1 00:00:02,380 --> 00:00:26,720 Was. Point, I welcome all of you to the opening session of the Beckham's third year of operation. 2 00:00:27,340 --> 00:00:37,310 Uh, as you know, uh, Beckham All the political economy in Financial Markets program was established two years ago by, 3 00:00:37,790 --> 00:00:41,900 uh, under the leadership of Max Watson, uh, sitting over there. 4 00:00:42,410 --> 00:00:53,720 And he has led this program to great heights and we've had two very productive years and were about to embark on the third year. 5 00:00:54,410 --> 00:01:03,830 Max suffered a health setback over the summer. So he's taking a backseat at the moment, but a very active, vigorous backseat role. 6 00:01:04,580 --> 00:01:09,080 And David Vines has taken over temporarily as acting director. 7 00:01:09,770 --> 00:01:17,360 David was going to be here tonight to open this this year's season, as it were, but he had to be in London. 8 00:01:17,360 --> 00:01:27,710 So I'm going to chair today's session. And for those of you who want to get more involved with this, Julie Adams just popped out. 9 00:01:28,370 --> 00:01:35,059 Is does the administration. And if you go to Julie she'll give you get you on the mailing list and also 10 00:01:35,060 --> 00:01:40,430 point out to the website that you can access full publications on the platform. 11 00:01:41,920 --> 00:01:47,860 We have six seminars here at European Studies Centre this term and there are two others one a 12 00:01:47,860 --> 00:01:55,420 burial and one Chatham House that connected with Bentham in early November of the six seminars. 13 00:01:56,140 --> 00:02:01,470 This term I would characterise for them as on the uh the the arc, 14 00:02:01,480 --> 00:02:07,480 the financial architecture in the reform of the financial architecture in the wake of the crisis. 15 00:02:07,930 --> 00:02:13,270 But also there are two which I would characterise as falling under the rubric of ethics and economics, 16 00:02:13,270 --> 00:02:16,480 of which this one I think falls into that category. 17 00:02:17,400 --> 00:02:28,770 And call him Matt. We are talking in part drawing on his book Firm Commitment that looks at the role of the corporation in society. 18 00:02:29,250 --> 00:02:35,430 And then next week, David Lines will be talking about trust in finance. 19 00:02:36,090 --> 00:02:39,060 So narrowing the focus a bit onto ethics and finance. 20 00:02:39,480 --> 00:02:49,590 And as you probably know, this topic has been very much subject matter focus in the debate lately from all different disciplines. 21 00:02:49,980 --> 00:02:56,400 And you can expect them to remain very active in this debate in the coming year. 22 00:02:59,170 --> 00:03:05,230 There will be a podcast for the presentation for this week and also for the later weeks. 23 00:03:05,740 --> 00:03:14,230 And but after the podcast, which is simply in the public domain, the question and answers will be held under the Chatham House rules, 24 00:03:14,620 --> 00:03:19,180 which means that they are you cannot cite individuals in what is said. 25 00:03:22,120 --> 00:03:28,780 Now I turn now to Professor Mann. He is the Peter Moores professor of management at the Syeed Business School. 26 00:03:29,080 --> 00:03:34,120 And you are a dean of the school from 2006 to 2011. 27 00:03:34,630 --> 00:03:37,150 And you're a Professorial Fellow also at Walden College. 28 00:03:38,140 --> 00:03:48,460 You're an expert in all areas of corporate governance, finance and taxation, as well as of the regulation of financial institutions. 29 00:03:49,000 --> 00:03:52,540 And you're a fellow of the European Corporate Governance Institute. 30 00:03:53,830 --> 00:03:56,930 I think it's right to describe you as essentially an Oxford man. 31 00:03:56,950 --> 00:03:59,380 As you did your first degree at ORIEL. 32 00:03:59,950 --> 00:04:07,150 But you've also been at Harvard, the Bank of England, and a large number of other distinguished universities in your career. 33 00:04:08,410 --> 00:04:12,370 You're also a director and chairman of Observer. 34 00:04:12,580 --> 00:04:14,020 How about that? If I pronounce it correctly? 35 00:04:15,700 --> 00:04:23,080 Between 1986 and 2010, which is now one of the most important and largest economic consultancies in Europe. 36 00:04:23,590 --> 00:04:26,890 So a lot of praise, perhaps. Maybe I should now hand over to you. 37 00:04:28,120 --> 00:04:32,170 Well, Adam, thank you very much indeed for that and for the introduction. 38 00:04:32,770 --> 00:04:42,100 As Woody Allen said, since light travels faster than sound, people appear bright until you hear them speak. 39 00:04:44,830 --> 00:04:49,600 Well, I'm extremely grateful for the invitation to be here. 40 00:04:50,350 --> 00:04:59,200 I'm particularly grateful to Max for having suggested it, and particularly delighted to see you here today. 41 00:04:59,230 --> 00:05:03,130 So thank you very much indeed for taking the trouble to be here. 42 00:05:04,540 --> 00:05:08,710 I'm also very grateful to David Vines for having invited me. 43 00:05:08,740 --> 00:05:12,170 Having invited me, he then promptly announced that he was not going to be here. 44 00:05:12,190 --> 00:05:19,330 He he's gone to London to give a rival talk. So it's, in any event, a great pleasure to do this. 45 00:05:21,450 --> 00:05:28,380 The last few years have been a torrid time for the financial system. 46 00:05:28,830 --> 00:05:36,000 We've had the accounting scandals, market manipulations, payment protection, mis selling, mortgage, mis selling, 47 00:05:36,300 --> 00:05:46,080 the LIBOR scandals, forex scandals, the financial crisis, executive remuneration scandals, tax avoidance. 48 00:05:47,640 --> 00:05:57,360 And all these problems are basically associated with a variety of different underlying causes. 49 00:05:58,560 --> 00:06:03,450 I'm going to suggest that, in fact, they don't have a variety of different causes, 50 00:06:03,870 --> 00:06:09,570 that there's a common underlying problem that requires a common solution. 51 00:06:10,570 --> 00:06:22,930 And that common underlying problem is the corporation, and the solution to it is to fix it and not everything else around it. 52 00:06:24,430 --> 00:06:30,370 Underlying the corporation is an economic concept of a production function that takes inputs of material, 53 00:06:30,370 --> 00:06:34,990 labour, land and capital and converts them into goods and services. 54 00:06:35,470 --> 00:06:41,170 Or it it's regarded as a legal nexus of contracts binding together the various parties to the firm, 55 00:06:42,130 --> 00:06:48,490 or it's a social construct for reducing the costs of transacting in the market relative to that in the firm. 56 00:06:48,820 --> 00:06:54,070 And above all, the corporation exists to serve the interest of its owners, 57 00:06:54,070 --> 00:07:03,340 its shareholders and its directors owe its shareholders a fiduciary responsibility to uphold their interests and to maximise the value of the firm. 58 00:07:04,670 --> 00:07:11,990 And when that maximisation varies from the our interests as societies and communities, 59 00:07:12,440 --> 00:07:17,330 then we seek to regulate the firm or if necessary, we take it into public ownership. 60 00:07:17,960 --> 00:07:22,270 And when the corporation fails more, we regulate it more and we nationalise it more. 61 00:07:22,280 --> 00:07:27,830 And when regulation and the state fail more than we liberalise and privatise, 62 00:07:28,820 --> 00:07:38,040 and that notion of shareholder oriented corporations, regulation and state ownership is a widely accepted consensus. 