There probably has never been a better time to be a regulator. While some have been accused of sleeping on the job, others are making the most of the new appetite for greater regulation. Paul Koster is the new chief executive of the Dubai Financial Services Authority (DFSA) in his office at the Dubai International Finance Centre (DIFC). He is a Dutchman with a wealth of experience, ranging from his time as the commissioner of the Autoriteit FinanciŽle Markten (Netherlands Authority for the Financial Markets), executive vice president of Royal Philips Electronics and chief compliance officer at the Amsterdam Stock Exchange. He has carried out a number of senior finance functions in his earlier career, having trained as an accountant with Arthur Andersen.
Q) What attracted you to Dubai? A) It's a new market. There is a very good spirit here. The ruler has made positive comments about his vision. What has been accomplished over the past five to six years in setting up a financial system is amazing. It is simply amazing how this organisation got itself established as a recognised body. It attracted me because I have had lots of experience in Europe and I'm trying to apply the knowledge and know-how that I gained there in this environment. People are very eager to learn. There's a positive attitude, even during bleak worldwide circumstances.
How successful have regulators been here in the past? I haven't studied it well enough to say what the critical points are. The DFSA has gained lots of credibility over the years, also with the Central Bank stepping in and ESCA (Emirates Securities and Commodities Authority) doing their jobs. See, for us it's a goal to work more closely together. Ultimately you can't separate the DIFC from the UAE. It's still a part.
What about transparency? There is not enough transparency in the region. The ruler has said he wants more. It's a key element in the success of financial markets here. Take a look at what happened with AIG (American International Group): they will come out with information of who owns what and who is liable for what - but why didn't they disclose that earlier? What are the areas that you will be focusing on here?
International co-operation is one. We think the Middle East should be heard. What do you think of monetary union for the Gulf? I am in favour of monetary union because I've experienced it in Europe with the euro. Without the euro, Europe would have been in a shambles and all currencies would have gone in different directions. The strength of the euro is that there is a co-ordination, a co-ordinating system. It's important to be recognised as a currency you can trade in. Countries that are somewhat weaker can be part of stronger union.
What else needs to be developed here? Bond markets. One of the problems we see is that secondary trading is not taking place. One of my goals, along with others in the region, is to look at opportunities to make that grow. As long as there is a problem, foreign investors will move out. A strong regional bond market, where local regional investors are interested in participating, is a good thing. It's not about protectionism - that involves using tariffs and other tactics. We need to educate the investors worldwide.
Should bankers be publicly hanged for what they've done? In a way we [regulators] are part of the problem. We should all realise we've been part of the developments and the things that were missed and we should all work together. There will be court cases, but public hanging is a bit extreme ... So what should happen now? One of the issues is that if you look at all the failures, it's very obvious to me that business model changes have been part of the problem. When a business model change occurs in isolation and everyone's happy with results, and no one pays attention to what you're doing, the result is AIG. AIG was a very successful insurer. I also believe that boards need to have permanent education, as much as auditors and lawyers do. Boards need to be far more aligned to business interests than they have been.
I have anecdotal evidence of people not understanding business. They did a study in the Netherlands on mutual fund activities - issues with doing after-hour trades and intrinsic value calculations. In looking around, it was amazing to see how little board members knew about what was going on. We have created a system that is so complex it is very difficult for just anyone to grasp. On an individual basis, you might understand risk but when it comes to seeing the whole systemic change, no one managed to think about it.
So what went wrong? When we have the time to reflect we will see that the crisis started in the periphery and went on into the centre [of the financial system]. My favourite analysis so far is that you have layers of protection. We have the agency model. The principle and agent have layers of protection inside the companies, then they have a second layer of intermediaries. We've seen problems with accountants early in the century. There are huge problems with credit rating agencies. Do they understand business? Have they taken the time to study it thoroughly? And what about board members: one would be a board member for some years because it brought status but not the scrutiny that was needed. The third layer is the regulators. Now, the fourth layer is the politicians. This is the agency model, though the model itself is somewhat under attack.
Is there anywhere that regulators did a good job? They didn't fail on all fronts. Sometimes, when regulators ask for more politicians stop them. How do we as regulators pinpoint the moment where a product or new development becomes so critical that we need to monitor it? I've been pleading to create a financial stability forum that is not unlike the US FDA (involving drug approval procedures) for new products and activities.
We wouldn't stifle the process of innovation, but we would have a committee that could monitor the developments and more easily spot trends - it's time that we had a discussion on additional regulatory steps. For instance, when hedge funds grew exponentially, I vividly remember reading US$600 billion (Dh2.2 trillion). Four weeks later it's $800bn; four months later it would be way over in the trillions.
It's clear that when an industry becomes captured under one name that regulators should monitor what's going on and see how that could possibly affect the system. I'm surprised that we let it escape. Hedge funds have a competitive advantage over mutual funds because mutual funds are regulated, whereas hedge funds could easily change their investment portfolio. Those kinds of trends should be spotted much earlier on without the political side interfering. That's a major problem.
Can you have too much regulation? Of course. If we stifle creativity, it's not helpful. It's like with drugs: if you make it more difficult, there may be no innovation which might actually be good for health purposes. It should be flexible enough with built-in sensors. There are many good international organisations that exist. What about global regulation? There is a lot of talk about global regulation - I have no idea what that means. It sounds good, but it doesn't give a formula. To me, there are regional elements that you could have addressed by the regional activity, so you could see that develop.
Who regulates the regulators? It is the politicians. But it's not so much who regulates the regulators, but more how can the regulators, knowing that they have an oversight and many international bodies that come together, still have auditing oversights? In Dubai, we try to be part of those international bodies and participate in discussions. We can't do anything in isolation any more, we need to have co-operation. It is increasing, but needs to be focused. By this I mean co-operation with central banks.
Could there be a regional version of Madoff in the building? That makes me a hostage to fortune (laughs). There could be a case, but I don't think it's very likely given our scrutiny. We are totally active in trying to anticipate as much as we can and avoid any hiccups. The changes in the financial system in the West are just incredible. AIG, Lehman Brothers, Bear Stearns, Freddie Mac and Fannie Mae; these have been decimated or disappeared. However, this creates opportunities for new markets. It helps you to be humble. AIG and Citigroup were worth about $250bn each a few years ago. What are they worth now?
The message to me is that light-touch regulation is a thing of the past. That doesn't mean that as a regulator you can't co-operate; I'm very much in favour of co-operation. I'd rather go in and have discussion about a problem that we might kill early on rather than having more of a "hush, hush" approach. Co-operation to me is a far more productive way as a regulator than coming in with a bang. At times, you have to show your teeth.