House of Commons - Financial Regulation: a preliminary consideration of the Government's proposals

Financial Regulation: a preliminary consideration of the Government's proposals - Treasury Contents

5 Consumer protection and markets regulation

101. Besides the PRA, the Government will also legislate to create a new conduct of business regulator, provisionally named as the Consumer Protection and Markets Authority (CPMA). Unlike the PRA, it will be separate from the Bank, regulating the conduct of all financial firms, including those prudentially regulated by the PRA. The CPMA will also "be responsible for making rules in respect of industry funding of the FOS [Financial Ombudsman Scheme], FSCS [Financial Services Compensation Scheme] and CFEB [Consumer Financial Education Body]". It is anticipated that the remaining two-thirds of the FSA staff will join the CPMA.

Can the CPMA be a true 'consumer champion'?

102. The Government is keen to brand the CPMA as a 'strong consumer champion'. During our inquiry, we have received a great deal of evidence suggesting that it is problematic to call a regulator a 'consumer champion', with the industry fearing that regulatory decisions will be biased towards consumers, causing confusion and unfairness to firms. The BBA argued that, rather than being a champion, the CPMA should create a regulatory environment where consumers can make informed decisions and be responsible for the consequences:

We are concerned about the CPMA being described as a consumer 'champion'. This, to our mind, has the potential of creating an imbalance in its objectives from the outset and also reinforces the concern that we have of the CPMA somehow being detached from responsibility for its actions. We would prefer therefore a description based more on the development of a marketplace in which consumers are provided with clear and understandable product information from which they can make informed choices. This involves placing consumers in a position where they can take responsibility for their financial decisions. The implication that the new authority will somehow become their advocate does not help this.[90]

103. Other trade bodies decried the champion idea as emotive and ill-defined. The Financial Services Practitioner Panel argued that 'there may be further consumer costs if the CPMA's role as consumer champion is interpreted too narrowly. If it restricts firms from developing new products and working the market effectively, there may be less choice available, with consumers paying more for products which are less suited to their requirements'.[91] The ABI also told us that "it is entirely inappropriate for an independent regulator to act as a 'champion'. It should instead take an evidence based approach to policy-making and supervision taking account of the views of all stakeholders."[92]

104. Angela Knight of the BBA denied that the banks were scared of having a consumer champion, but drew a distinction between a regulator and a consumer champion:

[...] A regulator should be a regulator and a consumer champion should be a consumer champion. The regulator is there to produce rules and requirements. Let's say on the consumer side to ensure that the rules are right for consumers; open, transparent and understandable. They get redress when redress is due if something has gone wrong. That's the role of a regulator. We think a consumer champion is an entity that is separate from a regulator and takes on the consumer issues and really brings them to the forefront, whether it is with a regulator, governments, industry or whatever. We don't run away from there being a consumer champion. We think that it is confusing if you put it in with a regulator.[93]

105. Tony Boorman, Decisions Director and Principle Ombudsman from the Financial Ombudsman Service (FOS), believed that calling the CPMA a consumer champion could compromise FOS's impartiality, as the FOS would be linked to the CPMA:

[...] our role is not to be a consumer champion. We are an important part of the safeguards set up in the FSMA structure but our role is not consumer champion. One of our perhaps rather esoteric concerns about a link with a CPMA that is a consumer champion is to continually make that point, that our role is independent of championing of consumer interests or championing of industry interests.[94]

106. Martin Lewis told us that the CPMA should certainly be pro-consumer, but giving it the title of a champion could go too far, and questioned "whether, in reality, a regulator can truly be 'the' consumer champion".[95] As Mr Lewis said, there are organisations, such as Which?, which are already widely regarded as consumer champions. Mr Adam Philips, the Chairman of the Financial Services Consumer Panel, told us that he regarded his panel as a consumer champion.[96]

107. Not surprisingly, consumer groups were more supportive of the 'champion' idea. Citizens' Advice explained that:

The governance of the CPMA should reflect its stated role as a consumer champion rather than a referee trying to balance the interests of consumers and the financial services industry. The interests of industry would of course be represented through both what the consultation describes as the 'have regards' principles of good and proportionate regulation and through continuing practitioner panels. But the CPMA board should be constituted primarily with the view to ensure that the Authority meets primary consumer protection (and we would argue inclusion) objectives.[97]

108. Given the strong opinions from both sides, we pressed the Financial Secretary on whether calling the CPMA a consumer champion was a good idea. He reiterated that the CPMA will focus on conduct of business issues, and because of this pure focus, it will act as a champion for consumers. We are not convinced by this argument, because, by definition, a consumer champion lobbies for consumers, while a regulator ensures that people comply with rules.

