Impact analysis: UK outline of new approach to financial regulation
By Susannah Hammond
LONDON, Feb. 24 (Complinet) -The British Treasury’s latest proposal for reshaping financial regulation, published last week, has given more detail to the plans set out in an outline last summer. The fundamental shape of the new bodies now looks to have been finalized, but many fine points on how the new approach will actually function in practical, operational and cultural terms are still under consideration.
Following is a discussion of the major elements of the consultation, “A new approach to financial regulation: building a stronger system,” and how they may affect the UK financial industry:
BANK OF ENGLAND
The Bank of England itself will be given extended powers and tools with regard to its role in ensuring financial stability, as well as responsibility for the regulation of settlement systems and central counterparty clearing houses. These will sit alongside its existing responsibilities for payment system oversight. The bodies to be created are discussed in more detail below.
FINANCIAL POLICY COMMITTEE
The Financial Policy Committee will be created within the Bank of England and will have responsibility for considering the macro-economic and financial issues that may threaten financial stability. The Bank of England’s existing financial stability objective will be amended to read that:
— An objective of the bank shall be to protect and enhance the stability of the financial system of the United Kingdom (the “financial stability objective”).
— In pursuing the financial stability objective the bank is to work with other relevant bodies, including HM Treasury, the proposed Prudential Regulation Authority and the proposed Financial Conduct Authority (which previously had the working title of the Consumer Protection and Markets Authority).
The FPC is designed to serve the bank’s financial stability objective through the identification of, monitoring of, and taking of action to remove or reduce systemic risks, with a view to protecting and enhancing the resilience of the UK financial system.
These systemic risks include, in particular:
— Systemic risks attributable to structural features of financial markets or to the distribution of risk within the financial sector, and
— Unsustainable levels of leverage, debt or credit growth.
This does not require or authorise the FPC to exercise its functions in a way that would in its opinion hurt the financial sector’s ability to contribute to the growth of the UK economy in the medium or long term.
“Systemic risk” means a risk to the stability of the UK financial system as a whole, or to a significant part of that system.
In practical terms, the FPC will seek to discharge its responsibility to address systemic risk through powers of recommendation and direction to the PRA and the FCA.
PRUDENTIAL REGULATION AUTHORITY
The Prudential Regulation Authority will be structured as a subsidiary of the Bank of England and will have responsibility for the prudential regulation of deposit-takers, insurers and certain investment firms. The PRA will have a strategic objective which focuses on financial stability, with an operational objective that highlights the role of the PRA in promoting the soundness of firms in a way that does not rule out the possibility of firm failure.
— The PRA’s strategic objective is to contribute to the promotion of the stability of the UK financial system.
— The PRA’s operational objective is to promote the safety and soundness of PRA-authorised persons.
Promoting the safety and soundness of PRA-authorised persons includes seeking to minimise any adverse effect that the failure of a PRA-authorised person could be expected to have on the UK financial system.
FINANCIAL CONDUCT AUTHORITY
The FCA will be a stand-alone body . Its strategic objective is to protect and enhance confidence in the UK financial system. Its operational objectives are facilitating efficiency and choice in the market for financial services, securing an appropriate degree of protection for consumers, and protecting and enhancing the integrity of the UK financial system.
The authority will have responsibility for:
— Supervision (including prudential supervision) of all firms not regulated by the PRA, including most investment firms (likely to be about 18,500 firms).
— Consumer protection in financial services (including through taking a stronger role in competition matters).
— Regulating the provision of consumer credit (the subject of a separate consultation which closes on March 22, 2011).
— Regulating conduct in financial services generally, including in relation to firms authorised and supervised by the PRA.
— Regulating market conduct, including taking action to impose civil penalties for market abuse and pursuing criminal prosecutions.
— Regulating investment exchanges and providers of trading facilities.
— Primary market regulation (including listing).
The FCA must, so far as is compatible with its strategic and operational objectives, discharge its general functions in a way which promotes competition, according to the consultation.
COORDINATION AND TRANSPARENCY
A big part of the HM Treasury consultation sets out how the different bodies in the new regulatory architecture will coordinate with one another and outlines proposed increases in the transparency of the regulatory process. New legislative provisions will be needed to create coordination mechanisms which ensure that regulatory processes will operate effectively and efficiently.
The PRA and FCA will both have the remit and powers necessary to deliver their strategic and operational objectives, and they are intended to be equal in status. There must be complete clarity around the ability of each regulator to take decisions within its areas of focus and expertise. This is vital not only to ensure the effectiveness of the regulatory authorities, but also to ensure that they are accountable for their decisions.
The arrangements must enable the PRA and FCA to manage any conflicts that arise.
Regulatory “underlap” (the risk that important issues and activities may be neglected as they do not fall into either authority’s jurisdiction) must be avoided, and regulatory overlap or duplication managed in a proportionate way.
