The Treasury’s paper, ‘a new approach to financial regulation - building a stronger system’ of the 17th February, begins with the customary emphasis, stating that the financial services sector is one of the UK’s key industries. The financial crisis, it continues, was caused by the failure of financial institutions to manage themselves prudently and of the regulators to spot the risks that were building up across the system as a whole – the result of what is described as the flawed system of financial regulation introduced by the previous administration.
The key message from this paper is that steps must be taken to ensure that financial firms are never again allowed to take on risks that are so significant and so poorly understood that they result in a financial crisis. But the limitations on what the UK can achieve on its own are made explicit on the very first page – the UK reforms “are part of a wider picture” with the international reforms led by G20, the IMF, Basel and the EU setting the substantive agenda for change.
This report provides analysis of the Government’s proposals for the new regulatory regime; the box text is taken from Hector Sants’ speech on ‘Reforming Supervisory Practices: Progress to Date’ on 13th December 2010.
What is proposed?
- A Financial Policy Committee within the Bank of England responsible for macro-prudential regulation. This will “create the focus for macro-prudential regulation that is missing from the current framework”.
- A Prudential Regulation Authority, a Bank of England subsidiary, responsible for prudential regulation of significant firms (principally banks and insurers) with the objective of ensuring financial stability for the firms that it regulates.
- A Financial Conduct Authority (which was previously to be called CPMA) overseeing conduct of business and market regulation for all firms, and prudential regulation for non-PRA firms. It will “put appropriate consumer outcomes at the centre of the regulatory process” as well as being a “centre of excellence for markets regulation”.
- The Bank of England will directly supervise providers of systemically important infrastructure – settlement systems, payment systems and recognised clearing houses. It will also co-ordinate crisis management, with the Treasury responsible for deciding on the use of public funds.
What is the objective?
Taken literally, it is to prevent a recurrence of the last financial crisis. This is probably an optimistic target since most of the changes can be associated with one or more specific failings experienced during the last crisis and which may not be replicated in the next one. However, recognising firms’ assumption and management of risk as a key determinant of financial stability provides the new regulators, and especially the PRA, with a clear and central policy upon which to found their operations. As for conduct risk, the FCA will be basing its policy on a continuation, albeit with refinements, of FSA’s developing style of intrusive and judgemental regulation. This is set fair to succeed, but only if FCA is prepared to use its powers with discretion and gives full credence to the doctrine that consumers do retain at least some responsibility for their decisions.
Within this “never again” goal are some operational targets for the UK to
- retain a competitive, world-leading financial services industry
- have a rigorous and effective regulatory framework.
It is unlikely that many market participants or consumers will take issue with either objective. Instead, the challenge is whether the creation of a wholly novel system of regulation can be achieved with minimal disruption and maximum effectiveness at a time when firms are still recovering from a prolonged period of economic and financial volatility.
Two further objectives are
- For regulators to provide firms with sufficient certainty of expectations and actions
- For unnecessary regulatory burdens to be minimised or eliminated.
Firms will certainly endorse these objectives, but the challenge here is how they can in practice be reconciled with the policies of two regulators who are designed to be intrusive and judgemental, and where the FCA is said to have a lower risk appetite than FSA. The threat is that predictability will be achieved – but only of intrusive and negative intervention, and that against this background no rule will ever be viewed as unnecessary for ensuring stability or investor protection. Firms will need to be bold in holding to their positions and the regulators confident in their judgements, in order to avoid this most undesirable of possible outcomes.
What is the timetable?
A White Paper and draft Bill to enact these changes will be published around May 2011. The target is for the Bill to be introduced in Parliament in mid-2011 and enacted by mid-2012. In the meantime FSA is being re-modelled to mirror the intended new structures and the formal transition, when the current regime is “switched off” and the new legislation is “switched on” – possibly in a big bang but with some parts staggered – is planned for the end of 2012.
What are the main features?
The rationale for these changes is similar to that set out in the Turner Report of 2009, which recognised the same flaws in the regulatory system but proposed that they be addressed by reforming FSA. The Government’s plan differs in that it institutionalises the different functions of UK regulation.