109. There is a wider regulatory issue here. It would be possible to have a regulatory system which was so tightly controlled that the risks to the consumer were minimal. However, such a system would be highly costly to the consumer, stifle innovation and would eliminate any individual choice as to the level of risk, and consequently of likely returns, an individual could take. It would have knock-on effects for the wider economy. It would not increase overall welfare. The converse of this, a system in which there was no regulation and abusive behaviour was tolerated, would also reduce welfare.

110. The debate about whether the CPMA should be a consumer champion demonstrates the importance of making sure that definitions are clear. We have no doubt that effective conduct regulation should be in consumers' best interests and will involve a high degree of consumer protection. Nonetheless, branding the CPMA as a consumer champion would be inappropriate, confusing, and potentially dangerous. The job of the regulator is to ensure that regulation is effective and proportionate. That requires a balance between preventing abusive behaviour and ensuring that regulation does not impose excessive costs and restrictions, in order to optimise economic efficiency. Financial markets manage and price risk; they do not remove it. If a regulator is promoted as a consumer champion, consumers may falsely believe that all financial products are risk free, creating moral hazard. It is simply not possible to protect every interest at all times. We strongly urge the Government to drop the title of 'consumer champion' from the CPMA. There are other organisations which campaign for consumers; the regulator's task is to be alert to abuse, and to ensure that consumers are appropriately protected in an open and fair marketplace with the minimum of moral hazard.

Promoting competition and innovation

111. Under section 2 of the Financial Services and Markets Act 2000, the FSA, in discharging its general functions, must have regard to:

i. the need to use its resources in the most efficient and economic way;

ii. the responsibilities of those who manage the affairs of authorised persons;

iii. the principle that a burden or restriction which is imposed on a person, or on the carrying on of an activity, should be proportionate to the benefits, considered in general terms, which are expected to result from the imposition of that burden or restriction;

iv. the desirability of facilitating innovation in connection with regulated activities;

v. the international character of financial services and markets and the desirability of maintaining the competitive position of the United Kingdom;

vi. the need to minimise the adverse effects on competition that may arise from anything done in the discharge of those functions;

vii. the desirability of facilitating competition between those who are subject to any form of regulation by the Authority.

112. As noted above, the FSA needs to have regard to facilitating competition in the financial sector. However, evidence from the last decade suggests that the existence of the FSA did not lead to any increase in competition in financial services. The creation of the new regulatory bodies presents an opportunity to review regulation's role in promoting competition, in particular, as the consumer champion, whether the CPMA should have a primary objective in promoting competition.

113. The industry is broadly in favour of the CPMA having a competition objective, but stops short of endorsing a primary responsibility for the regulator. For example the BBA argued that there is a need "for the authorities to be given responsibility for maintaining a competitive marketplace"[98], but did not elaborate on whether a primary or 'have regards' objective should be given. The Financial Services Practitioner Panel was more explicit, noting that "it is vital that all the new proposed bodies should have to pay regard to the need to maintain competitiveness in the banking and financial services sector." but "It is not a regulator's role to promote competition."[99] The Small Business Practitioner Panel echoed its views, and stressed that "market forces should be allowed to create healthy competition, but as the regulator is intervening in that market, it must have regard to the impact of its actions on competitiveness. However, we do not believe that it is the role of the regulator to actively promote competition."[100]

114. However, since the Government has proposed the CPMA as a consumer champion, a primary competition mandate seems to fit in well with the champion idea, as greater competition will ultimately benefit consumers by lowering prices and increasing choice. The Financial Services Consumer Panel believed that "the CPMA's primary objective should be to champion consumers of financial services and to ensure wholesale market integrity, promoting effective competition in retail and wholesale markets wherever possible and ensuring good consumer outcomes."[101] Peter Vipond from the ABI believed "it is very important [...] [that] both the PRA and CPMA [have] a remit to look at competition and the competitiveness of the sector."[102] Which? also believed that both the PRA and CPMA should have a duty to promote competition, alongside the OFT and Competition Commission:

