Newsmaker: RBS turns to an architect of "light touch" regulation

By Matt Scuffham and Lauren Tara LaCapra

LONDON/NEW YORK (Reuters) - The man synonymous with the "light-touch" regulation which allowed Royal Bank of Scotland to spiral out of control before its 45.5 billion pound ($71 billion) government rescue looks set to guide it back to private hands.

Howard Davies, who set up the discredited and now defunct Financial Services Authority (FSA), has been handed the job of chairing RBS through a critical period in which it is restructuring and cleaning up issues of past misconduct ahead of a possible sale of the government's shares.

RBS, 79 percent-owned by taxpayers following its bailout during the financial crisis of 2007 to 2009, on Thursday appointed Davies to succeed Philip Hampton, whose six-year tenure as RBS chairman will end this year.

Davies, then deputy governor of the Bank of England, was asked to create a new city watchdog when Britain's Labour Party came to power in 1997 and became its chairman for the next six years.

The FSA was part of a tripartite regulation system established by finance minister Gordon Brown which has since been blamed for not policing Britain's banks effectively.

The tripartite system split regulation between the Treasury, FSA and Bank of England, with most of the central bank's responsibilities for financial stability handed to the FSA. But a report by the House of Lords Economic Affairs Committee concluded that failures of regulation and supervision contributed to the financial crisis in Britain.

Under Davies' chairmanship, the FSA followed a strategy of 'principle-based regulation', where a broad set of guidelines are laid out for banks to follow, differing from 'rules-based regulation' which sets out a specific rule book.

Davies, 64, will have a chance to put his thoughts into practice at RBS, still hampered by a number of investigations by regulators into past misconduct at the bank, threatening to undermine Chief Executive Ross McEwan's plans to turn it around.

The bank said on Wednesday that it had suspended another two employees as part of its own probe into its foreign exchange business..

It is also being investigated by regulators looking into its selling of bonds backed by residential mortgages in the United States and by British regulators examining its treatment of struggling small firms.

"RADICAL MANIFESTO"

With uncanny timing, Davies re-entered the debate on financial regulation this week publishing a book entitled 'Can financial markets be controlled?'.

It promised readers "a radical alternative manifesto of reforms to restore market discipline and create a safer economic future for us all".

In it, he criticises reforms initiated since the crisis suggesting that they have not gone far enough -- putting him at odds with many senior bankers who feel banks are being hamstrung by regulations that make it impossible for them to operate some businesses.

Davies, a fan of English Premier League soccer champions Manchester City, has served as a director of Morgan Stanley since 2005 and his colleagues there speak glowingly of his qualities, describing him as ideal for the role.

"Sir Howard is among the finest directors I've ever served with," said Erskine Bowles, a fellow director at Morgan Stanley.

"His understanding of global economics, risk, and their impact on global financial institutions is invaluable. He also brings a wonderful wit that can lighten a moment in just the right manner," he added.

Davies has not managed to entirely avoid controversy since leaving the FSA. In 2011, he resigned as director of the London School of Economics after the university was criticised for accepting funding from a foundation run by Libyan leader Muammar Gaddafi's son, Saif.

The prize for Davies, if he can help McEwan and other senior executives clean up RBS, will be to the lead it back to private ownership.

That could start to happen as early as 2017, according to industry sources, if the bank can settle outstanding regulatory investigations and complete its restructuring.

Those at the helm when it gets there will enjoy the prestige associated with turning around a bank almost destroyed by an acquisition binge overseen by former chief executive Fred Goodwin in the run up to the financial crisis.

The irony could be that the man leading the bank's recovery will be seen by some as the architect of the rules which allowed Goodwin to embark on his folly in the first place.

Davies was unavailable to comment on his appointment on Thursday. ($1 = 0.6455 pounds)

(Editing by Keith Weir)