From firms’ perspective, coordination must result in regulatory and supervisory engagement which is cost-effective and offsets the risk of duplication. Firms should not receive conflicting views from regulators. The arrangements should be sufficiently clear and flexible to allow for decisions to be taken in unforeseen or urgent circumstances.
Neither regulator should be required to second-guess the other’s statutory objectives but should instead consult and take account of the other regulator’s view, and reconcile conflict with these as far as is consistent with its own statutory objectives.
An important practical issue which will require extensive and visible coordination between the new bodies is the UK’s voice in Europe. As the proposals currently stand, the FCA will represent the UK interest on the European Securities and Markets Authority and the PCA on the European Banking Authority and the European Insurance and Occupational Pensions Authority.
COMPLIANCE TIPS AND NEXT STEPS
Compliance officers should invest some time in undertaking a line-by-line review of the 138 pages of the consultation. Among other things, the proposals cover the future of authorisations, the approach to client assets, change of controller, transfers, how a firm could come to be “designated” as regulated by the PRA, as well as the future stance regarding the Financial Services Compensation Scheme.
Two areas which may be of particular interest to many firms are the changes to enforcement and to the Financial Ombudsman Service (FOS).
On enforcement, legislative changes are planned to allow for publication of the fact that a warning notice has been issued, and of a summary of the notice (including, for example, the grounds on which action is being taken). This new power will apply to both the PRA and the FCA. Although there is an expectation the regulator will disclose the existence of a warning notice, it will have discretion rather than a duty to publish the fact that a notice has been issued or information about the notice. It is expected the regulator would consider the potential effect of disclosure of information about a warning notice on the person subject to the warning notice (or indeed its own objectives) when considering whether to disclose information.
Where the regulator decides to take no further action after it has made public the fact that enforcement has commenced, it will be required to publish the fact that it has issued a “notice of discontinuance.”
The inference is that final notices will continue to be published as previously under the Financial Services Authority.
With regard to the FOS, it is intended that it will remain as an operationally independent alternative dispute resolution service, and for the FCA to take on the FSA’s existing functions in relation to the FOS.
A number of changes have been planned, however. The statutory function and responsibilities of the ombudsman scheme remain quite distinct from those of the regulator. This distinction should become clearer as a result of the FCA’s greater focus on improving firms’ retail conduct and the action it will take to tackle potential causes of consumer detriment before their effects become widespread. The FCA will have tools at its disposal to act early and decisively, including the newly updated Financial Services and Markets Act 2000 s404, which gives the regulator powers to require firms to establish and operate consumer redress schemes. This will help to ensure that the FOS is able to focus on its function to deal with individual disputes on a case-by-case basis.
The roles of the ombudsman service and the regulator can also be made clearer by strengthening the mechanisms which specify how they should work together, in the context of their respective remits, to help promote consumer outcomes. Critically, a formal mechanism will be put in place so that the FOS will be able to support the FCA in its preventative and issues-based approach to regulation, under which the government will require the FOS to pass to the FCA any information which could be important in helping to promote better consumer outcomes.
Lastly, the government will introduce a statutory obligation for the FOS and the FCA to publish and maintain a memorandum of understanding, building on the voluntary understanding already in place between the FOS and the FSA.
Firms have until April 14, 2011 to respond to the 32 questions which the Treasury has posed, and they should take the time not only to consider carefully the sweep of changes planned but also to brief and consult with their firms’ board. Where possible, compliance officers would be well-advised to include in their discussions with the board an assessment of whether the PRA and the FCA, or the FCA alone, will regulate their firm by the end of 2012.
The government intends to publish a white paper in the spring of 2011 which will include a draft bill for parliamentary pre-legislative scrutiny. The bill is expected to be introduced in mid-2011 and will receive royal assent in mid-2012, although the timetabling of pre-legislative scrutiny and legislation is a matter for parliament.
In the meantime, the FSA is on track to make the transition to the new regulatory structure at the end of 2012. In April 2011 the FSA will, as planned, replace its current risk and supervision business units with a prudential business unit and a consumer and markets business unit. Following that, the focus will be on progressively changing the regulatory processes (insofar as the FSA’s current statutory remit allows) so that the FSA can begin to operate distinct prudential and conduct approaches to regulation. This approach is intended to provide an opportunity to “road test” some important elements of the new supervisory structure before the formal transition at the end of 2012.
As was stated in a “Dear CEO” letter on the transition to the new regulatory structure, however, the move to a risk-based, judgement-led approach by the prudential business unit will mean that lower-risk firms are subject to a more appropriate level of supervision. This will release management resources so that the supervision of high-risk firms continues to be intensive.
(This article first appeared in Complinet (www.complinet.com). Complinet, part of ThomsonReuters, is a leading provider of connected risk and compliance information and on-line solutions to the global financial services community.)