The 2020s: a decade for investor action to support more robust financial regulation?

This question was front and centre on our March 4, 2020 Corporate Lobbying Alignment Project (CLAP) online roundtable. The eighth in our series brought together speakers from international organizations, credit rating and regulation and monetary policy experts and focused on how investors can best support regulation that supports financial stability and sustainability. Speakers drew on lessons from the Global Financial Crisis to suggest new areas for investor engagement.

Alongside this month’s online investor roundtable, we have also published a new CLAP discussion note on opportunities for investor engagement with financial regulators. The discussion note highlights how the 2020s could be a decade for asset owners and other long-term investors to take actions that support more robust financial regulation, and to ensure that its goals – financial system stability, integrity, and trust in markets – are prioritised ahead of short-term corporate and trade association interests. 

Revolving doors & conflicts of interest in the global financial regulatory system

One important case study of corporate influence over financial regulators is the use of post-public sector employment opportunities to influence regulator actions and the relationship with regulated entities. The ‘revolving door’ between regulators and regulated entities can create conflicts of interest when financial regulators, lawmakers and/or their family members have or expect to have direct financial stakes in the industries they are meant to regulate. These risks become more acute when regulators expect to have a highly remunerated position waiting for them upon exit from public service. 

A common practice in the United Kingdom, for example, is the granting of advisory roles or seats on company boards to former or serving politicians, such as David Cameron’s advisory role at the now insolvent supply chain finance firm Greensill Capital [1]. Academic research explains how a ‘revolving door’ of exchange of staff between corporations and regulators dampens regulatory action to prioritise public interests, and enables the business interests to influence and control political decisions [2]. Former Governor of the Bank of England Mervyn King’s senior advisor role at Citi [3], Mark Carney’s new role with Brookfield Asset Management [4], former Governor of the Bank of Canada Stepehon Poloz’s move to Enbridge two days after finishing his Governorship [5], and former President of the European Commission José Manuel Barroso’s decision to become the executive chairman of Goldman Sachs are all examples that indicate the potential for revolving door influence over regulators [6].

Asset owners and other long term investors can engage with regulators

As active participants in the financial system with in-house legal and public affairs teams, investors have to start acting to change the system from the top down. In order to achieve change, investors must engage more assertively in regulatory dialogues and processes across markets. If the work of engaging with regulators to determine market structure and regulatory priorities is left to industry lobbyists, this will continue to create new risks.

The discussion note flags six possible areas for investor action to address the risk of negative lobbying practices damaging the integrity of financial regulation. These are high-level engagement areas where we think investors can have an impact across the financial systems. They are not meant to be an exhaustive list of investor engagement options, but provide the starting point for more structured engagement plans. To start with, investors can:

1. Engage with financial sector trade bodies to affirm that robust financial regulations are necessary to ensure market integrity and enable long-term capital deployment;
2. Publicly communicate support for the OECD Principles on Transparency and Integrity in Lobbying [7], and associated action at international bodies, including the Financial Stability Board [8],  the International Organization of Securities Commissions (IOSCO) [9], the International Accounting Standards Board (IASB) [10] and with institutional investor associations including the UN-backed Principles for Responsible Investing and the International Corporate Governance Network, to ensure that anti-corruption and associated principles on the need for integrity in regulatory systems are followed across the financial system;
3. Support or file shareholder resolutions on lobbying transparency by companies in all sectors to send a clear and consistent message on investor expectations for transparent lobbying and influence activities. Extend these resolutions to explicitly encompass lobbying of financial regulators. 
4. Instruct in-house counsel and legal and public affairs team to engage with regulators on the need for transparent and robust regulation that promotes financial stability and investor confidence ahead of narrower vested interests of market participants.
5. Request more transparent disclosure from regulators about the input they receive  from lobbyists on key regulatory issues to better understand how corporate influence is shaping regulatory priorities. 
6. Engage in targeted dialogue with the largest credit rating agencies regarding incorporation of ESG risks into ratings methodologies and the need for greater simplicity and transparency in ratings on structured finance products that led to the Global Financial Crisis [11].
7. Support the potential for application of the precautionary principle in financial regulation [12]. The precautionary principle seeks to improve decision-making under conditions of uncertainty. The principle, with origins in international environmental law, indicates that if an action or policy has a suspected risk of causing harm to the public then, in the absence of a clear consensus among researchers, the burden of proof that it is not harmful falls on those taking an action rather than on those who seek to prevent it.

