World Bank Financial Sector Conference. New Delhi. June 5-6, 2004

Strengthening Co-ordination Among Separate Regulatory Agencies

* David Knott

Ladies and Gentlemen I want you to imagine that, having listened to the excellent advice of Dr Carmichael yesterday, our political masters have now selected a regulatory structure. We've had no say in that decision, but we are now given the great honour of making it work.

We will probably find that some practical issues of implementation have been overlooked in the design stage –making our role as the regulatory manager all the more challenging. But here we are, on day one of our new regulatory regime, full of optimism and determined to make it work.

While we clearly regard ourselves as the country's most important regulator, it's apparent that we're not alone. At least one other agency has been created as part of this new regime and it's been suggested that we should together co-ordinate our work in a spirit of co-operative partnership.

Well, that shouldn't be a problem. I'm yet to encounter a professional colleague who didn't support the concept of cooperation and coordination – in principle. So we've convened this internal meeting this morning to work out our approach –and as head of the agency I'll be looking to you for ideas and inspiration.

{You needn't look so worried, this is just a hypothetical}.

Here at the World Securities Regulator (SecReg) we have regulatory responsibility for all conduct and disclosure issues in the securities markets and across all sectors of the business economy. Our business is ensuring proper corporate conduct and disclosure.

Our good friends at the World Prudential Regulator (PruReg) have responsibility for the prudential supervision of the banking and insurance sectors. Their business, in essence, is to monitor the financial safety of those sectors.

*Mr Knott has held senior regulatory positions in Australia covering both prudential and securities regulations. He was Chairman of the Australian Securities and Investments Commission 2000 – 2003.

Accordingly, at least in respect of banks and insurance companies, we have two regulators each exercising jurisdiction, so I can see the point in coordinating our activities. Apart from anything else, we want to avoid any duplication or other operational inefficiency that might impose unnecessary costs on those we both regulate.

As head of SecReg, this seems straightforward enough to me. We may have overlapping jurisdictions, but given that we have separate functional regulatory mandates I can't see any significant obstacles in the path of our coordination with PruReg. Have I overlooked anything? Do any of you have any concerns?

I realise this is our first staff meeting and that some of you may be shy so I'll take any questions or comments in written form.

OK, the first one comes from Terry Tough, the head of enforcement. Terry came to us from another securities regulator which has faced these issues in the past. He seems a bit agitated. I'll read what he says:

"I am very concerned that PruReg will be soft on enforcement. My experience with prudential regulators is that their main focus is to contain systemic risk and that they would rather keep misconduct quiet than run the risk of making things worse by taking enforcement action. As a conduct regulator SecReg needs to diligently enforce the law, because unless we send strong signals to offenders, investors will be ripped off and we won't be doing our job. How are we going to deal with PruReg on their approach to enforcement?"

Yes, well thank you Terry. Before I try to deal with that question, I see that the head of our markets disclosure section, Trevor Transparent, has a supplemental question. Let me read it:

"I want to fully endorse Terry's concerns and say that similar issues arise in the context of market disclosure. Part of the job we've been given is to improve the quality and timeliness of company disclosures to the stock exchange, so that investors at all times have access to relevant information. But those guys over at PruReg don't share that commitment to transparency. They have a disincentive from revealing events or conduct that might publicly disclose a problem that they are working to fix –for example, by merging a failing institution with a sound one. They're worried that if news gets out, their rescue deal may fall through and that depositors may panic.

They are also concerned that their access to sensitive information from financial institutions will dry up if they take a rigorous approach to disclosure and enforcement. How can we reconcile that attitude with our responsibility to promote a fully informed market and what coordination arrangements should we have on this front?"

Why do I get the sinking feeling that this is harder than I expected - perhaps because I see a number of you nodding in implicit agreement with the questions raised by Terry Tough and Trevor Transparent.

I do not believe that we should under-estimate the potential difficulties of their issues. They are both experienced practitioners who have encountered these problems in the field. They have reminded me that it would be premature to tackle the coordination agenda with the Chairman of PruReg without first carrying out a detailed analysis of our respective regulatory mandates seeking, in particular, to identify areas where we may have competing objectives. We should not assume that this will always be obvious.

As a markets conduct and disclosure regulator, enforcement and transparency are essential and primary mechanisms for discharging my investor protection role. It had not really occurred to me before today that things might look somewhat different to my good friends over at the prudential regulator.

My general counsel, Karl Careful, has pointed out that PruReg's primary responsibility is to protect bank depositers and insurance policy holders – that is to say, the customers of banks and insurance companies not their shareholders. He believes that this may justify PruReg in taking a less robust approach to enforcement and disclosure than us.

I am sceptical about this, but whatever the truth of the matter, I am convinced that it could become a major source of irritation unless some understanding is reached between the two regulators.

