The Regulator

Sir Howard Davies, Sloan ’80, has packed lots into half a century. A one-time McKinsey man, he also has been a diplomat, advisor to Britain’s finance minister, and No. 2 at the Bank of England. Davies, 51, is now the most powerful regulator of financial services companies in the world, a job he has had for five years and will hold until January 2004. Few expect anything other than a high profile for Davies for some considerable time to come. 

PHOTOGRAPH BY JILLIAN EDELSTEIN

WHEN TONY BLAIR BECAME BRITAIN'S PRIME MINISTER five years ago, a key pledge was to transform the hit-or-miss way the country’s financial services sector was regulated. The industry accounts for as much as 10 percent of GDP in the world’s fifth biggest economy. A string of scandals, from the dramatic collapse of Barings Bank following a billion-dollar loss to the misleading of millions of pension buyers, was clear evidence that change was needed.

Britain had been operating under regulations set in 1986, when—somewhat naively perhaps—it was believed that the market would regulate itself and that established-by-statute regulators with real teeth, such as those in the United States, were unnecessary. Ten years and a string of scandals later, it was clear that self-regulation was not working. It was past time for change.

The powers vested in the Financial Services Authority (FSA) were sweeping. In place of a myriad of self-regulating industry bodies, the FSA was established with Davies as its executive chairman, bringing responsibility for the supervision of nearly all niches of the financial services industry under one roof. Davies, then deputy governor of the Bank of England, wound up regulating everyone from door-to-door insurance salesmen to the rocket scientists in the fiendishly complex and rapidly evolving derivatives business.

Although finance types were nervous about the creation of such a Leviathan, few in the business criticized Davies’ appointment. First, he was well qualified, not least because the Bank of England had, up to that time, been in charge of the prudential supervision of the banking system, one of the many roles to be centralized at the FSA Moreover, his considerable experience in the private sector, at McKinsey and Co. (among others), allayed concerns of some who feared the appointment of a chief with a bureaucratic heart poorly attuned to the ways of profit making.

His appointment also put an end to whispers that the top man would be a government yes man, delivering heads on plates at the behest of politicians too eager to grab headlines. Not a member of any party, Davies had been appointed to posts by both the current Labour Party government and its Conservative Party predecessor. He also is known for independent-mindedness, a characteristic that his Sloan Program classmates noted back in 1980. Jean-Pierre Dupret, chairman of Brussels-based firm ROVA, recalls that Davies, despite his relative youth, would not hesitate to take a view contrary to the majority. What’s more, says Dupret, his air of calm authority ensured that others listened.

This willingness to follow his instincts has, at times, ruffled feathers. As head of the government Audit Commission in the 1980s, Davies unsettled some local politicians by taking a tough stance with municipalities that dabbled in derivatives. After his appointment to the FSA in 1997, he raised eyebrows by staying on as president of a high-profile charity for the elderly and continuing as governor of De Montfort University, one of Britain’s largest academic institutes and well known for its close links to industry.

Among consumer groups, his was not an unwelcome appointment. Davies was already a nationally known figure. As director-general of the Confederation of British Industry, the country’s main business lobby group, he appeared regularly in the national media arguing the case for business. Media friendly and unflappable, he cut a figure that the public could relate to, in contrast to the often austere and unbending image of some of his predecessors.

Davies typifies the new generation at the top in a more meritocratic Britain. He was educated in a publicly funded school in Manchester, an unglamorous city in England’s northern half long associated more with declining smokestack industries than financial services. On his own steam he made it to Oxford, the country’s best university. He is married to a highly successful broadcast journalist, and his passion in sport is for soccer, the average guys’ game, rather than rugby, traditionally the field sport of the well-heeled.