63 00:07:38,040 --> 00:07:41,840 It's the basis of national and international policies around the world. 64 00:07:42,770 --> 00:07:45,140 But I'm going to suggest it's fundamentally wrong. 65 00:07:46,100 --> 00:07:55,009 And the reason it's wrong is that that conception of the firm as a production function or a nexus of contracts 66 00:07:55,010 --> 00:08:00,950 or a social construct that reduces the costs of transacting in the firm knowledge of the market is wrong, 67 00:08:01,790 --> 00:08:09,110 and above all that the corporation does not exist to maximise the shareholder value. 68 00:08:09,920 --> 00:08:17,030 It exists to do things to make goods and services that benefit us as consumers and communities. 69 00:08:17,660 --> 00:08:27,080 And the corporation is exceptionally well placed to do that because it can balance the degree of commitment that it gives to different parties, 70 00:08:27,410 --> 00:08:36,140 to the control that it exerts over them. It can contract to be contracted employee, be employed, sue and be sued just like us. 71 00:08:36,950 --> 00:08:44,960 But it can actually do much more than that. It can offer degrees of commitment that we as individuals can only aspire to. 72 00:08:46,640 --> 00:08:55,760 It's a veritable Alice in Wonderland, but over time, it's become a Frankenstein in Transylvania. 73 00:08:56,810 --> 00:09:06,050 And the reason for that is it's been hijacked by one particular interest group, its shareholders, and very short term shareholders at that. 74 00:09:07,340 --> 00:09:10,970 70 years ago, the average holding period of shares on the stock market was eight years. 75 00:09:11,000 --> 00:09:14,390 30 years ago, it was four years. Today, it's a matter of months. 76 00:09:14,780 --> 00:09:21,740 Or in the case of high frequency trading, a matter of days, hours, seconds or nanoseconds. 77 00:09:23,520 --> 00:09:29,370 Now that shortening the horizon of corporations has had devastating consequences, 78 00:09:29,370 --> 00:09:36,779 consequences for our economic systems, our financial systems and our environmental systems. 79 00:09:36,780 --> 00:09:47,100 Because in the pursuit of shareholder gains, corporations have been willing to sacrifice our interests as creditors, communities and customers. 80 00:09:48,580 --> 00:09:52,959 Now that problem of a shortening of horizons, 81 00:09:52,960 --> 00:10:03,400 of shareholder interests has been exacerbated by a misdiagnosis of the underlying problem and therefore a prescription of the wrong cure. 82 00:10:05,830 --> 00:10:11,290 The problem to which they're changing ownership of corporations and financial 83 00:10:11,290 --> 00:10:16,090 institutions is thought to give rise is what is termed an agency problem. 84 00:10:16,870 --> 00:10:24,399 That is to say, a separation between the ownership of companies and their control because of 85 00:10:24,400 --> 00:10:28,600 the very dispersed nature of ownership in many countries around the world, 86 00:10:28,600 --> 00:10:36,100 not least in the UK and the US. There's very little incentive for any one particular shareholder to exert a great deal 87 00:10:36,100 --> 00:10:41,200 of effort in terms of overseeing the running of firms and financial institutions. 88 00:10:42,040 --> 00:10:46,569 And as a consequence, management runs right. It pays itself egregious salaries. 89 00:10:46,570 --> 00:10:50,830 It engages in wasteful investment. It undertakes disastrous acquisitions. 90 00:10:52,030 --> 00:10:58,780 And nearly all policy towards the corporation over the last 30 or so years has been directed towards 91 00:10:58,780 --> 00:11:06,040 solving that one particular problem of aligning the interests of management better with with shareholders. 92 00:11:06,580 --> 00:11:12,790 Sarbanes-Oxley in the United States, Dodd-Frank. After the financial crisis in the United States, the cap recurred. 93 00:11:12,790 --> 00:11:17,790 In the U.K., the European. Unions. 94 00:11:18,450 --> 00:11:22,110 Shareholder Activism Directive, which came out recently. 95 00:11:22,140 --> 00:11:29,310 All of those have as their objectives, to align the interests of management better with shareholders. 96 00:11:30,850 --> 00:11:35,950 But the problem that underlay the financial crisis was not an agency problem at all. 97 00:11:36,850 --> 00:11:46,690 Indeed those financial institutions. That had the highest powered incentives that aligned the interests of management best with our 98 00:11:46,690 --> 00:11:52,389 shareholders were the ones that took the greatest risk and those that had the best corporate governance, 99 00:11:52,390 --> 00:11:58,510 according to conventional measures of corporate governance standards, were the ones that failed the most. 100 00:12:00,330 --> 00:12:05,310 The problem with the financial crisis was not an agency problem at all. 101 00:12:05,910 --> 00:12:10,290 It was something very different. It was essentially a problem of fraud. 102 00:12:11,800 --> 00:12:16,210 I don't mean fraud in the simple sense, which we might associate it with. 103 00:12:16,360 --> 00:12:21,280 For example, Bernie Madoff. I'm talking about something that is much more subtle, 104 00:12:22,000 --> 00:12:27,430 something that we teach our students in economics departments and business schools to do all the time. 105 00:12:28,390 --> 00:12:31,760 To make money. There are two ways of making money. 106 00:12:31,780 --> 00:12:39,340 The first is to do good or to make goods. And the second is to engage in wealth transfer. 107 00:12:40,460 --> 00:12:44,990 By wealth transfer. What I mean is making money at the expense of others. 108 00:12:45,980 --> 00:12:49,580 That was the problem of the financial crisis, 109 00:12:49,580 --> 00:12:58,309 because there's a fundamental divergence between the two main parties associated with financial institutions, between the shareholders, 110 00:12:58,310 --> 00:13:01,670 on the one hand, who benefit when the financial institution, 111 00:13:01,670 --> 00:13:08,150 the bank is doing extremely well and when it's doing so badly that it's in distress or bankruptcy. 112 00:13:08,540 --> 00:13:13,280 Then it's the creditors or ultimately the taxpayer that bears the losses. 113 00:13:13,940 --> 00:13:21,650 So from the point of view of shareholders, it's a heads I win, tails you lose scenario. 114 00:13:22,600 --> 00:13:25,780 And therefore they like institutions to take risks. 115 00:13:26,050 --> 00:13:30,910 They like them to flip the coin, and they incentivise management to do exactly that. 116 00:13:31,810 --> 00:13:36,100 That was precisely the issue that arose in relation to the financial crisis. 117 00:13:36,100 --> 00:13:39,400 And it's not just the problem of excessive risk taking. 118 00:13:40,000 --> 00:13:47,200 It's also a problem of excessive leverage because they incentivise management also to raise debt, 119 00:13:47,620 --> 00:13:53,380 to pay that money raised out in the form of dividends and share buybacks to their shareholders. 120 00:13:54,220 --> 00:13:57,350 And it's not just a problem that afflicts financial institutions. 121 00:13:57,370 --> 00:14:04,120 It's a problem that afflicts employees who devote specific capital to the companies for which they work, 122 00:14:04,450 --> 00:14:11,100 and suppliers to companies that dedicate physical capital to companies that they supply. 