Whatever its primary objective, we believe the CPMA should have a duty to promote effective competition. It should be given the necessary powers to regulate the sector to achieve this, including the ability to apply specific licence conditions to banks and exercise competition and consumer protection legislation. Its competition powers would be concurrent with the competition powers of the OFT and will enable the regulator to make market investigation references to the competition commission.[103]

The PRA should have a specific duty to promote competition. This would help support its focus on not preserving the status quo or existing institutions, but creating a market with the realistic prospect of failure. It would also ensure that the PRA does not impose excessive barriers on new entrants, by making them carry higher levels of capital or liquidity than existing banks.[104]

115. The Treasury Committee is currently undertaking a separate inquiry into choice and competition in banking, and will report in the following months. However, given the importance of this area to financial regulation more broadly, we asked the Financial Secretary whether the new authorities should 'have regard' to competition, as in the case of the FSA, or whether a primary competition mandate should be given to the PRA or the CPMA.

116. The Financial Secretary reiterated the importance of having competitive markets in financial services, and said that the Government would consider carefully the regulatory boundary between the new authorities and the OFT on competition. He stressed that the CPMA will have a primary objective to enhance confidence and integrity of markets, but seemed to suggest that competition will not be one of its primary objectives, as the regulator would lose focus:

Michael Fallon: [...] What would be wrong with just putting in, as one of its primary objectives, a duty to promote and secure competition at all times? What would be wrong with doing that?

Mark Hoban: I believe it will be reflected in its objectives, but I think we need to be very careful that we don't end up having a series of objectives that means that the regulator loses focus on its primary responsibility. What we have said when it comes to the CPMA is that it must ensure there is confidence in markets and integrity in those markets.

Michael Fallon: So competition would be a secondary objective?

Mark Hoban: I think it flows from those objectives.[105]

117. Mr Fingleton, Chief Executive of the Office of Fair Trading, told us that while "If we go down the road of thinking the regulator sets prices in the market, we would probably have a very inefficient sector, and it might be worse than it is now", he was supportive of "giving [the CPMA] a competition objective, and making sure it has the tools to nudge the transparency issues in the right direction, that it is really forcing the market to sort this issue [of competition] out".[106]

118. Competition is a highly effective means of protecting consumers' interests. The response given by the Financial Secretary when we pressed him on whether promoting competition should be treated as a primary objective for the new authorities was disappointing. The CPMA should have competition as a primary objective. This will benefit consumers directly and indirectly. Not only will there be a greater choice available for consumers, but the transparency which effective competition brings should reduce the need for heavy-handed regulation. Greater competition should also help prevent firms becoming too big to fail. We do not, however, believe that the regulator should have a remit to facilitate innovation—a properly functioning market will do that.

'HAVE REGARDS' CLAUSES

119. More generally, the Government asks whether the regulators should have a single remit, or whether they should be given secondary objectives, or enjoined to "have regard" to particular matters.

Should the FPC have a single, clear, unconstrained objective relating to financial stability and its macro-prudential role, or should its objective be supplemented with secondary factors? [...];
If you support the idea of secondary factors, what types of factors should be applied to the FPC?
How should these factors be formulated in legislation—for example, as a list of 'have regards' as is currently the case in the Financial Services and Markets Act 2000 (FSMA), or as a set of secondary statutory objectives which the FPC must balance? [...];
whether the PRA should have regard to the primary objectives of the CPMA and FPC;
whether the CPMA should have regard to the stability of firms and the financial system as a whole, by reference to the primary objectives of the PRA and FPC;
whether, specifically, the requirement to have regard to potential adverse impacts on innovation or the competitiveness of the UK financial services sector of regulatory action should be retained; and
whether there are any additional broader public interest considerations to which the CPMA should have regard.[107]

120. Too narrow a remit may restrict the effectiveness of regulation. We have already proposed that the CPMA should have a primary objective of promoting competition, and there may be other places where regulators need a spread of objectives. However, we are unconvinced that 'have regards' provisions are effective in directing a regulator. The regulator will have to decide what trade-offs to make when desirable objectives compete: secondary statutory objectives are likely to be a more satisfactory way to specify such objectives for all but the most general provisions.

