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UK FSA Comments on Draft Financial Services Bill

Thursday, September 29, 2011

Richard Powell | Bloomberg LawJoint Committee on the Draft Financial Services Bill, Memorandum from the Financial Services Authority, 5 September 2011 The Financial Services Authority (FSA) has published a memorandum setting out its views on the draft Financial Services Bill together with an assessment of the major implementation risks arising out of the UK's new financial regulatory structure. The draft Bill is currently before Parliament for pre-legislative scrutiny and is likely to be enacted in 2012 or 2013.1 The FSA urges the joint Parliamentary committee considering the draft Bill to ensure that the new prudential and conduct regulators' "objectives are clearly articulated and agreed at the outset and that they are given the necessary statutory powers." It fears that industry pressure may limit the regulatory tools available and therefore reduce the effectiveness of the regime. In recognition that the new system of regulation will move the industry away from a light-touch, non-interventionist approach, the FSA voices concern that society as a whole, through the Government and Parliament, should provide regulators with guidance on the balance to be struck between a number of competing priorities. These include "the cost and effectiveness of regulation; consumer freedom and protection; early intervention and innovation; and structural intervention and market autonomy." All these questions have been raised recently by FSA senior management.2

Prudential Regulation Authority

With respect to the establishment of the Prudential Regulation Authority (PRA), the draft Bill is seen as an opportunity to improve on current arrangements to promote UK financial stability. That said, significant improvements have been made since the crisis of 2008, principally by means of a "more intensive and intrusive" supervisory regime. Endorsing the PRA's objective to promote the stability of the financial system through the supervision of individual firms, the FSA explains this will be achieved by:
  • An improved capital and liquidity regime implemented through CRD IV;3
  • More emphasis on recovery and resolution planning;
  • Judgement-based supervision with the replacement of the Advanced Risk Responsive Operating Framework (or ARROW), together with a framework for proactive intervention when required; and
  • Improving market discipline by greater transparency.
PRA supervision will target those matters which have the potential to damage an entity's "safety and soundness" and will focus on outcomes compared to processes. This will entail PRA staff analysing business models, governance and capital and liquidity as well as the risks posed to the financial system as a whole. The PRA is expected to operate within its current equivalent budget with the same staff, albeit numbers have grown considerably in recent times.

Clearing & Settlement

Under the draft Bill, responsibility for clearing and settlement passes from the FSA to the Bank of England (BoE) which already supervises payment systems. The FSA considers that future co-ordination between the PRA and the Financial Conduct Authority (FCA) would be assisted if the former was responsible for the prudential supervision of clearing houses. It accepts though that a further re-organisation would not be helpful at present. Instead, the FSA calls for the proposed draft Bill to be drawn in such a way that this might be altered in future without the need for fresh legislation (i.e., by HM Treasury making a designation order). The FSA also calls upon the Government to recognise the FCA's role in supervising clearing and settlement systems on conduct issues. This would reflect the position amongst other EU competent authorities and also place the FCA on the same footing in its dealings with the European Securities and Markets Authority.

