Regulation

A Regulator of Repute


By Marcus Killick, Chief Executive Officer, Gibraltar Financial Services Commission (07/12/2009)

As I write this article, it is difficult to think of football as the ‘beautiful game’. This week has seen arrests throughout Europe in relation to the biggest match-fixing case in history, and the Irish failing to have their crucial World Cup qualifying match with France replayed because of a handball by French striker, Thierry Henry, in the build-up to the winning goal. This was despite Henry saying that a replay would ‘be the fairest solution’. Yet football will survive, the fans will still buy the shirts and pay to watch their teams. Its reputation will be tarnished, some people may go to jail, teams will be penalised, but the game will go on. Its reputation will recover.

 

Football is a blend of self-regulation and regulation from without. Much of what goes on during a game is reliant upon the sportsmanship of the players. Yet as the rewards for playing have become greater, so the players’ notion of ‘fair play’ seems to have deteriorated. We are now faced with the possibility of video replays to help the referee, together with new rules and greater penalties for the culprits. It would be difficult to conceive of a major game without the ‘men in black’ to keep order. Is the game better as a result? I doubt it. Yet it will still be watched by countless millions every week and sponsorship money will still flood in to the big clubs.

 

Once upon a time the financial world was driven by self-regulation and self-discipline. Stock Exchanges were run in accordance with their members’ requirements and rules (such as the expulsion of those who failed to honour a deal) were designed in the interests of those members. Yet, as with football, the era of operating any type of financial institution without outside interference and direction is drawing to a close. Even the last bastions, such as the hedge funds, are now succumbing to the inevitable.

 

So what about the so called ‘offshore’ centres? Is there still a place for them in the world of the OECD and its ‘white lists’, the world of the G20 and of ever increasing obligations to cooperate?

 

Despite the smaller financial centres not being responsible for the global crisis (indeed, some are victims of it), significant focus is being placed upon them. Within the British Overseas Territories there was the recent Foot Review. Elsewhere the FATF are assessing which jurisdictions should be the first to face the latest review of compliance with international standards in the fight against money laundering and the financing of terrorism. These reviews are being backed by real action against those who fall short of what is expected. Furthermore, huge budget deficits in major countries has led to the introduction of ever more draconian measures to recover money they believe has been hidden outside their jurisdiction to evade taxation.

 

So what is the biggest key to survival for the smaller centres? In my view, survival will predominately hang upon reputation and, in particular, the reputation of a jurisdiction’s regulator. However, the issue of reputation is not simply one for the regulator, it affects the government and industry equally

 

Turning first to the regulator. The reputation of financial service regulators has hardly been enhanced over the last two and a half years. Pilloried for having failed to see the impending crisis, for having been slow to react and then swift to over-react to it, supervisors, like many of the institutions they watch over, have been characterised as dangerously complacent. Work has commenced to repair this tarnished image. It will take time but quantifiable steps are now being taken.

 

However, there is an additional wrinkle; some regulators also have a statutory duty to ‘protect the reputation’ of their jurisdiction. It is a good phrase, but what, in reality, does it mean? Are we like some latter day prince, mounted on a white stallion, there to protect the honour and virtue of the virginal jurisdictions we have been entrusted to guard? Or are we closer to some political spin-doctor looking to place a positive gloss on whatever unsavoury activity may be going on. In this article I will set out what I believe a regulator’s role in protecting the reputation of a jurisdiction should be. Unsurprisingly, it is neither of the two roles mentioned above.

 

Let me start with the easy bit. Regulators should keep those who are not fit and proper out of the industry. Not just crooks but also the seriously incompetent. This must not be done in an arbitrary way, denying people on the basis of rumour, gossip or innuendo. The reputation of a jurisdiction can be equally damaged if the regulator is not perceived as fair. Regulation, like licensing, is by its very nature a matter of risk assessment, risk management and risk mitigation. If regulators did not accept that some risks were inevitable, there would be no finance industry. They do accept it, because they know there is a trade off between risk and reward. Though risk cannot be eliminated, a license should not be granted where it cannot be managed or mitigated. Yet it is not the place for a regulator to focus on what an applicant brings to a jurisdiction in terms of employment or tax revenue.

 

In respect of the applicant itself, there are a number of key issues which have to be addressed, including whether or not the regulator can effectively supervise its activities. Regulators have sometimes been unable to gain the necessary skill sets to understand the business they supervise. This lack of understanding has, on occasion, proved fatal and cannot continue going forward. There is bound to be an increased cost as the resources and skill sets of many regulators are made fit for purpose as the industries they supervise grow increasingly more sophisticated and complex.

 

More and more, applicants will need their own premises and staff – the days of ‘brass plate’ applicants are clearly numbered. Core activities of the firm will need to be undertaken in the jurisdiction rather than being outsourced. This need for real activities, as well as mind and management being located in the centre, is given added impetus by the knowledge that tax authorities in some jurisdictions have tried to challenge the tax status of firms that do not, in their view, have sufficient presence in the offshore centre.

 

One lesson the crisis has taught all regulators is that bigger is not always better. I have little doubt that both Northern Rock and Lehman Brothers would have been welcomed in virtually any jurisdiction a couple of years ago. Today, regulators in smaller centres can gain a reputational advantage by being more approachable than their larger colleagues, enabling them to adopt a case-by-case approach. This flexibility, particularly when aligned with a swiftness of response and no subsequent loss of regulatory or supervisory standards, makes such regulators much more attractive. The smaller centres are ideal for attracting small niche players, including new players in insurance and banking. These players are often far easier to supervise than their larger more complex and older peers.

 

Next is the issue of the reputation of the jurisdiction. I personally believe this should encompass notions of fairness, consistency and impartiality. The reputation of government is particularly important. Smaller centres have benefited from their ability to respond rapidly to changing market conditions and new opportunities. They can be more innovative in their corporate structures (Protected Cell Companies being but one example). Legislation facilitating changes can be passed more rapidly because of the lower level of bureaucracy.

 

Finally, let’s consider the industry itself. Ultimately, industry is the main beneficiary of a good jurisdictional reputation, but everybody involved – from captains of industry to industry foot-soldiers – must also be industry’s guardians. Neither regulators nor governments can vet every client or analyse every business risk. Industry alone can act as gatekeeper by undertaking good due-diligence, not simply in the fight against money laundering but also in ensuring that the jurisdiction attracts quality business. Some centres historically relied upon quantity. This may have served them well in the past; it will not do so in the future.