OPINION:Pride and prejudice: industry lobby groups in Ireland misunderstand the severity of the financial crisis and the clear need for sharpened regulatory design
FINANCIAL SERVICES Ireland plays a pivotal role in the design and implementation of regulation in the State. It is to be welcomed, therefore, that its director, Brendan Kelly, acknowledges that a “well-informed and thoughtful debate is required to fix a system so obviously broken” (Opinion and Analysis, yesterday).
It is also encouraging, if self-evident, that changes made to both the structure and purpose of the regulatory regime should have “international credibility”.
Moreover, it is both fit and proper for Ibec, the major employers’ representative body, to differentiate, if warranted, “Ireland’s international banking, insurance, and fund administration businesses” from the “present fundamentally different regulatory issues to our domestic banks”.
The problem is that these issues are not sufficiently differentiated.
Kelly condemns “lazy analysis” for suggesting that Dublin’s International Financial Services Centre (IFSC) sought light-touch regulation and states, without evidence, that “the truth is that the quality and quantity of financial regulation in Ireland are the same as in any western market economy”.
But the coherence of the argument is fatally undermined by his very next sentence: “Unfortunately, it has not always been applied and enforced as comprehensively as it should.”
Kelly compounds the error by making categorical statements that are clearly falsifiable. According to the director of Financial Services Ireland, “far from encouraging this situation, the IFSC has consistently argued for greater resources and expertise within the Financial Regulator. Also, the financial services industry has warned the Financial Regulator about the risks of increasingly complex financial markets for many years.”
How can one square this with the way in which Dublin emerged as the premier reinsurance market in the world, in large part through the urgings of John Houldsworth, the former director of Cologne Re? Houldsworth led a team which, according to his own testimony, manipulated the earnings of American International Group (AIG) in 2005. He had earlier conducted a similar scam for FAI in Australia – a process that eventually led to a Royal Commission of Inquiry and Houldsworth’s ban from the Australian marketplace. The Irish regulator did not send a representative to the hearing, citing, somewhat implausibly, budgetary restraints.
What was the response of the IFSC or indeed the Financial Regulator? Did either castigate Houldsworth for bringing the market into disrepute? Did they ban or curtail his operations or ascertain the systemic consequences? No. They relied on an internal investigation provided by Cologne Re’s own lawyers.
Dissembling is no substitute for analysis. What, for example, is one to make of the following from Kelly? “It is important to note that the vast majority of financial regulation in Ireland is derived from EU law, and is exactly the same as in any other EU state. However, our enforcement and supervisory structures represent something of a regulatory solo-run, as they were devised 10 years ago as a response to very specific problems in the domestic banking sector that came to light at that time,” he wrote.
Here two thoughts are conflated. The first move is to present Ireland as a victim of a wider malaise. It isn’t our fault that the best and brightest in the EU failed to anticipate the consequences of financial innovation. Second, he suggests that innovation applies only to market-based product design not to regulatory testing. This is simply not true.
Ireland made a calculated decision to transpose the European directive on reinsurance into domestic law within weeks of its passage in 2005. It was presented as an example of just how responsive the Dublin market had become. The failure to make available industry submissions in advance of transposition contravened international best practice. No word of dissent was forthcoming.
Finally, Kelly seeks solace in the “rules versus principles” debate. It is true the global financial crisis has been indiscriminate in its falsification of both regulatory approaches. The crucial public policy issue, however, has not been the failure of rules but the desultory incapacity of principles to offer a coherent and cohesive alternative.
It is also worth bearing in mind the collateralised debt obligation market was designed and marketed in London by a firm named, appropriately enough, Gordian Knot.
Furthermore, while the regulatory system in the US demonstrably failed, it is also the case that capacity was progressively undermined from 2002 onwards. Industry representatives feared excessive enforcement and complex rules placed New York at a competitive disadvantage to London and other emerging markets, including Shanghai, Sao Paulo, Dubai and Dublin itself.
To add insult to injury, Kelly seeks to minimise Irish culpability in the failure of two major German saving banks operating in the IFSC through inappropriate and reckless lending practices.
If the wider financial community in Dublin really took its responsibility seriously, then the risks posed by a defective “passport system” of oversight would have been passed to the Financial Regulator and through to both Germany and the EU.
It would be interesting to see the documentary evidence about the specific warnings passed on and, by Kelly’s account, ignored.
Accountability, transparency and responsibility cut both ways. We cannot rely solely on the capacity of the regulator to employ “the brightest and the best”. We need those who work in the market to exercise self-restraint and to blow the whistle when self-restraint is ignored or tolerated.
Sadly, there is no evidence that this has taken place – in either the domestic banking sector or the IFSC.
We are all paying the price.
Justin O’Brien is professor of corporate governance at the Centre for Applied Philosophy and Public Ethics in Canberra and author of Engineering a Financial Bloodbath, to be published in April by Imperial College Press