- By giving the Bank of England explicit oversight of UK regulation, the Government is recognising that economics drives change in markets and investor behaviour, and that a central bank is best placed to identify emerging trends and translate these into regulatory action. One of the weaknesses of FSA has been the slow regulatory reaction to rapidly changing economic conditions with the regulator so often lagging behind new products and techniques.
- FSA was “all things to all men”, a rolled-up prudential, conduct and markets regulator with no single focus. By creating two specialist regulators under common oversight, the Government plans to give each one a clear and uncluttered mission. The PRA’s strategic objective, for example, is the “promotion of the stability of the UK financial system”, while its operational objective is “promoting the safety and soundness of PRA authorised persons”.
- Co-ordination between the three bodies will be critically important, and one of the Government’s key critiques of the current system during the financial crisis was that the “Tripartite” arrangements between FSA, Bank of England and Treasury simply failed to function. Proposals to address this include a statutory duty to coordinate, binding Memoranda of Understanding, cross-membership of boards and a form of veto held by PRA. Whether this works under fresh conditions of stress, so that the the fault lines between Bank of England and FSA are not replicated at regulator level, will be crucial to the successful operation of the new regime.
- The international aspect is constantly and rightly emphasised. The conduct rules that PRA and FCA impose will remain those contained in EU directives, as are capital standards themselves under change through the EU-wide Basel and Solvency II processes. Further developments are being driven through G20. What this means in practice is that the key impact of the Government’s plan will be more about the style than content of regulation.
This points to two important issues.
- First, as Mervyn King famously remarked, international banks are global in life, but national in death. The collapse of firms operating trans-nationally such as Lehmann Brothers and the Icelandic banks emphasised the need for greater international supervision and coordination of regulation. It is key that the UK regulators engage effectively and proactively with the international forums that determine financial services regulation – and this needs to come at governmental as well as regulator level. The Government says that it places renewed emphasis on international engagement, and it expects the UK regulators to put significant time and effort into being heard in Europe where the new pan-European regulators will work towards establishing common technical standards and a single rulebook. A criticism of the former administration is that it failed to head off the Alternative Investment Fund Management Directive before it had become established policy.
- Last, the real changes that firms will experience when the new UK regime is introduced will be in the remaining areas where a national regulator retains powers – authorisation, supervision and enforcement, each of which remains areas where it may exercise considerable discretion.
Will this make a real difference for firms?
Yes, definitely. A likely consequence of the new scheme will be clearer “economic connectivity” between macro-economic developments, such as global interest rate changes or imbalances in investment flows, and the resulting UK microprudential change, such as changes to interest rates, the requirement to increase firms’ capital, or restricting the distribution of certain products. The FPC is being given tools and levers to bridge the gap between economics and rule making, and it is certain that firms will start to see these used during the course of the next few years.
Further, we are promised a credible and intrusive prudential regulator and a judgemental and effective consumer regulator. These words are used deliberately – the message to the market is that the Conservative-led reforms presage no return to the “light touch” and market-friendly regulation of years past. These policies are not at all novel, and firms currently regulated by FSA will be entirely familiar with what judgemental and intrusive regulation looks like on the ground. What will be new, however, is the formalisation and institutionalisation of these practices. The market is likely to experience a sharper, more informed and more directional form of regulation than ever before, and one where even a well-run firm will struggle to keep abreast of rapidly evolving regulatory requirements.
The Financial Policy Committee
The creation of the FPC is the keystone of the Government’s reform of financial regulation. Under the present regime financial stability “fell between the gaps”. The FPC puts the Bank of England at the heart of the financial system and returns the UK to the classic 20th century central bank-as-regulator model because the FPC, as a committee of the Banks Court of Governors, will be made responsible for delivering systemic financial stability through macro-prudential regulation.
The intention is to facilitate a judgement-led approach to achieving financial stability, managed by a single institution dedicated to macro-prudential operations that focuses on risks to the whole financial system, or large parts of it – systemic risk.
