry – most are employees and owners – so they understand the industry’s perspective.

Finance and investment professionals must pay heed to their professional obligations as well as their commercial goals. They regularly need to make judgments about the balance between fairness and efficiency, if the two are competing priorities. This allows them to understand the viewpoints of both the regulators and the industry. Professions are therefore ideally positioned to act as a useful broker between the two when new rules are proposed. 

Another important role of the professions is to naturally complement formal laws and regulations by establishing norms for ethical conduct. These are expressed as standards and guidelines to which members must adhere. Sanctions and disciplinary processes are applied for those who do not abide by them. In addition, professional bodies provide for a minimum level of education and provision for continuing professional development to ensure members are properly qualified and remain current in their expertise. This focus on ethics and education builds character and competence amongst practitioners, which also provides investors with greater assurance. 

Regulators should work with the professions to raise the standards of conduct of individuals and firms. Establishing professional standing as a condition for the right to practise in many roles would provide ample incentive for employers and their most valued employees to change their behaviour for the better and put investor interests first. By way of comparison, regulators of other economic sectors such as healthcare and legal services, for example, require licences to practice; related professions provide for the attainment of such licences.

With the increasing complexity of financial markets and products, aided and abetted by globalisation and new advances in technology, comes an increasing supervisory burden. Budgetary pressure on regulators means that they cannot easily attend to the increasing number of issues that fall within their jurisdiction and need to be addressed. Nor can they monitor risks adequately on a variety of fronts. 

This challenge will have to be met with a mixed system of regulation that combines the formal role of regulators with a new array of self-regulatory organisations (SROs), private regulators and professional bodies.

A difficulty in advocating such an arrangement is the erosion of trust in many forms of self-regulation resulting from the recent financial crisis. The experience revealed inherent conflicts of interest and poor governance at SROs. But with reflection and resolve, these weaknesses can be remedied or at least significantly mitigated. Improvements to governance structures which increase the independence of boards, enforcing transparency and requiring greater accountability to regulators would all make SROs fit for purpose. 

An example of a fully operational and efficient model for an SRO would be the Global Investment Performance Standards (GIPS) which covers the investment industry. Although compliance with the GIPS standards is voluntary, the standards have become law in many jurisdictions. Widespread adoption of the standards has created a climate in which non-compliant firms are at a competitive disadvantage. This means the industry effectively regulates itself, effectively pre-empting the need for official regulators to prescribe the rules for reporting investment performance.

For effective governance, the GIPS Council and the GIPS Executive Committee allow for representation of all 37 country sponsors of the standards, while giving voice to technical areas represented by interested stakeholders. This structure operates like a legislative governance model, with representatives elected by regional chairs. New standards are proposed, vetted, and implemented on a global basis, all without the intervention of an official overall regulatory body. 

GIPS was proposed by the investment profession and created in collaboration with the industry in order to support the regulation of performance presentation. As a result, investors are protected and the competition between investment managers is fairer. SROs like GIPS would complement the formal regulation of national and global supervisors. Many opportunities exist for the regulator and the industry to work in partnership with the profession.

While financial regulators and the finance industry share a common objective in upholding the integrity of financial markets, their priorities and perspectives often differ. The Janus-like finance profession can usually see both sides, and can help each to better understand the other. A constructive coalition leading to due bargaining and negotiation would provide the best outcome for each of these protagonists. Ultimately, citizens, investors, finance professionals and shareholders would prosper.

Nitin Mehta is managing director, EMEA, for the CFA Institute

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