If Diversification is Central to Investment, Why Not Regulation?

Financial markets thrive on diversification. Investors spread risk across asset classes, sectors, and geographies to avoid overexposure to any single failure. It's an ironclad principle; too much concentration increases vulnerability.

 

Yet, while diversification is considered fundamental in investment strategy, the UK government is moving in the opposite direction when it comes to financial regulation. Key policymakers, including Business Secretary Jonathan Reynolds and Chancellor Rachel Reeves, have signalled a desire to streamline the country’s financial watchdogs, arguing that the UK has too many regulators.

 

What’s their rationale? A leaner, more agile regulatory framework will cut bureaucracy, encourage investment, and boost economic growth.

 

Are too many cooks spoiling the broth?

 

An interesting question; but, if concentration is considered a risk in financial markets, why would regulatory concentration be any different? Could reducing the number of financial regulators lead to a fragile oversight system, where fewer watchdogs increase the risk of blind spots, inefficiencies, and unchecked financial misbehaviour?

 

It’s fair to say this shift demands deeper scrutiny.

 

The case for regulatory consolidation: A necessary reform?

 

Currently, the UK’s financial system is overseen by multiple bodies, including the Financial Conduct Authority (FCA), the Prudential Regulation Authority (PRA), and the Competition and Markets Authority (CMA), among others. The argument for reducing their number is straightforward; too many regulators create complexity, slow decision-making, and discourage investment.

 

We know the UK government has prioritised economic growth, and some believe that a streamlined, business-friendly regulatory environment will foster more investment. If the system is too slow, too rigid, and too fragmented, businesses may choose to list or operate in other jurisdictions. A single, powerful regulator could simplify processes, reduce compliance burdens and make the UK a more attractive financial hub.

 

But history tells us that simplification and efficiency do not always mean better oversight.

 

The risk of regulatory over-concentration

 

While reducing inefficiencies is a noble goal, consolidating financial oversight into fewer regulators could backfire spectacularly. In finance, the lack of proper checks and balances has often been a prelude to crisis.

 

Surely the 2008 financial meltdown should serve as a stark reminder. Before the crash, UK regulation was dominated by a single entity; the Financial Services Authority (FSA). Critics argue that its failure to detect systemic risks in banking and mortgage markets played a role in the crisis. After the collapse of Lehman Brothers and the subsequent near-failure of UK banks, the FSA was dismantled, creating multiple regulators (including the FCA and PRA) to ensure no single institution held unchecked oversight power.

 

The problem isn’t just historical. Even today, international markets rely on diversified regulatory structures to maintain financial stability:-

 

· The US maintains multiple layers of oversight - including the SEC, CFTC, and Federal Reserve - ensuring that financial risks are assessed from different perspectives.

· The EU employs specialised regulatory bodies that focus on distinct areas, recognising that no single regulator can oversee everything effectively.

 

Would the UK be wise to reverse this diversification in favour of consolidation?

 

Should regulation follow the same principles as investment?

 

Investors never bet everything on one stock, so, why should an entire financial system bet on a single regulatory body?

 

Diversification in finance is not just about growth, it's about risk mitigation. Multiple independent perspectives assessing and managing risk surely strengthen a market's resilience. Financial oversight should be no different.

 

A single (or dominant) regulatory entity could:

 

· Become overburdened, unable to effectively oversee the full complexity of financial markets.

· Develop blind spots, missing emerging risks in fast-changing areas like FinTech, digital assets, and ESG investment.

· Fail to act independently, becoming subject to political pressure or corporate influence.

 

Maybe the real solution isn't fewer regulators; its better coordination. Instead of eliminating regulatory bodies, the UK could enhance collaboration, ensuring financial stability while cutting inefficiencies.

 

Efficiency or fragility: A regulatory crossroads for the UK

 

The UK government now faces a pivotal decision; pursue regulatory consolidation for the sake of efficiency, or maintain a diversified oversight structure that prioritises stability. Or maybe they can achieve both?

 

The financial sector is inherently complex, with risks that can escalate rapidly if left unchecked. A system with fewer watchdogs could be more efficient on paper, but efficiency in regulation is not the same as effectiveness.

 

The irony is glaring. The very industry the UK seeks to regulate understands the value of diversification. If financial institutions spread risk across portfolios to avoid catastrophic losses, why should financial oversight be any different?

 

If we trust in diversification to protect investment, it may be time to ask; shouldn't we apply the same principle to regulation before it's too late?

Back to News