George Brown’s creation, the Financial Services Authority, is to be done away with and replaced by a radically different regime. As Osborne Clarke’s Nick Thody reports, this could have dramatic implications for all those operating (and advertising) in the financial services sector. Catch his “need to know” heads-up on the Coalition Government’s recently published consultation paper.
The Government yesterday published a consultation paper setting out its plans for the comprehensive reform of UK financial services regulation. This proposed reform will have an impact across several of our practice areas, and will mean that many of our clients will be dealing with considerable change in the way that they, their products or their conduct are regulated.
Why should I read this note?
This note will be relevant if you:
- are authorised by the Financial Services Authority;
- conduct financial promotions regulated by the Financial Services Authority;
- interact with the UK Listing Authority;
- are subject to the provisions of any of the Listing Rules, the Disclosure Rules and Transparency Rules and the Prospectus Rules;
- are affected by any provisions of the Financial Services and Markets Act 2000 (FSMA);
- are banks, building societies or insurers;
- operate payment systems;
- operate under the Consumer Credit Act 1974;
- engage in consumer credit advertising governed by the Consumer Credit (Advertisements) Regulations 2010;
- deal with Lloyd's of London; or
- advise any of the above.
What is happening?
The principal financial regulator of the last thirteen years, the Financial Services Authority (FSA), is, in effect, to be abolished. In its place, two new "properly focused" regulatory bodies will be created. The Bank of England will acquire, or re-acquire, greater powers to ensure financial stability and to operate the system of prudential regulation. A new "companies regulator" may also be created. Primary legislation will be needed to achieve many of these outcomes.
Why is this happening?
Because, in the Government's words, "the tripartite system [being the system created in 1997 and consisting of the division of responsibility for financial stability and regulation between HM Treasury, the Bank of England and the Financial Services Authority] of financial regulation failed to ensure financial stability – in particular by failing to identify the risk posed by the rapid and unsustainable increase in debt in the economy. This resulted in considerable economic costs in lost output and in a substantial deterioration in public finances. The regulatory system cannot be restructured without primary legislation."
Can you outline the main changes?
1. A new Financial Policy Committee (FPC) will be established within the Bank of England (and so will be a counterpart to the existing Monetary Policy Committee). The FPC will have responsibility for considering the macro-economic and financial issues that may threaten financial stability.
2. A new Prudential Regulatory Authority (PRA) will be created as a subsidiary of the Bank of England to have responsibility for the prudential regulation of deposit-takers, insurers and broker-dealers (investment banks).
3. A new Consumer Protection and Markets Authority (CPMA) will be established to have responsibility for consumer protection in financial services and for regulating conduct in financial services, including in relation to firms authorised and supervised by the PRA. A CPMA markets division will lead on market conduct regulation. The CPMA will also be responsible for the regulation (including prudential regulation) of all firms not regulated by the PRA, including most investment firms, investment exchanges and providers of trading facilities, and the provision of consumer credit.
4. The Bank of England will have responsibility for the regulation of settlement systems and central counterparty clearing houses to sit alongside its existing responsibilities for payment system oversight.
5. The Government is also considering whether the UK Listing Authority (UKLA) should be merged with the Financial Reporting Council under the Department for Business, Innovation & Skills, or whether it should remain within the CPMA markets division.
Some detail – the Financial Policy Committee
The FPC will be part of the Bank of England. It will have responsibility for macro-prudential regulation. The FPC will "monitor and address systemic or aggregate risks and vulnerabilities that could threaten the stability" of the financial services sector as a whole and endanger the wider economy.
The FPC will be able to give directions to the PRA (and, if relevant, to the CPMA) on the regulatory tools that should be deployed in pursuit of macro-prudential policy and will give recommendations to the PRA and CPMA where the FPC believes that specific regulatory actions (including, potentially, amendments to rules) are required in order to protect financial stability.
Some detail – the Prudential Regulation Authority
The PRA will be a legally distinct subsidiary of the Bank of England. It will be responsible for micro-prudential regulation, with the "focus, expertise and mandate to ensure effective prudential supervision and regulation of individual firms". "The Government will ensure that that processes and legal framework of the new PRA will support and facilitate a new, more judgement-led style of prudential regulation." The following categories of firms are expected to be authorised, regulated and supervised day-to-day by the PRA:
1. Banks and other deposit-takers, including building societies and credit unions
2. Broker-dealers (investment banks)
3. Insurers, including friendly societies.
The PRA will be responsible for making prudential rules for the firms it regulates, covering all issues affecting the safety and soundness of individual firms, including remuneration
Some detail – the Consumer Protection and Markets Authority
The CPMA will regulate:
1. The conduct of all firms, including all firms authorised and subject to prudential supervision by the PRA, in their dealings with ordinary retail customers, "taking a proactive approach as a strong consumer champion". This will include the core function of making the rules governing the conduct of financial firms in both the retail and wholesale spheres, the granting of permissions for all regulated activities classified as "non-prudential" and the approval of individuals to perform conduct-related controlled functions within financial firms that are also prudentially regulated by the PRA, and the approval of all controlled functions where firms are solely regulated by the CPMA.