Financial Conduct Authority

Against a background of poor public confidence in financial services, the FSA welcomes the powers to be granted to the FCA to improve consumer protection. The inadequacy of regulating conduct issues by intervening at point of sale – a reactive approach – is recognised. Instead, the future FCA will be ready to intervene earlier in the "product chain" before risks come to fruition. While the FSA has been moving in this direction it sees the draft Bill as an opportunity to bolster this strategy which success is seen as vital if public confidence is to improve. This new style of regulation is said to have significant cost implications with efficiency savings being insufficient. — Objectives It is with the FCA especially, however, that the UK regulator holds significant concerns on the draft Bill. The strategic objective of "protecting and enhancing confidence in the UK financial system" is seen to be too wide to understand exactly what the FCA's must achieve. Instead, it is suggested that this is amended and should read as "contributing" to the protection and enhancement of confidence. Similarly, there is potential for conflict over the operational objectives of "efficiency and choice" and of protecting of consumers. Not only does the FSA consider that confusion could arise between the FCA and the Office for Fair Trading (which has a general responsibility for competition issues within the UK) over their roles, it also considers that the FCA itself may have to adjudicate between promoting choice and protecting consumers (e.g., through use of its early intervention powers). The Treasury Parliamentary Select Committee and the Independent Commission on Banking have previously suggested giving the FCA a fully fledged competition objective.4 However, the FSA sees this proposal as moving the conduct regulator away from consumer protection. Instead, it proposes dispensing with the operational objective of "efficiency and choice" and relying on the independent duty in the draft Bill to promote competition where otherwise compatible with its objectives. This would, it is argued, clarify the FCA's role. — Significant Influence Functions A further area of concerns relates to the approval of senior management in PRA, FCA dual-regulated firms. Under the draft Bill it is the PRA alone which approves individuals to carry out significant influence functions (e.g., the chief executive of an investment bank). While the PRA would consider an applicant's fitness and propriety and consult with the FCA, the FSA believes that this is insufficient because the attitude of senior management to conduct issues indicates how those businesses treat their customers. Drawing on the experience of the Netherlands, which also has a "twin-peaks" system of regulation, Parliament is urged to include a requirement that the FCA must actually consent. — Warning Notices The draft Bill would allow regulators to publish details of a warning notice issued to the subject of a regulatory investigation. Such notices contain details of the untested case against a firm or individual, and currently, only the decision notice reflecting any representations made can be published. No doubt reflecting the controversial nature of this proposal the proposed legislation requires a regulator to consult with the recipient prior to publication.5 The FSA calls for this provision to be dropped as, in its opinion, this would impede publication and potentially lead to satellite litigation – as recently seen in the High Court and the Upper Tribunal (Tax and Chancery Chamber) between Swift Trade Inc. and the FSA.6


The ability of the UK to represent itself in the EU and internationally has been a continual theme of the debate on regulatory reform. Historically, the FSA was perceived not to have articulated UK interests as fully as they might have been and going forward the "twin peak" structure is seen as complicating the representation of UK interests before what are essentially EU sectoral supervisory authorities. The FSA therefore takes the opportunity to call on Parliament to see that the draft Bill clearly identifies who is responsible for any particular issue and that the relevant regulator must take into account the views of other interested regulators. An early test will be in the context of the new EU technical measures or standards; UK regulators must have sufficient discretion for judgement-based decisions that take into account the wider picture. As to co-ordination generally between regulators, close working will be needed. For instance, there is likely to be a degree of "overlap and duplication" between the PRA and the FCA over the supervision of some 2,000 dual-regulated firms. As a temporary measure the FSA and the BoE are labelling the FSA Handbook to make clear which regulator is responsible for what provision.

Final Questions

A final plea from the FSA to Parliament concerns where the line should be drawn to ensure regulators are publicly accountable while respecting the exercise of their discretion. This is considered essential where regulators make judgments and sometimes these decisions will be subject to criticism. Although regulators will accept some risk – both conduct and prudential – the FSA also questions whether this is realistic in terms of public opinion and calls for a further parliamentary debate on this issue. Disclaimer This document and any discussions set forth herein are for informational purposes only, and should not be construed as legal advice, which has to be addressed to particular facts and circumstances involved in any given situation. Review or use of the document and any discussions does not create an attorney-client relationship with the author or publisher. To the extent that this document may contain suggested provisions, they will require modification to suit a particular transaction, jurisdiction or situation. Please consult with an attorney with the appropriate level of experience if you have any questions. Any tax information contained in the document or discussions is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code. Any opinions expressed are those of the author. The Bureau of National Affairs, Inc. and its affiliated entities do not take responsibility for the content in this document or discussions and do not make any representation or warranty as to their completeness or accuracy. ©2014 The Bureau of National Affairs, Inc. All rights reserved. Bloomberg Law Reports ® is a registered trademark and service mark of The Bureau of National Affairs, Inc.

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