123 00:14:11,110 --> 00:14:16,810 All of them are dependent on the continuation of the firms with which they engage. 124 00:14:18,860 --> 00:14:23,540 So the problem is not an agency problem. 125 00:14:24,290 --> 00:14:27,830 It's something that is really very different from that. 126 00:14:28,520 --> 00:14:33,770 And what I'm trying to emphasise is that while we think about the problem of the corporation as 127 00:14:33,770 --> 00:14:38,600 being essentially an agency problem of aligning the interests of management with shareholders, 128 00:14:38,960 --> 00:14:41,150 it's at least a three dimensional problem. 129 00:14:41,150 --> 00:14:48,740 It's a problem as well of aligning the interests of the company with its other stakeholders, its customers and its communities. 130 00:14:49,040 --> 00:14:57,350 And it's a problem of aligning the interests of both current generations of shareholders and stakeholders with the interests of future generations. 131 00:14:58,880 --> 00:15:05,750 Now, to deal with these problems, we have essentially one instrument. 132 00:15:06,980 --> 00:15:12,200 You might think that perhaps the reputation of financial institutions and companies 133 00:15:12,200 --> 00:15:17,210 might be sufficient to encourage them to act in a broader social interest. 134 00:15:17,540 --> 00:15:23,329 But if you think that you'd be mistaken, it was July the 27th, 2012. 135 00:15:23,330 --> 00:15:30,110 Up on the ticker tapes of the New York and London stock exchanges flashed the announcement that Barclays Bank 136 00:15:30,260 --> 00:15:39,380 had been found guilty of the libel scandal between 1:30 p.m. and 4:30 p.m. when the London stock market closed, 137 00:15:40,010 --> 00:15:43,940 the share price of Barclays Bank rose. 138 00:15:44,750 --> 00:15:50,750 The stock market was overjoyed to hear that Barclays Bank had been found guilty of the libel scandal. 139 00:15:51,670 --> 00:15:59,710 Now you might think, well, that was just a temporary blip and that after the share price of Barclays declined well over the subsequent six months, 140 00:16:00,280 --> 00:16:08,530 Barclays Bank had to set aside £2 billion of provisions to pay compensation, not just for the LIBOR scandal, but also for payment protection. 141 00:16:08,800 --> 00:16:10,270 And over that six month period, 142 00:16:10,270 --> 00:16:19,810 its share price rose by 65% during a period in which the stock market as a whole went up by 10%, a 55% abnormal return. 143 00:16:20,410 --> 00:16:33,040 Lloyds Bank had to set aside £7 billion of compensation for investors and customers, and its share price also rose by 65% over the same period. 144 00:16:35,490 --> 00:16:42,780 And it's a problem that not only affects financial institutions, but it's a problem that's been widely observed. 145 00:16:42,780 --> 00:16:48,150 For example, in relation to environmental regulation, when companies violate environmental laws, 146 00:16:48,630 --> 00:16:53,970 their share price is found to either go up or to remain unchanged. 147 00:16:54,240 --> 00:17:01,550 And this is exactly what one would expect if it's the case that a company is perceived to have acted more in the interests of their shareholders. 148 00:17:02,690 --> 00:17:08,290 Then the share price should respond positively in relation to that announcement and revelation. 149 00:17:08,330 --> 00:17:17,750 So from the point of view of society. The impact of reputational facts that come from the stock market are entirely perverse. 150 00:17:18,810 --> 00:17:24,240 Now, the one instrument that we've got available to us to deal with that problem is regulation. 151 00:17:24,990 --> 00:17:34,500 And in response to the failure of the in the financial crisis in this country, we're introducing a ring fencing between retail and investment banks. 152 00:17:34,890 --> 00:17:40,200 We are introducing rules regarding bankers pay. 153 00:17:40,470 --> 00:17:46,110 The European Commission is limiting the extent of bonus payments that can be paid relative to base pay. 154 00:17:46,560 --> 00:17:54,690 We are determining who can run banks, how much they can get paid, what they can do, and how much they can charge for the services they provide. 155 00:17:55,140 --> 00:17:58,800 We are running rings around the banks and what is going to be the consequence of that? 156 00:17:59,340 --> 00:18:05,549 The consequence is going to be that banks are going to do less of the things that are regulated, like lending money, 157 00:18:05,550 --> 00:18:13,320 which we might want them to do, and more of the things like derivative trading, which is unregulated, which we might not want them to do. 158 00:18:13,620 --> 00:18:18,959 They're going to do less of the things in this country and more things abroad. 159 00:18:18,960 --> 00:18:27,600 They're going to do less things in the form of formal, regulated banks and more in the form of unregulated shadow banks. 160 00:18:28,410 --> 00:18:33,360 And the reason that this is happening is that the only way in which we can encourage 161 00:18:33,360 --> 00:18:39,650 more ethical conduct on the part of institutions and companies is to regulate them. 162 00:18:40,830 --> 00:18:47,970 But far from encouraging more ethical compliance, it encourages instrument avoidance. 163 00:18:49,040 --> 00:18:57,230 Anyone who's been associated with the regulatory departments of utilities know that those are supposed to be compliance departments. 164 00:18:57,740 --> 00:19:02,990 But in fact, anyone who's been involved in them would appreciate that. 165 00:19:02,990 --> 00:19:13,520 Actually, they are avoidance departments designed to minimise the impact of regulation on the conduct of those institutions and companies. 166 00:19:15,570 --> 00:19:29,070 Now in terms of trying to address the issue of how to actually encourage more acceptable conduct on the part of institutions and companies, 167 00:19:29,520 --> 00:19:37,560 then what we might start by doing is perhaps looking at a few cases of where conduct has been a bit more acceptable. 168 00:19:39,120 --> 00:19:44,340 The most successful bank in Europe at present. 169 00:19:45,390 --> 00:19:53,820 Is a bank that is expanding rapidly in this country, opening branches all over this country at a fast rate. 170 00:19:54,300 --> 00:20:00,570 It's one of the most profitable and high return banks in terms of equity returns in Europe. 171 00:20:01,740 --> 00:20:06,570 It's a bank that did not have to be bailed out at all during the financial crisis. 172 00:20:06,840 --> 00:20:09,990 It did not have to be bailed out during the Swedish banking crisis either. 173 00:20:10,620 --> 00:20:12,420 It's the Swedish bank Handelsbanken. 174 00:20:13,670 --> 00:20:21,890 Now there are a number of interesting features about this bank, the first of which is it pays its staff no bonuses. 175 00:20:22,580 --> 00:20:29,030 No bonuses at all, except for when, at the age of 60, they finally retire. 176 00:20:29,420 --> 00:20:33,860 Which stage? They can have a claim on the pension fund of the bank. 177 00:20:34,070 --> 00:20:37,640 This performance is related to the financial performance of the bank. 178 00:20:38,510 --> 00:20:46,430 The second interesting feature of this bank is that it delegates all decision taking to the branches, to the branch managers. 179 00:20:46,670 --> 00:20:50,300 There's virtually no centralisation of decision taking. 