2. Dealings in wholesale financial markets, including the conduct of all financial services firms in wholesale markets, firms providing market services (such as investment exchanges and providers of multilateral trading facilities) and market conduct more generally. This will include using existing FSMA powers to impose penalties for market abuse.
The CPMA will adopt the FSA's Retail Conduct of Business Strategy and continue the Retail Distribution Review, Mortgage Market Review and work on responsible lending. The CPMA will take on responsibility for the Financial Ombudsman Scheme and the Financial Services Compensation Scheme and will oversee the Consumer Financial Education Body.
The CPMA will be independent of Government and will take the corporate form of a company limited by guarantee, financed by the financial services industry. The CPMA may be established by adopting the legal corporate entity of the Financial Services Authority.
Sounds like there is potential for regulatory overlap between the PRA and the CPMA?
The consultation paper acknowledges this. "The basic principle regarding the scope of responsibilities of the PRA and the CPMA is that each regulatory authority will be responsible for taking decisions – for example, on rule-making, authorisation, approval of individuals performing controlled functions, supervision and enforcement – in relation to the activities it regulates. Whilst this principle is very clear, putting it into practice will require a significant degree of cooperation and coordination [to avoid] duplicating efforts…"
The consultation paper's accompanying impact assessment paper states that most of the approximately 20,000 firms currently regulated by the FSA will be regulated solely by the CPMA after the reforms have been implemented. About 1,500 to 2,000 firms are likely to be prudentially supervised by the PRA while also subject to conduct of business regulation by the CPMA. There are about 100 – 200 groups containing both PRA and CPMA firms.
You mentioned a new "companies regulator"?
The UKLA currently regulates primary market activities such as issuing shares and bonds, official listings of shares and bonds and the related activity of disclosing information in accordance with the disclosure and transparency obligations of listed issuers.
The Government suggests in the consultation paper that the UKLA's functions could be merged with "other regulatory functions relating to companies and corporate information, notably those of the Financial Reporting Council (FRC). This would have the benefit of bringing the UKLA's regulation of primary market activity alongside the FRC functions relating to company reporting, audit and corporate governance. The Government is therefore considering whether the UKLA should be merged with the FRC under the Department for Business, Innovation and Skills, or whether it should remain within the CPMA markets division".
If these bodies are merged, the result would be a "powerful companies regulator established with responsibilities for regulating corporate governance, corporate information and its disclosure, and the stewardship of companies by institutional shareholders." BIS is to bring forward detailed proposals on this for consultation "in due course", and the Government "is also seeking views on whether there are other aspects of financial market regulation in which the links with companies law are sufficiently close to warrant consideration of transferring them to the potential new companies regulator".
You mentioned the Consumer Credit Act?
The consultation paper notes that responsibility for regulating consumer finance is currently divided between the FSA and the Office of Fair Trading (OFT), and that this division can lead to confusion. The Government is therefore intending to consult on the merits of a transfer of responsibility for consumer credit from the OFT to the new CPMA. That consultation will be published in the autumn and will also consider how the legislative framework underpinning consumer credit might be simplified and whether it should be brought under a single regulatory regime.
….and Lloyd's of London?
Lloyd's of London is currently regulated by the FSA, which also regulates the firms that provide services to the market, to names and to other market participants. Some of those activities would fall to the PRA to regulate and some to the CPMA. The Government will consult with the Bank of England and with the FSA as to how regulated activities relating to Lloyd's of London will be allocated between the PRA and the CPMA.
Anything on economic crime?
The Government proposes to consider whether to transfer responsibility for prosecuting criminal offences involving insider dealing, other forms of market abuse and other criminal law breaches which the FSA currently prosecutes to a new Economic Crime Agency. This will be the subject of a separate consultation.
What will happen to FSMA?
The Government intends to legislate to divide the powers and functions of FSMA into separate standalone prudential and conduct regulation frameworks. To prepare this legislation, the Treasury will systematically work through the FSMA to establish which of the current powers and functions provided for within FSMA each of the new authorities will require in their specific areas of responsibility, and any necessary modifications.
What is the timetable for all of this?
This programme of reform is plainly going to be both complex and time-consuming. The consultation paper states that the FSA will "work to introduce" a "shadow" internal structure, allocating staff and responsibilities in anticipation of the formal creation of the PRA and the CPMA, with the "intention to introduce" this approach in the first quarter of 2011. The Bill (i.e. the primary legislation) required to implement the reforms and changes described in this note will be brought forward in mid-2011 and, "in order to minimise uncertainty for regulated firms", the Government is seeking to get the legislation passed within two years i.e. by July 2012.
This will be the most substantial change to UK financial services regulation since at least 1997. All those affected will need to keep a close eye on how this plays out in terms of new regulatory structures and new approaches to enforcement. There is the suspicion that the motivation behind some of these changes is personal; the current regulatory structure was the creation of Gordon Brown. So, as Carthage was to Cato the Elder, so is the Financial Services Authority to George Osborne; it must be destroyed.