Financial markets have structural features that make the system vulnerable to shocks, such as
- Information problems – a lack of information or transparency
- Misaligned incentives – decisions that appear rational but cause problems elsewhere in the market
- Market illiquidity
- Contagion where innovative products or practices increase the network of interconnections between financial institutions
- The existence of numerous systemically important financial institutions
- Inadequate market infrastructure
- Narrow distribution of risk exposures, such as sub-prime mortgages
- Cyclical risks such as cycles of risk and appetite.
The FPC’s objective
The financial stability objective of the Bank of England is to protect and enhance the stability of the financial system of the UK.
The objective of the FPC is to contribute to the Bank’s achievement of this objective, primarily by identifying, monitoring and minimising systemic risks to protect and enhance the resilience of the UK financial system.
These systemic risks include those resulting from the structural features of financial markets, the distribution of risk within the financial sector, and unsustainable levels of leverage, debt or credit growth.
The FPC’s functions
The FPC’s main functions will be to monitor the stability and resilience of the UK financial system and to use the levers and tools at its disposal to address those risks.
The levers are to make a public pronouncement, to seek to influence macro-prudential policy in the UK and overseas, and to make recommendations or (when empowered) to give directions, probably on specific and system-wide issues, to PRA and FCA.
Potential macro-prudential tools include the following, but the FPC should only use them with force of a direction to PRA or FCA where there is national discretion – in other words, where the matter is not determined by an EU directive or an international accounting standard. Subject to this limitation, they may include
- Creating a counter-cyclical capital buffer
- Varying risk weightings applied to a firm’s asset exposures
- Limiting leverage
- Enhancing liquidity requirements
- Require a firm to provide against prospective future lending losses
- Increasing collateral requirement
s - Adding to disclosure requirements
- Requiring stress tests to be conducted.
Each of these is a technique that can be used to damp down demand and calm a heated market - referred to as removing the punch bowl while the party was still in progress, a phrase originally coined by William McChesney Martin of the US Federal Reserve.
The Prudential Regulatory Authority
“…The PRA should be judged by the avoidance of failures which incur a cost to the economy and in particular to individual tax payers and customers. This objective contrasts with the situation the FSA found itself in, namely no acceptance from the media or politicians that the FSA was not a “Zero failure” institution.
… In many respects, the regulatory philosophy of the PRA is an evolution of the current approach taken by the FSA – particularly with respect to intensive and judgement-based supervision, focusing on the things that matter … [but] The focus on orderly resolution is far more pronounced in the new prudential body than is the case under the FSA’s current statutory obligations … there will be greater emphasis that … the rules are primarily standards designed to minimise risks to an institutions’s soundness and sustainability, and emphasise that regulators and firm management should focus on adherence to their purpose and substance. In addition … there will be strong and clear links between macro and micro-prudential policy and supervision.”
Hector Sants’ speech of 13th December 2010.
One of the key lessons of the financial crisis, says the paper, is that no one properly understood the risks that firms that dealt as principal – banks, insurers and broker-dealers – were accumulating. So the defining characteristic of their prudential regulator, the PRA, will be to gain a deep understanding of risk across the system as well as in individual firms so as to be able to make judgements on the soundness of these firms and their business models.
The Government considers that a weakness of the current UK regulatory system is that no one authority has overall responsibility for promoting financial stability. By creating the PRA and making it a subsidiary of the Bank of England, the design is to bring macro- and micro-prudential regulation together under a single institution. While the PRA will be fully independent of the Bank of England, and have a strong independent board, it will share staff with the Bank and benefit from a flow of information. In consequence, while action such as to place an insolvent bank into the new Special Resolution Regime can only be taken by PRA, this decision will be taken after a joint analysis of the risks and determination of the best course of overall action.
The PRA’s proposed objectives are
- Strategically – promoting the stability of the UK financial system (and this is similar to the Bank’s and FPC’s strategic objective)
- Operationally – promoting the safety and soundness of each firm that it authorises, and minimising the adverse effect that its failure could have on the UK financial system.
The target is thus that a bank, insurer or broker-dealer is sound but that if it does fail, as must occasionally happen in a nonzero failure regime, the consequential disruption is minimised.