Indeed, he spends many of his weekends taking his two teenage sons to see Manchester City, an ever-struggling team that he has been passionate about since his youth. Tom Hayhoe, MBA ’80 and a former McKinsey colleague, recalls Davies’ editorship of the club’s fan magazine in his limited free time at McKinsey. Davies’ appetite for journalism also extended to reviewing books on a range of topics for the Economist newspaper.

Much of Davies’ time at FSA has been spent at institution building, a task made difficult by the need to legislate the FSA into existence in the first place and one that ended up taking longer than anyone had anticipated, Davies included. When the legislation finally took effect last December 1, it had earned the distinction of being the most amended act in Britain’s long parliamentary history.

In an industry as well resourced as financial services, armies of lawyers and lobbyists were hired to pore over the proposals, Davies says. With the FSA granted virtually unlimited power to investigate and fine, firms wanted to be sure some seemingly innocuous clause did not prove costly down the road.

Indeed, one does not have to travel far in London’s financial district today to hear the murmurings. Some go so far as to liken the new body to Frankenstein—made up of many different bits and, ultimately, destined to run amok. Even less excitable souls remain wary, and an eagle eye is kept on anything that looks like empire building.

Davies acknowledges this fear and partly counters it with openness and transparency. In fairness, he has put his money where his mouth is. Last year he took a reduced bonus after admitting that the agency slipped up when okaying an insurance company that subsequently ran into financial difficulties. His manner helps, too. He is clearly a man who is comfortable in his own skin, a characteristic that helps to put others at ease. At the same time, he gives nothing away. He knows exactly the points he wants to get across and uses words and body language to do just that. “Not a single FSA decision has been reversed in the courts, and charges of acting with excessive zeal have been few and far between,” he says pointedly during an interview. But no wonder, say industry sources. “The FSA acts as judge, jury, and executioner; the costs of seeking judicial review fall entirely on the company that has been accused of wrongdoing,” said one, who, like all others, agreed to speak only on condition of anonymity—a further indication of just how powerful the FSA is.

Once a period of reputation building has been completed, Davies says, those whom the FSA regulates will see his one-stop-shop as saving time and money when they need clearance to enter a new business or launch a new product. Sooner or later, he says, the FSA will enjoy the same high reputation with the public and industry as does, for instance, the U.S. Securities and Exchange Commission.

But to compare the FSA with the sec may mislead. It is far more than a British sec with bells and whistles. To get an idea of just how wide-ranging are its powers, consider that it does the work of the SEC (overseeing the business of brokering stocks and trading bonds) along with doing the scrutinizing part of the Fed’s job (keeping tabs on banks) and the states’ insurance regulators (monitoring players in that industry), among others. “The U.S. has more than 70 separate regulatory agencies for our one FSA. Moreover, there are 26,000 people in the U.S. doing the work of our 2,000-strong super-regulator,” says Davies. Even allowing for the difference in size between the two countries, these are efficiency gains.

That said, he does not go so far as to say the FSA way is better. Much has been learned from the American way, he says, but with little statutorily established regulatory infrastructure in place in 1997, his country had to build a structure from the ground up.

Though it may sound strange to American ears, as recently as 20 years ago the financial services industry was cartel-ridden, with laws preventing real competition and practices that had changed little in decades. This was all far too cozy for Margaret Thatcher, the most reform-minded British leader of the past half-century. She ignited the “Big Bang” of 1986, allowing foreign firms in, sweeping away fixed commissions for stock-brokering services and giving banks the freedom to trade in securities for the first time. The liberalizing gales unleashed allowed firms the freedom to innovate and grow. By almost any measure—turnover, profits, or jobs—the industry has grown in multiples. In a number of global niches, such as currency trading, London is the world leader.

But the Big Bang brought losers, too. The slow to adapt went out of business or were gobbled up, usually by U.S. players. (This was the fate, for instance, of all of Britain’s investment banks.) Reflecting wider social change, the once gentlemanly business of finance ceased to be the exclusive preserve of the privileged. In highly competitive marketplaces, merit came to matter more than old school ties and one’s capacity for bonhomie.

