Editorial

Editorial

Article Type: Editorial From: Journal of Financial Regulation and Compliance, Volume 24, Issue 1

Rebuilding trust, empowering markets and enhancing consumer responsibility. Challenges facing financial regulation and compliance

Introduction

This is my first editorial since assuming the role of Editor in August 2015 from the outgoing editor of over 10 years, Kevin Keasey. In this editorial, I will reflect on and elaborate some of the updated aims and ambitions of the journal and consider why robust and critical research in the field of financial regulation and compliance is as important at this time as anytime of the journals previous 24-year history.

The past decade has seen a huge shift in the public attitudes towards finance. While a bank shared the Nobel peace prize for its work in promoting economic and social development in 2006, in recent years, widespread public mistrust of finance and financial regulation has become commonplace in many nations. Despite this growing public suspicion as to the utility of finance and its regulation, the use of financial services remains critical for existence within a monetarised economy, and has a central place within the everyday lives of billions. Indeed, public engagement with financial firms and markets is growing rather than reducing with some financial markets now more ubiquitous than telephony or gas supply (European Commission, 2007).

In light of the foregoing, rebuilding trust in finance is a vital process in which financial regulation and compliance needs to play the central role. Academic discourse can also do much to assist this development through asking original questions, using distinct data sets and interrogating assumptions. Indeed, academic enquiry requires the guise of a critical commentator, rather than compliant observer (Zingales, 2015).

This discussion will develop by outlining the uniqueness of financial regulation and compliance as an area for scholarly investigation, and sketch three developed and emergent policy themes which underlie and frame our discussions of financial regulation and compliance. These themes of neo-liberalism, consumer protection and trust and corporate cultures are all policy agendas which have influenced why, for whom and how financial regulation is undertaken. It is posed that cognition of such themes is required for critical research in financial regulation and compliance to emerge.

The challenges of financial regulation and compliance

Regulation can take a multitude of forms from a set of rules or laws to influence commercial or social behaviours to any form of behavioural control enacted by a public body over activities valued by a community. Regulation can adopt collective approaches within which a law is directive and public, to systems where regulations facilitate the pursuit of private interests within certain regulatory restraints. Within the financial realm, the scope of questions and concerns addressed by these regulatory approaches are substantial and are commonly framed within preventative, remedial and resolution scenarios. These are applied to prudential concerns directed at ensuring the continued operation of financial institutions and systems, the conduct of business and impact of finance and financial firms on the public or the competitive operation of markets. Other policy questions have also emerged such as whether all firms and individuals should be treated equally, are there more and less appropriate methods to arrange regulatory institutions and how financial markets may be engaged to achieve other policy goals. Indeed, the current scope of financial regulation and supervision, while varying significantly between nations, has been extending in scope and complexity in recent years.

Despite this growing remit, regulation rarely received plaudits from the public, and regulators are often attributed responsibility for resolving complex and often intractable circumstances. Financial regulators also operate in a changing world where finance is becoming less predictable over time, distinctions between the activities of different financial institutions are blurring and a diversity of non-financial institutions has entered the financial services marketplace. In such an environment, it can be testing for a regulator or compliance professional to explain the importance of a regulatory act which may constrain profits and bonuses, create additional work and provide little personal benefit to an employee who may desire to pursue personal or corporate interests. By encouraging financial firms to undertake actions against their wishes, if not their interests, regulation can breed resentment, complicating and extending the regulatory challenge.

Regulation of the financial sector is also shrouded in greater ambiguity than is experienced in other commercial sectors (Allen and Carletti, 2010). When regulating firms such as utilities, the regulatory task is often much clearer, be this reducing prices or ensuring appropriate levels of investment. In financial industries, this clarity of regulatory objectives is rarely the case. Financial firms can display market failures common to firms in other industries yet also have unique concerns, such as liquidity provision, financial contagion or the mis-pricing of assets complicating the regulatory task. Subsequently, a diversity of regulatory forms have arisen internationally, reflecting national priorities and circumstances.

Finally, due to the high taxation receipts and the economic influence they exercise, financial firms often possess political authority. Financial firms can utilize this influence and lobby politicians to amend and curtail regulation. Similarly, consumers and consumer representatives can petition their politicians to address real and perceived injustices and to extend and augment regulatory solutions favouring certain groups over others. As these debates are influenced and affected by lobbyists, changing government priorities and the economic cycle, policy-making can become opaque. In essence, financial regulation can form as much as a political compromise between competing constituents as a reflection of technical and economic concerns.

