The end of light-touch regulation

Last week, the governor of the Bank of England, Mervyn King stunned the City by telling leading financiers assembled at the Mansion House, that he did not have sufficient powers to fulfil his new statutory duty of ensuring financial stability. Likening the Bank to a church, he warned that at present, it “could do no more than issue sermons or organise burials”.

With his call for sweeping powers and a restriction on the size of financial institutions, he heralded a new era of tough regulation that insurers will face alongside the banks.

But it is not just King looking hard at the system. Across the globe, governments and regulators are locked in boardrooms trying to thrash out the shape of the new economy. In the US, President Obama is trying to push through the Geithner package that would see the Federal Reserve handed a new role to guard against systemic risk, in the face of widespread Senate opposition. In Europe, Gordon Brown has been fighting proposals led by the French for three new cross border supervisors, one of which would control insurance.

And even here in Whitehall, the chancellor, FSA and Bank of England are fighting one another for power and squabbling over blame. So what does all this mean for insurers and brokers operating in the UK?

Firstly, it is clear that there is still much to play for. The financial crisis has not yet run its course and the world’s powers are far from agreeing on its causes or remedies.

But there are already important indications of what the new landscape will look like.

The De Larosière report released in February called for early adoption of the Solvency II Directive; increased cross border regulation; and reform of the International Accounting Standards Board. It has won widespread support from the insurance industry, and the acclamation of the ABI.

In March, Lord Turner’s Review of the regulatory system, commissioned by the UK government, backed the call for Europe-wide supervision, as well as proposing stringent capital requirements on banks and an overhaul of the fair value accounting system.

Global financial landscape

That is the way the wind is blowing on the other side of the Atlantic, too. The Geithner reform package proposes giving the Federal Reserve the power to oversee companies whose collapse would pose a systemic risk – such as AIG. In what would be the biggest regulatory regime change since the 1930s, capital and gearing rules would be tightened across the markets. Insurers, which are regulated on a state-by-state basis, would be subject to a new federal supervisor. The plan yet has to win Congressional approval, but has the staunch backing of President Obama.

“At the top level, things are pretty clear,” says John Liver, partner in regulatory financial services at Ernst & Young. “There are going to be stronger capital rules; stronger liquidity rules; a need for more robust supervision; and much more granular information provided to the regulators more frequently. There will be a much lower risk appetite among regulators, because we can’t go through this again. All this is consistent, but the devil really is in the detail.”

Europe and the UK are already several steps ahead of the US. While there are mixed opinions on what the extent of cross-border regulation should be, all member states are signed up to Solvency II, which will see enhanced capital requirements and transparency from 2012.

As Sean McGovern, Lloyd’s director and general counsel, says: “It will drive up regulatory standards across Europe and is being closely followed by many other jurisdictions. It should in time help to bring about greater harmonisation of regulatory standards across the world.”

Certain member states, led by France, have been pushing to bring in new rules much faster. Draft proposals put to the European Commission last week would have given a new Europe-wide regulator the power to arbitrate in a dispute between EU countries over a cross-border bank. If the sides could not agree, the new regulator would have been able to impose a decision that could have a fiscal impact on the countries concerned. However, Brown fought off these proposals and the EU announced on Friday that: “Decisions taken by the European System of Financial Supervisors should not impinge in any way on the fiscal responsibilities of member states.”

Tarred with the same brush

Brown does support the introduction of a European Systemic Risk Council of central bankers and officials in charge of monitoring financial stability across the EU, but the extent of its powers remain open to debate.

Meanwhile, he has the divisions in the tripartite UK system of the Treasury, the Bank and the FSA to contend with. As King’s speech showed, there are disagreements over the extent of the Bank’s power. King believes that because it is in charge of the banking system (at a “macro-prudential” level), it should also have the power to regulate individual banking institutions (at a “micro-prudential” level. The FSA disagrees, pointing to events such as the failure of AIG, an insurer dabbling in banking, to argue that a cross-industry approach is needed.

The ABI favours the establishment of a new “macro prudential committee” to pick up any issues that fall between the tripartite structure.

Although there is broad support for Europe-wide regulation in the insurance industry, many warn that this must not translate into a greater regulatory burden, and that insurers must not be tarred with the same brush as banks.

“What is needed is better regulation – not more – which is proportionate and balanced,” says Lloyd’s McGovern. “But we need to be clear, what we currently face is not an insurance crisis but a banking crisis and – unlike the banks – the insurance industry is operating normally, accepting risk and settling claims.”

Groupama Insurance UK chief executive Francois Xavier Boisseau fears that insurance has already been tarred with the same brush as the banks.

Although the FSA has acknowledged the need for a different approach between the two, it has not yet made clear what that difference will be – and Boisseau worries that it will abandon its proportionate approach, whereby smaller groups received less regulatory attention.

“Insurance is bundled in with the banks, but the specifics are not mentioned,” he says.

“Large banks should be looked at more closely because they are getting too much credit for diversification,” he says in reference to rules that allow larger groups to hold less capital, based on the idea that their risk is spread across a greater number of countries, and that while one economy may fail, all are unlikely to. Obviously, recent events have raised questions over this theory.

Moreover, Boisseau fears that the expanding role of non-executive directors, encouraged by the FSA, will leave executive managers stuck between a rock and a hard place. “The FSA is already trying to run the company; now they seem to expect the non-executives to do

the same,” he says. “It is going tobe very, very difficult for the management to actually manage.”

Brokers are subject to over-regulation too, argues Biba chief executive Eric Galbraith.

“We are very concerned that some of the regulatory issues will spill over into the insurance sector,” he says, pointing to the requirement for brokers to subsidise banks under the Financial Services Compensation Scheme as an example of unfair regulation.

Over the coming months, all these issues will be on the table. But as King told those financiers at the Mansion House, one thing is for sure: “Change is necessary”.

Light but tough regulation – if it ever existed – has ended.