180 00:20:50,510 --> 00:20:57,319 The risks are managed by the individual branch managers to the extent that the Oxford branch manager, for example, 181 00:20:57,320 --> 00:21:02,510 there is an Oxford branch and Botley determines the products that they're going to sell, 182 00:21:02,510 --> 00:21:07,970 the prices they're going to sell, the way in which they're going to advertise the products in the area. 183 00:21:09,310 --> 00:21:17,740 So all of the decision taking is devolved. The third interesting feature, the bank, is its ownership. 184 00:21:19,570 --> 00:21:24,430 It's owned by two large shareholders. 185 00:21:25,030 --> 00:21:29,620 The first one of which is. It's own pension fund octogenarian. 186 00:21:30,880 --> 00:21:37,030 The second is it's owned by a Swedish investment company called Industry Varden. 187 00:21:38,080 --> 00:21:41,950 And if you pose the question, well, who's the main shareholder in industry? 188 00:21:41,950 --> 00:21:44,950 Varden. You've guessed it. It's Handelsbanken. 189 00:21:45,880 --> 00:21:53,920 It's a cross shareholding. So here is a bank that pays no bonuses, devolves all decision taking, not at the board, 190 00:21:53,920 --> 00:21:58,720 but right down to the branch manager level and is across shouting by every account. 191 00:21:59,470 --> 00:22:04,510 It has all of the worst features that one can possibly imagine of a bank. 192 00:22:04,780 --> 00:22:11,470 And what would generally be regarded as completely impossible from the point of view of recruiting any staff. 193 00:22:13,130 --> 00:22:21,840 Let me give you another example. The the most successful period of British banking was, of course, 194 00:22:22,290 --> 00:22:32,370 at the end of the 18th century when Britain had a whole series of local banks situated all over the country. 195 00:22:33,300 --> 00:22:41,460 Those local banks were basically the basis on which the Industrial Revolution was financed. 196 00:22:42,390 --> 00:22:46,770 Those were the basis of Britain becoming the workshop of the world. 197 00:22:48,290 --> 00:22:58,070 Now those local banks suffered from a problem, and that is that they were exposed to their local economies when those local economies failed. 198 00:22:58,310 --> 00:23:01,760 And so too did the banks and the central bank. 199 00:23:01,760 --> 00:23:06,020 The Bank of England reacted then, as it did during the last financial crisis, 200 00:23:06,380 --> 00:23:13,400 by trying to protect the financial system, culminating in the collapse of the city of Glasgow Bank in 1878. 201 00:23:14,240 --> 00:23:20,060 And what it did to to correct the problem was essentially to encourage banks to merge. 202 00:23:20,480 --> 00:23:30,200 So banks merged with each other and when they merged with each other, they shifted their headquarters from localities around the country to London. 203 00:23:31,520 --> 00:23:36,950 And as they did that, then they severed their relationships with the companies that they were financing. 204 00:23:38,000 --> 00:23:45,049 And basically the financing of small and medium sized enterprises ended in Britain at 205 00:23:45,050 --> 00:23:51,590 the end of the 19th century when they were consolidated in five large banks in London. 206 00:23:52,720 --> 00:24:02,650 And ever since then we've been trying to revive bank lending for small and medium sized enterprises in Britain, but with virtually no success, 207 00:24:02,950 --> 00:24:17,200 except for one example of success, which came out of the Macmillan Committee that produced a report on the equity gap in Britain in the 1930s. 208 00:24:17,470 --> 00:24:25,090 And the recommendations of that committee were that a new institution needed to be established to fund 209 00:24:25,990 --> 00:24:33,250 British enterprise and in particular to provide financing for relatively small and medium sized enterprises. 210 00:24:33,520 --> 00:24:44,410 And the institution that eventually emerged out of this in the post Second World War period was the Industrial Commercial Finance Corporation, ICF C. 211 00:24:45,820 --> 00:24:50,650 Now, the interesting feature of ICF C is, first of all, its ownership pattern. 212 00:24:51,340 --> 00:24:57,490 It was owned as a consortium by the clearing banks and the Bank of England. 213 00:24:58,790 --> 00:25:07,580 So it was basically protected from market forces by the fact that it had a long term, stable ownership pattern. 214 00:25:08,900 --> 00:25:19,370 The second feature of it is that it devolved decision taking on lending to the individual branches of the bank, 215 00:25:20,000 --> 00:25:28,580 and it employed people known as controllers who had a very rare feature for British bankers. 216 00:25:29,120 --> 00:25:37,280 They knew something about industry. They had industrial expertise as well as financial expertise. 217 00:25:38,560 --> 00:25:49,720 And the result of this was that I CFC became an extraordinarily successful lender to SMEs in Britain. 218 00:25:50,200 --> 00:25:53,590 To give you one illustration of a company that basically survived. 219 00:25:54,720 --> 00:26:03,930 As a consequence of it and would not have without it. Oxford Instruments borrowed from ICF C in the early phases of its development. 220 00:26:03,960 --> 00:26:13,500 Not only was it basically the mechanism by which many small and medium sized enterprises were financed in the post-Cold War period, 221 00:26:13,500 --> 00:26:17,130 it was also an extremely profitable bank. 222 00:26:19,390 --> 00:26:27,970 It also had an arm known as finance for industry, which was a provider of equity as well as debt finance to SMEs. 223 00:26:28,720 --> 00:26:38,020 And towards the end of the 1970s, HDFC merged with a sister organisation, Finance for Industry to form. 224 00:26:39,590 --> 00:26:48,370 Investors in industry. And investors in industry later changed its name to three. 225 00:26:49,870 --> 00:27:01,210 Now, during the 1980s, investors and industry was essentially a venture capital firm, and it was indeed the largest venture capital firm in Europe. 226 00:27:01,780 --> 00:27:08,380 And for a brief period of time, Britain had one of the most successful venture capital industries in the world. 227 00:27:10,310 --> 00:27:16,730 But in its infinite wisdom and as part of basically a Thatcher privatisation. 228 00:27:17,960 --> 00:27:25,610 It was decided that the Bank of England would sell off its share in three and so to with the clearing banks. 229 00:27:27,050 --> 00:27:32,510 So at the beginning of the 1990s, three, as it was then known, 230 00:27:33,380 --> 00:27:39,680 floated on the London stock market and virtually overnight it stopped doing lending for SMEs, 231 00:27:39,680 --> 00:27:44,899 it stopped doing venture capital financing, and it became a management buyout business. 232 00:27:44,900 --> 00:27:57,230 And basically since then we've had no significant as lending and a much reduced venture capital market in this country. 233 00:27:58,980 --> 00:28:05,160 Now. The common features of the successful elements of financing that I've just described is, 234 00:28:05,160 --> 00:28:09,720 first of all, the nature of the ownership of the institutions, the fact that. 235 00:28:10,710 --> 00:28:16,170 Each successful owner, each successful institution had a long term owner. 236 00:28:17,110 --> 00:28:28,690 The cross shareholdings in the case of Handelsbanken, the families in the case of the local banks and the consortium in the case of C and then three. 