This was the height of self-regulation for the financial sector and the supervisory role of the Bank of England. The financial market favoured the approach as it allowed so much freedom and didn’t involve costs but showed the public that there was a form of regulation in order to gain market confidence. However, the self-regulating organisations (SRO’s) were of so many and wide spread over the sectors of the financial market that there was confusion as to what ends each SRO should concentrate their means. The problem needed another piece of legislation which came in the form of the Financial Services Act 1986 (FSA). The FSA created the Securities and Investment Board (SIB) which was specifically designed to oversee the work of the numerous SRO’s. The SIB was a private company and therefore was limited by guarantee but it exercised many powers transferred to it from the DTI. The main aim for the SIB was to ensure that the SRO’s were regulating in a way that was aimed in the interest of the general public. There was much criticism of the FSA 1986 with people comparing it with the statutory regulator of the USA, the Securities and Exchange Commission (SEC), which was against the self-regulation that the UK’s financial organisations so adored.
In the late 1970’s self-regulation was judged by the amount of scandals and insider dealings which were reported by the media, of which there had been many. There was a debate on whether or how the financial services market would be regulated when dominated by the dark shadow of scandals and abuses. The FSA 1986 introduced a substantial degree of statutory regulation into the financial market for the first time in the UK’s financial history.
The Financial Services Act 1986 allowed the Securities and Investment Board (SIB) to have more power than any other financial institution had done to that day. The SIB were to be the supervisor of the financial market, however, the Self-Regulating Organisations (SRO’s) would be the institutions to regulate the majority of the financial sector. The FSA 1986 had an emphasis of ensuring that self-regulation stayed intact which was greatly wanted by many financial business organisations. Self-regulation to that point had generally succeeded. A good example would be the Panel of Take-overs and Mergers (PTM), which was widely acclaimed to be efficient, ensured integrity and was professional. However, on the downside there were also huge failures such as the Council for the Securities Industry (CSI). An academic, Clarke described the failure:
“ …CSI never proved competent or efficient, lacked the characteristic needed to resolve problems and tensions. Their mandate was unclear, they lacked leadership, had an inappropriate composition and never had enough resources.”
There seemed to be a fairly good structure that would allow self-regulation, however, the institutions that regulated the different sectors of the financial market were not good enough to handle their responsibilities. Not only this but there were still some sectors without its own SRO and some with more than one.
The FSA 1986 tried to bring in a statutory instrument to ensure that these SRO’s were able to do their job efficiently just like the PTM. In short it was to be a statutory framework based on self-regulation, avoiding the same form as existed in the US. Professor Gower described this structure as:
“ Statutory regulation monitored by SRO’s recognised and under the surveillance of a self standing commission.”
The self standing commission referred to was obviously the SIB which was the first institution to have delegated powers from the Secretary of State for Trade and Industry, until this function was given to the HM Treasury under the Transfer of Function (Financial Services) Order 1992. However, if the SIB did not fulfil its role efficiently, the HM Treasury could retake these delegated powers. The SIB was to be assessed by the Financial Services Tribunal who would report to the HM Treasury.
The sector boundaries were to be eroded between insurance and investment including using the same regulatory status to be given to the London Stock Exchange which was previously regulated under the Prevention of Fraud (Investments) Act 1958. Another change made by the FSA 1986 was the de-regulation of building societies under the Building Societies Act 1986, which allowed the societies to directly compete within the primary banking industry.
In relation to financial crime, the SIB issued a Code of Conduct to be followed by the SRO’s and financial organisations, authorisation was received from the SIB to conduct financial service trade. An objective of the SIB was to establish a satisfactory monitoring and enforcement system to promote and maintain high standards of practice that would hopefully ensure that business organisations were aware of money laundering and would report and suspicious transactions.
However Bank of England seemed to be struggling with its statutory responsibilities as noted by Sir Thomas Bingham with the report of the Bank of Credit and Commerce International (BCCI) scandal 1991:
“…[The Bank of England], on occasion seemed reluctant to use it’s powers to the full.”
