History lesson that casts doubt on the regulators' thesis

Anthony Hilton12 April 2012

PUBLIC relations consultants GCI Focus and the law firm Simmons & Simmons ran a seminar on Wednesday night which looked at the impact of the Financial Services and Markets Act and the new market abuse regime.

The most frequent justification for this legislation is that if markets are well regulated they will attract more business. People outside Britain will use our markets in preference to those of other countries because they know ours are clean, transparent and fair.

I remember Michael Howard, now the Tory Shadow Chancellor, making this very point when he was piloting the first Financial Services Bill through Parliament back in 1986. Interestingly, no one sought to challenge this assertion then, any more than they seek to now. Yet there is not a shred of evidence for it.

It needs to be challenged. One of the basic laws of economics is Gresham's Law of Money, which holds that bad money will drive out good. It was born of an age of coin-clipping but if anyone doubts whether it holds today they should look at the recent experience of Argentina and its peso, which only a few months ago was pegged to the US dollar and now is accepted by no one.

What intrigues me is that if this works for money, why should it not work for markets? How can we be sure that good markets will drive out bad - the regulator's thesis - rather than that bad markets will drive out good?

Recent evidence comes down firmly in favour of the bad markets. First, cast back three years to when what is now called Eurex took the German Bund contract from Liffe, the London financial futures exchange. The London market was far better regulated, the London market's price discovery mechanisms were much more reliable, the London market's liquidity was far greater than anything Frankfurt had to offer. But Germany was cheaper, and brokers and clients could not get their business over there quickly enough.

More recently, post-11 September, new money has been flooding into the insurance market to take advantage of higher premium rates. But while the regulated and long-established Lloyd's of London has attracted £2bn, the unregulated market in Bermuda has attracted £10bn. This is sophisticated capital saying it will take its chances on the frontier rather than incur the costs of the law-abiding town.

What this suggests is that when markets have the opportunity to vote with their feet they do so - but they go not to the regulated and safe markets but to where they think costs are lowest, which is quite a different matter.

We should not be surprised. Financial centres down the ages from Venice to Amsterdam and then London came to prominence because domestic economic strength threw off surplus capital and foreigners needed the currency so that they could trade. They are a reflection of domestic economic strength.

London is unique because it continued to be a Premier League financial centre even when its economy tumbled into the Third Division North and sterling ceased to be an internationally desirable currency. It was unprecedented for a financial centre to float free from the shackles of its domestic economy. But the key to why this happened, the key to London's success, was the absence of regulation.

The willingness of the Bank of England to allow foreign banks to set up and innovate without regulation, created the conditions that gave rise to the Eurobond market - and that saw London through the lean years of the 1960s and 1970s. London survived as an international financial centre because of absence of regulation in earlier times, not because of it.

It is a pity, however, that it is no longer politically correct to admit this.

Stock answer

SHARES in the business that is the London Stock Exchange soared on Wednesday on rumours that the US Nasdaq exchange had renewed its interest in a takeover. Further reports today said 'advanced discussions' had been taking place at Lazard's offices in New York. The investment bank is adviser to Nasdaq, as it was to OM, the Swedish markets and technology group that failed in a hostile bid 18 months ago.

Challenged to say what was going on yesterday, London Stock Exchange chief Clara Furse replied: 'We are not for sale.'

The cleverly-worded answer implies that nothing is going on, but it is most emphatically not a denial. If she had said 'no we are not in bid talks' or 'no we have not received any approach nor any indication that an approach is likely', that would be a denial. To say that 'we are not for sale' is simply to outline a negotiating position.

With these rumours swirling, there is a danger of a false market in the shares. In the interests of maintaining an orderly market, it is time for the Stock Exchange to instruct itself to issue an official statement of clarification.

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