237 00:28:29,830 --> 00:28:41,410 The second feature is a combination of knowledge about business as well as finance on the part of lenders loan officers. 238 00:28:42,580 --> 00:28:49,990 Third feature is the devolution of decision taking to those respective parties. 239 00:28:51,970 --> 00:28:53,440 Now in terms of. 240 00:28:54,630 --> 00:29:06,220 Thinking about how to generalise this going forward and what this points to as an important component of the development of financial system. 241 00:29:06,480 --> 00:29:09,090 Then I think there are three elements that this brings out. 242 00:29:09,120 --> 00:29:17,759 First of all, there has to be a clear notion as to what the purpose of the institution is, what is the function that it's supposed to perform? 243 00:29:17,760 --> 00:29:23,760 It was very clear in the case of the local banks during the Industrial Revolution 244 00:29:24,060 --> 00:29:28,620 that their role was there to support the growth of new enterprise in Britain. 245 00:29:29,400 --> 00:29:37,470 It's very clear if you look at the way in which Handelsbanken sets out its mission statement, what it sees as its purpose as being, 246 00:29:37,770 --> 00:29:46,410 and that is to promote the development of lending to individuals and to companies in particular. 247 00:29:47,500 --> 00:29:53,830 And it was very clear precisely what a CFC and three were supposed to do. 248 00:29:55,550 --> 00:29:59,690 Now, although it's the case that we sometimes believe. 249 00:30:00,490 --> 00:30:09,750 That the only purpose that companies that are listed on stock markets can perform is to uphold the interest of their shareholders. 250 00:30:09,760 --> 00:30:11,530 That is not in fact the case. 251 00:30:12,970 --> 00:30:20,950 In a survey that was undertaken of middle management in five countries around the world, that middle management was asked the question, 252 00:30:21,520 --> 00:30:27,339 do you believe that your company is being run purely in the interests of your 253 00:30:27,340 --> 00:30:31,300 shareholders or in the interests of your stakeholders more broadly defined? 254 00:30:33,050 --> 00:30:36,170 In the case of the UK and the US, 255 00:30:36,590 --> 00:30:40,489 70% of the middle management said that they thought that their companies and 256 00:30:40,490 --> 00:30:44,030 institutions were being run solely in the interests of their shareholders. 257 00:30:45,360 --> 00:30:53,220 In 20% of the French and German companies. They gave that response and in just 3% of the Japanese companies. 258 00:30:54,430 --> 00:30:58,089 And those differences really matter because the middle management will also ask 259 00:30:58,090 --> 00:31:03,160 the question If your company gets into financial into financial difficulty, 260 00:31:03,850 --> 00:31:08,830 do you believe that it would cut employment or cut dividends? 261 00:31:09,760 --> 00:31:12,459 In 90% of the British and American companies. 262 00:31:12,460 --> 00:31:19,550 The middle management said that they thought that the companies would cut employment in 40% of the French and German companies. 263 00:31:19,570 --> 00:31:23,770 They gave that response and in just 3% of the Japanese companies. 264 00:31:25,120 --> 00:31:33,609 Now, the the notion that institutions and companies could have a purpose beyond just their 265 00:31:33,610 --> 00:31:40,030 shareholder interests depends critically on not only expounding what that purpose is, 266 00:31:40,540 --> 00:31:46,150 but also in having owners who are committed to uphold that purpose. 267 00:31:47,040 --> 00:31:53,549 Now, the problem that is that arises in the case of in particular the UK and the US is not an agency. 268 00:31:53,550 --> 00:31:58,050 Problem of inadequate control by shareholders is exactly the opposite. 269 00:31:58,590 --> 00:32:07,050 It's the absence of any committed shareholders who are dedicated to supporting the pursuit of long term policies. 270 00:32:08,160 --> 00:32:13,690 It's essentially a problem of having dispersed shareholders who are anonymous. 271 00:32:13,710 --> 00:32:16,470 You cannot have a relationship with the anonymous. 272 00:32:17,370 --> 00:32:27,809 And what British management finds in major listed companies is a significant problem is establishing what the 273 00:32:27,810 --> 00:32:33,960 shareholders of the company are seeking as the purpose of the corporation beyond just making shareholder returns. 274 00:32:35,800 --> 00:32:48,190 Now the feature of long term committed ownership is something that is very much observed in most listed companies around the world. 275 00:32:48,970 --> 00:32:57,160 Those committed shareholders are, in many cases, families, so that while companies are listed on stock markets in most countries around the world, 276 00:32:57,160 --> 00:33:04,600 they also have large, dominant family owners who hold shares for long periods of time. 277 00:33:06,760 --> 00:33:09,970 Even in the case of the United States, 278 00:33:10,510 --> 00:33:22,750 there is a greater prevalence of committed long term ownership and more of a presence of what this slide brings out here as block owners, 279 00:33:23,170 --> 00:33:27,490 that is to say, significant concentrations of ownership in companies. 280 00:33:27,940 --> 00:33:37,629 So this slide shows along here the average size of blocks in companies in different countries around the world and in the vertical axis, 281 00:33:37,630 --> 00:33:40,690 the proportion of firms that have block holders at all. 282 00:33:41,530 --> 00:33:49,989 And you can see that the UK is marked out by having very few firms that have got significant block holdings at all. 283 00:33:49,990 --> 00:33:55,510 And where they've got them, the size, the average size of those block holdings is very small. 284 00:33:56,460 --> 00:34:00,360 The US, in contrast, has shown up. 285 00:34:00,360 --> 00:34:09,000 There is a country which is not dissimilar to many other countries around the world in having relatively significant share blocks. 286 00:34:10,230 --> 00:34:22,709 And the US allows management a much greater degree of independence in terms of the way in which they choose to structure the ownership and control. 287 00:34:22,710 --> 00:34:33,300 It permits companies to have anti takeover provisions such as poison pills, which protect management from hostile acquisitions. 288 00:34:33,540 --> 00:34:41,460 And it allows companies to have dual classes of shares that concentrate control in the hands of particular long term shareholders. 289 00:34:41,790 --> 00:34:45,330 So, for example, Google when it came to the stock market. 290 00:34:47,760 --> 00:34:53,250 Kept control in the hands of Sergey Brin, Larry Page and Eric Schmidt, the founders of Google, 291 00:34:53,580 --> 00:35:01,470 through a dual class structure linked in when it came to the stock market cap controlling the hand of Reid Hoffman, who founded the company. 292 00:35:01,710 --> 00:35:04,720 Mark Zuckerberg retain control of Facebook recently. 293 00:35:05,310 --> 00:35:14,459 So all of these companies essentially ensure a greater degree of continuing control through the use of dual class shares. 294 00:35:14,460 --> 00:35:21,480 Dual class shares are not permitted. The companies that come to the London stock market because the London Stock 295 00:35:21,480 --> 00:35:26,310 Exchange is concerned about protecting the interests of other shareholders. 