This causes me to consider whether my political masters got it right by creating two separate agencies. Would it have been better to consolidate all the functions into a single mega-regulator, of which I naturally would be Chairman? Karl Careful has prepared a very long legal analysis and has concluded that the same problems of competing regulatory objectives would exist within a combined securities and prudential agency.

My personal assistant, Pamela Pragmatic, has said "yes, but if you were the boss of both you could quickly resolve any such conflict without the need for inter-agency protocols and all the politics that goes with it."

Pamela Pragmatic is very wise.

But just as I am contemplating her remark, I receive an email from my chief accounting officer, Pauline Pennyless, drawing my attention to PruReg's recent budget appropriation. It seems that the Government has allocated them a much more generous budget than we received at SecReg and this is seen as very unfair by my troops. There has been much ranting and raving in the corridors and some of my colleagues have been moved to describe our friends at PruReg in uncomplimentary terms. Some of Terry Tough's enforcement colleagues have adopted an even less conciliatory approach to cooperation, seeing themselves more as competitors with PruReg than co-regulators. They are convinced that the only way we at SecReg can press our claim for increased funding is to impress our political masters with our robust enforcement outcomes – and they don't want to be hamstrung by PruReg's more passive approach.

Of course, as head of SecReg I realise that there is indeed some competition between government agencies and departments for funding, but I had perhaps under-estimated this as an obstacle to inter-agency cooperation. I again reflect whether the designers of this model considered any of these most human and practical considerations.

But I don't reflect for long, because Pamela Pragmatic announces the arrival of representatives from our leading financial industry association. They have come to pay their respects and to express their fervent hope that the two primary regulators will act in concert to avoid inconsistencies of approach and duplication of effort. Much to my surprise they are extremely complimentary about their dealings so far with SecReg and equally critical of their dealings with PruReg. The reason I am surprised is that I heard a report of their meeting last week at PruReg where they expressed precisely the opposite sentiments.

Being a lifelong student of military history I recognise the "divide and conquer" stratagem when I hear it. The existence of separate regulators in the same sector will almost always stimulate regulatory arbitrage of some type – including the tactic of playing one regulator off against the other. I make a mental note to include this on the list of issues to raise with PruReg when we meet to discuss coordination protocols. Perhaps we will need to insist that both regulators attend at least some of the regular liaison meetings with industry groups, making it harder for industry to employ this tactic. Pamela Pragmatic makes a note and comments softly that this wouldn't be an issue if there was only one regulator instead of two.

During my meeting with industry I have been alarmed to learn from the insurance representatives that both agencies have been asking for similar information, but often in different form or detail. This seems to be putting the industry to unnecessary inconvenience and expense. Surely, we should get our act together and devise a way of consolidating the requests and sharing the information at agency level. I agree that I will look into this matter as part of our coordination arrangements with PruReg.

After the meeting I call in my general counsel, Karl Careful, and brief him on some of the issues. He produces a further comprehensive memorandum of advice that, as far as I can tell, says that there is no easy answer to anything. While we have been requiring information from individual insurers to provide evidence of their compliance with conduct and disclosure obligations, PruReg has been seeking information to compile general industry statistics for publication. Although the requests for information often covers similar ground, their purpose is different - as is the required formatting of the information.

Moreover, Karl informs me that the capacity of the two regulators to share much of this information is restricted by privacy laws and by the secrecy provisions of our own legislation. "Well then", I reply, "perhaps we should collect the information and publish the statistics instead of PruReg". But Karl informs me that we have neither the power nor the budget to do so. Another item is added to the agenda for the coordination protocol discussions.

I must digress at this point to mention that I have just received a further written note from the audience –from…. Peter Perfect, who runs our conduct and governance directorate. He is hopping mad. His note almost explodes with anger - let me quote:

"The architects of our regulatory regime clearly intended that we would look after governance, but those guys over at PruReg are meddling in our territory. They are presuming to tell insurers and banks how they should structure their Boards and manage internal governance. It's an outrage. What are you going to do about it?"

I must say that I am taken back by PruReg's intention to directly enter the governance field which I think is clearly a matter of jurisdiction for SecReg. My problem at present is that we do not have any clear protocol for dealing with such contentious issues and all I can do is telephone my counterpart at PruReg and ask for an explanation. Fortunately, she is a nice woman, but she tells me quite firmly that all prudential regulators have to monitor operational risk –and that the way a bank or insurer is governed falls squarely under that heading. I become even more perplexed because, running that line of argument could result in almost all conduct issues being described as part of operational risk –thereby generating huge overlaps in regulatory responsibility. It seems to me that the Government would not have established separate regulators if this overlap was intended.