Consumer protection versus markets regulation

121. While the thrust of the reform is to separate responsibilities more clearly, the creation of the CPMA will leave two rather different areas of the FSA under one roof— consumer protection and markets regulation. The Government believes that consumer protection can be achieved through a strong consumer division within the CPMA, with the markets division responsible for promoting confidence in the integrity and efficiency of the financial markets. However the industry is less comfortable with this arrangement. For example, the Financial Services Practitioner Panel believed that markets should be part of the PRA, rather than the CPMA:

We have found it difficult to identify what the government is trying to achieve with the changes proposed for markets. It seems it would be better to have Markets in a stand-alone regulator, or as part of the PRA, rather than the CPMA.[108]

122. The London Stock Exchange argued that this new arrangement could be made to work, but would need a clearly defined set of responsibilities between the two areas:

The CPMA retail and wholesale responsibilities must be operationally distinct and run by separate CEOs who report into an overarching Chairman. This will ensure appropriate regulation for each division of the CPMA and that each is run by a specialist champion. A strong and cohesive markets division within the CPMA will need to maintain a strong link between the primary market (where companies raise capital) and subsequently where shares in companies are traded (in the secondary market). This is necessary to maintain investor protection, ensure effective real time market supervision, tackle market abuse and execute enforcement activities.[109]

123. The CPMA will have a dual remit between consumer protection and markets regulation. The Government believes that a strong consumer division is required to deliver protection for consumers, while the industry believes there is a need for a strong markets division. It has also been suggested that market supervision might fit more naturally within the PRA. We urge the Government to give more detail about its thinking on this subject in the next consultation paper, and, in particular, what structure it proposes to ensure that both market regulation and consumer matters receive the attention they need. Further consideration may need to be given to the name of the new organisation—we note that the Government has described the title as provisional.

UK LISTING AUTHORITY

124. The Treasury's consultation document stated that "the Government is considering whether the UK Listing Authority (UKLA) should be merged with the Financial Reporting Council (FRC) under the Department for Business, Innovation and Skills, or whether it should remain within the CPMA markets division.[110] The Government believed that there would be synergies from merging the UKLA's regulation of primary market activity with the FRC's functions relating to company reporting, audit and corporate governance. Also, this would help create a "powerful companies regulator", with responsibilities ranging from regulating corporate governance, corporate information, disclosure and stewardship of companies by institutional shareholders.

125. The industry raised significant concerns over this proposed combination between the FRC and the UKLA. The London Stock Exchange, as the world's leading fund raising marketplace, undoubtedly has an interest in this debate. It strongly believed that the UKLA should be located in the CPMA:

To ensure effective regulation, the UKLA must be part of the CPMA markets division. Our strong view is that CPMA markets division, as the main UK securities regulator, would be the appropriate place for the UK Listing Authority (UKLA). The proposed merger of the UKLA and Financial Reporting Council (FRC) offers little by way of synergies and would serve to fragment the regulation and supervision of primary and secondary markets, to the detriment of investors and issuers. The regulation of the UK's capital markets requires experience on a global scale and sophisticated real-time monitoring and response capabilities to ensure preservation of the market quality for issuers and investors. Only the CPMA markets division can provide this.[111]

126. The FRC believed that the proposal could be made to work, but argued that a better option would be to create a new separate securities regulator, combing the FRC, UKLA and the existing markets division of the FSA. It explained that:

A new Securities Regulator would [...] secure the synergies of an FRC/UKLA merger without the same boundary problems. The market monitoring issues would be reduced. The EU problem would be largely eliminated as the new body would closely match ESMA.[112]

127. Having considered the industry's responses, the Financial Secretary announced on 18November 2010 that the UKLA will be located within the CPMA. Writing in the Financial Times, he explained that "some suggested a new standalone securities regulator would provide a better fit with Europe. But we concluded this risks fragmenting the domestic architecture, while also increasing the burdens on regulated firms. A third new regulator may also have not been economically viable. [...]."[113]

128. We welcome the Government's decision to put the UK Listing Authority in the CPMA, rather than splitting responsibility for markets regulation between three bodies, as first proposed. However, there are still issues to be resolved, such as the concern about the UK's corporate governance position within Europe, where the CPMA will represent the UK in the European Securities and Markets Authority, although many corporate governance issues remain with the Financial Reporting Council. The success of the London markets underpins the success of the United Kingdom financial services industry; the markets division within CPMA must be adequately resourced, and may need a wider focus than pure conduct of business.

Financial stability versus consumer protection—an inferior CPMA?

