The Bank of England is seeking to build an 'Open Forum' Building real markets for the good of the people. I am participating in this forum and here I seek to address the questions
- Are reforms creating the soft and hard infrastructure to ensure FICC markets are effective and retain their social licence?
- Where has too little been done? In some areas, might reform have gone too far?
- Does the reform agenda form a coherent whole or are there gaps and inconsistencies?
- How should the programme of reform be made dynamic and adaptive to current and future innovations in markets?
In summary I believe the reforms focus on specific actions but do not address fundamental issues around how markets are perceived. This reflects the Bank’s desire to deliver concrete proposals to solve a range of specific problems. The risk is that the reforms tackle situations already identified and are not robust to new phenomena.
The basis of my argument rests on a matter of fact: two hundred years ago banking, and commerce generally, was conceived of as being conducive to social order; today it is generally perceived as socially destructive. Before the nineteenth century, in theory, the primary concern of markets was fairness in exchange. Through the nineteenth century this concern was replaced by profit maximisation. I would assert that contemporary market malfeasance is a result of this transformation; practices become justified by a consequentialist argument that profits, however generated, are ultimately beneficial to society.
The Bank and market regulators seek to correct market misconduct, in the main, by creating new rules and regulations; a deontological response. The weakness of this approach is that rules and regulations, necessarily, relate to specific situations and so are slow to evolve to new technologies.
Both consequentialist and deontological moralities rely on predictability, something rarely encountered in markets. Consequentialism rests on an assumption that we are able to calculate the consequences of our actions and deontology that we can identify the set of possible situations that need proscribing. In the presence of uncertainty the ethicist should turn to character, or virtue, based morality. The Fair and Efficient Market’s Review recognises this and highlights the need to improve standards, professionalism and accountability, issues of character while the 3 ‘pillars’ of Basel reflect deontological (Pillar I) , character (Pillar II) and consequentialist (Pillar III) approaches.
I believe that the Bank will struggle to actually deliver its objective of ‘Markets for All’ so long as market participants are taught to adhere a consequentialist ethic to maximise profits while the regulator focuses on developing rules to restrain these instincts. Alongside the work on strengthening rules and regulations in order to deliver ‘Markets for All’ I assert that the Bank of England must undertake a programme of work focussing on the culture of banking.
Character is developed through practice in the context of a culture. This is reflected in the meaning of the Greek word at the root of ethics and the Latin word at the root of morality, both relate to practice. Thirty years ago many bankers, including Bank of England employees, started their careers directly from school as apprentices, learning their trade in practice. Today, the majority of City bankers will have gone through an academic training rooted in a consequentialist ethic and built on profit maximisation in the presence of scarcity.
While many see the decline in commercial ethics as being a recent phenomena, Milton Friedman, Reaganomics and Thatcherism are often mentioned, I point to the 1950 English Trust Law case, Buttle v Saunders ([1950] 2 All ER 193), where in the High Court ruled that the fiduciary duty to maximise a client’s profits superceded any conception of commercial ethics, such as ‘my word is my bond’; introducing the practice of ‘gazumping’ into English commercial practice. I also highlight that at this time, because of the Bretton-Woods system, exchange rates, and hence interest rates and commodity prices, were fixed. That is, in 1950 the FICC markets were broadly predictable and in this environment the ideology of profit maximisation, formulated in the academic sphere, came to dominate financial practice.
I have argued that the current perception of markets as being competitive arenas designed to maximise profits is misguided. A truer conception of markets is as a response to radical uncertainty and that markets are forums, centres of discourse, where the aim is to reach a consensus on prices. This position is developed on the identification of reciprocity (fairness in exchange) as being deeply embedded in contemporary financial mathematics and reflects the origins of mathematical probability theory being in the ethical assessment of contingent contracts. Reciprocity, I argue, is a key ‘norm of market discourse’, along with charity and sincerity.
My case is based on the view that in the aftermath of the Enlightenment instrumental mindsets that sought to optimally achieve predetermined ends in the context of an underlying need to control external events emerged and dominated science. This approach is founded on an assumption of predictability, that emerged in the nineteenth century, and that fails in the face of radical uncertainty.
Integral to my case is the view that western commercial practice has driven the development of both western science and western democracy. The explanation is that society learns about discourse in the marketplace, and discourse is at the basis of both democracy and science. Greek commerce was uniquely based on money and delivered a unique approach to science and politics. The commercial revolution of twelfth century Europe ended feudalism and resulted in Europe's mathematisation of physics. Thomas Gresham and Simon Stevin preceded Isaac Newton and Christiaan Huygens. This turns table on the conventional standpoint that commerce is built on science and democracy and emphasises the merit of markets.
On this basis, my responses to the questions presented are as follows.
- Are reforms creating the soft and hard infrastructure to ensure FICC markets are effective and retain their social licence?
I cannot see (perhaps based on ignorance) initiatives to address the ‘soft’ infrastructure to the same extent as there are initiatives to address the ‘hard’ infrastructure. I am not surprised by this given Bank’s desire to deliver concrete actions to solve a range of specific problems, but I think the bones of the hard infrastructure are useless without the meat of the soft infrastructure.
- Where has too little been done? In some areas, might reform have gone too far?
I cannot find a clear vision of how the culture of Banking will be improved. There is a commitment to making the rules and regulations stronger but it is assumed that everyone agrees on what a market is and why it exists. I believe the Bank should bring clarity to this fundamental issue. As long as a market is seen by some as a panacea while others see it as demonic the ultimate objective of markets regaining their social license will be at risk. I believe the ‘Open Public Forum’ needs to deliver a generally accessible and widely agreed understanding of the role of markets.
New financial technologies, such as crowdfunding, peer-to-peer lending and alternative currencies, are characterised by their distributed, non-centralised, nature. My case that markets are forums for achieving consensus is more sympathetic to these new technologies than the conventional approach that markets are to maximise profits. The new financial mechanisms have been reviewed by regulators. There is concern that regulators will force the emergent mechanisms to mimic existing structures, which are profit maximising, destroying their beneficial distinctiveness and the FCA consultation was debated in the UK Parliament (18 December 2013, `Crowdfunding and the FCA'). and during the debate it was observed that the UK has the potential to be the global leader in crowdfunding because the US SEC has over-regulated it and “strangled the baby at birth''.
- Does the reform agenda form a coherent whole or are there gaps and inconsistencies?
I don’t think the reform agenda is incoherent and implicit in the agenda is a desire to address the culture of banking. However I do not think this is explicit and so will be lost.
- How should the programme of reform be made dynamic and adaptive to current and future innovations in markets?
I would argue that the Bank should promote dialogue and research on the how markets are perceived. Whilst finance is in the midst of an ethical crisis it is also undergoing significant change driven by technology and there is significant public interest in finance, unprecedented in recent history. Because markets are intrinsically unpredictable and it is impossible to identify how they will evolve, what is needed is to harness this interest in honest discourse about how markets should develop.
Finance, science and democracy are all failing to deliver a robust consensus on important issues, can finance return to its ethical roots and teach the other domains how it is done?
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