Labour's proposals aren't radical enough for the City

The Sumitomo copper affair, the Barings collapse and the Deutsche Morgan Grenfell unit trust scandal have given a new lease of life to a long-running argument about whether there should be a root and branch reform of financial regulation.

We've been here before, of course, but a curiosity of this latest debate is that some of the most senior figures in the City are proposing much more radical solutions than the Labour Party. The politicians who on the hustings are most inclined to put the boot in have actually taken quite a conciliatory approach to the issue.

The story begins with Labour's proposal that all the regulators governed by the 1986 Financial Services Act should be rolled up into a single institution.

The Securities and Futures Authority, Imro, the fund management regulator, and the Personal Investment Authority, which looks after savings, would be merged into the senior regulator, the Securities and Investments Board. The result would be a single statutory organisation, similar to the US Securities and Exchange Commission, though perhaps with rather more input from practitioners than in the US.

The Government does not like this idea at all, and prefers the status quo. Among the regulators themselves, the SIB is thought to be discreetly supportive of the thrust of the Labour proposals - unsurprisingly, since it would be the winning bureaucracy. However, executives in charge of the junior regulatory bodies such as the SFA, the PIA and Imro think it a rather poor idea.

The SFA and the PIA are canvassing openly for much more radical reorganisation than the Labour Party has proposed, and they have a number of influential City figures cheering them on.

One explanation of the concerns of the junior regulators is, of course, that they may be worried about becoming mere division heads at the SIB under a Labour government. But they do have a convincing point to make about the risks of merging the entire gamut of regulation of personal savings and of the professional markets into a unified body.

Savings regulation is basically consumer protection, to prevent sharks preying on small fish, as they did in the pension transfer scandal.

For the markets the priorities are rather different. Certainly, the sharks need to be kept out of the pool if at all possible. But professional investors and dealers should be better able than savers to look after themselves, so the priorities are fair and open trading and financially healthy and well-run firms.

Regulation should therefore be divided on functional lines between a consumer protection and a market policing organisation, to reflect these differences of emphasis.

The $2.6bn losses made by Sumitomo in the copper market and the hundreds of millions Deutsche Bank is pouring into Morgan Grenfell to pay for the losses at its unit trust business illustrate the difference between the two types of regulation. The former was an entirely professional market and the latter a savings business.

However, Barings gives a third dimension to the argument, as the the Commons Treasury Committee pointed out this week.

It is hard, in modern markets, to make a clear distinction between banking, which is supervised by the Bank of England, and the securities and investment markets, which are covered by the Financial Services Act.

Banks are deeply involved in securities trading, while the securities industry has been stealing business from banks by persuading their customers to borrow in the markets instead. Indeed, convergence between the two industries has gone so far that this week a group of banks has been discussing setting up a formal market in which they can trade bank loans between themselves - treating them exactly as if they were securities such as bonds.

Taking the ideas canvassed by the SFA and the PIA to their logical conclusion, what is the justification for the continued separation of banking and securities regulation? If a bank or a securities firm gets into trouble, the investigations overlap at every point, making a hard task more difficult.

To merge banking and securities regulation would have important implications for the Bank of England, as the select committee pointed out, because it might lose its banking supervision role to some new body.

The select committee went no further than threatening the bank with losing the supervision function if it did not improve its performance. The MPs drew back from making this a firm recommendation. Labour, too, has steadily backed away from its earlier investigations of whether to break up the Bank of England.

There are some well-rehearsed arguments against creating a new independent super- regulator for securities and banking, and they should not be dismissed lightly.

Indeed, the Bank has a much better reputation for its supervision techniques among its oversees peers than it has in the UK, so it cannot be doing everything wrong. Problems such as Barings pale into insignificance compared with the savings and loans collapse in the US, the Japanese and Swedish banking crises and the French debacle over Credit Lyonnais.

The Bank has shown no signs so far of wanting to hand over supervision to anybody else. But some detect a softer line emerging. It is possible to imagine Eddie George, the Governor, launching an examination of the merger of banking and securities regulation, in certain circumstances. He might agree to give up supervision if Britain stays outside the single currency but gives its central bank true independence.

An argument against radical change, put forcefully by Sir Andrew Large, chairman of the SIB, is that no matter how good the alternative system, the years of change will be disruptive and dangerous, so that slow evolution is preferable.

Labour's difficulty is that by embracing a half-way solution, which includes substantial changes but may well not be radical enough to cope with the markets of the 21st century, it will have the worst of both worlds - much disruption for little real benefit.

It would make more sense to do nothing at all until a very good look has been taken at the more radical ideas emerging from the City.