Research note. Parallel Universes: Financial Market Regulation and Democracy

N. Dorn (2015), Democracy and Diversity in Financial Market Regulation, Routledge, London

Research note by Nicholas Dorn

The unfolding financial crisis – and its extension from markets to states, from states to the European Union, and from the EU to citizens – shows that there is something fundamentally wrong with the relations between markets, states and citizens. States are clearly not ‘sovereign’, when it comes to their relations with financial markets. Equally, the meaning of citizenship within democracies is being severely test. Successive financial crises – subprime, securities, bank bailouts, the Eurozone, states in its so-called periphery – are symptoms of a deeply entrenched historical democratic deficit.

How can we theorise this? There is acknowledgement amongst political, regulatory, and legal scholars that they have been a little behind the curve, and too insular. Henceforth, scholarship must be more innovatory, more cross-disciplinary and also more explicit over normative questions raised by financial markets. Legal scholar Julia Black has called for new ways of ‘seeing, knowing, and regulating financial markets’ that have the effect of “moving the cognitive framework from the economic to the social” and hence revitalising regulation.

I would add that we also need a stronger historical and political dimension to the analysis, bringing democracy back in. Regulatory activism at international, European and national levels has yet to touch the core problem, which is that there never has been public regulation of financial markets by the Europe Union (although in the US there was once, briefly, for which see Justin O’Brien’s book, The Triumph, Tragedy and Lost Legacy of James M Landis). On both continents, financial market regulation has been functionally private. The famous ‘political independence’ of regulation – recently critically remarked upon by Laurenz Enneser-Jedenastik on OAIR – has enough truth in it to be a problem for citizens, who find themselves cut out of the governance loop. Paradoxically (from the point of view of safeguarding democracy), the deeper the crisis, the more politically inaccessible becomes financial regulation. Experts argue amongst themselves in a language that is as assertive as it is impenetrable to citizens.

How has this situation arise? In chapter 1 of my recent book, Democracy and Diversity in Financial Market Regulation, I apply a historical analysis to the development of financial market regulation in the UK. The UK is a good place to start for several reasons: London today provides largest international platform for financial markets; up until 2008, it defended its international position by offering offshore-like self regulation within a classy wrapper; London was centrally involved in the formation of international and European regulatory architectures and cultures. The history of this city very clearly illustrates the core problem: the internationalisation and interlinking of occupational ‘status groups’ and ‘closed clubs’, as Max Weber called them.

Here is that history, in very condensed form. Up until the twentieth century, rule making and enforcement in all centres of trade were rooted in direct social contacts between traders, within geographically and culturally specific communities. Each of these economic communities had its own cultural, moral and (self-) regulatory coherence. Such self-organisation served practical purposes within economic communities (resolution of disputes, etc) and it also had political boundary-maintaining purposes, in two senses. The economic activities in question were reserved for those who had been accepted into the group (guild, club, cartel). Moreover, club regulation or private regulation (as we would call it today) kept at bay outside interference in the rules of the game.

Financial markets, in particular, ‘were regarded as being beyond the realm of party politics’ (Cain and Hopkins 1987). The governance arrangements in place in London for many centuries, right up until the post-Second World War period, were strongly inward-facing. As Daunton (1989) put it, ‘The [City] corporation and the guild companies had managed to avoid reform, so that they still remained largely beyond government control. The ancient right that the monarch could not enter the City without the permission of the lord mayor survived and this privilege had, in a sense, been inherited by the commercial and financial institutions of the City’. The general franchise of 1918 did not touch these arrangements: democracy had arrived, yet financial market self governance carried on as before, the two running in parallel universes.

We now come to the 1980s when – according to the orthodoxy – financial market self regulation was swept away and public regulation began, with the formation of an ‘independent’ regulator, the Financial Services Authority (FSA). However, did the birth of the FSA really mean the end of self regulation – can it really be counted as Independent Regulatory Agency (IRA), in the sense of being independent of both state and market? No, say Michael Moran, Karel Williams and their colleagues, who in series of important works have explored the ideational and structural conditions in which crisis was brewing. They suggest that regulatory arrangements in the UK constituted a Potemkin village, meaning that it was meant to deceive: bureaucracy was introduced (giving the form of an IRA) but governance retained its market mentality. Also the FSA was funded by the industry, hardly a recipe for independence of spirit. George Gilligan’s deployment of the notion of ‘relative autonomy’ to describe UK financial market regulation goes in a similar direction, without implying bad faith. Either way, the UK ended up with what I describe in my book as ‘private regulation behind a public façade’. Post crisis, there has been a whirlwind of regulatory activism at international, European and national levels, however this ‘tightening up’ has yet to touch the core problem: there never was public regulation of financial markets. Not even today.

