Last week the UK Treasury unveiled a package of financial regulatory relaxation measures named the ‘Edinburgh reforms’. Their aim? Apparently not to protect consumers or ensure orderly markets. These long-held, cherished axioms of financial regulation are yielding to something seemingly more sacred – ‘securing the UK’s status as one of the most open, dynamic and competitive financial services hubs in the world,’ according to Jeremy Hunt, the UK chancellor.

In a presaging twist to their mandate, regulators are now asked to consider not only the financial wellbeing of Joe Public and the smooth functioning of markets, but also the competitiveness and growth of the UK economy.

A recent Amplify article by Lawrence Lever, executive chairman of Citywire, argues that asset managers today face ‘a massive edifice of regulation – a global industry costing billions’.

As someone who has lived and worked in the industry for more than 40 years, I feel profoundly Lawrence’s depiction of what regulation has become. Yet I feel that the ‘Edinburgh reforms’ address the symptoms of the disease, but not the cause.

Regulation is not the problem

The starting point is to recognise that financial regulation is a necessary good. It has helped reduce harm to consumers while promoting orderly markets and limiting market abuse. Thanks to regulation and controls, the financial services industry has moved forward from the systemically institutionalised, highly conflicted and predatory environment in which I first started my financial career more than 40 years ago. At the same time, cornerstone reforms enhanced the competitiveness and growth of those economies moving towards regulatory best practice.

It is not the regulation that has, at times, left me deeply frustrated and angry with the path of regulatory reform – it is the regulators.

I have worked within a regulated umbrella my entire career, in the UK, the US and Europe. In that time, regulatory progress has been characterised by cure, not prevention; it has been reactive, not predictive; it has lacked sufficient vision and leadership; and it has globalised much slower than the industry it regulates, opening up opportunities for regulatory arbitrage and persistent bad behaviour.

Regulators have been poorly staffed in terms of manpower and skills, and are often slow to react to brewing and actual great harm. And when regulators finally respond they typically mistake onerous regulation for good regulation, overreacting to their lack of foresight and the harm that it has led to, punishing on the way both the good and the bad.

Madoff in the US, Woodford in the UK, Wirecard in Europe, 1MDB in Asia, and even the global financial crisis (which had its roots in clear and obvious conflicts of interest): a global smorgasbord of lax standards and misunderstandings. Disregarding the tell-tale signs and repeated warnings are common charges against the regulators in question.

The regulatory journey has suffered from the zebra-crossing syndrome: it takes a collision with a child at a dangerous road junction before a zebra crossing is installed to protect them… along with traffic lights, yellow boxes, cameras and maybe a lollipop lady too. Ex-post cure rather than ex-ante prevention, where all drivers, good or bad, are potential villains, punished for the sins of the few, and must be protected from themselves by burdensome, all-encompassing controls – regulation based on the lowest common denominator, as Lawrence rightly pointed out.

DeFi belief

Look no further than crypto for the latest example.

It originated with smart people who understood blockchain technology and decided to apply it to the financial services world. Wrapped in an appeal to the anti-establishment community as decentralised finance (DeFi), exploiting early price momentum by playing to gambling and speculative, get-rich-quick instincts, all inside an unregulated and highly liquified environment.

This ‘successful’ mix meant that, despite poor regulation, it entered and contaminated the institutional world of fund management, plan sponsors, and even banking, spawning a plethora of trading, transactional, lending and investment platforms enjoying the lack of appropriate regulatory oversight and regulation.

The delusion went so far that Samuel Bankman-Fried (SBF), founder of the spectacularly bankrupted cryptocurrency exchange FTX, was an adviser to the US Congress on crypto regulation. Proclaimed at one time as the next Warren Buffett, now more of a dorky Billy the Kid, his testimony to Congress will, ironically, be more poacher than gamekeeper.

But can regulators and policymakers really feign surprise?

Self-manufactured digital currencies and coins, elevated to assets of value without any ability to evaluate or calculate intrinsic value, were sold on a DeFi story, fuelled by excessive liquidity, price momentum, get-rich-quick stories and paid-for celebrity endorsements with a due diligence culture based at best on delusion, at worst on fraud – and facilitated by the lack of regulatory oversight.

Create value out of nothing, apply leverage and debt, add lax controls and poor transparency and hey presto! The kids get run over. So obvious, so blatant and yet so unregulated. And only now is it clear to so many pundits and gurus. ‘Professionals’ and ‘reputable’ people such as SBF, who helped to spread the delusion of a fool’s gold were once peddled as crypto evangelists but are now regarded as no better than snake-oil salesmen. Even regulators suspended disbelief, sanctioning not controlling the crypto market. In reality, this was an unregulated Wild West – and the regulators were bystanders.

Even before the failure of FTX, the crypto market had been imploding. BlockFi, Three Arrows Capital, Voyager Digital, CoinFlex, Celsius Network, Luna and TerraUSD are among the names that have failed this year – whether a cryptocurrency, hedge fund, exchange platform or lender, there seems to be no place to hide. The Ponzi house of cards is in danger of collapse. It has been estimated that about $2tn of value has been destroyed in crypto this year.

Were regulators confused by crypto or is this just the latest gross example of regulation by cure, rather than prevention? They are in a race to catch up. Somewhat belatedly, to say the least, only now is the US Securities and Exchange Commission fighting with the Commodity Futures Trading Commission over who should regulate crypto.

Change of focus required

Unlike the industry players they regulate, regulators are untouchable. They are not subject to any rigorous or formal performance measurement, nor subject to the fines or reputational damage they inflict on the institutions they regulate. It is difficult for those in the industry to voice complaints about whether regulators and regulation are fit for purpose as we are assumed to be conflicted. To complain means you are not on board and not fit for the fiduciary world.

I understand that industry participants would not welcome carte blanch ex-ante preventative regulation and I am not calling for that. By definition, financial innovation is not predictable. However, it would not be conceivable that a major new drug would be released for use without passing through stringent regulatory interrogation. Why not when it comes to our financial health? Instead, with financial innovation, we are left to fall back on ‘buyer beware’. Meanwhile, we wait for harm to occur and regulation to follow that will inevitably overburden the industry with belated, expensive, time-consuming rules and controls that satisfy and appease regulators’ tardiness and sense of guilt.

Self-regulation is not the answer for an industry where the temptations and rewards from bad behaviour are too high and too costly to society. Regulation is necessary. But welcome or not the ‘Edinburgh reforms’, the ability to protect consumers and markets from major harm going forward will depend more on the performance of our regulators.