Within this stimulating and creative research setting, many “truths” from other disciplines are challenged. Innovation may be transformed from a positive attribute to an avenue of obfuscation and risk seeking, choice can become excessive and competition can be viewed to be both a welfare enhancement and potentially a challenge to stability. Thus, determining an optimal, appropriate or plausible process of regulatory and compliance activity rests on academic skills of comparison, empirical investigation and theorising from many academic disciplines.

Developed and emergent regulatory themes

In light of these anxieties as to determining what are the more appropriate or plausible forms of financial regulation and compliance, it is critical to further the perspectives applied by past editors. For instance, Keasey and Hudson (2007) cautioned the academic treatment of finance gravitates towards parochial and self-constrained explanations with an undue focus on a restricted quantity of questions. Further, the examination of financial regulation and compliance is predisposed to examining a constricted scope of data sources, using a constrained assortment of methodologies and often overlooking the context and complexity of the subject matter.

Addressing these concerns and comprehending the context of regulation and for whom such regulation is formed is of vital importance (Moloney, 2015). While financial regulation and compliance is often nationally distinct, regulation is shaped and influenced by wider intellectual themes and policy traditions which permeate our interpretation and comprehension of these issues. As an illustration, the implications of three financial regulation and compliance themes are outlined. First, in many nations, neo-liberal approaches have been forwarded to encourage greater engagement with financial markets, facilitate the unfettered disciplinary influence of market forces and constrain the development of bureaucratic, expensive and unwieldy regulation. Second, in the past decade, alternative consumer protectionist agendas have grown in importance. Finally, following the last crisis, there has been much discussion as to the role of corporate cultures in financial regulation. It has been proposed in many nations that financial institutions tend towards poor, inappropriate and even dishonest behaviours due to a learned culture and way of doing things. This has resulted in a diversity of regulatory responses to pierce the corporate veil and to influence how financial firms manage decisions at the board level and, in some cases, far deeper within the firm, altering both how and which financial services are sold and decisions undertaken.

Neo-liberal concepts have been at the heart of many regulatory developments. Here, the focus of regulation is to intervene less and empower individuals. The citizen is to engage with the financial economy, accepting responsibility for their own actions and providing for their own well-being. In this guise, the citizen becomes a part of the regulatory process through participation within and scrutiny of the market (Moloney, 2015). The role of the state and the regulator is to enhance the financial literacy of consumers, and enable the citizen to undertake these roles. Through such a process, it is envisaged that slow and bureaucratic oversight is avoided, personal creditors are protected and the incentives of politicians and regulators are muted.

This process has had its distractors. Questions arise as to whether efficient markets actually exist and if market monitoring is a plausible process for disciplining firms. Further, it may be seen that fundamental assumptions underlying neo-classical economic analysis, and supportive of this policy agenda, have been disputed by the relatively new intellectual tradition of behavioural economics. Neo-liberalism may have been actively encouraged and disseminated by those which benefit from reducing the scope and power of regulators. Indeed, during the past decade, neo-liberal views have been increasingly challenged by consumer protection viewpoints. This reflects many industry developments, including an increasing focus on the marketability of financial services (Boot, 2011), underinvestment by individuals in retirement savings or how customer behaviour can diverge from rational actions, be this due to greed, passivity or other explanations.

These concerns have reinvigorated the malaise surrounding many market manipulation, mis-selling and fraud cases in finance. In particular, individuals with the least to lose and the most vulnerable to poor financial practices have been affected by security price falls, inappropriate sales and the manipulation of financial markets more generally. These customer risks are amplified, as individuals have had to take increasing responsibility and autonomy for their financial decisions (Benartzi and Thaler, 2002); historically, low levels of saving exist in many nations (Kirsanova and Sefton, 2007), and a high proportion of households internationally face financial fragility, and have little money to lose (Lusardi et al., 2011).

While it is plausible to think that customer protection is at best a “peacetime” matter preferably overlooked during more dramatic financial circumstances, in recent years, these perspectives weakened across the world. It became clear that different forms of regulation were required, and previously unfashionable yet long-standing[1] consumer protection regulation has been revisited. This far more paternalistic tradition of regulation advocates active intervention into financial markets, to enable and encourage optimum choices and control market access (Erta et al., 2013). Methods of regulation also differ, including product regulation, prohibition of business practices and modes of distribution and a focus on the sales process. These approaches assume that the customer is vulnerable and requires protection from unscrupulous market participants, assumptions which betray a jaundiced view of the firm and require an enlarged role for the regulator.

Finally, it has been recently advocated that business cultures and the social context of financial market operations should be the important focus of regulatory intervention (Financial Stability Board, 2014). Such insights follow a lead from legal scholarship (Blair and Stout, 2001), economics (Guiso et al., 2007) and psychology (Garling et al., 2009), which report that the social context can shape norms of behaviour in financial markets. Concerns with risk seeking, accountability and, in particular, trust dominate these discussions; the latter are generally viewed to be underestimated as a social compromise within regulatory solutions and as an essential element driving financial market participation (Guiso et al., 2007).