This is both a normative problem and a functional one. Normatively, it must be unacceptable that such a core aspect of governance should be convened outside the arena of common politics. We need to re-visit the political separation between democratic politics and markets – and the parallel disciplinary separation between economics and politics. We need to challenge the political structure within which basic assumptions are shaped, knowledge is constructed and the broad lines of policy are negotiated. Looking at the contexts within and levels at which financial market regulation occurs – the restricted, technocratic circles involved and the upward, elitist drift of networking – one notices the lack of wider political debate in the run-up to the crisis. Did we see widespread and vigorous contestations, through which not only politicians but also political parties and citizens might get engaged? Not really, nor even that much today. Even in the ‘periphery’ of the Eurozone, where the lives of many have been deeply touched by down-turns in investment and by the austerity measures that are the flip side of bank bailouts, responses have been muted. There has been public anger, yet this has taken the form of widespread cynicism over elites, alongside displacement of anger unto foreigners and marginal groups – rather than attempts to move banking and other financial services into the centre of political debate and democratic decision-making.

Centrist political parties of both left and right hold much responsibility here, for their failure to take up fundamental questions about banking and other aspects of financial markets and to stimulate debate and deliberation.  Shamefully for centrists, it has been left to fringe parties to engage with these issues, starting from the political orientations of their constituencies, then from there articulating visions of the broad purposes that should be served by financial markets. For example, unreconstructed free marketers, such as neoliberal Republicans and Tea Party people in the US, disfavour state ‘interference’, whether that would restrict, shape or support capital; they favour leaving the industry to its own devices. By contrast, and with some relevance in parts of Europe, political constituencies that are left wing articulate the issues in terms of economic justice, close direction of the sector and possibly public ownership of some categories of financial entities or infrastructures. Alternatively, for green parties the purposes of the financial industry, as with other industries, include transformations aiming to safeguard the planet and its ecosystems. And so on… The general approach indicated by such vignettes is that party politics can and should start not with bankers’ or regulators’ agendas, but rather with its own, diverse convictions, then seeking to shape finance accordingly: chacun à son gout.

What good might such politicisation (and possible polarisation) of debate on financial markets do? In my book I advance the claim that, if the historically-constructed separation of regulation from democratic deliberation and design can be breached, then one result would be less global convergence in regulation, less herding in markets and less international contagion and systemic crisis. The vagrancies of democracy would introduce greater diversity into international regulatory regimes, which would address deep-seated issues of ‘too connected’ and ‘too similar’ financial markets.

Stepping towards such a diversified international regime means re-assessing so-called ‘Balkanisation’ of financial market policies and regulations, championing this as a global public good. Pluralisation is not a curse, it is a blessing. Of course, democratisation and diversification of finance will not stop it having crises – that’s the nature of the beast – but the crises that occur will be more idiosyncratic, local, less systemic and less devastating. Whenever an apple cart overturns, there can be a messy situation, which nevertheless is locally confined. If the apple carts are increasingly tightly roped together then the situation can be more serious. The answer is to untie the apple carts. Democracy provides the means.

Historically, democracy fluffed three opportunities to address financial markets. First, at the time of the general franchise, private regulation of financial markets sidestepped the realm of public politics. Secondly, after the Second World War, private regulation adopted a public guise at home and a networked persona internationally. Thirdly, within the European Union, recent signs have not been encouraging, with mechanisms to save the Eurozone and its banks, whilst binding its citizens. If the recent stirrings of democracy in some parts of Europe result in financial markets policies and regulation being politicised – in the vulgar meaning of the word – then that would be momentous. The odds, of course, are against.

dornNicholas Dorn is a sociologist, inclined to law and politics. He is an associate research fellow with the Institute of Advanced legal Studies, University of London. Previously he worked for Erasmus School of Law, Rotterdam. His book Democracy and Diversity in Financial Market Regulation was published in August 2014 by Routledge. This book draws upon that book and upon LSE’s European Politics and Policy blog. His 2015 web page is at