UK: Financial Regulatory Reform In 2011

The Government published last month its latest consultation paper on the proposed reforms to the UK's financial regulatory landscape, entitled "A new approach to financial regulation: building a stronger system" (the Paper). The Paper sets out the next stage of the Government's thinking based on the results of its July 2010 consultation and ongoing policy development being carried out by HM Treasury, working alongside the Bank of England (BoE) and the Financial Services Authority (FSA).

Consultation responses

To recap the basic agenda, the reforms focus on three key institutional changes. First, a new Financial Policy Committee (FPC) will be established within the BoE, with responsibility for macro-prudential regulation of the financial system as a whole. Second, a new subsidiary of the BoE will be the Prudential Regulation Authority (PRA), which will be responsible for microprudential regulation of certain financial institutions that deal with substantial risks on their balance sheets. Third, there will be a specialist body called the Financial Conduct Authority (FCA) (previously given the working title of the Consumer Markets and Protection Authority (CPMA)), which will have responsibility for conduct issues across the entire spectrum of financial services.

The Government summarised the responses to its July 2010 consultation as follows:

  • the need for the regulatory authorities' core statutory objectives to be balanced and supplemented with other factors;
  • the importance of accountability and transparency for the PRA, FCA and FPC;
  • the need for a strong, coherent markets regulation function within the FCA, including the functions of the UK Listing Authority (UKLA);
  • the importance of the European and International agenda; and
  • the importance of effective coordination between the new regulatory authorities.

Key developments to the current proposals

Legislation

It has emerged that the reforms will be implemented through primary legislation amending the Financial Services and Markets Act 2000 (FSMA). The Government has justified its opposition to a wholesale repeal of FSMA on the basis of cost and disruption to firms. However, one has to wonder whether this would be more complex than an (arguably) more straightforward "repeal and replace" procedure. It is generally acknowledged that costs under the new regime are likely to be higher for some firms anyway in light of having two regulators as opposed to one.

The Financial Policy Committee

The FPC will sit within the BoE and its main function will be to monitor the stability and resilience of the UK financial system as a whole, with a view to identifying, assessing and addressing systemic risks.

The FPC will be able to make recommendations or directions to the PRA and the FCA (although the FPC will not have any direct powers over regulated firms themselves) and issue public announcements and/or warnings, or otherwise raise public awareness about financial stability issues. It will also play a key role in shaping macro-prudential policy on the European and international level. As of February 2011, an interim FPC has already been established within the BoE in advance of the permanent FPC being set up.

The Financial Conduct Authority

The FCA will be an independent body financed by the financial services industry. Its key objective will be to protect and enhance confidence in the UK financial system, predominantly though policing firms' conduct. Omission of the word "consumer" in the authority's title will, according to the Paper, not detract from the FCA's role as a "consumer champion". The name change does, however, reflect a focus on conduct of business issues and developing the increasingly interventionist approach being taken by the FSA. To this end, the FCA will have various new powers, for example, the ability to amend or withdraw misleading financial promotions with immediate effect and to publish the fact that it has done so.

The civil and criminal powers that the FSA derives under Part VIII of FSMA will pass to the FCA. The FCA will therefore be responsible for enforcement against financial crime. Whilst it is expected that these particular powers will not materially alter, the FCA is expected to take a tougher stance to impose consumer redress. Another interesting and somewhat controversial point for many is that the FCA (and the PRA) will receive new powers to publish the fact that a "warning notice" has been issued and a summary of that notice. (This contrasts with the current situation where such details would only become public once a final notice is issued). This new power in particular has generated concern about the risk of irreparable reputational damage in instances when enforcement action may later prove to have been unnecessary or unfounded.

The FCA will have responsibility for the conduct of business regulation of all financial institutions, including those that are regulated prudentially by the PRA and those that "passport" their services in the UK. It will also be the prudential regulator for some 18,500 firms that will not fall within the scope of the PRA's regulatory umbrella and who do not passport their services in the UK. This will include some investment firms, investment management firms, authorised professional firms, providers of market trading infrastructure, non-bank mortgage lenders and mortgage or insurance intermediaries. The majority of firms will be entirely regulated by the FCA, although certain "prudentially significant" firms will be "dual-regulated" by both the FCA and the PRA.

Another significant development for the FCA is that the UKLA will transfer to the FCA and will operate under the same legislative framework as the FCA. It is likely that the move will strengthen the UKLA's powers, for example, by extending such powers to impose sanctions and extending the limitation period for taking action for breaches of the listing rules from two to three years.

