Under proposed reforms, the current UK financial services regulator, the Financial Services Authority (FSA), will be replaced with a new "twin-peaks" system of financial services regulation, planned for the end of 2012. This article outlines the current proposals relating to enforcement under the new regime.
Enforcement under the Current Proposals
The new UK regulatory authorities that are referred to as being the twin peaks are the:
Current draft legislation, the draft Financial Services Bill, provides that enforcement proceedings may be instigated by the PRA in certain circumstances,2 which generally relate to the PRA's supervision of PRA-authorised firms. The FCA will then have enforcement powers "in respect of all other offences."3 This approach suggests that while the majority of enforcement will fall within the scope of the FCA, the PRA will need to have certain capabilities (or access to certain capabilities) in order to conduct its own enforcement investigations.
The Consultation Process
The first substantive consultation paper relating to the proposed regulatory regime was published on 26 July 20104 and provided that: [t]he basic principle regarding the scope of responsibilities of the PRA and CPMA5 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 that it regulates. While some respondents to the consultation agreed with this proposed model, commenting on the benefits including a clear focus and ethos within each regulatory authority, more than 75 percent preferred an integrated model which, in their view, would remove the possibility of regulatory arbitrage, ensure resources were being used efficiently, and reduce burdens on firms. A number of respondents also suggested the creation of a joint "shared services" company, which could operate integrated functions such as authorisations, permissions, approvals, fees, enforcement, and data requests.6 Although acknowledging stakeholder opinion, the UK Government has since confirmed that it is continuing with the proposals for the PRA to undertake enforcement action in relation to PRA-authorised firms that breach its rules. The FCA, in turn, will continue to be responsible for enforcing its own conduct and prudential rules.
The FCA's Approach to Enforcement
As stated above, the majority of enforcement actions will fall within the scope of the FCA. This means that as well as enforcing breaches of its rules, the FCA will also be responsible, for example, for exercising the civil and criminal powers the FSA currently has for tackling market abuse and in relation to the listing regime. It has been well publicised that the FSA has taken a more intrusive approach to supervision in recent years as part of its credible deterrence strategy, which has led to a greater number of referrals to its enforcement and financial crime division and increased penalties. It is expected that the FCA will continue with this approach and the Government has stated that the FCA will "be tougher and bolder, building on and enhancing the FSA’s credible deterrence strategy, using its new powers of intervention and enforcement."7
The PRA's Approach to Enforcement
In May 2011, the BoE and the FSA produced a joint document relating to the approach that the PRA will take to banking supervision.8 This document provides that rather than taking enforcement action, the PRA's preferred approach will be to request or recommend that a firm takes certain measures, for which the PRA must provide clear rationale. This is also referred to as being a "forward-looking approach" to prudential issues, requiring remedial action to be taken in advance of problems emerging. This approach leads to the result that the "successful application of the PRA’s approach should mean that enforcement actions will be relatively rare."9 Therefore, even where the PRA has the power under FSMA to take enforcement action, in practice the PRA's approach to supervision is likely to lead to a relatively low number of enforcement proceedings. There was some support among respondents for this approach, with the Council of Mortgage Lenders stating that they "welcome the confirmation that although the PRA will have the same powers as the FCA, they are likely to be used only rarely. We think that this is the correct approach for the prudential regulator."10
Co-operation Between the FCA & the PRA
During the consultation process some respondents highlighted that there may be an overlap in the enforcement responsibilities of the PRA and the FCA. In this respect, the Government stated that: As already noted in general terms, the PRA and CPMA will work together to coordinate supervisory action in relation to firms where both authorities have a supervisory interest. It may also be necessary, in some circumstances, for enforcement action to be coordinated. Coordination will be managed through supervisory colleges where appropriate, and supported by information gateways allowing the flow of supervisory information between authorities.11 It is likely that issues such as these have led to the proposed statutory duty for the FCA and the PRA to co-ordinate the exercise of their respective functions, generally where either of them is proposing to exercise their powers in a way that might have a material adverse affect on the objectives of the other regulator.12 In relation to dual-regulated firms, the Government has stated that the FCA and the PRA will put in place arrangements for co-ordinating their operation of regulatory processes, including provisions for the FCA to notify the PRA before taking enforcement action. In relation to the FCA notifying the PRA before taking enforcement action, it is interesting to consider this in the context of the proposed power that would allow the PRA to require the FCA to refrain from specific action. In short, where the FCA proposes to exercise any of its powers in relation to one or more PRA-authorised firms, the PRA can give a direction requiring the FCA not to act in a specified manner where, in the PRA's view, this would threaten the stability of the UK financial system or result in the failure of a PRA-authorised firm in a way that would adversely affect the UK financial system.13 The Government has stated that there will be a high threshold for this "PRA veto" and has provided the example of "where the FCA wished to exercise its discretion to impose a penalty on a firm of such a magnitude that it could lead to the firm’s sudden and disorderly failure in a way that could destabilise the financial system as a whole."14 This example suggests that enforcement is an area where the PRA may wish to consider using this veto. There are, indeed, safeguards in place relating to prior discussions between the FCA and the PRA and disclosure of any PRA directions to HM Treasury and Parliament. The creation of supervisory colleges, as mentioned above, is also intended to allow the PRA and the FCA to share their views of the risks posed by a firm or group and "reflects the need to avoid conflicting directions to firms by the two regulators." However, as the PRA veto relates to the FCA proposing to exercise any of its powers which relate to the regulation of authorised persons, it will be interesting to see how this applies in the context of FCA enforcement action. Some respondents to the consultation also highlighted concerns relating to this PRA veto. For example, the Citizens Advice Bureau stated that: [w]hile we are reasonably reassured that the PRA veto over FCA decisions . . . is intended to be used only in very exceptional circumstances, we are not sure how more day-to-day tensions between the approach of the two regulators will be resolved in a way that does not undermine consumer protection.15
The Investment Management Association also stated that
[w]e have a particular concern about the power . . . for the PRA to veto proposed actions by the FCA . . . the interests of a prudential and a conduct regulator respectively may sometimes be in conflict. Section 3H in effect provides that in such an event financial stability considerations shall always override consumer detriment.16 Indeed, Consumer Focus went further and stated that "[w]e strongly believe that the PRA veto provision . . . should be deleted in its entirety."17
It seems that while the PRA will have powers to take enforcement action against PRA-authorised firms for breaching its rules, in practice it will prefer discussing proposed actions with firms rather than undertaking enforcement proceedings. The FCA, on the other hand, has a much wider enforcement remit and the Government has stated publicly that the FCA will continue the FSA's recent more intrusive approach which is likely to lead to an increased amount of enforcement actions. With the many "checks and measures" that are likely to be in place it currently seems unlikely that the FCA will take any enforcement action against a PRA-authorised firm without first discussing this with the PRA. The PRA will also be able to use its veto power in certain circumstances.
Adrian Brown is a partner and head of the financial services regulatory practice at Nabarro LLP. He advises investment banks, broker dealers, fund managers and corporate finance houses on all aspects of financial services regulation. Telephone: +44 (0) 20 7524 6400; E-mail: firstname.lastname@example.org.
Sam Robinson is a senior associate in the financial services regulatory practice at Nabarro LLP. Sam has advised a number of clients including banks, stockbrokers, fund managers and investment advisers on all aspects of financial services regulation. Prior to working in private practice Sam worked for seven years at the FSA, the majority of that time in the FSA's General Counsel's Division. Telephone: +44 (0) 20 7524 6836; E-mail: email@example.com.
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