“If society wants a more proactive approach, it must accept that it will have a larger and more expensive regulator,” said Hector Sants, Chief Executive of the Financial Services Authority (FSA), in a press release accompanying the publication of the FSA Business Plan 2010/11. Mr Sants’s words were no doubt aimed at the Conservatives, who intend to abolish the financial watchdog and dole out its portfolio to the Bank of England and a new consumer protection agency.  

In the forward to the Business Plan, Hector Sants says the potential plans inhibit the FSA’s ability to retain quality staff and to develop its culture. The FSA now has to wait for the outcome of the election to carry out its plans to “deliver organisational change”. This can only be problematic given the long list of proposed regulatory reforms that will have to be scrutinised and implemented in the next few years. Rosali Pretorius and Ming Da Wang review the regulator’s outlook for 2010/2011.

Expansionary policy

The key themes in this year’s Business Plan revolve around the FSA’s shift towards a policy of “intensive supervision”, implementing the regulator’s much-heralded “outcomesbased approach”. To deliver on its new supervisory philosophy, the FSA intends to expand. The regulator will hire 460 new staff in 2010, increasing its funding requirement by 9.9 per cent. The increase, while substantial, pales in comparison with last year’s jump of 36 per cent. The FSA’s supervisory and risk units account for most of the planned spending, with the budget for risk jumping 42.5 per cent since last year’s Business Plan - a reflection of the FSA’s emphasis on risk identification.  

Statutory objectives

The FSA’s mandate is also expected to grow after the enactment of the Financial Services Bill. The Bill, currently before Parliament, will formalise preserving financial stability as the fifth statutory objective of the FSA. In light of its anticipated new responsibilities, the FSA devotes the first section of its Business Plan to financial stability and prudential oversight. The rest of the Plan is organised around the four existing statutory objectives.

Financial stability

The FSA expects a “major intensification” in its approach to supervising firms, focusing on corporate governance and introducing “living wills”. In particular, the FSA targets senior management of financial firms, introducing a new regime aimed at testing their competence (not just the duals hired to perform these roles). In relation to “living wills”, the FSA plans to launch a consultation after Q2 of this year based on the results of its pilot exercise, which is under way.  

Reform of the regulatory framework was identified as a key concern in the FSA’s Financial Risk Outlook 2010 (FRO), a report published by the regulator earlier this month. The FSA expects to work with the Basel Committee and European authorities to develop new standards of capital adequacy, with a view to implementing the Capital Requirements Directive at the start of 2011. The FSA also plans to continue the rollout of its liquidity requirements set out in a Policy Statement issued in October 2009. The Business Plan conspicuously makes no reference to the withdrawal of exceptional Government liquidity extended during the financial crisis, which the FRO identifies as a risk that may lead to a serious funding shortfall for UK banks.

Stress testing is expected to play a central role in the FSA’s regulatory regime going forwards. The FSA has published an adverse “anchor” macroeconomic scenario, to be updated regularly, to supplement firms’ own stress tests. Firms will also be expected to comply with the FSA’s rules on “reverse stress-testing”. This test will be based on a “nightmare” scenario that firms individually identify as being most likely to cause their business model to become unviable. Major firms will be subject to the FSA’s own stress tests regularly going forward, including potential “black swan” tests involving multiple major banks.  

The regulator will work alongside insurance firms in preparing for implementing the Solvency II Directive, the revamped capital adequacy regime for insurance firms. The FSA will spend a significant portion of its resources to ensure that firms subject to the Solvency II requirements understand and are capable of carrying out their plans in the lead-up to 2012.  

The FSA confirms that it will publish consultations on its client money rules following the confusion caused by the collapse of Lehman Brothers. Stricter measures for protecting client money, client money reporting and an expedited regime for the return of client assets can be expected.  

Market confidence and fighting financial crime

The key market confidence issues include regulating OTC derivatives and taking action against insider dealing.  

On OTC derivatives, the FSA’s focus will be to guide international and European decision-makers towards a commercial and globally consistent regulatory solution. Key issues (identified by the FSA and the Treasury in 2009) include a move towards greater standardisation of OTC derivative instruments; standards for central clearing counterparties; and international consensus on products eligible for clearing.

The FSA affirms its commitment to reduce market abuse by highlighting its two insider dealing convictions in 2009 and further trials fixed for 2010 (including the conviction of ex- Cazenove partner Malcolm Calvert). As part of its “credible deterrence” philosophy, the FSA says that it will continue to pursue insider dealing convictions in the criminal courts. The FSA also urges firms to improve their financial crime controls, promising to highlight examples of good and bad practices met by its specialists in its published findings. In its role as the UK Listing Authority, the FSA also identifies financial reporting on UK listed markets as being a key area. The FSA intends to put in place a new IS system to replace the current systems over the next three financial years.  

Consumer protection

In a speech made earlier this month, Mr Sants said the FSA’s focus has been too late in the product lifecycle to prevent consumer harm. As part of its intensive supervision of retail firms, the FSA will address this issue by working with banks and conducting tests at an early stage in financial product design. The FSA hopes to catch unacceptable products before they are marketed to consumers. The regulator will focus on larger firms in 2010/11. It will be instructive to see the extent to which the FSA intervenes in the financial product design under this ambitious new regime.  

The FSA will continue to address problem retail sectors and products. The regulator intends to take its Mortgage Market Review and Retail Distribution Review forward in the next year, publishing consultation papers on the issues identified in the reviews. Payment Protection Insurance will continue to be monitored by the FSA in the coming year, with the uncertainty of radical consumer protection remedies suggested by the Competition Commission potentially coming into effect soon.

A will to regulate?

In its Business Plan, the FSA has outlined a panoply of regulatory tools in pursuit of its new “intensive supervision” philosophy. The FSA seems eager to prove to any new government that it has the tools and the will to deliver effective regulatory outcomes for the UK financial industry. However, in its response to the Business Plan, the British Bankers’ Association warns that increasing compliance costs could damage the UK economy, with strict capital requirements choking off lending to recovering private sector demand. Caught between an unsympathetic government-to-be and a resurgent yet fragile banking industry, the FSA must now learn to be deft as well as robust to face the challenges of the coming year.