The Prudential Regulation Authority

As previously confirmed, the PRA will constitute a subsidiary of the BoE and its objectives will be to promote the stability of the UK's financial system and the soundness of PRA authorised persons. It will supervise all banks, building societies, credit unions and insurers. In addition, certain investment firms that are deemed to pose a significant risk to the financial system will be regulated by the PRA. Criteria clarifying exactly which of these firms will be regulated will be set out in secondary legislation, although investment firms that deal in investments as principal and are classed as "BIPRU EUR730k" will most likely fall under the PRA's scrutiny.

The PRA will adopt "principles-based" and "judgment-led" approaches in relation to how it collectively applies rules, how it goes about authorising firms and how it approves persons. The procedures available to the PRA in relation to enforcement are still under debate, but the Government is considering whether appeals ought to be heard on more limited grounds in the Upper Tribunal as opposed to the full merits review in relation to FSA supervisory decisions. The PRA will most likely take a rigorous approach to its responsibilities and, similar to the FCA, another notable change concerns the proposed power to publicise enforcement warning notices and corresponding summaries.

Regulatory coordination

Successful interaction between the PRA and the FCA will be crucial to the new system. Quite apart from the obvious risks of overlap and duplication, there is the risk that one regulator's view may conflict with the other. To this end, the Government has said that there will be a statutory duty on the PRA and FCA to coordinate their activities and also to establish a Memorandum of Understanding between them. Ultimately, it appears that the PRA will have a power of veto over the FCA, to be used in circumstances where it perceives that action being taken by the FCA would lead to a disorderly failure of a firm or to wider financial instability.

Concerns remain as to how the regulators will divide their responsibilities. For example, it is not clear how the authorisation process will work in practice. Dual-regulated firms will need the consent of both the PRA and FCA, which will each have powers to designate sole or lead jurisdiction to one authority in respect of each threshold condition. There are two alternative proposals: the "lead approach", where each regulator receives separate applications for permission (ie, prudential and conduct approvals); and the "alternative" approach, where one authority is charged with processing each application subject to seeking the consent of the other regulator on areas of relevant expertise, prior to granting permission. Neither seems particularly favourable and each seems as cumbersome (and costly) a process as the other.

Other areas appear to be somewhat clearer, although scope for confusion remains, and the potential for things to "fall between the gaps" between both new regulators will be high. For example, in relation to the responsibility for controlled functions, it is likely that the PRA will be responsible for those functions associated with "prudentialsoundness" (such as position of CEO) and the FCA will lead on functions concerned with the retail or customer interface. Similarly, it seems that the FCA will have responsibility for the general administrative oversight of the passport process; whereas the PRA will be responsible for setting liquidity standards and assessing the wider impact of crossborder firms on financial stability generally. Time will tell if this will all work smoothly in practice.

Beyond the UK

In seeking to ensure that our domestic institutions are well represented and influential on both a pan-European and international level, the Government has said that there will be a statutory Memorandum of Understanding between the Treasury, the BoE, the PRA and the FCA on overall international coordination within the UK system. It is hoped that as our own institutional arrangements evolve, they will take a leadership role in EU and international reforms. In particular, it is envisaged that the PRA will hold the UK's voting seat on the European Banking Authority and the European Insurance and Occupational Pensions Authority. Similarly, the FCA will hold the UK's voting seat on the European Securities and Markets Authority. Any seats held by the FSA in relation to various international bodies will most likely pass to the PRA.

The Government's timeline

The Government is still firmly committed to putting the new regulatory architecture in place by the end of 2012. The following illustrates the progress made to date and the next steps:

  • (July 2010) The Government set out its initial policy thinking on financial regulation reform in a consultation paper published in July 2010, "A new approach to financial regulation: judgment, focus and stability". (For more commentary on this particular consultation, please see our previous briefing note, "The Changing Shape of Financial Regulation: HM Treasury's consultation paper" published in August 2010.)
  • (February 2011) The Government published its latest consultation paper containing further details of the objectives, powers and proposed coordination between the new regulators.
  • (April 2011) The FSA will replace its current risk and supervision business units with a prudential business unit and a consumer and markets business unit so that the FSA can begin to operate distinct prudential and conduct approaches to regulation.
  • (14 April 2011) Closing date for responses to the February 2011 consultation paper.
  • (June 2011) The Government will present a White Paper, including a draft Bill for parliamentary pre-legislative scrutiny.
  • (Mid-2011–mid-2012) The Government expects that the Bill will be introduced in mid-2011 and will receive Royal Assent in mid-2012, although the exact timetabling is yet to be determined.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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