the cold shoulder

viral compliance and trust

The new book is going in some unusual directions, and is consequently spawning some offcuts. This week I got to thinking about one of the oddest but most effective financial regulators I’ve ever known – the City Panel on Takeovers and Mergers. (I’m talking here about the old-fashioned, pre-2006 Panel; things are a bit different today).

This body has the responsibility of ensuring fair practice when public companies are taken over – basically, that minority shareholders get a fair deal, that incumbent management don’t abuse financial structuring to protect themselves and that companies aren’t disrupted too much from their actual business by speculative and aggressive tactics. Basically, it’s operating in that middle ground between law and professional ethics which I wrote a bit about in “Lying for Money”, the space where the internal best practices of good behaviour in a particular market start being elevated to the level of legal rules, simply because the thing itself is so important.

One interesting thing about the Takeover Panel is that it was mainly staffed by secondees from the banking industry. This was itself an indication of a very high-trust society, of course. If you wanted to have a senior career in investment banking in London, then you sort of accepted that part of that career would involve doing your time on the Takeover Panel, like an equivalent of national service for capitalism. Also, everyone trusted each other enough to be confident that the secondees on the Panel wouldn’t favour their own employers’ deals, and all the employers understood that although it was inconvenient to lose the services of one of your best bankers for a couple of years, they benefited from the system as a whole, and everyone took a turn.

But the most interesting thing about it was the way it enforced its judgements. Before 2006, the Takeover Panel had no statutory authority at all, but nevertheless it was extremely feared and people for the most part did what they were told by it, even if they thought the decision which had gone against them was very unfair. Because the Takeover Panel had the ultimate sanction at its disposal – the “cold shoulder”.

The cold-shoulder order was very infrequently used indeed, because people were so terrified of it. It simply involved publishing a notice that a particular person or firm was to be cold-shouldered. And the understanding was that if you worked with or for someone subject to the cold-shoulder, you would be cold-shouldered yourself. Because everyone knew that the big and important banks which formed the backbone of the Panel would always respect the cold-shoulder, it had a sort of viral property; nobody who relied on being able to work with Barclays would touch anyone who was cold-shouldered, so nobody who relied on being able to work with one of those firms would dare to, and so on; basically, anyone who got cold-shouldered would be completely shut out of the financial industry.

As I noted above, this was put on statutory ground in 2006, and now it’s just an FCA regulation that licensed professionals have to respect the cold shoulder. But this wasn’t because the viral version wasn’t working, far from it. The legislation was just made necessary by a European Directive, which was passed because other financial centres hadn’t been able to make similar arrangements work.

Viral sanctions like this, in my view, aren’t used enough; they could be a very good way of extending enforcement into areas where it’s proved difficult in the past, like social media platforms and AI governance. The state has a really useful property that it’s a very big client that lots of people really want to do business with, which makes it an ideal “seed” for a cold-shouldering regime. If you just say “we think that [some pattern of destructive activity] is bad, and that facilitating it warrants the cold shoulder”, then as long as you’re prepared to go through with that, then even if the bad actor has structured its operations so as to avoid direct enforcement, it will find it increasingly difficult to do business, simply for want of customers and providers of essential inputs.

It interests me that this is almost, but not quite, what the USA has done with the global dollar network.It’s also, as far as I can tell, how the Advertising Standards Agency informally works (the ASA has almost no statutory powers of enforcement, but advertising is a small world in which the principal players all know that they benefit from maintaining standards).This is a kind of positive version of Gresham’s Law, in which good practice co-ordinates to drive out bad, and I think we might need to make much more use of this kind of mechanism to reverse our otherwise inexorable slide into the bad, low-trust equilibrium.