The PRA will regulate
- Deposit takers – banks, building societies and credit unions
- Insurers – with the PRA focusing on the soundness of insurers and their role in systemic stability with the FCA supervising their day to day conduct of business. The PRA’s supervisory stance will recognise that an insurer’s business model does not present the risks of a bank in terms of liquidity risk or interconnectivity and insurers will undergo less intensive supervision than banks. The Government will give further thought on how insurers should be regulated, and particular reference is made to with-profits business as presenting a challenge.
- Lloyd’s – PRA will supervise prudential and organisational operations with the FCA responsible for conduct of business. Lloyd’s and Lloyd’s managing agents will be dual regulated, while members’ agents, advisers and Lloyd’s brokers will be FCA regulated.
- Other firms that are viewed as potentially posing significant risk to the financial system or to PRA-regulated firms within their group. These risks may arise from scale or complexity of operations or interconnectivity with other firms or the system itself. This policy is to be developed but likely candidates are major principal dealers and BIPRU 730k firms.
The extent of regulation will mirror FSA – the PRA will authorise a firm, approve its senior management, make rules, supervise the firm and take enforcement action when it breaches PRA’s requirements. The Government is considering restricting firms’ right to challenge the PRA’s judgement-based enforcement decisions save where a case for judicial review could be bought. This would be disturbing because it would effectively enable the PRA to take decisions immune from effective challenge as grounds for judicial review are restricted to grounds of irrationality, most notably where no reasonable regulator could have taken that decision.
The PRA will “take a judgement-led supervisory approach” to the firms that it regulates. It will proactively identify weaknesses and, when needed, intervene to require that they are addressed. This style will be very familiar to many FSA regulated firms, especially to banks and insurers where FSA has recently challenged their business models, required changes to senior management, refused permission for acquisitions or required the postponement of mergers or of product launches.
It will adopt a principles-based rulebook (similar to the way in which FSA makes use of the 11 Principles for Business) which will enable it to require a firm to take action by reference to a broadly stated principle, such as (perhaps) “A firm shall maintain adequate systems and controls to recognise and manage risk”, rather than needing to determine that the firm’s conduct infringes a more narrowly-focussed rule.
“A particular focus of our initial thinking has been around establishing whether a slimmer, more purposive and accessible rule book can be produced for the PRA. The PRA will not do away with rules altogether, but an important change in focus for the PRA will be in ensuring that it is clear to all what purpose its prudential rules are intended to achieve. We expect to review the prudential aspect of the current FSA Handbook with a view to achieving this end, subject to constraints imposed by EU directives - as well as in making the material shorter and easier to navigate.”
Hector Sants’ speech of 13th December 2010.
The PRA will establish a proactive intervention framework. This is to be finessed, but appears to mean that PRA will operate under a presumption that regulatory action shall be taken at a pre-determined point – for example, that if an insurer’s level of solvency falls below x%, or a bank’s risk management framework is determined to be inadequate, then PRA will suspend its operations unless there are good reasons not to. The object of this policy is started to be to “reduce the risk of regulatory forbearance.” Secondly, the occurrence of stated events will trigger coordinated actions by the authorities to minimise systemic disruption.
The Financial Conduct Authority
This has been renamed; the previous consultation referred to the CPMA.
“The Government has also introduced the notion of the CPMA acting as a “consumer champion” … The CPMA is being set up with the clear intention of securing better outcomes for consumers. This will mean it will engage with consumers, their representative bodies and consumer intelligence earlier than has been the case with the FSA – being prepared to intervene as soon as potential concerns begin to emerge and having a willingness to take a greater risk of being overturned on appeal if it thinks that early intervention is warranted. While the CPMA will pursue a more aggressive consumer protection agenda, the CPMA will not always assume that the consumer is right, or that consumers have no responsibility to look after their own interests when dealing with financial firms…”
Hector Sants’ speech of 13th December 2010.
