Accountability in Financial Regulation

Marcus Fysh Excerpts

Thursday 9th February 2023 Commons Chamber

[Mr Marcus Fysh (Yeovil) (Con)]

It is a pleasure to be here for this last debate before recess to discuss such a crucial topic, and one that the House should find of the utmost interest. My background in finance comes from the self-regulatory age, but I have watched developments over the past 20 years with great interest.

The context is that the UK needs to raise its sights and raise its game to ensure a bright sovereign future. That necessitates taking significant and essential steps to make the UK competitive for the next generation as an independent country. For that, it must first complete Brexit by replacing the Northern Ireland protocol with sovereignty-compliant arrangements. That would reinstate the legal effects of the Good Friday agreement by removing the stain on the rights of the Unionist community in Northern Ireland. We should not shy away from using the Parliament Act on the Northern Ireland Protocol Bill, if necessary, to do the job of protecting the EU’s border on behalf of a reluctant EU. Secondly, we must address the small boats issue to control our borders by taking surgical steps to remove the effect of the European convention on human rights in cases of illegal arrival. Thirdly, we must remove all unnecessary EU-inherited law and replace what remains with regulations drafted in the common-law style that are appropriate for UK conditions and best able to enhance our future.

However, the reversion to our common-law approach, which will be a huge competitive advantage in the long term, will not be complete unless we address a significant problem that has crept into our system over the last decades, including, most significantly, for the financial industry. This is the problem of our regulators lacking sufficient accountability under the law. Almost all of those who spoke in the Lords debate on the Financial Services and Markets Bill agreed that this is a problem. We must seize the opportunity to fix it as part of its passage.

The Bill devolves the inherited EU rulebook to the regulators to manage and adjust, so that they can rewrite it quickly in the common-law style and remove unnecessary provisions. A major problem, however, is that at present there are no mechanics for ensuring that regulators draft clear rules and apply them predictably and consistently. Parliament, through the Treasury Committee, oversees the regulators at a high level. That Committee should be capable of ensuring that the rules are appropriately calibrated. In the Lords, a proposal to expand the arrangements to comprise a Joint Committee of both Houses has much to commend it. However, parliamentary oversight alone cannot address the validity of individual decisions. For that, the only solution is our judiciary, since only the courts or tribunals provide an independent review of regulatory action, using accepted methods of analysis and reasoning. Lord Lilley has tabled a number of what seem to be excellent amendments, which would resolve the overall problem. I wish to speak in favour of those amendments, and ask that they be adopted by the Government.

First, I should say what these proposals are not. They are not, it seems, designed to introduce yet another administrative fix in an attempt to insulate our regulators from our courts, tribunals and lawyers. The reason is that such fixes will not work here. No administrative solution could ever address the need for firms and senior managers to be able to question individual decisions in an independent forum where their arguments are properly heard. No quango can be set up to achieve such sophisticated levels of justice. Only the courts and tribunals can provide the solution. If we shunt aside our courts and tribunals, we will be ignoring the grain and the lessons from our entire political and administrative system.

Our political life in Parliament involves debate and finality, where distinctions are made as a result of arguments, and put to a vote. Our approach to matters of law is similar. Facts and arguments are presented to our courts or tribunals, leading to a final reasoned judgment. The quality of the reasoning behind those judgments means that our system is commonly accepted as providing world-leading justice. What our current arrangements do not recognise is that regulation is a form of law. It is not some sui generis thing that is exempt from legal discipline. Over the past few decades, regulation has become a core part of our legal arrangements, whether we like it or not, and regulation needs to be stitched properly into those arrangements so that it operates at the necessary levels of sophistication.

Without the availability of courts or tribunals, firms and senior managers who are subject to regulation and supervision inevitably feel that they are subject to arbitrary decision making. Their arguments, when they arise, currently have no way of being properly heard. Unfortunately that is where we are now, but how did we get here? The current system evolved while we were in the European Union. The critical disciplines found elsewhere in our legal system have not been developed to match the growth of regulation. Instead, our system relies on our unquestionably excellent regulators acting at their best at all times. However, no system is perfect, and without independent checks and balances over individual decision making, the system as a whole is weaker than it should be.

