Tuesday, 7 February 2017

A Specialised Regulatory “Office”: A Blunt Spearhead

This post is based on an element of a current work-in-progress article that seeks to ascertain the regulatory framework that may surround the Credit Rating Industry within the U.K. in the event of a ‘hard-Brexit’ – i.e. a situation whereby the U.K. would have to regulate the rating industry directly, after relying upon the EU and the European Securities and Markets Authority’s regulation of the rating agencies. One of the suggestions within that piece is whether a dedicated ‘Office’ within a regulatory body, akin to the ‘Office of Credit Rating’ that was set up by way of the Dodd-Frank Act in the U.S. (in response to the appalling conduct of the Big Three agencies – Standard & Poor’s, Moody’s, and Fitch), would be a suitable option for UK regulators. Whilst that can be debated, this post will look at whether that ideal of a specialised Office is even worth transplanting into the U.K. regulatory framework.

Whilst there is still a long way to go before we even know the form in which the secession from the E.U. will take, one option that is certainly ‘on the table’ is a so-called ‘hard-Brexit’, which would essentially mean a total-secession. In that scenario, the regulatory framework that has been amalgamated with the E.U. would need to be redesigned and it is that redesign that is of interest here. One option that is suggested in the soon-to-be-released piece is whether the U.K., via one of its regulatory bodies (most probably the Financial Conduct Authority), would be best suited adopting an ‘Office’ similar to that in the U.S., for the purpose of maintaining an increased level of supervision by those with an intense knowledge of the intricate, and crucially important financial industry. A dedicated ‘Office’ is designed to ‘promote accuracy in credit ratings issued’ by way of focused supervision, whilst also ensuring that ‘ratings are not unduly influenced by conflicts of interest’[1]; however, while the narrative is correct, the actions taken are not. The Office has two major problems, and it is suggested here that an Office in the U.K. would fall to the same iniquities.

Firstly, the ability of the Office to function as designed is really dependent upon the sentiment of the host regulator, which in the case of the U.S. Office highlights a lack of appetite on behalf of the SEC – The Office was not even staffed for the first 12 months of its existence[2]. Therefore, if there are any issues with the regulator itself, the composition of the Office will be irrelevant. Secondly, and more importantly, an Office dedicated to supervise the Ratings Industry (or any industry for that matter), is primed for ‘capture’ – a term used to describe when the regulator succumbs to pressure or incentive from the regulated parties and, in effect, ends up championing the cause of the regulated, rather than the people they are paid to protect. With the Office at the forefront of the State’s regulatory efforts for the Industry, there are a number of factors at play which would suggest that regulatory capture would be a major concern. Because of the need for specialists to populate such a specialist regulatory endeavour exists, it effectively means that you will need to hire people who have an intimate knowledge of the Industry – with the likelihood being that they have had some contact with the Industry in a personal capacity before becoming a regulator – this is known as the ‘revolving door’ theory because of the moving between private and public office (often more than once)[3] - the result of this is that those people will be more than aware of the riches that are on offer in the private sector, as opposed to the salaries of public officials which cannot even compare. We are therefore left to cling on to the hope that people will prioritise their civic duty of their personal gain.

It is for this reason, above all else, that the idea of a specialised ‘Office’ is not suitable for a new regulatory framework in the U.K., if that what is required after the country leaves the E.U. An Office can work, but it is dependent upon the appetite of the State to create such a framework, the appetite of regulators to prioritise the needs of the public over the needs of the ‘economy’ (which, contrary to popular opinion, is not the same thing), and finally dependent upon the ethical composition of individual regulators. Whilst not every regulator is susceptible to regulatory capture, enough are. The ‘revolving door’ exists, and for that reason alone the regulation of financial entities is fraught with the potential for capture. Unfortunately, the only way to reduce this danger is by either educating ‘regulators’ from an early stage as regulators, or by increasing the remunerative packages for regulators. Both of these solutions are achievable, but unrealistic in the modern climate, so we must look for other solutions if a new regulatory framework for the regulation of the credit rating industry is required in the U.K. after the secession from the E.U.

[1]  Robert J Rhee ‘On Duopoly and Compensation Games in the Credit Rating Industry’ [2013] 108 Northwestern University Law Review 133.
[2] Aline Darbellay and Frank Partnoy ‘Credit Rating Agencies and Regulatory Reform’ in Claire A Hill, James L Krusemark, Brett H McDonnell, and Solly Robbins Research Handbook on the Economics of Corporate Law (Edward Elgar Publishing 2012) 280.
[3] For a succinct explanation of the ‘revolving door’ concept, whereby regulators transition between regulatory office and the firms they are tasked with regulating, see Andrew Baker ‘Restraining regulatory capture? Anglo-America, crisis politics and trajectories of change in global financial governance’ [2010] 86 International Affairs 3.

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