Conduct of business regulation is fundamental – confidence that a firm will conduct itself appropriately is key to maintaining a strong and efficient financial system. The Government states that under FSA “the regulation of conduct ... has not always received the attention that it requires”, a surprising assertion in view of FSA’s ceaseless conduct-focused campaigns such as on “Outcomes-Focused Regulation” and “Treating Customers Fairly”, although the Government does acknowledge the effectiveness of FSA’s credible deterrence and new product-focused strategies.
The core purpose of the FCA will be to protect and enhance retail and wholesale consumer confidence with focus on developing a new model of retail regulation using early and proactive intervention to protect retail customers – a fundamental shift from focusing on the sales process and seeking to ensure adequate disclosure. The Government qualifies its earlier statement that the FCA will be a “consumer champion”, but only to the extent of emphasising that FCA will be impartial, recognise the importance of proportionality and the limitations of regulation, and that consumers have responsibility for their own choices. It is clear that FCA will vigorously pursue and indeed develop FSA’s current policy of scrutiny, challenge and intervention.
The FCA’s proposed objectives are
- Strategically – protecting and enhancing confidence in the UK financial system
- Operationally – 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.
This wording mirrors FSA’s statutory powers and is couched at a level of generality to give the FCA substantial freedom to determine its policies and operations within these broad guidelines. The requirement to facilitate efficiency and choice is intended to remind FCA that it should work to remove unnecessary regulatory barriers and should recognise that competitive markets yield benefits of pricing and delivery. While reminiscent of FSA’s former slogan of “we work with the grain of the markets”, FCA’s level of challenge and intervention will likely be viewed as hostile and confrontational rather than market-friendly.
The objective of ensuring an appropriate degree of protection for consumers is intended to empower FCA to stop, as well as to remedy, detrimental actions. The word “appropriate” is intended to enable FCA to differentiate between the needs of different types of consumer, and to emphasise that consumers do have responsibility for their choices. However, it is clear that retail investors are viewed as being at a significant disadvantage when dealing with a financial firm and will continue to receive the highest practicable level of protection – and one that aspires to offer more effective protection than FSA had achieved.
The integrity of the UK financial system objective focuses on FSA’s responsibility as the regulator of UK financial markets and encompasses the themes of combating financial crime, ensuring the soundness and resilience of the UK financial system and improving the functional integrity of the UK financial markets.
The FCA is required to discharge its general functions so as to promote competition. The Government sees this as a wide power, enabling FCA to take action in respect of competition in pursuit of its objectives. This suggests that the FCA may exercise its powers of intervention where it considers that a market, for example for retail financial advice, is not subject to normal competitive pressures.
The FCA will have five principal functions
- Fighting financial crime
- Prudentially regulating non-significant firms
- Regulating conduct of business
- Promoting competition
- Overseeing wholesale business and markets.
Fighting financial crime
FCA will focus on seeking to reduce the extent to which a financial firm can be used for financial crime. It will be responsible for combating money laundering and market abuse and will be responsible for coordinating action with the governmental crime agencies.
Prudentially regulating non-significant firms
FCA will be the prudential regulator of some 18,500 fund managers, non-bank mortgage lenders, and personal investment firms and insurance/mortgage intermediaries. By and large none of these will individually pose a threat to financial stability. The key focus of FCA’s prudential regulation will be in preventing consumer detriment so that, if they fail, consumer detriment in minimised. The main method of achieving this – as currently employed by FSA – will be to require adequate capital resources to achieve an orderly wind-down.
Regulating conduct of business
FCA will regulate the conduct of business of some 27,000 firms
- Firms regulated by PRA, mainly banks and insurers
- Firms only regulated by FCA
- Inwardly passporting EEA firms
- And possibly consumer credit providers
“Another key element of the CPMA’s approach to policy making will be striking the right balance between rules and principles … Overall, in contrast to the FSA, it is likely that there will be a shift towards more detailed prescription.”
Hector Sants’ speech of 13th December 2010.
FCA will adopt what is termed “a new approach to conduct regulation” that will be fundamentally different from FSA’s in that FCA will
- Have a lower risk appetite
- Be less prepared to see detriment occur
- Be readier to act to prevent losses
This will be backed up with a continuance of FSA’s enforcement policy of credible deterrence and, combined with increased issues-focussed (meaning thematic, for example in relation to client assets) supervision, is likely to lead to an increase in enforcement activity.
