8 May 2011
Stephanie Biggs and Lisa Cawley ask whether the proposed shake-up of financial regulation in the UK is really as dramatic as it seems
The credit crunch resulted in a global outbreak of politicians’ logic: something must be done (or, perhaps, something must be seen to be done). In the UK the Government has decided that the financial regulatory system should be fundamentally reformed “to ensure that financial [companies] are never again allowed to take on risks that are so significant and so poorly understood”.
To that end, the existing tripartite regulatory system under which the Treasury, the Bank of England (BoE) and the FSA share regulatory responsibility, is to be replaced with a new framework under which responsibility for financial stability will be clearly located within the BoE. A new agency, the Financial Conduct Authority (FCA), will take responsibility for consumer protection and the regulation of markets.
The proposals sound far-reaching, and those who lived through the introduction of the current framework just over a decade ago may have a sense of having been here before, but it remains to be seen how different the new system will really be.
The Treasury’s consultation paper, in February, begins to flesh out the details of the new system. The most substantial reforms relate to prudential regulation. These are rules intended to ensure the soundness of financial services companies both individually (microprudential regulation) and throughout the system as a whole (macroprudential regulation), generally by requiring them to hold so-called regulatory capital as a buffer against financial shocks.
In the Government’s view, one of the primary regulatory failings highlighted by the crisis was that the BoE had statutory responsibility for financial stability but only limited tools to deliver it, whereas the FSA had the right tools but such a wide regulatory mandate that it did not focus sufficiently on financial stability issues. In addition, no regulatory body was responsible for synthesising issues arising within companies into an overall assessment of risk within the system, leading to significant regulatory ’underlap’.
Here’s the plan
The Government’s proposed solution is to locate responsibility for financial responsibility firmly within the BoE, giving it the regulatory tools to be effective at both a macro- and a microprudential level. Macroprudential regulation will be the responsibility of a new policy committee to be established within the BoE. An interim committee has been operating on an informal basis since February in anticipation of the new system.
Microprudential regulation will be the responsibility of the Prudential Regulation Authority (PRA), a new subsidiary of the BoE that will regulate prudentially significant companies such as banks and insurers.
Conduct of business regulation will be the responsibility of the FCA which will be, to all intents and purposes, a revamped FSA. The FCA’s strategic objectives will be to protect and enhance confidence in the UK financial system, with the emphasis on securing appropriate protection for retail consumers. It will regulate all companies in relation to conduct of business issues such as financial promotions, suitability of advice and conflicts of interest.
The FCA will also be the UK markets regulator, regulating investment exchanges and other trading platforms, and inheriting the FSA’s powers to prosecute in relation to market abuse. To the relief of market participants, the Government has confirmed that the UK Listing Authority (UKLA) will be retained within the FCA, crucially ensuring that the UKLA has a voice within the new EU securities regulator, the European Securities and Markets Authority.
One of the difficulties with dividing responsibility in this way is ensuring that the new regulatory bodies work effectively together and avoid duplication. The PRA and the FCA will have a statutory duty to coordinate the exercise of their functions. Reflecting the paramount importance of financial stability, the PRA will be given a veto in the event of disagreement, which can be used if the PRA considers that a proposed action by the FCA would lead to a disorderly failure of companies or systemic instability. The success or otherwise of this system of cooperation is likely to determine whether the new arrangement is effective in preventing financial failures.
The Government has set a tight timetable for implementation of the new regime. The final consultation closed in mid-April and the Treasury proposes to bring forward a draft bill for scrutiny shortly, with primary legislation to be enacted by the end of 2012.
In the meantime, the FSA is shadow-running the new system, dividing its operations into a prudential division and a conduct division. Perhaps inevitably, this means there is a suspicion that the changes may, in the end, not be as substantial as they appear.
Stephanie Biggs and Lisa Cawley are partners at Kirkland & Ellis in London