How did this situation arise? After the 2007-8 financial crisis an extraordinary intellectual leap occurred, where the EU’s controlling instincts and engrained suspicion of Anglo-Saxon financial markets, particularly investment banking, became orthodox within the UK system. 

Michel Barnier, the then Financial Services Commissioner, led the charge in asserting that the EU’s own, code-based legal methods, based on Franco-German methods of the 19th century, should govern the City. Christine Lagarde, who spoke on a platform with the author, said: “I can’t tell you what it means to me for the City of London to be regulated in Paris.”

Yet the EU’s analysis was flawed. The reason for the crisis was the collective error across the EU (including UK) and US in believing the markets could root out poor practices. Events showed, catastrophically, that this was mistaken, and that systemic risk needs to be overseen and managed by the regulators. 

With erroneous logic, the solution was misconceived. The imposition of the EU code-based approach to rule making not only dampened market activity, displacing it into less regulated “shadow banking”, but the new top-down EU scheme in fact introduced risk in vast quantities, due to the need to paper over the cracks of the half-built eurozone.

Now, we need to recapture the benefits of our traditional legal method, with high standards but fewer, more focused rules. The way to achieve this is to ensure that our regulators operate more fully under the law, with arrangements for accountability that ensure regulatory predictability and a general respect for commercial choices. 

For that, we need to rethink the response to the financial crisis. The missing ingredient of pre-crisis regulation was the oversight of systemic risk. Many other aspects of regulation were broadly correct in structure though not entirely in form.

Most regulation can be framed and applied in a predictable manner. Much of our traditional method of requiring firms to make disclosures which ensure that other firms can evaluate the risks of their counterparties brings with it a critical discipline, which is superior to what the regulators can ever achieve. Intrusive oversight is not necessary in such a context.

However, this will be insufficient. There also needs to be greater parliamentary oversight, informed by expert input, which can address whether the regulators are broadly acting in the intended manner. In addition, accountability is required in respect of particular regulatory decisions, and for this an increased role of the courts is necessary. At present, the regulators are largely judges in their own cause. A Tribunal is occasionally used to determine regulatory matters. Firms also have the right to seek judicial review, largely for where a decision is so unreasonable no regulator could have arrived at it, with the result that the chances of success are negligible.

The solution is to provide by statute that the financial regulators must write rules that are predictable in effect, and must supervise and enforce against those rules in a predictable manner. For matters involving complex prudential judgment, which are less susceptible to the following of rules, there should be a statutory objective of treating like cases alike. 

Then, in order to ensure these things happen, all enforcement actions, even when a settlement is reached, should be required to be brought before a court before any penalty is applied. The court, as part of its review, will verify that basic legal disciplines have been observed. There should also be the right of appeal to a court over a supervisory decision. 

It is only when firms have the ability to take their arguments to a court that we shall quash the notion that what matters most is the nature and strength of a firm’s relationship with its regulator. Legal actions will generally be rare, but the discipline will ripple through the system to beneficial effect.

For it is only through the law that commercial freedom arises – to innovate and act, without having to seek permission, when actions are lawful. Firms will be assured that, if challenged, the courts will uphold conduct in accordance with a reasonable interpretation of the rules. This in turn will ensure regulators are held to the task of conceiving the rules carefully in advance, rather than relying on an ability to wield vague standards after the event.

Barnabas Reynolds is a partner at Shearman & Sterling.