This was closely followed by the collapse of the Barings Bank in 1995, which spread criticism on whether the Bank of England was the right institution to supervise the banking sector. Further problems came into light with the continuing merger of the financial sectors creating a very fragile and competitive financial market. The many different bodies were all trying to regulate the same businesses, the SIB would be powerless to stop the confusion as its only role was to ensure public interest. The SIB’s tasks had been failed. The collapse of the Bearings Bank was to highlight the failure of the system as a whole. Bearings Bank offered many different financial services to the public. However, the securities section of the business came into difficulties and the rest of the bank suffered. Either bad regulation or an insufficient system was causing the slow downfall of many large financial market business organisations.
The new economic reality of a super financial business organisation made a new system of regulation as necessity to stop the UK’s financial market plummeting into chaos. There were two reports into the state of financial affairs in the UK, the first was by Michael Taylor, and the second by the Australian Commission of Inquiry. Both of these reports highlighted the fact that if regulation was to be effective then it required regulatory convergence. The reports had quite an influence as on May 20th 1997 the Chancellor of the Exchequer made a statement saying:
“It is clear that the distinctions between different types of financial institution – banks, securities firms and insurance companies – are becoming increasingly blurred. Many of today’s financial institutions are regulated by a plethora of different supervisors. This increases the cost and reduces the effectiveness of supervision.”
This statement showed that the Labour Government recognised that the financial market needed a regulatory overhaul to reflect the new economic realities. The obvious, although radical, move was to create one regulatory institution that would oversee the whole financial market.
As expected, although controversial, the Financial Services and Markets Act 2000 (FSMA) created an independent governmental institution which is now the super financial regulator known as the Financial Service Authority (FSA). This organisation was formally known as the Securities and Investments Board (SIB) and was merged with the power of banking supervision previously bestowed upon the Bank of England. Other powers were also brought to the FSA including those previously honoured upon the Building Societies Commission (BSC) regulating the secondary banking sector, the Friendly Societies Commission (FSC), the Investment Management Regulatory Organisation (IMRO) which obviously dealt with the investment sector. There was also the Personal Investment Authority (PIA), the Register of Friendly Societies (RFS) and the Securities and Futures Authority (SFA). The FSA was also given powers to legislate upon the mortgage sector. Obviously the FSMA went much further than just creating the FSA, it has more powers of supervision, regulation, litigation, authorisation and execution within the UK’s financial market than any known before. However, the FSA must report to HM Treasury, which appoints the Board of the FSA, consisting of a Chairman, a Chief Executive Officer, two Managing Directors, and 11 non-executive directors. The Board creates the FSA’s policies although the day to day organisation is left to the Executive. The FSA works closely with the Department of Trade and Industry (DTI) in relation to litigation and insolvency. There is also co-operation with the Department for Work and Pensions (DWP) and the Occupations Pensions Regulatory Authority (OPRA) in relation to working pension policies. There is also the Office of Fair Trading to help with consumer protection and the Serious Fraud Office (SFO) to investigate and prosecute for serious fraud which within itself requires co-operation with national intelligence services. The FSA must also work with the Bank of England, which itself, has a statutory objective of ensuring economic stability in the UK. The FSMA directed the FSA in the form of four statutory objectives. These are public awareness, consumer protection, market confidence and the reduction of financial crime. Needless to say these four objectives are all linked in one way or another. For example, money laundering is a financial crime, covered by the fourth objective, if strife within the UK’s financial market, many investors may take their money elsewhere where it is believed to be safer, objective three. This means that the consumers suffer due to poor international investment in the UK market, which has economic side effects, objective two. The first objective of public awareness includes making the public aware of money laundering and the provisions being taken against it such as electronic credit card chips. However, the FSA are limited by costs, the balance of responsibility and power, especially in relation or competition and authorisation all of which define the characteristic of the UK’s financial market.
However, there were to be more considerations apart from the FSA; the Bank of England would be awarded independence from governmental fiscal policy, self regulation was to be ended as the fiasco of the Barings Bank and BCCI was to show its failure in an ever developing economic market. There was also an urge to try to respond to these scandals as best as the government could manage making the public confident in the UK’s financial market.