“…the consumer objective for the CPMA … emphasises early and proactive intervention, a braver approach to enforcement and redress, and a willingness to improve the consumer experience. However, in order to achieve this goal the CPMA will need to be given more powers of intervention and disclosure than the FSA currently has...”
Hector Sants’ speech of 13th December 2010.
While the plan to scrutinise firms’ business models and product governance to ensure the soundness of their offerings builds on FSA’s current strategy, the message is clear – FCA will be at least as proactive, challenging and interventionist as FSA has become in recent months. While certainly not designing a “zero failure” regime, there can be little doubt that FCA will develop and amplify FSA’s current stance of “exercising judgements on managements’ judgements”.
A key element of FCA’s retail strategy referred to in the Government paper, which will be subject to further development and consultation, is concerned with what it terms product intervention. This entails
- Earlier identification of risks through gathering intelligence from wider sources
- Placing requirements on products and product features to remedy a problem – perhaps disclosure of a specific feature or prohibiting a limitation
- Mandating minimum product standards similar, perhaps, to those adopted for stakeholder products, but applied where a problem is perceived
- Restricting product sales to certain classes of consumer – as, for example, currently happens with unregulated collective schemes but in this case done on a protective basis. For example, a capital at risk product might perhaps only be sold to an investor with at least twice the amount in ready funds
- Halting a product launch or continuing sales for up to 12 months, for example when this is not already covered by existing rules.
While shying away from introducing a requirement for general product pre-approval, it is clear that FCA is intended to be significantly more prescriptive in relation to retail products than its predecessor. Although FSA probably has the power to achieve most of these objectives, bringing them together and making them express gives the FCA a clear emphasis on consumer protection. The Government may not introduce powers that run contrary to the EU single market directives and it is not clear whether these powers are at present compatible with the provisions of MiFID or the IMD, or whether the Government will require special dispensation to introduce them.
The Government intends that FCA will be an open regulator, disclosing information about its activities when appropriate, and that it should have the power to require firms to make more disclosures. While both powers are subject to overriding duties of confidentiality, and also safeguards to ensure that firms maintain an open relationship with FCA, it is clear that more information will be made public earlier on than at present.
Two specific new powers proposed are for FCA to publicise that
- A firm has been required to amend or withdraw a misleading advertisement or sales practice.
- It has commenced disciplinary action against a firm.
These are both concerning because they would empower FCA to give publicity to a damaging assertion before the facts have been fully determined or the firm has had an adequate opportunity to make representations. In particular it is unfair for FCA to be able to air damaging allegations against a firm of a type brought in enforcement proceedings where the allegations may not have been fully investigated, have not been tested by any tribunal, and the firm does not have an equal opportunity to respond.
The FCA is to have a “credible and effective role in competition” to assist it to achieve its objective of promoting efficiency and choice, and its powers will be refined as part of the ongoing review of UK competition law. The proposal is to empower FCA to make rules that have “beneficial competition outcomes”, and the example is given of prohibiting the sale of Payment Protection Insurance at point of sale by a loan provider because this enables the provider to exploit a position of effective monopoly – a current situation where resolution has only been achieved through a more cumbersome process. The Government is considering whether to give the FCA the power to make a referral to the Competition Commission (i.e. a concurrent power with the Office of Fair Trading).
Overseeing wholesale business and markets
While there is no clear distinction between the needs of wholesale and retail business, the paper comments that “greater intervention will generally be less appropriate for market participants at the sophisticated or professional end of the spectrum”. The FCA’s main focus in this area is likely to be continuing to monitor the conduct of market participants and its impact on market efficiency and integrity.
As for markets and market conduct
- FCA will assume FSA’s current powers in respect of market abuse with little change.
- The UK Listing Authority will become part of the FCA with minor alterations to its powers.
- FCA will have responsibility for the conduct and prudential regulation of UK recognised investment exchanges and multilateral trading facilities, again with few substantive alterations to current powers.