This suits Davies, as he is not one of the back-slapping boys. He is an excellent networker and exhibits none of the awkward stiffness for which the English used to be known. At the FSA, dress-down informality has replaced the once obligatory pinstripe suit and starched white shirt of London’s financial districts. When interviewed for this profile, Davies himself was tieless and hiply shod; he personally collected this interviewer from the lobby of the FSA’s shiny, new 15-story home on the banks on London’s Thames. His eschewal of formality goes as far as foregoing the entitlement to be called “Sir” (he was knighted last year in recognition of his work with FSA); Davies is referred to by his first name by everyone from his pa to the security staff.

Davies says he believes the all-under-one-roof approach is especially logical now because of the way the industry is changing. With the lines between different businesses blurring and the consequent emergence of giant financial services groups whose operations include everything from selling pensions and life insurance to running big trading floors, he sees advantages in being able to gather experts quickly if questions arise about a firm or industry. Indeed, the stability of the financial system depends on the speed with which he can muster his forces at a time of crisis—for example, the collapse of Long-Term Capital Management, a U.S. hedge fund, in 1999.

The LTCM debacle also illustrates yet another benefit of the single-regulator approach. The financial services industry is not only among the most globalized of industries but is itself an engine of the globalization process. This means regulators in different jurisdictions need to be in almost constant contact. Davies says he believes that a single super-regulator smoothes the interface between authorities in different countries.

Apart from the bilateral ties, the FSA is involved in many forums that seek to do everything from cutting down on money laundering to redesigning the architecture of the international financial system. Indeed, Davies chaired a g-7 committee that recommended a series of measures to strengthen the foundations of the world’s financial system.

Another foreign connection is the United Kingdom’s membership in the European Union, Europe’s experiment in merging its national economies and some of their political functions. But creating a single European market in financial services, particularly in sectors such as life insurance and asset management, has proved difficult to achieve, a constant reminder of the difficulties of welding together different regulatory practices and traditions.

The September 11 attacks in the United States mean that cooperation is a matter not just of economic security but also of physical security. As a result, contacts between regulators have reached a new intensity. Davies expresses a deep sense of personal shock at the attacks, in part because of the closeness of New York and London, often said to be sister cities owing to the connectedness of the world’s two preeminent financial centers—links that were so tragically evidenced by the 53 Britons who died or are still unaccounted for in the attack on the World Trade Center.

Davies moved quickly to look for evidence of suspicious transactions in the days before the attacks but found none. A longer-term effort is under way to strangle the financial networks of terrorist groups. Legislation went into force in December giving the FSA greater powers to combat money laundering. It now can fine financial institutions that fail to ensure that their clients’ money is clean. More informally, increased information exchange on suspicious transactions already is taking place as the world learns to live with the threat of terrorism on a previously unimaginable scale.

The FSA also is dealing with the potentially destabilizing effects of mammoth liabilities incurred by the re-insurance industry. The sheer scale of the September 11 destruction, Davies says, raises new questions about precisely what is and is not insurable and about the balance sheet positions of some of the biggest re-insurers. He says that his agency is keeping an eagle eye on the sector, using experience gained during the 1990s when London’s financial district was devastated on a number of occasions by terrorist truck bombs and paid out hundreds of millions of dollars.

An age of hyperterrorism has seen premiums being jacked up, particularly for airlines, improving insurers’ cash positions and, Davies worries, possibly lulling some of them into a false sense of security, as it remains unclear at the time of writing as to the size of the payouts and on whom they will fall.

As the interview wraps up, Davies expresses optimism that with regulatory practices being constantly improved, there are multiple benefits. Not only does good regulation cut down on opportunities for criminals and terrorists, but it also attracts the best business. With London still head and shoulders above any of its Continental European competitors as a financial services center, at least some credit must go to the man who has been at the helm of the FSA since its launch.