Of course, we do not want a system where firms are constantly questioning the proper judgments of our regulators. The regulators’ judgements need to be respected when validly formed and within reasonable bounds. Neither do we want an overly expensive or time-consuming process invoked more than occasionally, which soaks up the time of our regulators in unnecessary disputes. However, it would be a mistake to accept that those imperatives mean that we cannot and should not tolerate the involvement of our courts or tribunals in any meaningful way. That is to give up on building a system with the necessary disciplines, and would instead involve placing inordinate trust in an institution that we are about to endow with huge new powers. No Government are given such trust, and neither should our regulators be given it.

A blind faith approach would not only be an objectionable deviation from our constitutional principles; it would doom our financial markets gradually to decline in competitiveness, and trend towards the competitiveness of those systems that operate on the continental code-based legal systems. In fact, we would most likely do worse than those systems, since our administrative machine is not tuned to run such processes to the level of quality of the code-based systems. The core magnet of competitiveness for the UK is our common-law approach to the rule of law and the trust and confidence that that engenders, and that I, when I was the Minister responsible for exports, was keen to ensure was front and centre of our global export offer.

Lord Lilley’s proposals would enhance the way in which the upper tribunal considers appeals from regulatory enforcement decisions. Indeed, they would improve the quality of those decisions before they even reach the tribunal. There are amendments to make the internal review bodies to the regulators—the Regulatory Decisions Committee and the Enforcement Decision Making Committee—fully independent to ensure that most decisions emanating from the regulators will have been made properly, in accordance with desired common-law disciplines. Those cases would never get to the upper tribunal. When cases do get there, because a firm or senior manager believes there has been a fundamental failure of analysis by the regulators in respect of their own rules, the assessment would not be whether the rules are valid or necessary; it would merely be whether the firm or senior manager could have adjusted their conduct in advance to avoid the breach.

The basic and essential discipline intrinsic to the rule of law may require our regulators to enhance their legal teams to some degree by placing a handful of high-end lawyers at the top, who can ensure these disciplines are followed. However, the cost will be small. When that is done, adverse decisions in the upper tribunal should be few and far between. The consequence should be that firms and senior managers can go about their business of innovating, being entrepreneurial again, and driving enterprise, the UK economy and global growth by matching capital in the most efficient way with those who need it, on appropriate terms negotiated and supervised here.

The armies of compliance staff can be reduced in number and replaced by a smaller number of people applying thoughtful judgment against clear, or vaguer, rules that are nevertheless clear in their application as a result of guidance or case law precedent, using accepted common-law methods of legal reasoning. That will be in stark contrast to the regimes elsewhere in the world, which are overly bureaucratic or controlling, or unnecessarily litigious, because challenges are too easy to make and the standards are less exacting than those that our system, at its best, can deliver. In fact, the proposed changes are slight but their effects will be significant. They will introduce a discipline that will ripple through the regulators’ behaviours, because the regulators will know that there is someone ready to mark their homework—someone who is managing the rulebook and supervising and enforcing against it. Obviously, regulatory judgment is essential and, in some areas, the regulators cannot be expected to set out in advance how they intend to act. However, in such areas, there can nevertheless be a level of predictability, which means people know what they are expected to do.

Firms can apply more legal judgment when seeking to apply the regulators’ rules, but this method is highly effective, as is demonstrated by areas of the law that are dependent on high-level principles, such as the law of negligence. In the more judgment-based areas of financial regulation, the regulators’ rules will be more open-textured, but the general mischiefs that the regulators seek to prevent can nevertheless be made known in broad terms, and the regulators can apply their discretion to remove or dampen behaviours that they believe to be damaging.