A huge reason for trying to regulate the financial market is to stop financial crime. This is caused by the human nature of greed. However it is aided by three other factors, weak governments, poor national financial regulation and corruption. One of the biggest causes has become more reported since the disaster of 9/11 which is terrorism. The terrorist need to be funded and are doe largely through illegal gains. The effect of financial crime is quite severe, it can diminish the reputation of a countries financial sector desecrating its economy. National security can be threatened with an increase in criminals using the market for illegal purposes. Interest rates can be unstable due to the high integration of capital markets. Finally it reduces tax revenues through underground economies, competes unfairly with legitimate business organisations, damages financial markets and disrupts economic development. The FSA are concerned with 3 main types of financial crime, money laundering, fraud and dishonesty, and market misconduct such as insider dealing. One of the biggest financial crime problems is money laundering, this is defined as:
“ The methods criminals use to hide and disguise the money they make from their crimes”
In other words it is the way that criminals make it incredibly hard to trace their monies origins back to anything illegal. This process can be done in small or large ways and has been made easier by the development of technology and its use in the global financial market. In 1920 the American Mafia found that they could do this in large amounts through starting legitimate businesses such as launderettes or slot machine companies. In today’s society it is possible to transfer huge amounts of money in seconds all around the world through many different accounts and transactions. Each transaction makes it harder to trace the origins of the money. It is currently estimated that the amount of money that is laundered world-wide makes up 2.5% of the world’s gross domestic product (GDP). This constitutes to between an amazing 590 billion dollars to 1.5 trillion. The lower figure would be the equivalent to Spain’s economic output per year. The Financial Action Task Force (FATF) reported these figures.
The process of money laundering comprises of three different sections. The first is placement, the second layering and lastly integration. Placement was discussed in the case of Crown v Duff. The placement is the break up of large sums of money into smaller amounts. Layering is where the criminal engages in a series of transactions to disguise the money from its source. Integration is where the money has re-entered the legitimate economy. Obviously the easier it is to launder money the more that will be laundered. The FATF was set up as an inter-governmental organisation, which aims to develop and promote policies to combat money laundering. Currently the FATF has 31 members.
Money laundering was to be tackled by many different institutions in the UK. The police would obviously be close to the acts of criminals, which would include money laundering. However the police only deal with minor offences, major cases are passed on to specialised agencies such as MI5 and MI6. The Serious Fraud Office (SFO) is an independent governmental institution, which prosecutes for serious or complex fraud. The SFO was established in 1988 after trials, just after the FSA 1986, however it was created by the Criminal Justice Act 1987 (CJA). The flaw with the SFO is that it only investigates fraud of over 1 million pounds and so can be avoided if the money laundered is anything below this limit. The National Criminal Service (NCIS) works on behalf of the police and other law enforcers and is one of the special organisations mentioned above. The Economic Crime Branch was developed as a specialist division of NCIS primarily dealing with economic offences, such as money laundering. This was created after the FSMA 2000 but obviously not a bi-product of it. However the organisation would work closely with the FSA, this was greatly received news as John Abbott, the director of NCIS stated:
“This important agreement reflects the increasing focus on anti-monetary laundering activities that NCIS has long supported.”
Since the FSMA the FSA have produced a Handbook of Rules and Guidance. This Handbook is like a code of conduct that all financial business organisations must follow or risk losing their licence of trade issued by the FSA itself. In respect to money laundering, all business organisations and individuals that carry out a regulated activity must be assessed to be competent, honest and is financially sound. Once authorised, the FSA supervise the financial businesses to make sure, among other things, that suspicious transactions are reported and that precautionary procedures are implemented effectively. All of the procedures are highlighted to the firms in the newly issued Code of Market Conduct and those firms that are found not to be following the code can have a financial penalty given to them or could even lose their authorisation of trade. Further powers are given to the FSA in respect to criminal activities through the Criminal Justice Act 1993 and the Money Laundering Regulations 1993. The FSA have powers of enforcement including the power to interview and seize documents. The FSA decide which cases to investigate through a policy of risk taking, they take in to consideration the impact the cases have on the regulatory objectives set be FSMA and the general principles of good regulation. However, the FSA has to consider the Human Rights Act 1998, stemmed from the European Convention on Human Rights, to ensure that they are not acting illegally.
