Treasury needs to play nice with regulators to make a success of post-Brexit rules

Uncertainty is a killer for businesses. Too bad it is everywhere you look.

Unknown unknowns are impossible to root out, but firms have developed coping strategies to allow them to live in a deeply fragile world.

The underlying factors that triggered the financial crisis were unknown unknowns to (almost) everyone, even if they seem obvious when we look back.

But there are fundamental differences in today’s regulatory regime that means the global financial system is able to cope better with information gaps.

Leaving the EU has presented an opportunity to strengthen the regulatory system to make it more in tune with the nuances of the City. Regulators can be empowered to shape laws in our own image. So the Treasury has tasked the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA) with the mammoth job of cleansing the UK of legacy EU laws. They should be done in “several years”. Good luck to them.

This work will clearly eat up resources, but it is worth it. Regulators and lawmakers can be more agile when tweaking the existing regime, and, unbound from the EU courts, any inefficient rules can be changed.

This is an opportunity for the FCA and the PRA  to craft a regime to make transactions in the UK less costly.

They should focus on building on the most innovative parts of our regulations. For example, the FCA’s sandbox allows thriving, young fintechs to test out new products without the spectre of losses and failure looming over them.

Upfront costs are often a barrier to entry for small firms. So, by bearing some of the initial risk, regulators can guide fast growing startups during the early stages of business development without exerting too much control over their ambitions.

This light-touch approach can bolster the City’s leading fintech industry. But, if the government interjects too much in the market, innovative entrepreneurs could be crowded out and unproductive firms could be propped up for the sake of it.

In this sense, better scrutiny on the FCA and PRA is reasonable. If regulators are not up to scratch, they should be held accountable. The Treasury’s desire for new powers to haul in the FCA and the PRA if their actions are not “in the public interest” is understandable. But the pair also need enough freedom to carve out a new system without too much micromanagement. More importantly, the City’s input should carry greater weight than the government’s.

Perhaps the biggest danger of the UK taking the reins of its regulatory regime is unintentionally creating a system that manufactures perverse incentives by ignoring the perils of moral hazard. Doing so would damage the country’s reputation as a global financial leader and an attractive place to do business with accommodating rules.

The banking sector is a good example of where regulation needs to be more agile.

Lenders have weathered an assault of red tape since the financial crisis in a bid to stamp out risky behaviour that can threaten financial stability and consumers. However, onerous capital requirements have, on the margin, reduced the availability of credit, restricting new business creation and economic growth.

This is a microcosm of the trade offs the government is traversing as it embarks on creating a new financial regime. Striking a balance between stimulating growth in the short term while preventing problems in the long term lies at the core of regulation.

It will be no easy task  but an opportunity nonetheless.