Soon the Financial Services Authority (FSA) will cease to exist as the UK's sole financial services regulator. In its place will be three new regulatory entities: the Financial Policy Committee (FPC), the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA). The so-called "twin peaks" model which is to be adopted, referring to the split between conduct and prudential regulation, will create two new supervisors for regulated firms.
In this article, we provide a high-level summary of the key issues insurers of FSA-regulated firms and individuals need to be aware of in terms of the new structure, new powers and expected approach of the new regulators.
A draft version of the primary legislation bringing the key reforms into effect was first published in June 2011 in the form of the Financial Services Bill (the "Bill"). This will amend, as opposed to replace, the Financial Services and Markets Act 2000 (FSMA). The Bill was formally introduced to Parliament on 27 January 2012 and a number of revised versions have been issued since then. The Bill contains an extensively redrafted Financial Services and Markets Act 2000 (FSMA), as well as amendments to the Banking Act 2009 and Bank of England Act 1998. The Bill is now making its way through the committee stage of the House of Lords and it is currently expected that the new regime will come into force in spring 2013.
One of the main failures in regulatory oversight identified following the financial crisis was a lack of macro-prudential oversight. To address this failure and to enable the authorities to better spot systemic risks in financial markets, the FPC, a new body within the Bank of England (BoE), will have primary responsibility for the oversight of financial stability in the UK economy as a whole. In June 2012, George Osborne announced that the Government would be amending the Bill to include a secondary objective for the FPC to "support the economic policy of the government."
The FPC (which will be chaired by the BoE's Governor) will also be expected to monitor:
- The activities of the PRA and the FCA, to assess the financial stability implications of their actions
- The split in responsibilities between the PRA and the FCA
- Work undertaken by other parts of the BoE relevant to financial stability
- The FPC is expected to have a number of tools at its disposal to address any systemic risks which it identifies, including:
- Public pronouncements and warnings to raise awareness of issues, to encourage industry to find solutions or to influence opinions
- Influencing macro-prudential policy at an EU and international level
- Making recommendations to the PRA, the FCA and other bodies such as HM Treasury and other parts of the BoE
The PRA will be responsible for the authorisation, prudential regulation and supervision of:
- All insurers
- Deposit-taking institutions including banks, building societies and credit unions
- Systemically important' investment firms, meaning investment firms which present significant risks to the stability of the financial system.
In other words, the PRA will be responsible for regulating and supervising these firms in terms of their capital adequacy and stability. It is currently estimated that around 2,000 or so firms will be regulated by the PRA, half of which are expected to be insurers.
The broader strategic objectives of the PRA will be to:
- Contribute to the promotion of stability in the UK's financial system
- Promote the safety and soundness of those persons authorised by the PRA
The PRA will also have a separate insurance objective, namely to contribute to the "securing of an appropriate degree of protection for those who are or may become policyholders". This is in line with the Solvency II Directive which requires the protection of policyholders to be the primary objective of supervision.
It is said that the PRA will adopt a "judgement-based" supervisory approach which means that the nature and intensity of the PRA's supervision should match the level of risk a firm poses to its customers and to the stability of the financial system.
The FCA will be responsible for the conduct regulation of all firms, including those authorised and supervised by the PRA. It will also be responsible for the prudential regulation of all firms not regulated by the PRA. It will be responsible for all market conduct (including the market abuse regime) and the functions of the UKLA. Essentially, the FCA will be taking on the majority of the FSA's current workload, including most of its enforcement activity. It is estimated that the vast majority of financial services firms (around 25,000), will have the FCA as their sole prudential and conduct regulator. Firms regulated by the PRA in respect of prudential issues, but the FCA in respect of conduct issues, will be referred to as "dual-regulated firms."
The FCA will have a single strategic objective for "ensuring that the relevant markets function well". While there is no clear explanation of what "function well" means, the head of the FCA, Martin Wheatley, indicated in a recent speech that it should be interpreted as "consumers getting a fair deal."
