Patching up the City protectors: Laws meant to clean up financial markets have failed to stop the scandals. Peter Rodgers looks at the questions facing MPs

THOUSANDS of people have lost money because of wrongly sold pensions, bank collapses, pension fund scandals, stock market rigging and old-fashioned fraud since the 1982 Lloyd's Act, the 1986 Financial Services Act and the 1987 Banking Act.

These new laws were meant to clean up financial markets. But to the victims, the parliamentary time taken to pass them seems to have been largely wasted.

Tomorrow, the Commons Treasury Select Committee begins a wide-ranging investigation of the creaking edifice of financial services regulation and supervision in the UK.

The Government is strongly against introducing new legislation to reform the acts, does not wish to start afresh, and is committed only to tinkering with the old structure to make it work better.

But the committee has decided to confront government inertia by examining regulation across the whole gamut of financial services, from banking to life insurance and the Stock Exchange, as well as the impact of new European directives.

If it does its job properly, it may be able to offer a new long-term blueprint for investor protection.

Pensions have been the cause celebre of the past two years because of the Maxwell affair and new revelations about personal pension transfers.

The committee will focus initially on the life insurance and pensions industry, with Mick Newmarch, chief executive of Prudential, billed as first witness.

Pensions and life insurance are examples of where the FSA went wrong. The industry was given too much influence. The junior regulators, responsible for the nuts and bolts of financial regulation, were at one remove from the statutory authority, the Securities and Investments Board, and were dominated by industry practitioners.

The result was that the regulators were overawed by the life insurance and pensions salesmen, and this produced an unsatisfactory hybrid of self- and statutory regulation. The system has always been statutory but it has been cloaked, confusingly, in a layer of self-regulation, which lets the poachers sit with the gamekeepers. Some senior figures, including Mr Newmarch, now bitterly regret it, and say a fully statutory system would be better.

Fimbra, the regulator for financial intermediaries - the people who sell life insurance and pensions - was the first of the new bodies to be found wanting. Rationalisation is under way, with the formation of the Personal Investment Authority, but that will still report to the SIB in a two-layer system.

The select committee will consider whether this two-tier arrangement, in which junior regulators such as the PIA and the Securities and Futures Authority are overseen by the SIB, has worked. Will the MPs be tempted by the idea of a single body - perhaps the SIB itself - to take over the job?

Another option would be to have two statutory regulators, one to protect private investors and the other to police the City's professional markets. Despite its faults, the PIA is already seen as a step towards further separation of private and professional investor protection.

The committee's terms of reference suggest it could go further. It will look at whether the regulation of all financial institutions, including banks, building societies and insurance companies, should be integrated in one organisation.

That opens the question of whether the Bank of England should be broken up, by taking away its supervision department. But supervisors are not the same as regulators. The former look after the health of companies in the financial industry, the latter make sure that they behave properly towards their customers.

To do all that in one organisation would be horrendously complex, and it may not be sensible to ask a single body to run both regulation and supervision. A strong case could be made, however, for merging the Building Societies Commission, which reports to the Treasury, with the Bank of England's supervisory department, perhaps in a separate agency close to but not part of the Bank.

It is also an anomaly that the Department of Trade and Industry supervises the insurance industry while the Treasury and the Bank are responsible for most of the rest of the financial world.

One possibility is a separate insurance commission that might also take over the policing of the Lloyd's insurance market - which persuaded the Government not to include it in the FSA eight years ago.

Even if the MPs come down against radical change, there are still many anomalies in the present system. As Sir Bryan Carsberg, director general of the Office of Fair Trading, asks, why are banks not required to give 'best advice' when they sell mortgages backed by life insurance endowment policies to their customers in preference to repayment mortgages?

And while life insurers, including those owned by banks, obey regulations with statutory backing, why are ordinary, everyday banking practices regulated by a voluntary code of conduct?

One way to justify this is to distinguish between investments and services. A current account is a money transmission service, and a bank customer can move an account to a competitor without serious loss. A unit trust or an endowment policy is an investment that requires much greater safeguards. But the distinction between the two is increasingly blurred.

In the professional markets, the record of the Securities and Futures Authority, which also reports to the SIB, is not seriously being questioned, although there is a debate about how far the Stock Exchange should maintain its separate regulatory functions.

The biggest issue is the rather different one of how to enforce laws and regulations that already exist.

MPs are likely to question the Stock Exchange closely on its ideas for a unified agency whose job would be to prosecute insider trading and fine rule-breakers or expel them from the City.

The committee may also face a rather more basic question. Given all the disappointments, could it be that the FSA was sold on a false prospectus, promising levels of protection that were impossible to achieve by regulation?

With a unified European market in financial services looming, there will be nothing to stop Greek insurance salesmen selling direct to English customers. Investor protection in Europe will be as strong as its weakest link.

Perhaps it would be better to switch the emphasis from detailed regulation to expanding and improving industry-funded compensation schemes. There is nothing like a large bill for mistakes to make an industry vigilant.

And will MPs be satisfied with the performance of the SIB? After a bad start, it has done better under Sir David Walker and Andrew Large, but many in the City wonder whether it can ever be effective in its present shape. Even if it survives as it is, there is a serious question over whether the SIB should be more accountable to Parliament. It presents MPs with an annual report, but is answerable to the Chancellor, in private, and no one else.

(Photograph omitted)