BRITAIN
THE UK Government has launched a consultation about whether it is time to lighten the rules governing alternative asset managers, including private equity and hedge funds, in the belief that doing so will boost growth.
That is radical because, in its desire to ensure the City of London remains attractive post-Brexit, the government seems to have forgotten one of the major lessons of the 2008 financial crisis: when regulation is lax, risks accumulate. And there is little evidence to support this idea, but every reason to think it could exacerbate systemic risks.
The proposal is consistent with the Treasury’s belief that expanding the financial sector will deliver economic prosperity. It has suggested that post-crisis regulations went “too far”. Those regulations included an EU directive targeting alternative investment funds. Before 2008, these funds operated mostly in the dark. There was no means of systematically tracking the leverage they were using, nor the dangers this might pose.
Under the EU rules, leveraged funds managing Euros100m or more in assets had to comply with strict reporting requirements and hold enough capital to absorb losses. The Chancellor is now considering lifting that threshold to £5bn, which would exempt many funds from the full list of EU rules. It will fall to the Financial Conduct Authority to decide which rules to apply. This is troubling.
The FCA has been instructed to encourage financial “risk-taking”, and the regulator has boasted about slashing “red tape”. Taken together, this sounds like a recipe for recklessness. Though the marketplace for private equity and hedge funds was too small to cause a crisis back in 2008, it has since tripled in size. Many private equity funds have started borrowing from shadow banks, which aren’t subject to the same regulations or capital requirements as normal banks. Others have begun taking on even more debt than usual. The Bank of England raised the alarm about these risky practices in 2023, and has suggested that mainstream banks may be unwittingly exposed to the industry. Hence, these are reasons for more financial oversight and discipline, not less.
If the FCA loosens the rules, fund managers will be less constrained in their dealings. They lobbied to have the EU directive watered down in 2010, and the UK was one of the few countries to oppose the rules. Then, as now, the government wanted to protect the City, believing it to be a goose that lays golden eggs. This antipathy towards financial regulation was a prelude to the “Singapore on Thames” worldview promoted by Brexiters. Hedge fund and private equity managers donated heavily to their cause: a study of Electoral Commission data by the academics Théo Bourgeron and Marlène Benquet revealed some £7.4m was donated to the leave campaign, as opposed to just £1.25m for remain.
The Treasury seems to be of the belief that unless the City gets what it wants, Britain may lose its fund managers to countries such as Luxembourg. There are many reasons to be wary of liberalising finance. One is that it will hinder, rather than help, economic growth. Research suggests that once the sector exceeds a certain size, it starts to become a drag on growth and productivity. A study from the University of Sheffield found that the UK lost out on roughly three years of average GDP growth between 1995 and 2015 thanks to its bloated financial sector. Watering down regulations might be helpful for fund managers who like to take huge risks, but it is hard to see who else would benefit.
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