Magazine Issues » June 2009

LEGAL EASE: FSA hurdles post Turner

"Lord Turner had the unenviable task of striking a balance between producing a set of measured, workable proposals, while appeasing critics of the existing regulatory [email protected], writes David Berman

david_berman.jpgThe Turner Report, by Lord Turner, chairman of the UK’s Financial Services Authority (FSA), received a generally warm welcome ­– and hedge funds breathed a sigh of relief on learning that the Turner proposals do not reach as far as many had feared.

Lord Turner had the unenviable task of striking a balance between producing a set of measured, workable proposals, while appeasing critics of the existing regulatory regime. Most will agree that he succeeded; however, there are obstacles to be overcome if sustainable improvements are to result.  

Impact on hedge funds

The Turner Report draws a helpful distinction between banks and bank-like institutions on the one hand, and hedge funds on the other.  According to the report:
  • hedge fund leverage “is typically well below that of banks”;
  • hedge funds do not in general deal directly with retail customers (although they may have indirect contact via funds of funds);
  • hedge funds typically have not promised their investors that funds are available on demand and are able to apply redemption gates in the event of significant investor withdrawals.
In summary, “hedge funds in general are not today bank-like in their activities”. Furthermore, the report asserts, hedge funds have not contributed significantly to the current crisis, despite criticism that short-selling had exacerbated the problem.

The FSA will, however, be monitoring hedge funds to ensure that they are not displaying “bank-like features” – where a hedge fund starts to resemble a bank or becomes systemic in importance, it can expect to be subjected to increased scrutiny and, potentially, the requirements of prudential regulation (eg, capital and liquidity rules).

Arguably, the most important aspect of the Turner proposals relates to supervision – on the FSA’s admission, substandard supervision has contributed to the current crisis. It is imperative that the FSA recruits personnel with appropriate experience, insight and, crucially, an appreciation of the business models and operations of the firms they are supervising.   The FSA must supervise to the same standard of skill and diligence that its rules demand of the regulated community.  Any other reforms will certainly require proper supervision.

Non-executive directors
Relatively little attention is paid by Lord Turner to the role of non-executive directors (NEDs), to be considered in more detail by the forthcoming Walker Review. This does not, however, diminish the importance attached by the FSA to the role of non-executives. Indeed, with the FSA’s heightened emphasis on individual accountability, including a readjusted focus on competence (as well as probity), it will take a brave person to take on an NED role at a bank – to most, even vastly enhanced rewards will not justify the risks. This is all the more concerning given the dearth of talent.  

The Turner Report is to be read in conjunction with FSA Discussion Paper 09/2 (A Regulatory Response to the Global Banking Crisis), which proposes the creation of a European Union institutional structure, to replace the Lamfalussy committees. This new EU body would be an independent authority with regulatory powers, a standard-setter and overseer in the area of supervision and would be involved, alongside central banks, in macro-prudential analysis, leaving primary responsibility for supervision at member state level. Notable by its absence, however, is the explicit power to settle inter-regulator disputes. Arguably, this ought to be the most fundamental power with which this body is invested – otherwise, its role threatens to become little more
than cosmetic.

The proposals in the Turner Review and the related discussion paper need to be considered further and scoped out. It can only be hoped that international regulators use Turner as an impetus for regulatory change. The challenges ahead can certainly be resolved, but are not to be underestimated.

The FSA is under intense scrutiny. With its enhanced supervision programme, it has set the benchmark extremely high and there is no room for further supervisory failure. It is difficult to resist the conclusion that the FSA is drinking in the last chance saloon.

David Berman is a partner at City law firm Macfarlanes LLP

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