Replacing the FSA: a wake-up call to the financial services industry
Changes in the UK regulatory landscape took a significant step forward in May and June 2011 when the Bank of England and the FSA published their approach documents for the new Financial Conduct Authority (FCA) and Prudential Regulation Authority (PRA). These put some detail around the government’s consultation papers and recently published white paper “A new approach to financial regulation: the blueprint for reform, June 2011”. The next step in the legislative process is the start of pre-legislative scrutiny where a cross-party committee will scrutinise the draft legislation, which takes the form of multiple amendments to the existing Financial Services and Markets Act (FSMA) 2000.
As an interim step, towards the middle of 2012 the FSA intends to introduce an ‘internal twin peaks’ model, trialling the approaches of the FCA and PRA within the FSA and within the limits of FSMA. The new model will prompt substantial changes, including separated prudential and conduct supervision for dual FCA / PRA regulated firms and the introduction of new risk analysis approaches and tools.
The imminent changes to the supervisory regime present an urgent need for the industry to consider seriously the likely impacts on their businesses and the nature of their interactions with the supervisory authorities, which are certain to change given the extent of the reforms. George Osborne, Chancellor of the Exchequer, noted how the new approach “places the judgement of expert supervisors at the heart of regulation” and that it is a “programme for radical reform.” 1
The FCA: significant new powers
In what may prove to be a wake-up call to parts of the financial services industry, the FCA will be equipped with a variety of powers to support its statutory duty to protect consumers from detriment. Among others, the ability to ban the sale of particular products from a given financial institution for up to 12 months and taking action over misleading adverts or promotions, disclosing consequent disciplinary actions against individuals or firms. It will also be able to initiate referrals to the Office of Fair Trading.
Only time will tell how eager it will be to use its new powers, though it seems clear that the FCA may intervene in a more intrusive manner than even the FSA has started to recently. Indeed, high expectations appear to already have been conferred. As Mark Hoban, Financial Secretary of the Treasury noted, “We want the FCA to play a far stronger role promoting competition… [It] will be more interventionist than the regulatory authorities of the past2.”
Greater market-wide review and policy intervention
Higher level, holistic views of the market and individual firms’ business models will be among the FCA's priorities as it seeks to identify potential risk areas for consumers. This is likely to signal a clear and unequivocal move towards sector and thematic supervision and away from relationship-based supervision.
This shift will bring with it greater market-wide policy interventions along the lines of the Retail Distribution Review and the Mortgage Market Review, alongside an increased use of the S4043 redress process.
While there may be little discernable difference in current supervision of the markets through the listing authority (UKLA), wholesale supervision will be stepped up, although this may be hampered initially by constraints on the FCA's resources, consequently taking some time to ramp up to the FCAs desired level.
The PRA: the micro-prudential supervisors
The primary focus of the PRA will be on financial stability issues and the resolvability of firms that pose a threat to the financial system at large. Using highly qualified supervisors to judge firms’ safety and soundness, it is tasked with making forward-looking assessments to avert potential difficulties on the horizon and to minimise the risks of disorderly failure. Its starting position of business model analysis and a new risk model is a fundamental shift in approach to prudential supervision.
Acting under the instructions of the Bank of England’s Financial Policy Committee to tackle issues of micro-prudential concern, it is intended that the PRA will bring about a proactive intervention regime to deal with firms that get into difficulties. Speaking about this new regulatory approach to bank supervision, Paul Tucker, Deputy Governor, Financial Stability at the Bank of England, described it as representing “a profound review of the social contract between banks and society.4 ”
A move towards banking-style regulation?
Providing a swifter and more direct form of action under the Proactive Intervention Framework, firms may feel that the PRA will adopt a much more instructional style of supervision.
Firms should expect a greater emphasis on reporting assurance, published returns and the use of S166 reviews5. A more intrusive supervision of UK branches of overseas banks may also be a change of approach that the industry will need to learn to accommodate. This may create challenges between the UK and other European regulators, who have been traditionally very legalistic in their interpretation of the roles and responsibilities of Home and Host supervisors.
It seems likely that insurers will increasingly be regulated more like banks, given the culture, experience and style of the Bank of England. This is notwithstanding the fact that the industry has been at pains to point out that insurers are not banks, and came through the financial crisis of 2008-9 in an arguably much stronger position overall.
Will two regulators mean twice the burden on firms?
A key concern for many is how, and whether, the two new bodies will work in concert.There are already multiple touch-points within a financial services business by the FSA and there is some disquiet that the formation of the PRA and FCA will make the co-ordination and management of firms’ interactions with the regulators even more complex, burdensome and expensive.
Best intentions among the PRA and FCA may be to work together wherever possible (such as on authorisations) in order to avoid overlap and duplication. However, the crux of the reform is to create two independent regulators. Despite sharing insights and analyses at a macro level, coordination on the ground might prove substantially more difficult to achieve. Independent visits and approaches, and a divergence of agendas over time, appear to be a very real risk.
While the FCA’s challenge is to pre-empt issues around new products and distribution channels, the PRA’s challenge is centred around the entire business model’s sustainability and resilience. This overlap, yet fundamental difference, in the scope and statutory objectives of the two regulatory bodies will ultimately mean two separate agendas with firms.
Financial institutions should therefore already be waking up to the changes, which are far more significant than a simple name or structural change. These changes require them to stand back and think through their entire business through the lens of the new regulators; from strategy, business model, customer products and services, distribution, processes, risk appetite, to governance and controls, and their overall impact on the financial system. Viewing the situation as ‘more of the same’ may leave them exposed to some unpleasant surprises in the future.
Global FS Risk and Regulatory Centre of Excellence