129. As we describe above, the new authorities will need to work closely together. There may be occasions however when authorities disagree with one another, for example the CPMA may carry out a conduct of business investigation which would cause a firm-specific financial stability risk. The Treasury's consultation stated that:

the CPMA will be required to consult the PRA in advance of taking any decision that could cause a firm-specific financial stability risk, and to take the PRA's advice in such matters. The PRA's decision will be final, reflecting the important role of prudential judgement in the delivery of regulation.[114]

130. Angela Knight saw no problem with the PRA having the final say, arguing that "somebody's [decision] has to be final; so the PRA, fine. It has to be somewhere."[115] Which?, on the other hand, argued that the PRA should not be given primacy over the CPMA:

[...] We do not believe that the PRA should be given primacy over the CPMA. To permit the PRA to prevent the CPMA taking a firm-specific conduct decision sends a dangerous message to the industry that only firms which are small enough to fail without causing damage to financial stability will be forced to bear the full consequences of mistreating consumers.[116]

This assumes that large firms will not be allowed to fail, a proposition which we have already discussed in paragraph 89 above.

131. Hector Sants, who will become the head of PRA, believed that it was appropriate that the PRA's decision over the CPMA should be final, but stressed that the CPMA should not be seen as a secondary authority:

[...] conduct risk can evolve into prudential risk. For example, [...] mis-selling can obviously lead to prudential risk through the build-up of poor quality assets on the balance sheet, and it can also be a very important lead indicator of poor cultures, which can lead to prudential mismanagement. So there is a clear interaction between conduct regulation and prudential regulation.

[...] it is right that the CPMA should have to consult before taking an action with the PRA and, if the action it was taking was deemed by the PRA to have systemic implications, it is reasonable that the PRA should have an override. We all know that the cost of this crisis has been multiples of any single mis-selling event and therefore, in terms of the impact on society as whole, systemic failure is the most costly.[117]

132. Given that it is the Government's intention for the CPMA to be a consumer champion, it may be seen peculiar that its decisions can be overruled by the PRA, even on the grounds of financial stability. Mr Sants argued that 'systemic failure is [also] a failure that affects consumers",[118] and that:

this is not about a structure where consumers are second choice or coming off second best. It's about creating a structure where consumers are at the forefront and that is designed to give the best possible result for consumers.[119]

133. In principle the consequences of financial crises could pose more threats to consumers than individual cases of detriment. However, if the new arrangements work properly, choices between financial stability and consumer protection should be rare. If the FPC and PRA can produce a system in which companies can fail without financial instability, then CPMA decisions should not pose systemic risk. We welcome the Treasury's reassurance that the PRA's veto over the CPMA can only be used as a last resort. To ensure that this is so, cases when the power is exercised should be made public. It may not be possible to do so immediately, without threatening stability. In such circumstances the authorities should write to the Chancellor in confidence to notify him, explaining the reasons that the two authorities differed. We expect almost all such reports to be made public at the earliest opportunity, recognising that there may be exceptional circumstances. In such cases arrangements should be made to inform the Chair of this Committee.

134. In the summary of consultation responses, the Treasury stated that "The Government also considers that it would be important for each authority to establish its own distinct identity and supervisory culture. In developing legislation, the Government will seek to ensure that the PRA and CPMA have equal status, with the use of the PRA's veto only where necessary to protect financial stability."[120] If the PRA has the power to require the CPMA not to take regulatory action, there is a danger that the CPMA will be perceived as an inferior regulator. This could lead to problems in attracting high-quality staff and gaining respect from the industry. It is unfortunate that the individual expected to head the CPMA has yet to be appointed, while Mr Sants' role at the PRA has been confirmed. It is important that the PRA and CPMA work closely together on both prudential and conduct of business issues; the absence of a Chief Executive designate of the CPMA risks regulatory thinking being developed only by those responsible for the parts of the regulatory structure which are or will be directly related to the Bank of England. We are likely to return to the relationship between the CPMA and the Bank of England in future work.

90 Ev 196 Back

91 Ev 233 Back

92 Ev 216 Back

93 Q 151, see also Q 154 Back

94 Q 211 Back

95 Q 274 Back

96 Q 632 Back

97 Evw 57 Back

98 Ev 199 Back

99 Ev 236 Back

100 Ev 241 Back

101 Ev 231, see also Q 273 Back