296 00:35:27,160 --> 00:35:35,110 Now what this points to is the fact that the US has benefited from a much greater degree of diversity of ownership, 297 00:35:35,350 --> 00:35:44,319 including the prevalence of a much greater number of local banks that provide a local function 298 00:35:44,320 --> 00:35:48,310 that is not dissimilar to what we observed in Britain during the Industrial Revolution. 299 00:35:49,480 --> 00:35:51,820 The final component that's critical in terms of. 300 00:35:52,830 --> 00:36:02,280 The pursuit of longer term prosperity, of interest beyond that of just shareholders is the role of boards. 301 00:36:03,260 --> 00:36:08,149 Some of the most successful companies in the world are Bertelsmann, the media company. 302 00:36:08,150 --> 00:36:13,400 Carlsberg, the brewery. Robert Bosch, the automotive supply company. 303 00:36:13,760 --> 00:36:17,540 IKEA, the furniture company. Tata, the Indian conglomerate. 304 00:36:17,540 --> 00:36:21,350 Velux, the window manufacturer. All of those have one thing in common. 305 00:36:22,190 --> 00:36:25,400 They are all owned by industrial foundations. 306 00:36:26,370 --> 00:36:33,020 Those foundations devote a majority of their profits to charitable purposes. 307 00:36:33,030 --> 00:36:35,820 But it's not that charitable purpose that I want to emphasise. 308 00:36:36,800 --> 00:36:46,160 The boards of those foundations are responsible for upholding the purpose laid down by the founders of those foundations. 309 00:36:46,670 --> 00:36:52,790 And if the companies below them, like Carlsberg and Robert Bosch, fail to uphold those values and purposes, 310 00:36:53,000 --> 00:36:56,420 then it's the boards of the foundations that take responsibility. 311 00:36:56,420 --> 00:37:01,280 They essentially act like trustees, trustees of the companies below them, 312 00:37:01,580 --> 00:37:06,680 ensuring that the purposes and principles of the firms below them are indeed upheld. 313 00:37:07,760 --> 00:37:20,149 Now, while this combination of long term ownership clearly articulated, purposes and boards that are responsible for upholding those policies are, 314 00:37:20,150 --> 00:37:27,590 I believe, critical elements in terms of establishing companies and institutions that one could trust. 315 00:37:29,180 --> 00:37:37,280 The important point to to emphasise is that there isn't a single right model for how companies should be structured. 316 00:37:37,280 --> 00:37:44,060 Indeed, we should be promoting diversity rather than seeking to impose a particular form, 317 00:37:45,050 --> 00:37:52,910 because what is suited to small start up companies is very different from established high tech companies. 318 00:37:52,910 --> 00:37:59,030 What is suited to high tech firms is very different from more traditional firms. 319 00:37:59,390 --> 00:38:04,010 And what is suited, for example, to banks is very different from asset management firms. 320 00:38:04,880 --> 00:38:07,910 So we should really be pursuing diversity. 321 00:38:08,660 --> 00:38:12,170 And the types of approaches for pursuing diversity are, I think, 322 00:38:12,170 --> 00:38:17,700 illustrated by some of the ways in which it's done in the United States and elsewhere. 323 00:38:17,720 --> 00:38:24,890 So, for example, one of the most interesting innovations that has occurred recently in terms of public law is the 324 00:38:24,890 --> 00:38:30,530 emergence of what is known as the Public Benefit Corporation B corporations as they're sometimes term. 325 00:38:30,950 --> 00:38:34,760 These are corporations that have a clearly defined public purpose, 326 00:38:36,320 --> 00:38:41,930 and it's the role of the board to ensure that those companies abide by the public purpose. 327 00:38:42,650 --> 00:38:48,140 And if the company or the financial institution fails to abide by that public purpose, 328 00:38:48,410 --> 00:38:56,360 then the owners of that company can sue the board for a failure to uphold that public purpose. 329 00:38:57,690 --> 00:39:10,290 Now I think that this is particularly relevant in the context of companies and institutions that have a public function associated with them. 330 00:39:10,920 --> 00:39:20,550 So, for example, in the case of utilities, energy companies, systemically important banks and other financial institutions, 331 00:39:21,540 --> 00:39:29,430 companies with significant market power, companies that may have abused public laws in the past. 332 00:39:30,120 --> 00:39:40,170 In each of those cases, there's an argument to be said for those companies and institutions having a clearly defined public purpose, 333 00:39:40,560 --> 00:39:45,210 potentially buy it through a charter for which there should then be a board, 334 00:39:45,390 --> 00:39:53,130 essentially like the boards of trustees of the foundations which are responsible for upholding those public purposes. 335 00:39:54,010 --> 00:40:02,600 Because in essence, what is required to ensure the delivery of those public purposes is that there is not as 336 00:40:02,630 --> 00:40:09,640 present a divergence of interests between companies and those responsible for regulating them. 337 00:40:11,640 --> 00:40:24,060 Now turning to regulation. The traditional view of regulation is that there is essentially a separation between 338 00:40:24,060 --> 00:40:29,850 the regulation of banks on the one hand and securities markets on the other hand. 339 00:40:30,210 --> 00:40:37,380 Dating back to the Wall Street crash and the New Deal in the United States, 340 00:40:38,010 --> 00:40:47,219 Securities Regulation was introduced in the early 1930s in 1933 and 1934, and bank regulation, 341 00:40:47,220 --> 00:40:53,940 which established deposit insurance and the FDIC in the United States was part of the bank regulation, 342 00:40:53,940 --> 00:40:59,100 including the Glass-Steagall Act, that separated investment banking and commercial banking. 343 00:41:00,270 --> 00:41:05,190 And that distinction between securities regulation on the one hand and bank regulation on the other 344 00:41:05,550 --> 00:41:12,030 now is an established basis of regulation of most financial regulatory systems around the world. 345 00:41:13,260 --> 00:41:17,460 The second feature of regulation is it's very legalistic in nature, 346 00:41:17,580 --> 00:41:27,480 basically derives from the use of black letter law for determining how regulatory systems should be structured. 347 00:41:28,230 --> 00:41:31,710 The third feature is it's very institutionally based. 348 00:41:32,040 --> 00:41:39,570 It basically looks at the institution and it poses the question, what is the appropriate form of regulation of that institution? 349 00:41:40,410 --> 00:41:49,500 The fourth feature is it's very domestic regulation has really been evolved within countries on a domestic basis. 350 00:41:49,500 --> 00:41:55,979 And it's only recently that we've seen a significant degree of international coordination of regulation. 351 00:41:55,980 --> 00:41:58,080 And finally, for the most part, 352 00:41:58,080 --> 00:42:05,640 until recently it's focussed on the micro regulation of individual institutions rather than thinking of the more macro elements. 353 00:42:06,940 --> 00:42:17,709 Now I'm in the process of writing a book with four or five lawyers, four of whom are in Oxford John Armer Paul Davis, 354 00:42:17,710 --> 00:42:29,590 Jenny Payne and Dan Ory and Jeff Cohen, who's at Columbia, in which we argue that this approach to financial regulation is basically entirely wrong. 