The SIB was given both legislative and administrative powers and supervised the numerous SRO’s and Recognised Professional Bodies (RPB’s) within the financial market. The SIB gave licenses to the business organisations to trade in the UK financial economy but it was the RPB’s who regulated the policies of the professional organisations such as the Law Society and Lawyers. The SIB was designed to combine self-regulation and statutory regulation covering a wider scope than had been seen previously. The FSA 1986 also supported for standard and administrative criminal sanctions, affording civil remedies to investors who suffered a loss as a result of contravention of its provisions, or those of sub-ordinate rules and regulations or the corresponding provisions of SRO’s. The CJA 1993 and the MLR 1993 aided the SIB in prosecuting those who knowledgeably or negligently aided in the process of money laundering. The labour party decided, as well as other reasons, that the process of regulation was expensive as well as the fact that there had been at least two major scandals in the 1990’s which was evidence enough to suggest that the system was flawed. The FSA was created with its statutory objectives and its immense powers to regulate more of the financial market than ever before, making some people wary of making the institution too bureaucratic or unaccountable. The FSMA gave the FSA many of these powers creating the legal framework to support such a large organisation. It ensured that not only was the FSA the body to authorise and supervise but also to prosecute. The FSA would be able to work closely with other organisations such as the Serious Fraud Office. The FSA claimed that, in relation to money laundering:
“ We will be doing more work across the whole financial sector to assess the effectiveness of firms money laundering controls and customer identification procedures.”
However, statute helped the SIB to do exactly the same thing, the difference being that the FSA has complete control over the process including request or suggestions of new legislation to aid it in the fight against money laundering. Phillip Thorpe, MD of the FSA stated:
“ …the new act will for the first time give us new powers to instigate criminal prosecutions and to fine firms where their arrangements fail to come up to standard”
In conclusion, the SIB was on the right track in relation to money laundering; it identified where the problems could / would be and tried to enforce a Code of Conduct to ensure that financial organisations were operating at a standard that ensured that money laundering would be very difficult. However, the SIB lacked the powers necessary and weren’t able to supervise all parts of the financial services. There were many pieces of legislation made to aid the SIB such as the CJA and the MLR but neither allowed the SIB to enforce directly without going through the SRO’s. The FSA have been given more scope and enforcement as well as prosecution powers than the SIB ever had. The FSA is able to work with other organisations to ensure that they can meet objectives that the SIB lacked. However, I believe that the FSA could not be in such a powerful position without the aid of the SIB. The reason for this is because the SIB created a hierarchy that allowed self-regulation and had the policies to deal with money laundering but was unable to put itself into practice because of the lack of power and direct communication with the financial market. The FSA has been able to take the powers from the HM Treasury and the SIB who allowed the SRO’s to be abolished. The SRO’s wouldn’t have been able to prepare the financial market in such a way as if the FSA came into force in 1986. To summarise, I think that the FSA 1986 or the SIB was a preparatory stepping stone in the evolution of financial services regulation and the FSA wouldn’t be in the position it is now to deal with financial crime if this evolution had not occurred. However, the effectiveness of the FSA is yet to be determined and ultimately only time will show evidence of success or failure.
Financial Services and Markets Act: A practical Legal Guide, James Perry Ed, Sweet and Maxwell, 2001
Guide to Financial Services Regulation, 3rd Edition, Barry Rider et al, CHH Editions Ltd 1989, p8.
Regulating the City: Competition, Scandal and Reform, Open University, 1986.
Big Bang and City Regulation, Modern Law Review 1 p11, 1988.
Financial Services and Markets Act: A practical Legal Guide, The policy Background, James Perry Ed, Sweet and Maxwell, 2001, p7.
Twin Peaks: A Regulatory Structure for the New Century
Financial System Final Report (Canberra: Australian Government Publishing Service 1997)
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www.bbc.co.uk/drama/spooks/episodeguide_pg_ep4.shtml
FSA A New Regulator for a New Millennium, FSA 2000.