Money never sleeps

While there is complex regulatory reform taking place in the UK, much of the reform action is taking place abroad and financial institutions are facing huge changes.
By Robert Finney

Earlier this month the ­Financial Services Authority ­published its annual report for 2009. This recorded another busy year (perhaps ’hyperactive’ is more apt), as the FSA continued to respond to the financial crisis, sought to revive its influence abroad and fought for survival at home.

But the FSA is not to survive. Last Wednesday the Chancellor announced that the FSA and the UK’s tripartite structure for financial stability regulation will be abolished. It will be replaced by the so-called ’twin peaks’ model of regulation, comprising a prudential regulator on the one hand and a Consumer Protection and Markets Authority (CPMA) on the other.

Prudential regulation (both macro and micro) will become the responsibility of the Bank of England. It will cover prudential regulation of not just banks, but also ­investment banks, building societies and insurance companies. A new Financial Policy Committee will parallel the Monetary ­Policy Committee, but with responsibility to oversee financial stability. The rest of the FSA’s existing powers will be split between the CPMA and an economic crime agency. 

Numerous key questions remain unanswered. Many of which were raised in response to last summer’s Conservative Party proposals that these changes largely reflect.

Although the CPMA’s name suggests it will regulate exchanges and clearing houses, a central issue in the post-crisis focus on clearing OTC derivatives is the financial strength of central counterparties (CCPs) and the implications for financial stability. We were reminded of this again in last ­Monday’s consultation paper from the EC. Will prudential regulation of clearing houses/CCPs rest with the CPMA as a market regulator? And what about prudential regulation of ’financial firms’ not specifically mentioned by the Chancellor, such as ­intermediaries whose failure, though not a systemic disaster, harms consumers?

In contrast, the CPMA’s name might suggest that conduct of business with non-consumers will be outside its remit, but the Chancellor suggested the contrary.

So how will conduct of business with non-consumers be regulated, particularly conduct issues which interface with prudential issues such as governance?

The FSA’s track record in enforcement has improved markedly post-crisis and this covers prudential and conduct rules. Indeed, a large number of enforcement actions are based on systems and controls matters. It is not clear who will handle this in the future. 

The proposals have the disadvantage of continuing instability at the FSA. Most commentators agree that it is not so much the regulatory architecture that determines the regime’s effectiveness, but the substance of the rules and the quality of supervision. And, as Lord Turner (FSA’s chair) recently emphasised, the body is a very different ­regulator now than three years ago. Hector Sants’s agreement to continue as FSA CEO before moving over to the new prudential regulator will help to smooth the transition, but there will still be huge costs and ­disruption if other FSA officials leave.

Meanwhile, the Chancellor’s ’Independent Commission on Banking’ potentially creates uncertainty among large banks.  Given other major changes on the agenda, including the bank levy proposed in the UK and other countries, US regulatory reforms reaching a climax in Congress, new requirements on capital, liquidity, leverage and ­resolution plans, substantial restructuring of major institutions in the financial sector seems more than likely, whatever Sir John Vickers and his Commissioners conclude.

Despite last week’s developments at home, abroad is where much of the regulatory reform action is. The G20 meetings have set the agenda for reform, but it is international organisations such as the Basel Committee on Banking Supervision and the Financial Stability Board that iterate policies from previous summits.

Nevertheless, the G20 is still adopting new high-level policies relevant to financial regulation. For example, finance ministers and central bank governors at this month’s meeting said they were “committed to improving the functioning and transparency of ­commodities markets” and agreed wording which forms the basis for the bank levies that are proposed in various quarters.

While Basel works on refining capital standards and developing liquidity requirements and leverage limits, much of the implementation is happening at national level – or, in Europe’s case, in Brussels.

The EC has been pushing ahead with EU reform agenda, set in the de Larosière report on financial supervision. Often, like the FSA, the Commission is ahead of the ­international standards they are supposed to be im- plementing. This is driven by ­political pressure, ambition to influence those standards, and efforts to restore ­regulators’ credibility.

A tsunami of change is breaking over financial institutions, affecting almost every aspect of their business. Now, alongside all this, and including the move to a complex new European supervisory architecture, we must experience the tremors of restructuring the UK’s financial regulatory framework and probably of financial institutions, too.

Robert Finney is a partner at Denton Wilde Sapte