Centre for Economic Policy Research

particular issue ex ante rather than ex post does not amount to rating their own rat-
ings. It is rather a question of at what point in the process is it most efficient for
the special expertise of the rating agencies to be relevant. The Report’s 
conclusions with respect to separation of ancillary services by the rating agencies
go a step too far. Problems arising within firms – for example in what department
is the earning power of the firm greater and whether a short-run or long-run 
perspective is taken – should not be labelled ‘conflicts of interest’ in the usual
100 Conflicts of Interest in the Financial Services Industry

---

sense since they are by their nature internal to the firm. Market-based solutions to 
conflict problems are precisely designed to internalize the negative consequences
of certain behaviour. These are management problems of a more straightforward
variety, which still are serious, warrant attention and need a remedy.
As a conclusion Johnson reiterated her view that market discipline combined
with transparency was the primary course of action to be taken. Turning first to a
market solution is desirable because market forces are better able to respond and
adapt to change, and prompt and flexible remedy is essential. There are instances
where regulatory oversight and/or separation are needed, but these should be kept
to a minimum. Socialization of information is the right answer only in very 
special cases – such as weather forecasting.
James Sassoon 
HM Treasury
James Sassoon welcomed an important contribution to an on-going debate and
talked about the UK Government approach of working with market practitioners
to help frame policy responses to the problems outlined by the Report. The 
starting point for the analysis is the hypothesis that conflicts of interest in 
financial services can pose a real problem to prosperity and growth by 
undermining investors’ confidence in financial markets. It is important that the
conflicts be identified and addressed, but it is also crucial that the policy response
does not stifle risk-taking. Regulation should not kill off animal spirits. Three
points should be kept in mind. First, the policy response must be proper and 
proportionate and deal broadly with the corporate world and not narrowly
focused on one element or sector. Second, the solution should be developed in
association with market participants and not be left to lawyers. Finally, the new
regime should be based on principles rather than rules. 
The UK approach, very much in line with the recommendations of the Report,
provides a good example of how to apply these general principles, and shows
some differences to the approach of the United States. 
One of the foundations of the UK approach has been to increase the 
involvement of investors and shareholders. The Paul Myners review of 
institutional investment highlighted the importance of getting the incentives
right for the management of transaction costs, soft commissions, the bundling of
services and the arrangements between investment banks and fund managers. It
deserves more attention than it is currently getting in the United States.
Investors also need to have confidence in the quality of financial information
that companies produce. The UK Government’s coordinating group on audit and
accounting issues made several important recommendations to strengthen the
regulation and oversight of auditing and accounting including recommendations
on the rotation of audit partners and key audit staff. The approach is, however,
cautious on banning non-audit services especially regarding tax advisory services.
A preferred solution is greater disclosure in corporate annual reports, revealing to
shareholders exactly what fees were paid to audit firms and for what services, and
although this is going to be statutorily underpinned, companies may well begin
to introduce it voluntarily. In a second stage, new audit oversight bodies will have
a closer look at non-audit services. 
Among other developments in the United Kingdom, audit firms have 
voluntarily committed to publish a full annual report about their activities, 
management structures, a breakdown of their fees and their approach to 
remuneration. This is a progressive approach, using a light regulatory touch,
which has not been introduced in the United States.