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UNCLAS SECTION 01 OF 03 LONDON 000723 
 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: ECON EFIN ETRD EINV UK
SUBJECT: LORD TURNER: REFORM UK REGULATORY FRAMEWORK AND 
END LIGHT TOUCH REGULATION 
 
LONDON 00000723  001.2 OF 003 
 
 
¶1.  (SBU) Summary: Lord Turner, chairman of the Financial 
Services Authority (FSA), recommended an overhaul of the 
UK's regulatory regime and an end to its "light touch" 
approach to supervision, in his review of the causes of 
crisis and recommendations for strengthening the banking 
sector.  Turner stressed the importance of reforming 
capital adequacy and liquidity requirements, introducing 
macro-prudential analysis, and overhauling the FSA's 
regulatory approach ? making it more intrusive and more 
systemic.  He called for reforms to remuneration 
structures, credit rating agencies, and off-balance sheet 
vehicles and introduced the idea of product regulation. 
Reaction to the report was mixed.  Banking and business 
groups largely welcomed his ideas while the Liberal 
Democrats and unions dismissed them as being more 
rhetoric than substance.  His review, published March 18, 
is likely to be used as the basis for the UK's 
negotiations at the upcoming G20 Summit.  End summary. 
 
Background 
---------- 
 
¶2.  (SBU) Lord Turner, chairman of the FSA, was asked by 
Chancellor Darling in October 2008 to review the causes 
of the current financial crisis and to make 
recommendations on the changes in regulation and 
supervisory approach needed to create a more robust 
banking system.  His review, published March 18, is part 
of the UK's attempt to set the global regulatory agenda 
for both the G7 and G20 groups and is likely to be used 
as the basis for the UK's negotiations with the G20 April 
¶2.  Turner's recommendations would overhaul the UK's 
financial regulatory regime and end its "light-touch" 
approach.  His report identified three underlying causes 
of the crisis: macroeconomic imbalances, financial 
innovation of little social value, and deficiencies in 
bank capital and liquidity regulations.  It proposed 
recommendations to reform all aspects of regulation from 
capital and liquidity to remuneration structures. 
 
Capital and Liquidity Recommendations 
------------------------------------- 
 
¶3.  (U) Turner's report stressed the importance of 
reforms to capital adequacy and liquidity requirements in 
creating a sounder banking system.  It called for 
increased quantity and quality of bank capital, with a 
focus on Tier 1 and Tier 2 capital for systemically 
important banks, allowing the banking system to better 
absorb future shocks.  Additionally, Turner recommended 
an intensification of liquidity regulation and 
supervision to contain liquidity risks through the 
creation of counter-cyclical capital buffers, with 
capital levels increasing during booms and decreasing in 
recessions.  This, Turner said, would stabilize the 
banking system through the cycle.  He also discussed 
introducing measures to avoid the procyclicality in Basel 
2 implementation. 
 
Macro-Prudential Analysis 
------------------------- 
 
¶4.  (U) A system-wide macro-prudential perspective is 
vitally important to prevent a repeat of the current 
crisis, according to the report.  Turner suggests the G20 
leaders will need to turn high-level commitments to 
improved early warning systems, surveillance and peer 
review into robust international arrangements which 
empower the IMF to produce independent analysis of 
system-wide risks.  Macro-prudential analysis should 
identify trends in the economy and the financial system 
which have implications for financial and macroeconomic 
stability.  In the UK, prior to this crisis, there was an 
"underlap" of supervision such that neither the Bank of 
England nor the FSA looked at system-wide risks.  The FSA 
focused on the supervision of individual institutions 
while the Bank focused on monetary policy analysis 
without forming policy responses to offset the risks 
identified.  Going forward, Turner recommended the Bank 
of England and FSA work together to conduct macroeconomic 
analysis and gather insight from specific institutions 
and business model analysis. 
 
FSA Supervision: More Intrusive, More Systemic 
--------------------------------------------- - 
 
¶5.  (U) A principles-based, light-touch approach to 
regulation and supervision will be replaced with 
 
LONDON 00000723  002.2 OF 003 
 
 
"intensive supervision."  The FSA will devote more 
resources to supervising high impact firms, with 
increasingly frequent comprehensive risk reviews.  Its 
supervisory style will shift from focusing on systems and 
processes to focusing on business outcomes, risk and the 
sustainability of business models.  The FSA will have 
more intense contact with bank management and auditors in 
relation to public accounts and accounting judgment. 
Turner said the FSA will need to understand the assets 
and liabilities in bank balance sheets at a greater level 
of detail so it can properly understand business model 
risks. 
 