I start to consider whether I will need to invoke political intervention to sort through some of the issues that have arisen today. However, both PruReg and SecReg are established as independent authorities and no doubt we will be expected to solve our own operational problems. Indeed, we want to avoid politicising our agencies and, as Karl Careful has pointed out, the situation has been complicated by each agency reporting to a different Government Minister. So I scrap that idea and ask Pamela Pragmatic to read back from her notes the list of matters that have arisen during the day. She reads me the following:

1. an urgent need to carefully consider operational tensions that may arise from competing regulatory objectives – in the case of SecReg and PruReg this is most apparent in the areas of enforcement and disclosure. Because we will both be dealing with similar entities, differences of approach to these matters are capable of creating real conflicts and we need a way to manage them.

2. competition for budget and recognition –there's no easy solution to this problem but if we can identify some opportunities to work on projects together, and to secure better outcomes than we could by acting unilaterally, it may help to break down barriers.

3. regulatory arbitrage –we need to maintain a close dialogue with PruReg if we are to prevent regulated entities from playing us off against each other.

4. duplication and consistency –we cannot expect this new regime to be supported if the co-regulators decline sensible steps to rationalise compliance burdens and costs. This may require us to go back to Government to look at specific areas of our mandate and our ability to share information. It is essential that our secrecy provisions do not operate as barriers to cooperation.

5. Finally, the protocols for dealing with inter-agency issues need to recognise that different processes and different levels of seniority will be required depending on the nature of the issue. We will probably need at least one Memorandum of Understanding between SecReg and PruReg, but we may need more. For example, the enforcement area may require clear understandings about how a matter crossing both jurisdictions will be dealt with; including the possibility of formal handover from one agency to the other for investigation and prosecution. At the same time, we do not want to bog down in bureaucracy so we may have to differentiate between classes of offences. We should also consider how often the senior management and Commissions of the two regulators meet and how their agendas should be structured. Major misunderstandings –such as SecReg's concern about PruReg's intrusion into corporate governance –can only be effectively managed at this level. A regular pattern of dialogue should assist the resolution of such issues when they arise.

I check this list against my own notes, thank Pamela Pragmatic, and request my senior staff to start working on proposals to deal with each of these issues.

Ladies and Gentlemen, I have taken some liberties in scripting this scenario. For the sake of illustration I have presented issues from the perspective of a securities regulator. If I put on a prudential regulator's hat I would no doubt present the issues differently, although I believe that the underlying issues themselves would be similar.

I have deliberately focussed on practical, some might think mundane, aspects of inter-agency coordination. I have not canvassed higher level possibilities, such as the establishment of a Council that might bring agency heads together on a regular basis. I do not discount the usefulness of such possibilities. But in my experience, once you establish more than one agency with overlapping responsibilities, the key drivers to effective coordination will be operational.

All of the issues canvassed this morning have arisen in Australia. They have caused us problems and it has required significant resources to manage them. Key contentious issues have been identified and, where possible, written protocols have been agreed setting out inter-agency processes for handling them. Regular meetings are held between relevant agencies at both officer and Commission level to review those protocols and to discuss any areas of tension. Joint regulatory programs have been undertaken with some success. Legislative changes have been made to make it easier for relevant agencies to share information. A high level Council exists to overview this coordination, comprising our central bank, Treasury and agency heads. These have all been useful initiatives.

However, those who design the regulatory structure need to recognise the practical difficulties of attaining total coordination. It seems to me that if the regulatory functions to be performed are so different as to require separate agencies, then one would not normally envisage the need for a regulatory partnership that demands constant interaction between those agencies. For example, in Australia the regulatory mandate for anti-competitive behaviour is sufficiently “stand alone” as to require only limited coordination with other regulators.

If, on the other hand, the overlaps between two or more agencies truly demand an intense partnership in order to be effective, then perhaps the architecture is flawed. It might be better to consolidate that overlap in a single agency. This may not eliminate tensions arising from competing regulatory objectives, but it may make those tensions easier to mange.

Whatever the final regulatory structure, however, it will remain important that the capture and sharing of information across the regulated system is optimised –both in terms of improving regulatory outcomes and containing compliance costs. While the ultimate responsibility for making this happen lies with the regulators, they must be given a structure and functional powers that assist rather than hinder these objectives.

Finally, I cannot conclude without recording the increased importance of cooperation between international regulators. In my former role as Chairman of the Technical Committee of IOSCO I was impressed by the commitment of the world's securities regulators to improved information sharing and cooperation, particularly in relation to cross border securities crime. The international issues are somewhat different to those I have been discussing today, but the stakes are high and the work of IOSCO members, including the Securities and Exchange Board of India, deserve the strong support of their home Governments and policy makers.

Effective international co-operation requires a high level of confidence that the relevant countries share a mutual commitment to honest and fair markets – and that their regulators have the will and the capabilities to enforce that commitment. I look forward to expanding on these themes when I return to speak to you again later today.

Thank you.