Risk & The Private Bank: Endless Regulatory Pressures

By Professor Michael Mainelli
Published by WealthBriefing — Opinion of the Week.

An edited version of this article appeared online: www.wealthbriefing.com - Opinion of the Week (13 June 2006)

Society reacts to risk by wanting to eliminate or control it. When a risk reaches the point of public perception that “something must be done”, two extreme points of view tend to emerge. Government economists trot out, almost by rote, “regulate it”, the justification for government intervention being “market failure – externalities, information asymmetries and agent problems”.

Well these charges can be laid at any market. Almost any market has externalities, there is never perfect information symmetry and markets of any scale typically require agents to function. When things are regulated, then the Law of Unintended Consequence, Goodhart’s Law, Ashby’s Law of Requisite Variety and several other well-honed observations seem to recur.

Market economists trot out, almost by rote, “leave it alone”, the justification being that the costs of bureaucracy, the stifling of innovation and the inability to regulate the appropriate organisations or people, e.g. those who will operate outside the regulated market. When pushed, people in markets fight for self-regulation or publish codes of good practice. Societal reactions, however, can impair or even ruin markets. Many societal goals for markets can be achieved with more innovative regulation using standards markets that seem to bridge the market-government divide. Standards markets, such as those based on the International Standards Organisation or the International Social and Environmental Accreditation and Labelling (ISEAL) Alliance, counter Screaming Lord Sutch’s sublime question, “Why is there only one Monopolies Commission?”

The public debate often contains a glaring omission – the potential role of “standards markets” rather than onerous regulation or unenforcable principles. Numerous areas of commercial life seek to "regulate" without legislation and succeed through the use of standards markets, for instance, ISO9000/ISO14000 or credit card IT security or test laboratories. Standards markets are also used successfully by the environmental and ethical communities, e.g. the Marine Stewardship Council or Fairtrade or Social Accountability International. Private banking is not immune. Debates in the City of London surround asset management, treating customers fairly and pensions protection. More investors are questioning the fiduciary duties of vehicles in which they invest. Of course private banks counter with the crustiness of their reputations and the inability of any standard to aspire to their impeccable management. Nevertheless there is a lot of pressure to conform to external standards, however wobbly, such as the American Institute of CPA’s SAS 70, ISO 22222 for personal financial planning, the Centre for Fiduciary Excellence’s ratings (www.cefex.ca) or the UK’s mooted Pensions Protection Investments Accreditation Board.

Standards markets work where:

  • There is an open standard available to all, as well as a structured review process, e.g. the ISO processes;
  • Certification agencies compete for audit business – thus encouraging rational interpretation(s) of the standard and controlling cost and quality via reputational risk and competition; • there is an authorised accrediting body for certification agencies, e.g. the United Kingdom Accreditation Service (UKAS).

Accrediting bodies should promote the use of standards where they will help improve economic performance. Trust is essential whether in the high street, the supermarket or in business procurement. Consumers seek assurances that products and services match the claims made about them.

Standards markets are key to ensuring that consumers, suppliers, purchasers and specifiers can have confidence in the quality of goods and in the provision of services throughout the supply chain.

Private bankers ought to consider at least the following:

  • Informing themselves to the point that they can state their position on leading standards, as well as their position on fiduciary ratings;
  • Being prepared for informed discussions with clients and regulators about standards, for instance, looking at standards as a means of ‘outsourcing’ some compliance verification services;
  • Having a policy about standards and fiduciary ratings, e.g. “we are currently seeking x” or “we believe that external quality Standards are inappropriate for us because…”;
  • Encouraging wider debate and consensus through industry fora and lobbies. Standards may well be a way of helping regulators to consolidate a plethora of requirements, e.g. within a flexible ‘interpretation’ of ISO 9001;
  • Forcing standards organisations to prove correlations of standards implementation with improved performance or shareholder value.

A lot of future competitive edge will accrue to private banks that manage compliance and regulation well. Working to develop, and exploit, open standards markets should feature in any private bank’s strategic scenarios.


Z/Yen is a Specialist Consultancy Firm based in London.