While most evidence underlying social context or cultural reasons for regulatory intervention has sociological roots (Aldridge, 1997), recent experimental evidence as to the presence of business cultures in banking has been supportive of these concerns. Cohn et al. (2014) using experimental methods reported that bankers are as caring, considerate and honest as other people, yet only behave in this virtuous manner when they do not identify themselves with banks or act as bankers. When the identity of banker is adopted, these behaviours can decline, dishonesty arises and trust between financial firms and other actors can dissipate. While this behavioural adjustment could arise from a focus on material outcomes observed in finance or wider expectations which permeate this industry, it does appear that through acting as a banker, otherwise scrupulous, individuals can be transformed.

Ameliorating mendacious corporate cultures and rebuilding public trust has, therefore, become a new focus of financial regulation in many nations. The regulators tackling these concerns tend to intervene less in markets yet more in the firm itself with a focus turned towards enhancing the individuals’ responsibility for these actions. These approaches are nascent, and would benefit from more public discussion and academic scrutiny. For instance, should these systems be best enforced by regulators in a centralised manner? Alternatively, should financial firms manage these certification regimes through regulatory supervision? What is clear is that such interventions are overlooked by many academic commentators and remain of uncertain efficacy.

As poorly executed regulation is a substantial risk to the stability and well-being of financial markets and as different financial actors have time varying preferences, it is paramount that we comprehend how such themes influence financial regulation. Understanding for whom regulation is enacted and the principals on which regulation is founded is crucial, when assessing the worth and usefulness of regulation. Further, we need to comprehend how regulatory solutions can be finessed or whether regulation is undertaken to aggrandise a regulator, assist a firm or benefit a certain group of customers.

Conclusions

The Journal of Financial Regulation and Compliance has become a key outlet for the publication and discussion of high-quality and imaginative international research into financial regulation and compliance since 1992. During this 24-year period, the journal has developed a reputation for publishing work from a diversity of perspectives, adopting a pluralistic approach and not being constrained to a single discipline or professional concern.

In 2016, this critical, creative and pluralistic discussion of financial regulation and compliance has become even more pressing. Hangovers from recent credit booms and, particularly the 2007-2008 crisis, have been persistent. Further, this crisis took many academics, market participants and media commentators unaware and brought to the fore the concerns we had not previously weighed to be substantial. Such issues of liquidity management, financial innovation, bank resolution strategies and systemically linked financial markets have all become central to contemporary international financial regulation. While it is clearly important to incorporate these issues in post-crisis regulatory frameworks, we should not expect the next major financial crisis or damaging financial scandal to result from similar causes of past crises. We should not retrofit future regulatory systems just to address the causes and symptoms of the previous financial crisis. Indeed, the future challenges of financial regulation and compliance will arise from the multiplicity of factors which affect the provision of finance to the economy and society.

Today, anxieties exist that financial firms may not fully comprehend why certain services make profits, how funds flow through an economy and link the real and financial sectors or if financial bubbles are an intrinsic characteristic of the financial system or otherwise. Probing these and many other questions which exist beyond contemporary and fashionable concerns is of paramount importance. It is important to take risks in research by considering new questions, pursuing innovative methodologies and using different data sets, rather than follow fads and fashions of a discipline. It is also essential to examine previously underresearched functional and national markets, and compare and contrast different experiences of the practice and application of regulation and compliance. Much regulatory experience globally currently goes unreported just as issues of supervision and compliance are often not given due regard in the academic literature. To determine why some sectors or nations appear to be relatively successful or problematic in regulatory terms is a path to obtaining foresight into future concerns.

To conclude, in this editorial, I have outlined the importance of research of financial regulation and compliance. The importance of comparative, inter-disciplinary and most of all high-quality critical research using different methods and considering distinct and new questions is raised. This call is cast in a discussion of the context of financial regulation, be this the challenging nature of undertaking regulation in this field, for whom is regulation undertaken and the themes or theories justifying regulation. This editorial does not wish to apply value judgement to these themes, yet hopes for further critical enquiry of these traditions; indeed, searching for better regulatory solutions should be the journals’ guiding path.

John Ashton

Bangor Business School, Bangor University, Bangor, UK

Note

1. For example, Charles Babbage, the nineteenth-century computing pioneer and inventor of the difference engine, proposed commission for insurance sales “ought to be immediately abolished” [Babbage (1826), reported in Ericson and Doyle (2006)] in light of the financial mis-selling seen at that time.

References

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Corresponding author

John Kevin Ashton can be contacted at: j.ashton@bangor.ac.uk