Further retail protection
The Government is committed to maintaining the separate existence of the Financial Ombudsman Service (FOS), the Financial Services Compensation Scheme (FSCS) and the Consumer Financial Education Body (CFEB), which operates the Money Advice Service, in their present form.
- FSCS will be jointly overseen by both PRA and FCA, with each making rules for levies and funding for the firms they regulate, for which they will need to coordinate their activities.
- FOS will be overseen by FCA. The Government says that it wants FOS to focus on dealing with individual disputes on a case by case basis. But references to closer cooperation and to working together on cases that could have “wider implications” makes it likely that FOS will retain its role as a quasi-regulator because its determination that a firm has breached the FCA rules or the general law in a single instance and without being required to follow legal rules or procedures can result in the firm being required to compensate other similar cases. The Government also wants FOS to be able to publish its determinations, which will further concern firms.
Operating under dual regulation
Both the PRA and the FCA will be subject to six regulatory principles. Not to be confused with FSA’s principles for Business, they are modelled on the existing Principles of Good Regulation to which FSA is subject. They are
- To use resources efficiently and economically
- The imposition of a burden or restriction should be proportionate to the resulting benefits
- Consumers should take responsibility for their actions
- A firm’s senior management is responsible for compliance
- A regulator should seek to make information public
- A regulator should operate transparently.
These are similar to the principles that govern FSA’s operations which provide firms with little if any ground for challenge in relation to a specific decision or operational activity. What is notable is the emphasis on transparency in principles 5 and 6. This reflects the current move for greater openness in the workings of statutory agencies and is consistent with the Freedom of Information Act and FSA’s policy on disclosure. PRA and FCA are likely to publish material relating to firms, their business and – most significantly – regulatory actions, opinions and interventions – where FSA does not, and (where it already does make some information public) in more detail and at an earlier stage than FSA currently does.
There are numerous operational issues that will need to be resolved, for example where a firm is regulated by both PRA and FCA, or is a member of a group with firms subject to both regulators. Some specific instances for dual-regulated firms are
- Firm authorisation – a market entrant may need to apply to both regulators for authorisation unless one is allowed to act as lead approver.
- Variation of permission – this is needed when adding a new activity or when the regulator wishes a firm to suspend an activity. This power will be shared by PRA and FCA, with PRA having the final say in some cases.
- Individual approvals – PRA will approve individuals applying to perform controlled functions concerned with prudential soundness (such as CF3, the CEO) and FCA those who are customer-facing, such as a salesman (CF30). This proposal needs some further thinking because where this leaves the head of compliance (CF10) or sales director (CF1) is unclear.
- Passporting – this responsibility will be shared between PRA and FCA.
- Making rules – PRA and FCA will consult to ensure a consistent and coordinated approach.
- Supervision – PRA and FCA will consult to ensure a consistent and coordinated approach, with particular procedures for groups subject to consolidated supervision. As Hector Sants has commented “the challenge of unpicking the integrated regulatory processes, such as ARROW, should not be underestimated.”
Each of these areas will require very careful coordination and planning to ensure that the regulatory objective is achieved while a firm is not subject to burdensome, duplicated, possibly inconsistent and poorly coordinated regulation.
Regulation of an unregulated holding company has been on the regulatory “wish list” for some years, with the current emphasis being on requiring individuals in such firms who are thought to exercise influence over the regulated subsidiary to become individually approved by FSA. The Government proposes to further this approach by giving PRA and FCA a “power of direction” over a parent entity (or a UK parent entity – the drafting is inconsistent) that controls and exerts influence over a UK regulated firm. The extent of these powers is not spelt out, but the paper refers to applying “the same level of oversight and supervisory powers” irrespective of the legal structure of the group. This suggests enabling PRA or FCA to require the unregulated holding company to take or cease taking action, in which case it will probably have to be restricted to UK or third country holding companies so as not to interfere with EU rights. If, however, this power is only to be exercised over a UK unregulated holding company, then it has a shorter reach than FSA’s CF00 rule.