355 00:42:30,310 --> 00:42:37,840 First of all, the separation between securities regulation and bank regulation might have been appropriate at one time, 356 00:42:38,020 --> 00:42:48,160 but it's certainly not appropriate now and that one should have an integrated approach that looks at regulation in a holistic fashion. 357 00:42:48,190 --> 00:42:55,480 Secondly, that the underlying notion that regulation should be based on legal principles is also incorrect. 358 00:42:55,780 --> 00:43:04,150 That in essence, these are economic problems which need economic forms of analysis to derive what is the appropriate basis for regulation. 359 00:43:04,180 --> 00:43:09,250 Thirdly, that while the focus of regulation has been on institutional one, 360 00:43:10,120 --> 00:43:15,370 the notion that institutions are the appropriate basis for determining regulation is clearly undermined 361 00:43:15,370 --> 00:43:20,590 by the fact that many different types of markets and institutions do essentially the same things. 362 00:43:21,160 --> 00:43:27,700 So instead of thinking about what the nature of institutions one should think about the 363 00:43:27,700 --> 00:43:33,190 functions that those institutions are performing and regulate on the basis of function, 364 00:43:33,340 --> 00:43:50,050 not on institutional form. Fourthly, that clearly in a global financial market, the notion of regulation being based on national factors. 365 00:43:51,440 --> 00:43:57,950 Really needs to give way to thinking about how to formulate regulation on an international basis. 366 00:43:57,950 --> 00:43:58,730 And finally. 367 00:43:59,740 --> 00:44:10,629 The elements of systemic risk should be regarded as being essentially of paramount importance in terms of thinking about the design of regulation, 368 00:44:10,630 --> 00:44:18,550 not the failure of particular individual institutions, except insofar as they give rise to systemic failures. 369 00:44:19,030 --> 00:44:31,479 Now, the causes for these fundamental changes in the way in which one should be structuring regulation are firstly the fact that the there 370 00:44:31,480 --> 00:44:41,200 have been technological changes which have facilitated the provision of finance in forms that were inconceivable only a few years ago. 371 00:44:41,230 --> 00:44:46,090 You only have to think about crowdsourcing crowdfunding as a mechanism, peer to peer lending. 372 00:44:46,420 --> 00:44:52,209 The sorts of things that are beginning to emerge as being very significant elements to appreciate that what was really 373 00:44:52,210 --> 00:45:00,520 regarded as being forms of funding in the past are no longer going to be the dominant forms of funding gains going forward. 374 00:45:00,940 --> 00:45:08,560 Second element that's critically important is the fact that. Markets clearly have become global in nature. 375 00:45:09,490 --> 00:45:14,050 And the third element that's critically important is the emergence of shadow banking, 376 00:45:14,440 --> 00:45:23,230 which is essentially non-bank institutions performing similar functions to those of formal regulated banks. 377 00:45:24,950 --> 00:45:34,670 Now in terms then of trying to address issues about financial regulation from an economic standpoint, 378 00:45:34,880 --> 00:45:38,930 the first thing then to do is to identify what are the underlying market failures, 379 00:45:39,620 --> 00:45:43,399 and they're essentially full in nature, which are frequently emphasised. 380 00:45:43,400 --> 00:45:47,240 The first information problems asymmetries in information. 381 00:45:47,750 --> 00:45:51,740 The second are problems arising from free rider issues. 382 00:45:52,200 --> 00:45:58,370 The problem that individual customers, for example, cannot really engage in activities that, 383 00:45:58,370 --> 00:46:03,770 even if they are informed, ensure that they get delivered the types of services that they expect to get delivered. 384 00:46:04,760 --> 00:46:19,460 The third problem is a problem of the monopoly power that many financial institutions might have in ensuring effective competition in markets. 385 00:46:19,700 --> 00:46:24,919 And the fourth are potential failures and externality between institutions the sorts 386 00:46:24,920 --> 00:46:30,290 of externalities that give rise to systemic failures or the appropriate responses. 387 00:46:30,290 --> 00:46:38,660 Then a first of all, to think about disclosure as being in large part the way to deal with information problems, to think about enforcement, 388 00:46:39,410 --> 00:46:43,040 public enforcement as a way of supplementing private enforcement, 389 00:46:43,040 --> 00:46:50,030 where it's the case that for free rider problems, it's difficult for individuals to enforce contracts. 390 00:46:51,020 --> 00:46:54,050 Competition policy is clearly a critical element. 391 00:46:54,380 --> 00:46:56,180 And perhaps most importantly of all, 392 00:46:56,390 --> 00:47:07,550 we have to think about how to design systemic responses to internalise the externalities across individual institutions. 393 00:47:08,210 --> 00:47:16,970 And in particular, this point about emphasising these systemic elements is especially important because the approach of thinking 394 00:47:16,970 --> 00:47:24,290 about regulation to the micro-level has the problem that it gives rise to serious unintended consequences. 395 00:47:24,500 --> 00:47:31,280 You only have to think about the advice that suggested that banks need to hold relatively low risk. 396 00:47:32,230 --> 00:47:39,490 Assets to to avoid potential failures to appreciate that. 397 00:47:39,670 --> 00:47:48,639 That advice encouraged banks to hold government securities where we might have regarded government securities at one stage as being entirely riskless. 398 00:47:48,640 --> 00:47:53,380 But it's slightly questionable now whether or not that was indeed very valuable advice. 399 00:47:53,410 --> 00:48:00,550 Furthermore, in the process of encouraging institutions to hold particular types of assets, 400 00:48:00,970 --> 00:48:09,220 the ones essentially introducing a systemic risk because one is affecting the prices of those securities as a consequence. 401 00:48:09,220 --> 00:48:15,070 And those price effects then have implications and effects on other institutions. 402 00:48:15,640 --> 00:48:19,120 I mentioned at the outset that rules regarding corporate governance. 403 00:48:21,070 --> 00:48:24,450 Proved to be wholly inappropriate. Why is the screen for the gun? 404 00:48:26,230 --> 00:48:32,650 It's tearing itself off. It is that unintended consequence we have. 405 00:48:32,680 --> 00:48:39,489 You just have to think about the observation that those banks with the best corporate governance standards were the ones that failed the most. 406 00:48:39,490 --> 00:48:49,540 To appreciate that recommendations regarding corporate governance can have entirely the wrong types of effects. 407 00:48:49,540 --> 00:48:55,569 And likewise, the observation that those banks that paid the highest powered incentives were the ones that took the 408 00:48:55,570 --> 00:49:03,850 greatest risks is another indication of how particular recommendations can have quite perverse effects. 409 00:49:05,310 --> 00:49:11,310 Now, one illustration of this and let me try and put this back up is this slide, 410 00:49:11,310 --> 00:49:25,260 which shows the changing nature of the ownership of of British companies over the period from 1989 to 2000 and 2010. 