In addition, the FCA will have three operational objectives:
- Securing an appropriate degree of protection for consumers
- Protecting and enhancing the integrity of the UK financial system (as opposed to stability of the UK financial system which is the FPC's objective)
- Promoting effective competition in the markets for regulated financial services in the interests of consumers
There will also be a free-standing duty to have regard to the importance of taking action to minimise the extent to which regulated businesses may be used for a purpose connected with financial crime. This is to include the existing market abuse regime. The Bill also includes powers to enable the full transfer of consumer credit regulation from the Office of Fair Trading (OFT) to the FCA, and the Government proposes that the FCA do so from 2014.
It has been said that the FCA will adopt a more issues and sector-based supervisory approach compared to the FSA. More critically, the FCA is seeking to move from a "reactive to a pre-emptive approach to regulation" and, so, identify and address issues before they can develop into bigger problems including significant consumer detriment. To enable it to become more forward-looking, the Bill includes a number of new powers for the FCA additional to those which are currently available to the FSA (which the FCA will also acquire). These include:
- The power to direct firms to withdraw or amend misleading financial promotions with immediate effect, and to publicise that it has done so
- The power to make temporary product intervention rules for up to a year to address problems arising from financial products/services that it considers are detrimental to the interests of consumers or competition. Rules may require certain product features to be included, excluded, or changed, promotional materials to be amended, or
- restrictions (or in serious cases, a ban) imposed on sales or marketing of the product. (We consider this proposed new power in more detail in the next article.)
- Allowing consumer bodies to make super-complaints, and the FOS (and firms themselves) to make mass detriment references. A super-complaint will be able to be made to the FCA by designated bodies if they consider that a feature of the UK financial services market is, or appears to be, significantly damaging to the interests of consumers. By comparison, a mass detriment reference will be able to be made by either the FOS or by a regulated firm (in other words, a self-report) if either:
(i) it appears that there may have been regular failures by a firm (or firms) to comply with regulatory requirements; and (ii) consumers have suffered, or may suffer, loss or damage as a result; and (iii) a remedy or relief could be obtained in respect of this loss of damage if legal proceedings were brought; or
(ii) where it appears that a firm (or firms) have regularly acted in a way that, if a complaint were to be made to the FOS, it is likely that the complaint would be determined in favour of the complainant and an award made.
The FCA will be required to publish a response within 90 days of receiving a super-complaint or mass-detriment reference, in which the FCA must explain, what if anything, it intends to do.
In late October 2012, a number of "Approach Documents" are due to be published which will explain in more detail how the PRA and the FCA intend to approach their regulatory duties and exercise their powers.
While both regulators will have investigation and enforcement powers, enforcement action by the PRA is expected to be rare. Rather, most enforcement action will likely be taken by the FCA as it is solely responsible for conduct issues and will regulate more firms in terms of numbers. Only minimal changes to the existing investigation and enforcement powers are proposed.
Cooperation & coordination
It will be vital to have effective coordination between the two regulators if the new framework is to function properly. Acknowledging this issue, the Bill provides a variety of cooperation and coordination mechanisms including a statutory duty to coordinate the exercise of the regulators' functions. If coordination is left lacking, there is a risk of conflicting regulatory messages (particularly for dual-regulated firms) and compliance cost implications.
While it is difficult to predict whether new claims and coverage issues will arise by virtue of the new regulatory structure before it is fully operational, there are clearly certain areas to which FI insurers should pay particular attention. One area which may give rise to new issues is the focus on pre-emptive regulation and powers to engage with firms at an earlier stage if consumer detriment is foreseen as opposed to having in fact occurred. Super-complaints and mass-detriment references, which could lead to enforcement action and mass-redress programmes, also have the potential to impact on the claims environment for regulated firms.
It is clear that the new regulatory bodies intend to be pro-active, faster and tougher in their regulatory approach. However, it remains to be seen whether the rhetoric used when describing these aims and intentions will be borne out in practice.
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.