Other Recommendations 
--------------------- 
 
¶6.  (U) Turner set out a number of other recommendations 
in the report from remuneration policies to potential 
product regulation: 
 
-- Remuneration policies should be designed to avoid 
incentives for undue risk taking.  The FSA will examine 
the risk consequences of remuneration policies during its 
overall risk assessments.  It will enforce principles 
that align remuneration policies with appropriate risk 
management. 
 
-- Glass-Steagall type legislation that would enforce a 
greater institutional separation between commercial and 
investment banks is not needed.  Turner said such a 
separation is not practical in today's complex global 
economy, nor is it clear it would radically reduce 
banking system risks. 
 
-- The FSA will start consultations on the possibility of 
regulating products in both retail and wholesale markets. 
It will consider introducing maximum loan-to-value ratios 
or loan-to income ratios for mortgages and regulating 
wholesale market products that can adversely impact 
financial stability. 
 
-- Regulation should focus on economic substance, not 
legal form.  Off-balance sheet vehicles which create 
substantive economic risk must be treated like on-balance 
sheet for regulatory purposes.  Regulators should be 
given the power to apply prudential regulation to hedge 
funds if their activities become bank-like in nature or 
systemic in importance. 
 
-- The FSA supports legislation currently being 
formulated in the EU that will require credit rating 
agencies (CRAs)to register with and be supervised by 
financial regulators, coordinated at a European level via 
colleges.  Turner said supervisory oversight should 
require CRAs to only accept assignments where a 
consistent rating could be produced. 
 
Reaction: Useful vs. Too Watered Down 
------------------------------------- 
 
¶7.  (SBU) Turner's report was widely welcomed by business 
groups.  A rush to legislation would have risked a repeat 
of a Sarbanes-Oxley type over-reaction, compounding the 
effects of the recession, according to the Confederation 
of British Industry (CBI).  It praised Turner for 
producing targeted proposals dealing with specific 
failings and risks to the whole system, rather than 
responding to wilder calls for action against banks.  The 
British Bankers' Association (BBA) told us the report was 
useful because it injects a practical element into the 
issues discussed within the various international fora. 
Paul Chisnall, the BBA's executive director of financial 
policy, said the BBA recognizes that work needs to be 
undertaken in the regulatory sphere to prevent another 
financial crisis on this scale.  He told us the areas 
discussed in the report are mostly valid areas of 
consideration and that the BBA has no qualms with 
expanding the scope of regulation.  The BBA encouraged 
the introduction of a macro-prudential element to 
supervision, making the financial sector more aware of 
broader systemic threats.  Chisnall was particularly 
pleased Turner did not see any need for the introduction 
of Glass-Steagall type legislation.  But despite its 
broad approval of the report, the BBA is eager for more 
discussion and consultation.  Chisnall cautioned against 
veering too close to the headlines and introducing reform 
because an issue receives significant press attention. 
This is particularly true of potential regulation 
 
LONDON 00000723  003.2 OF 003 
 
 
governing mortgage products.  He said the FSA needs to be 
careful not to create a rigid structure that is anti- 
competitive. 
 
¶8.  (SBU) In contrast, other groups thought the 
regulatory chief had not gone far enough, arguing the 
whole regulatory framework should be restructured in the 
wake of such a widespread crisis.  Vince Cable, Shadow 
Chancellor for the Liberal Democrats, dismissed the 
review saying it was "little more than a watered down 
summary of policy changes" his party has been demanding 
for years.  He criticized Turner's decision to not call 
for the separation of low-risk retail banks from high- 
risk investment banks.  The UK's largest union, Unite, 
was equally unimpressed by the report, saying its recipe 
of "more rhetoric than substance" would do nothing to 
reassure bank customers or staff.  Unite's national 
officer, Rob MacGregor, said the report leaves key issues 
unresolved and HMG and the FSA should be brave enough to 
set out a new radical regulatory framework. 
 
LEBARON