411 00:49:26,070 --> 00:49:33,240 And basically, as you can see, what has happened is that in 1989, 412 00:49:34,110 --> 00:49:49,500 the holding of UK equity by institutions like pension funds and life insurance companies was around about it was around about 50%. 413 00:49:51,090 --> 00:50:02,580 But what if you see it now over here by the time that you get them and by the time that you get to 2010, 414 00:50:03,180 --> 00:50:13,050 the proportion of holdings by pension funds and life insurance companies has declined from 50% to 14% one 4%. 415 00:50:14,410 --> 00:50:21,860 It's better. Right. 416 00:50:22,760 --> 00:50:36,290 Thank you. Okay. So there's been a phenomenal decline in the holding of British equity by pension funds and life insurance companies. 417 00:50:36,770 --> 00:50:41,629 And a primary reason why pension funds have got out is that during the middle of the 1990s, 418 00:50:41,630 --> 00:50:44,060 we introduced something called the minimum funding requirement, 419 00:50:44,540 --> 00:50:57,140 which basically required pension funds to value their liabilities at a government index linked discount rate and to minimise their exposure. 420 00:50:57,170 --> 00:51:05,210 What they did was they then shifted from equities into gilts, into index linked government government gilts. 421 00:51:05,930 --> 00:51:14,060 And that has had the effect of driving down interest rates on government securities essentially to zero. 422 00:51:14,840 --> 00:51:22,489 Now, this is this was not an unintended consequence, and it's had a very serious impact on the structure of financing of companies, 423 00:51:22,490 --> 00:51:27,470 meaning that pension funds are no longer, in many respects, a serious player. 424 00:51:29,000 --> 00:51:40,850 An analogy of thinking about how one should structure regulation comes from essentially the contrast between public health and medicine. 425 00:51:41,300 --> 00:51:49,520 When we think about medicine, we're thinking about how to cure individuals, when we're thinking about public health. 426 00:51:49,970 --> 00:51:55,160 What we have in mind is how to provide protection to societies and communities. 427 00:51:56,030 --> 00:52:00,290 Medicine is concerned about diagnosis and prescription. 428 00:52:00,860 --> 00:52:08,360 Public health is concerned about how does one identify potential pandemics? 429 00:52:08,840 --> 00:52:12,530 How should one isolate the effects? 430 00:52:12,770 --> 00:52:15,770 How should one immunise against? 431 00:52:16,010 --> 00:52:19,610 And how should one intervene when failures occur? 432 00:52:20,800 --> 00:52:27,250 Now there is, in essence a very similar distinction that arises in relation to financial regulation, 433 00:52:27,670 --> 00:52:32,170 that if we're thinking about taking a systemic approach to regulation, 434 00:52:32,170 --> 00:52:38,050 what we should be doing is to basically focus on how to identify potential failures, 435 00:52:38,350 --> 00:52:47,050 how to immunise against them, how to isolate the effects of failures, and how to intervene when failures occur. 436 00:52:47,500 --> 00:52:52,270 And what that basically involves is, first of all, having systems, 437 00:52:52,570 --> 00:52:58,809 of being able to measure the extent to which there is exposure to failure to use capital to 438 00:52:58,810 --> 00:53:05,590 immunise against failure to allow for bail ins in the event of isolation being necessary, 439 00:53:05,860 --> 00:53:09,640 and to have methods of resolving failing institutions. 440 00:53:09,850 --> 00:53:18,520 In other words, we will need a new approach which has begun to emerge as being the basis of the regulation of financial institutions, 441 00:53:18,520 --> 00:53:22,330 but which really places systemic issues at the top. 442 00:53:22,990 --> 00:53:30,340 And what this suggests is that in terms of designing our institutions for regulating financial systems, 443 00:53:30,730 --> 00:53:37,330 then really what we should be doing is to place the systemic macro elements of regulation at the top, 444 00:53:38,410 --> 00:53:47,020 to put this in the context of an international perspective of how to regulate the financial system and to regard the micro 445 00:53:47,860 --> 00:53:58,480 elements as being overseen by the macro elements to ensure that these unintended consequences of micro regulation do not occur. 446 00:53:59,140 --> 00:54:08,260 So to sum up, what I'm suggesting is that basically there's a complementarity between the governance of 447 00:54:08,260 --> 00:54:15,730 individual institutions and companies and the regulation that occurs of financial systems, 448 00:54:16,150 --> 00:54:26,500 that we should regard institutions as taking responsibility themselves for their own conduct and not simply going on doing things until someone, 449 00:54:26,500 --> 00:54:36,610 namely a regulator, tells them to stop that they should have clearly articulated purposes that they should have long term owners, for the most part, 450 00:54:36,940 --> 00:54:47,380 that are committed to ensuring that those institutions and companies abide by those long term purposes, that they have independent boards that are up, 451 00:54:47,440 --> 00:54:54,999 that are responsible for upholding those purposes, and that we encourage diversity, not uniformity, 452 00:54:55,000 --> 00:55:01,329 in terms of the nature of the ownership and governance of institutions that from the point of view of regulation, 453 00:55:01,330 --> 00:55:11,770 what we require is a greater degree of emphasis on disclosure, on enforcement of failures such as bribery, corruption, 454 00:55:12,400 --> 00:55:22,000 market and market manipulation and market abuse through stricter enforcement of criminal penalties than has been the case to date, 455 00:55:22,600 --> 00:55:27,520 and that the particular emphasis of regulation should be on systemic protection, 456 00:55:28,180 --> 00:55:35,710 with a focus on getting the necessary international coordination that is required, as well as the domestic coordination. 457 00:55:36,160 --> 00:55:47,560 And it's that complementarity between the structure of regulation and the governance of institutions and companies that is critical to achieving this. 458 00:55:47,920 --> 00:55:56,410 Because if you have regulation where companies and institutions are solely focussed on maximising shareholder returns, 459 00:55:56,830 --> 00:56:05,380 then that regulation is essentially putting regulators in conflict with the companies and institutions that they're regulating. 460 00:56:05,830 --> 00:56:13,150 One has to have an alignment between a public purpose and the function that regulators are trying to perform. 461 00:56:13,900 --> 00:56:14,800 But on the other hand, 462 00:56:15,010 --> 00:56:27,339 one cannot simply rely on the governance and the the way in which the private market operates to ensure that social purposes are fulfilled, 463 00:56:27,340 --> 00:56:33,520 in particular, when there are market failures of the sorts that I was describing earlier on market failures of information, 464 00:56:33,970 --> 00:56:38,710 of free riding, of externalities, 465 00:56:39,130 --> 00:56:49,570 those require a public response and a public form of regulation which should be focussed on these elements that look at an improvement 466 00:56:49,570 --> 00:56:59,590 in disclosure enforcement and addressing problems at a systemic level and an international perspective rather than a domestic one. 467 00:57:00,430 --> 00:57:01,840 Okay. Thank you very much.