Lord Bridges has proposed an alternative to the courts, comprising an Office for Budget Responsibility-style arrangement for the oversight of the regulators. However, that would merely introduce another bureaucracy without the discipline necessary to ensure that the regulators operate their rulebooks properly. In fact, we already have such a solution on the points that really matter. The Financial Regulators Complaints Commissioner already provides a vehicle for an examination of regulatory failings. The only shortcoming of the existing FRCC arrangements is that its recommendations are not binding. The FRCC investigated the London Capital & Finance debacle—a problem for many of our constituents—and made findings that were not criticised for their thoroughness, but were nevertheless ignored by the Financial Conduct Authority. There is no indication that the findings were incorrect or improperly reached. Lord Lilley’s amendments address the lack of a binding nature to the FRCC’s recommendations, and would allow the FRCC to play a more significant role in analysing regulatory failings, but direct supervision of regulatory action by our judiciary has its natural limits.

On average, only 10 such cases have been brought by firms against regulators annually over the past two decades. Almost all such cases occupy no more than a day of the upper tribunal’s time. Lord Lilley’s amendments would not turn that trickle into a torrent, but they would improve the quality of the resulting judgments, so that the market could follow the legal reasoning and reap the rewards of predictability sown there.

By far the greatest prize that will result from predictability for the market is a conversion of the many cases that smaller businesses and consumers bring before the Financial Ombudsman Service each year against firms. At present, the FOS is not required to apply legal reasoning in deciding its cases. That is a huge lost opportunity for firms and consumers, who would benefit from certainty in the application of regulatory rules. The Lilley amendments would harness that case flow by applying our common-law method to it, so that the beneficiary of a decision would be not just the individual claimant in a case, but the entire class of potential claimants. They would be able to follow the legal reasoning and decide whether they, too, had cause for redress.

Do not mistake me: I do not mean that the amendments would apply substantive common law to these disputes. Small businesses and consumers already benefit from statute, and from regulatory rules that require firms to treat their customers fairly, whatever the terms of a contract. It is essential that those substantive obligations of fairness remain fully in place for the protection of buyers of financial services.

The amendments would import an obligation to apply legal reasoning to what “fairness” means in the cases that come forward for decision. In that regard, the amendments take as their model our employment tribunals; since their introduction in the 1960s, they have, along with the obligation on employers to be fair at the point of dismissal, explained to employers what that means in practice. A settled body of employment practice has emerged from case law, and that is now essential to the orderly operation of labour markets. These amendments seek to emulate the success that employment tribunals have had in delivering inexpensive and illuminating justice to customers of financial services, and to ensure the orderly operation of financial markets. The amendments would achieve those goals in many ways.

The first-tier tribunal takes as its model the employment tribunals, which are a proven means of delivering, at low cost, the considered decision of a three-person panel—a lawyer and two market participants—as to what it means to treat a person fairly. They do so in a non-technical way, guiding the unrepresented person through the important points that go to make up fair treatment. Their decisions are properly reasoned, so other firms will have a clear guide to how they should treat their customers. No longer will firms be able to complain that it is impossible to build reliable compliance programmes around regulations as no one can agree on what they mean. In that critical respect, Lord Lilley’s amendments would implement to the full the Treasury Committee’s recommendation of October 2018.

The amendments appear to be modelled on three tried and tested, world-beating precedents: our common-law system, our employment tribunals and our construction adjudication. They deftly remove the unconstitutional unaccountability of our financial regulators by stitching them into their proper place in our legal system, without compromising the regulators’ autonomy. The regulators will be free to continue their important work, but they will do it to a higher standard. They will be more predictable and consistent in their actions. That will be a competitive advantage to us as we look to fulfil our new role in the world.

In conclusion, there is so much change coming to the financial world, including the digital tokenisation of assets, artificial intelligence and the advent of sovereign digital currencies, that it is essential that we make our regulatory structure as sure-footed and competitive as possible. These light-touch amendments present a huge opportunity, and I recommend them wholeheartedly to the Government.