Proper consultation is the rock upon which good regulation is founded. And for the Financial Services Authority, consultation is in its DNA. So when it does the unthinkable and drops a bombshell without warning or discussion — as last week with the announcement of the Short Selling Instrument — people are bound to be left shellshocked and confused, especially if they are lawyers under pressure from clients to advise on what needs to be done.

Designed, allegedly, to bring greater transparency to the market in the aftermath of the recent rights issues shambles by HBOS and Bradford & Bingley, the measure could have been called the “short notice instrument” because there were mere days between its announcement and its operational effect. The FSA’s justification for the move was that market conditions gave rise to increased potential for market abuse and therefore “immediate measures” were necessary to “maintain market confidence and prevent potential abuse during rights issues”.

The resulting howls of fury that went up from some parts of the City were dismissed as just typical hedge funders (who normally move through the markets with the silence of the assassin) screeching at having their affairs being brought into the light of day.

But from the comments of a cross-section of City lawyers it is clear that some at least were offended at what they saw as rather shoddy conduct by the FSA.

One of the most outspoken was Darren Fox, of Simmons & Simmons, who specialises in assisting financial services firms to comply with FSA rules. “I was very surprised that the FSA failed to follow the normal consultation process,” he says. “This was confirmed when I actually saw the instrument. I immediately had at least 20 questions for clarification. Changes of this kind are very granular. In order to advise your clients you need the detail but none of the detail was there. Frankly, it was a complete mess.”

What particularly irked Fox was that the legal machinery used to introduce the instrument was, in his view, dubious. “They’ve confused ‘guidance’ with ‘rules’ in getting it through,” he says. “There could be a discussion about the legitimacy of the instrument. It could actually be void.”

Of course, despite the time pressure, lawyers and their clients worked hard last week to ensure that they could comply (at least as best they could) when the instrument came into force on Friday. But in a globalised market it is much more complex than that. The new rules apply worldwide including, for example, to hedge funds based in the Far East. “It is quite feasible that they are not aware of the changes and could be in breach of them,” Fox says. “And that would be down to the lack of consultation and sufficient advance warning.”

Will the FSA be vindicated by the benefits? Here again some — but not all — City lawyers are sceptical. Rob Falkner, head of securities regulation at Morgan Lewis in London, expressed the deepest reservations. “Personally I think that this is a knee-jerk reaction that is more concerned with social policy and is inspired by the Treasury rather than being a measured approach to a real problem,” he says. “Has there really been a difficulty in relation to the efficiency of the markets caused by the hedge funds? I’d question that.”

In fact, Falkner suggests, the hedge funds and short selling are just a convenient scapegoat and whipping boy. “Let’s call the crisis what it really was,” Falkner says. “It was Northern Rock 2 and the FSA was under pressure to show that it was doing something. This was not good regulation.”

Not that the FSA is entirely without its supporters. Rachel Kent, a partner in Lovells’ financial institutions group, agrees that the FSA was probably motivated to show that it “meant business” by taking a tough interventionist line. However, this was entirely justified. “The FSA is a relative newcomer as a regulator by international standards and this represented its coming of age,” she says. “Having staked its reputation on principles-based regulation it then had Northern Rock. When you compare how the Americans dealt with Bear Stearns and the French with Société Générale, the FSA was left looking very inadequate by comparison. So after the HBOS affair ‘doing nothing’ was no longer an option. All right, there were spelling mistakes and so on in the documents. But these were trivial issues. The FSA could justify what it was doing in terms of its twin objectives — ensuring orderly markets and maintaining consumer confidence.” Will the new rules make a difference? “I think that you will find that the banks are in favour — even if they are keeping rather quiet about it,” she says.

The FSA also has the sympathy of Jonathan Herbst and Peter Snowden, at Norton Rose, who even think that the regulator did a rather good job of the practical guidance. “Whatever we may think about the rights and wrongs of it, the priority now is to get on with ensuring that the new regulations are followed,” Snowden says. “What is more,” Herbst adds, “there is no possibility that the FSA will budge on the new rules. We have to learn to live with them. I thought the FSA staff on the help desk were very efficient.” Ah well, it’s nice to know you have satisfied somebody.

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