No-one needs reminding of the continuing and growing importance of international financial services firms that operate cross border. A crucial issue for regulators and the industry is how we should seek to regulate these firms – and how we can do this effectively, both in terms of achieving the prudential or conduct of business behaviour we want to encourage, and in terms of avoiding unnecessary costs or excessive and conflicting regulatory burdens on the firms themselves.
This question is particularly important in the UK where, as a deliberate and successful act of public policy, we have an approach more open to foreign investment in financial services than any other large EU country, and probably than any G10 country. We now have a major retail bank in the UK owned by a Spanish parent; one of the largest players in both debt and equity in the UK market is the branch of a European bank; our derivatives exchange is not UK-owned; and our equity exchange has faced bids from non-UK entities.

But the growing importance of cross-border activities is not just a UK phenomenon: the US banks are large players in Europe; German and Austrian banks in particular account for a very large proportion of the financial systems of several East European countries that have recently joined the European Union; EU banks – ABN Amro, Paribas, RBS are obvious examples – are expanding in the US; and many banks and insurance companies are eyeing the Chinese market.
This spread of international activity puts pressure both on the management of the banks and on their regulators. Managements have to identify and control the risks and conflicts that can occur in an acute form when running a 24-hour risk book in different cultural, regulatory, legal and political regimes, while regulators have a responsibility to ensure that management and control structures are equal to this task and that local and global requirements are being met.

The increased complexity of global operations makes it necessary for regulators to understand the activities of an international bank or securities company beyond the regulator’s own market, while the firms look to their regulators to organise their activities in a streamlined way that mirrors firms’ own organisation. Regulators are coming under pressure to do what they can to remove unnecessary, duplicative and inconsistent regulatory requirements imposed on international firms by the various regulators which they have to deal with across the world, or even simply across the EU.

There are, in other words, increasing demands for regulatory convergence. This is something which the FSA both understands and supports and I believe the following approach, which is based on three fundamental principles, provides a constructive way forward.

(i) First, any approach to regulatory convergence has to be based on a recognition of the realities. “Solutions” which ignore them, however simple and neat, are likely to prove a waste of time. One such “solution”, under discussion within the EU, is the concept of hard-edged lead supervision, ie that any international financial institution should be supervised, for prudential purposes at least, pretty much exclusively by a lead supervisor in its home country with the “host” regulators in other countries losing the scope to challenge the analysis and decisions of the home regulator or to act independently of them. In practice, this runs into all sorts of difficulties around the areas of legitimacy, democratic accountability, the varying legal powers and scope of national regulators and, in the broadest sense, questions of competence. Not all countries are able to devote the resources, or have the experience, to discharge all the responsibilities that might be expected of a lead regulator.

(ii) Second, we need to recognise that not all financial services are the same, and not all pose the same regulatory problems. The optimum type and amount of coordination among supervisors needs to vary according to both the nature of the firm concerned and its impact. The issues for a host supervisor would, for example, be quite different in relation to the following cases:

• A small bank operating simply in wholesale markets. It would be quite plausible in this case to see host supervisors being willing to place extensive reliance on the home authority, which could take on many of the characteristics of a “hard”
  lead supervisor
• A bank with a significant (or “high impact”) retail business in a host jurisdiction. In this case there will be real interests for the host supervisor which can’t be ignored – and in practice are not
• A bank whose failure would pose a systemic risk in the host country (although not necessarily the home country). This could raise formidably complex problems for deposit guarantee schemes as well as lenders of last resort and finance ministries, which might ultimately have to finance any bail-out
• An exchange. When it was suggested that the Deutsche Börse might buy the London Stock Exchange, we at the FSA were concerned to set out the regulatory implications, which embraced both the way in which the UK AIM market was regulated and aspects of our takeover code, were the combined entity to be regulated by the Land of Hesse, the regulator of Deutsche Börse. It is worth pointing out that the actual arrangements for LCH do not rely on home supervision – nor is the doctrine of lead supervisor supreme in relevant EU Directives affecting exchanges and payment systems
• A payments and settlement system, where the problems are comparable to those posed by exchanges

We need to develop a taxonomy regarding the allocation of tasks between home and host authorities that recognises these – and many other complexities.

