UK: Regulatory Reform: The Shift Towards Twin Peaks

As the Financial Services Bill starts its journey through the parliamentary process, the FSA has moved to a twin peaks model. For insurers this is a marked change in the way firms are supervised.

One of the key aims of the Government's regulatory reform programme is to split the prudential and conduct regulation and supervision of banks, insurers and major investment firms. This will result in the Prudential Regulation Authority ("PRA"), a subsidiary of the Bank of England, having responsibility for prudential supervision of these firms; and the Financial Conduct Authority (essentially the FSA renamed), focusing on consumer protection and market regulation. This "twin peaks" model replaces the current tripartite structure where the FSA operates alongside the Treasury and the Bank of England, introduced by the Financial Services and Markets Act 2000 ("FSMA").

The Financial Services Bill was introduced to Parliament on 26 January and is currently embarking on its journey through the legislative process. It is intended that the regulatory reform process will be completed by early 2013. This is an optimistic timetable for such an extensive piece of legislation, and is particularly during the period in which both the regulator and the insurance industry are gearing up for the tight timelines which will come with Solvency II implementation.

The implementation of a twin peaks model at the FSA has been on the cards for a while, with the regulator having undergone internal restructuring to some degree in 2011. Whilst it is not possible for the FSA to operate in a manner which will be entirely consistent with the Government's proposals, due to the constraints of the current FSMA regime, along with operational constraints such as IT systems and staffing levels, from 2 April the FSA moved to an internal twin peaks model replicating as far as possible the new regime.

What does this mean in practice for firms?

  • Firms, especially those who will be subject to dual regulation, will notice some differences in how they are supervised going forward. The key changes during this interim phase will be:
  • Insurers will be supervised by two independent groups of supervisors, one dealing with prudential issues and the other with conduct issues. Each will exercise their own regulatory judgements against different objectives. On the key issue of Solvency II it is likely that firms will not notice any change in their supervisory contacts and approach
  • Insurance intermediaries will be solely supervised by conduct supervisors
  • These groups of supervisors will act independently of each other, and will engage with firms separately, although they will share information between them as appropriate
  • One set of regulatory data will continue to be collected

Firms currently expecting an ARROW visit before Spring 2013 will still receive a visit as planned. The difference will be that there will be two supervisory teams participating in the visit, assessing the firm's risk against different objectives. Findings will be delivered by the two supervisory teams separately. There is a concern that these ARROW visits will take up more management time, without providing additional benefits, as management may find themselves the subject of two sets of document requests and questions some of which may overlap. This is particularly the case in the insurance industry where the line between prudential and conduct is blurred. Firms will also find themselves subject to two Risk Mitigation Programmes and will be expected to treat both prudential and conduct issues with equal priority.

Many insurers and insurance intermediaries may now find that they no longer have a dedicated supervisor at the FSA for conduct issues. Whilst all dual regulated firms will continue to have a dedicated supervisory contact for prudential issues, only the very largest institutions will continue to have a dedicated contact for conduct issues. The majority of conduct supervision going forward will be on a thematic basis.

The FSA's departing CEO, Hector Sants, has sent a Dear CEO letter to all FSA regulatory firms and firms should have received further details from their supervisors as to how they will be impacted by the shift to twin peaks regulation, and the contact details of their supervisors will be from 2 April. In a recent speech Mr Sants emphasised that the changes to the regulatory structure are not just operational and that both supervisors and firms must make behavioural changes.

Key changes in the Financial Services Bill

The Financial Services Bill is an extensive piece of legislation, the result of which will be a rather unwieldy amended FSMA. Whilst the headline of the Bill is the change to the regulatory structure, there are other changes to the current regulatory regime which firms should be aware of. Some of these are set out below:

  • The PRA and FCA will be allocated responsibility for separate threshold conditions by the Treasury and will have the power to make and issue 'threshold condition codes' which will supplement the threshold conditions for which they are responsible
  • The PRA will lead on insurance business transfers and will consult with the FCA
  • In addition to the existing power to impose requirements during the authorisation process, the new regulator will have a power to impose requirements where a party is acquiring control in an authorised entity if it appears to that regulator that the likely effect of the change of control is uncertain
  • The Bill introduces a definition of a with-profits policy as "a contract of insurance under which the policyholder is eligible to receive payments at the discretion of the insurer". The PRA will have responsibility for securing an appropriate degree of protection for those who are or may become policyholders of with-profits policies
  • Parent undertakings of PRA authorised firms and investment firms can be subjected to regulatory scrutiny in certain circumstances, which may result in requirements being imposed on the parent undertaking
  • The power to appoint a skilled person has been extended so that the appropriate regulator can appoint such a person themselves in addition to requiring the authorised person to do so. A skilled person will also be able to be appointed to collect and update information
  • The FCA will have an operational objective to promote effective competition in the markets in the interests of consumers

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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