OSFI: Supervision, Yes; Micromanagement, No

Julie Dickson, Superintendent of Financial Institutions, has made a speach at the Women in Capital Markets Distinguished Speakers Luncheon in which she made some very sensible remarks about a new micromanagement policy implemented by the UK’s Financial Services Authority:

A recent announcement by the UK’s FSA illustrates the importance of this issue and the divergent approaches internationally. The FSA has announced4 that it will be interviewing all proposed new employees for senior positions that will be performing Significant Influence Functions (SIF) at financial institutions in the UK.

The key purpose of the interview is to assess the candidate’s fitness and propriety, including their competence and capability to perform the role in question. The interview takes place at the FSA’s offices and normally lasts about 90 minutes.

The FSA has said that it is important for institutions to ensure that the person to be interviewed is well prepared and has an adequate understanding of its business model and the sector in which it operates so the FSA can more easily determine whether the person is fit and proper. The institution needs to engage the FSA early (when there is a short list, not when a preferred candidate has been identified), and should include supporting recruitment documentation when an application is made (e.g., a “head-hunter’s” report). In the past year, the FSA has conducted 172 interviews and rejected 18 people.

Incredible. The footnote (well done!) provides the link to the notice of the new FSA policy.

Ms. Dickson quite properly expresses grave reservations about the policy:

But, in considering the new FSA approach, we have asked ourselves whether, in the ordinary course, it is appropriate for the regulator to be involved in the actual selection of the people who hold senior positions in financial institutions, or whether such action clearly resides with the institution, and whether a requirement for regulatory “approval” crosses a line.

We also worry about the potential for unintended consequences in this approach. Will the regulator have qualms about intervening if approved candidates perform poorly?

Indeed. I suggest that the most important management issue related to bank regulation is the potential for regulatory capture – in which regulators and regulatees form a nice cozy little group-think club – which can at worst lead to revolving door regulation with good little regulators getting very nice jobs from the regulatees after they’ve finished putting in their time.

The FSA’s policy tilts the balance of probability up near the top on the regulatory capture scale.

I don’t think there’s a right answer for that. “Gardening Leave” after leaving the regulator might help a little, as might higher pay and increased prestiege for regulatory positions (to encourage the idea that regulation is what you to cap an illustrious career, rather than start or assist one), but ultimately it all depends on the character of the group at the top of the pyramid – and you can’t legislate character.

On a related note, a paper by former OSFI boss John Palmer (also footnoted in the text of Ms. Dickson’s speech – brava!) Reforming Financial Regulation and Supervision: Going Back to Basics notes:

Another observation from interactions with a variety of regulatory agencies over many years is that the senior people in such agencies often have a weak understanding of financial institutions, what drives their behaviours and the way they respond to regulatory and supervisory initiatives. This has often led to insufficient scepticism of financial sector activities and their underlying motivations. Factors contributing to this have included:
  • • Executives and staff within supervisory agencies who have little or no direct financial sector experience, including a growing number of lawyers in some agencies;
  • • Under-resourcing of supervisory agencies, making it difficult to recruit/retain experienced qualified staff and to maintain robust on-site examination cycles;
  • • Insufficient numbers of product and risk specialists in supervisory agencies and/or ineffective use of such specialists by the senior management of such agencies.

It’s a problem, and is a problem for any regulator. Too many people with industry background increases the chance of capture; too few and you don’t know what you’re doing.

All I can suggest is that Canada seek to emulate some of the US approach: there are a lot of academics at various universities who, although not usually directly employed by the industry, have privileged access throughout their careers and build up quite an impressive body of knowledge. There’s not much of that in Canada, although I have previously referenced an essay by Jeffrey MacIntosh of the UofT Faculty of Law (and a director of Pure Trading) on Pegged Orders. Canadian regulation could be improved by the endowment of professorships at the universities who would provide a critique of regulation and – if they build up a respectable name for themselves – supply a pool of qualified high level personnel.

And, of course, sunshine is the best disinfectant. OSFI must publish more of its internal – and, ideally, external commissioned – research so that investors can decide for themselves where the regulatory flaws might be. That is an integral support of the third pillar.

Leave a Reply

You must be logged in to post a comment.