Necessary steps towards bringing the precautionary principle into financial regulation

By taking these actions, investors can provide support for regulators and market supervisory authorities to challenge conventional wisdom and break out of group-think in their approach to systemic risks including economic inequality, the breakdown of democratic accountability, climate risk and unprecedented biodiversity loss. This process of supporting more robust regulation could help to extend the precautionary principle, with its origins in international environmental law, into important areas of financial regulation. 

The precautionary principle maintains that if an action or policy is suspected to risk causing significant harm to the public then, in the absence of a clear consensus among researchers to the contrary, the burden of proof that it is not harmful falls on those taking an action rather than on those who seek to prevent it. Financial regulators in some jurisdictions have begun to adopt measures consistent with the precautionary principle, and the covid recovery period, with highly unconventional monetary and fiscal policy, could be a good time for investors to push for new, more forward-looking approaches to financial regulation. 

[1] ‘Greensill Capital prepares to file for insolvency’ (03.03.2021): https://www.ft.com/content/968a1476-9d4b-478d-b3c7-84d22e54a8bf 

[2] ‘Still Going Round in Circles: The Revolving Door Between Banks And Their Regulators’ (27.02.2019):  https://www.finance-watch.org/still-going-round-in-circles-the-revolving-door-problem-between-banks-and-their-regulators/ 

[3]  ‘Lord King’s Citi role highlights need to police revolving door’ (01.08.2016):  https://www.ft.com/content/9cb6669c-57ec-11e6-9f70-badea1b336d4 

[4]  ‘Brookfield Announces Appointment of Mark Carney as Vice Chair and Head of ESG and Impact Fund Investing’ (26.08.2020):  https://bam.brookfield.com/press-releases/2020/08-26-2020-131930311 

‘Mark Carney Walks Back Brookfield Net-Zero Claim After Criticism’ (26.02.2021): Read more at: https://www.bloombergquint.com/politics/mark-carney-s-brookfield-net-zero-claim-confounds-climate-experts

[5]  ‘Enbridge Appoints Stephen S. Poloz to its Board’ (04.06.2020): https://www.prnewswire.com/news-releases/enbridge-appoints-stephen-s-poloz-to-its-board-301070475.html; ‘One Week Out of Bank of Canada, Poloz Lands Two Plum Board Seats’ (09.06.2020): https://www.bloomberg.com/news/articles/2020-06-09/one-week-out-of-bank-of-canada-poloz-lands-two-plum-board-seats 

[6] Other examples include JPMorgan’s hiring of former British prime minister Tony Blair in 2008 to advise on strategy, alongside former Italian finance minister Vittorio Grilli and ex-Israel central bank boss Jacob Frenkel serving as vice-chairmen. See ‘Citi appoints former UK foreign minister Hague as senior adviser’  https://www.reuters.com/article/us-citi-moves-idUSKBN1511HY 

[7]  https://www.oecd.org/gov/ethics/oecdprinciplesfortransparencyandintegrityinlobbying.htm 

[8] https://www.fsb.org/about/  

[9]  IOSCO is the global standard-setter for securities regulation and publishes the ‘Objectives and Principles of Securities Regulation’: https://www.iosco.org/library/pubdocs/pdf/IOSCOPD154.pdf 

[10] Responsibilities of the IASB:’ https://www.iasplus.com/en/resources/ifrsf/history/resource21 

[11] The business model for ratings continue to rely on fees that are paid by bond issuers, the “issuer-pays” business model which creates conflicts of interest and may lead to systematic ratings inflation.

[12] Chenet et al (2021): ‘Climate-related financial policy in a world of radical uncertainty: Towards a precautionary approach:’ https://www.ucl.ac.uk/bartlett/public-purpose/sites/public-purpose/files/final_chenet_et_al_climate-related_financial_policy_-_towards_a_precautionary_approach_20_dec.pdf; and on the Bank of England staff blog four years ago: ‘How should regulators deal with uncertainty? Insights from the Precautionary Principle’ (27.01.2017):  https://bankunderground.co.uk/2017/01/27/how-should-regulators-deal-with-uncertainty-insights-from-the-precautionary-principle/