(iii) Third, we need to develop protocols for the rights and duties of both home and host regulators. What information should be exchanged? Which decisions should be taken jointly by home and host regulator? What is the process for resolving disputes? The importance of these questions is now broadly accepted, including by advocates of the lead regulator model.

It may be surprising to US readers to realise the extent to which, in the EU, regulators are legally required to place reliance on one another. The relevant European directives, for example, place the prudential oversight of branches of a financial firm operating in other EU countries firmly within the responsibilities of the home supervisor of the firm.

This situation creates a tension in the UK, for example, arising from the fact that the FSA has a statutory duty to maintain confidence in the UK financial system while having no direct prudential levers over major European institutions operating as branches that may be integral to the stability of our system, but which are the regulatory responsibility of their home supervisors, not the FSA.
The legislation that governs home/host relationships within Europe does provide some legal safeguards. The new legislation dealing with Markets in Financial Instruments, for example, provides for “proportionate cooperation arrangements” in respect of regulated markets. The Banking Coordination Directive also makes some provision for host authorities to assume some legal powers over branches, though this is available only in specific circumstances and is legally somewhat ambiguous.

I am certainly not arguing that we should seek radical changes to the legal basis on which we undertake regulation in the EU, but rather we should seek radical change elsewhere, namely in the way in which regulators interact with one another de facto on a day-to-day basis. Specifically, we need to develop a set of protocols governing the behaviour of home and host regulators.
Most important of all, regulators need to be more intelligent and risk-based in the ways in which we interact with each other and with pan-European firms. Reverting to the example of systemic bank branches in London, I have no wish to assume new legal powers over such branches. But it should be possible to devise collaborative arrangements with relevant home supervisors that enable the regulatory task to continue to be carried out to a high standard, while providing hosts with the oversight or reassurance they need and offering the firms themselves a more streamlined approach.

Regulators have already made considerable progress in devising practical answers to these and other questions, often on a basis that goes beyond the boundaries of the EU. For example, for the two large Swiss banks – Credit Suisse and UBS – there are twice-a-year meetings of their lead regulator the Swiss Banking Commission with the Federal Reserve Bank of New York and the FSA – the three most relevant regulators in the three capital market centres of most importance to the banks. At these meetings the regulators compare views, exchange information and coordinate any necessary actions.

We at the FSA have recently begun to chair meetings of what we call the college of regulators for our largest banks. So far, these have been confined largely to discussions of plans for implementation of Basel II, but we would be keen to see these extended to cover a range of ongoing supervisory issues. In another context, arrangements have been developed between the Belgian, Dutch, French, Portuguese and British securities regulators to supervise the activities of Euronext.

We also need to develop this sort of approach to provide further guidance and help to those countries where a group’s activities are very significant to a country while not particularly important to the group as a whole. This issue is particularly acute in the case of some countries that have only recently joined the EU, whose banking systems are sometimes dominated by the activities of other EU banks.

These issues also arise in a transatlantic context – and may, since we are not bound by EU legislation, be more amenable to pragmatic solutions. I am glad to say that, on a UK:US bilateral basis, we are making much progress. There are a series of sensible and productive discussions on general issues such as hedge funds, prime brokerage and credit risk transfer. In one specific area – that of remedying deficiencies in standards of documentation in transfers of credit derivatives – we have worked particularly closely with our US regulatory colleagues to send clear messages to firms that they need to do better and that we will be completely joined up in ensuring that they do.

And in respect of US institutions working in the EU (most of whom run their European businesses out of London), there are collaborative arrangements for dealing with major EU banks and we have been able to cooperate still more fully with our US counterparts with the adoption of the Consolidated Supervised Entities regime for the major broker dealers.

By developing a taxonomy of institutions that are regulated and a protocol for information exchange between regulators, we can in practice advance on a basis that offers an excellent prospect of working in practice to regulate international financial firms in a way that is both effective and efficient.