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

Written evidence submitted by the Investment and Life Assurance Group


  1.1  Whilst we welcome the opportunity to comment on the proposed new system in response to the specific questions posed by the Committee, our remarks are necessarily coloured by our belief that institutional reform on the scale envisaged is not justified by the events of the recent financial crisis. As such, it will inevitably impose considerable, additional financial costs and burdens on:

    — the financial services industry in meeting the costs of the new structure, and

    — a significant number of individual firms—large, medium and small—in being supervised by two domestic regulators.

  1.2  That said, we acknowledge the need for a more purposeful approach to national financial stability entailed by the creation of a new body (Financial Policy Committee or FPC) within the Bank of England (BoE).

  1.3  However, we are less convinced of the arguments surrounding the proposed abolition of the Financial Services Authority (FSA) and the imposition of a system of dual regulation and supervision over many firms in the UK industry. Whilst we recognise a case for ceding back responsibility for prudential regulation and supervision of the banks to the BoE, other reforms should have been targeted at the internal workings of the FSA to achieve a more focused and sharper organisation rather than dividing up responsibilities between two brand new institutions.

  1.4  In particular, we are aware that EU initiatives such as the Capital Requirements Directives (affecting banks and investment firms) and Solvency II legislation (insurers) will govern firms' prudential reporting and capital reserves—as well as the whole business of financial risk management—and be implemented broadly at the same time as the new regulatory structure formally takes effect. It has to be said that not only is the FSA well advanced in developing these measures in a UK context but is also working closely with the industry in preparing firms for their implementation. To have this important process interrupted by upheaval and dismantlement of the FSA would be a very retrograde step.


Will the Government's financial regulation proposals improve the framework for financial stability in the UK? Will they work in a crisis?

Do the Government's proposals get the balance right between tackling the problems of the last crisis and preparing the UK financial system for the next one?

How do the Government's proposals dovetail with initiatives currently being undertaken at European and the global level?

What costs will the regulatory structure place on consumers?

  2.1  In theory, the proposed establishment of new institutions, and particularly the FPC, should improve financial stability in the UK but the "acid test" will only come when the next crisis occurs and how effectively these new arrangements then operate in practice. It is vital that there is full and proper co-ordination of activities and a clear decision-making path. On that level, we harbour concerns especially given the number of bodies involved.

  2.2  Some critics have argued that the new framework only responds to the last financial crisis and that all crises are, by their very nature, unpredictable. Whilst we accept that some regulatory changes should be made it is more about having the right people, processes and culture in place to manage the next crisis than the make-up of the institutions themselves.

  2.3  Equally, the origins of the crisis will have a major bearing on the effectiveness of UK action. Where the crisis is of a global or European nature the scope for unilateral measures—and their ultimate success—may be limited. It is therefore essential that, at least on a European level, machinery to give early warnings and take remedial action is fully integrated as between EU and UK institutions. In particular, the proposed FPC and PRA must have a close and continuing rapport with the embryonic European Systemic Risk Board (ESRB) and European Supervisory Authorities (ESAs), respectively, involving inter-linking systems and processes.

  2.4  Inevitably, setting up this new regulatory structure will involve additional establishment and on-going costs and mean that, in having to bear the funding itself, the industry will be forced to pass on much of this cost to consumers if it is to remain competitive in the global marketplace. In particular, the insurance sector regrets that subsequent higher premiums and product prices, and possibly even complete withdrawal of some product lines, will only excacerbate the existing savings and protection gaps in this country—especially when it played no part in causing the recent crisis.

  2.5  We enlarge on these issues in later comments.


Do the Government's proposals appropriately assign roles and responsibilities between the different regulatory institutions?

Will there be unintended consequences of the Government's proposals for regulation on the prospects for non-bank financial institutions?

  3.1  As far as can be gauged, the split of roles and responsibilities appears logical if one accepts the premise that regulation is best divided between two bodies—three if the FPC is included.

  3.2  As to "unintended consequences" these only really become apparent after the event but based on the last financial crisis there are reasons to fear that they might re-occur and that the whole financial services sector may have to pay again for the sins committed by one particular sector. We would hope that none of the bodies would be so fixated on the need to take either pre-emptive or remedial action at short notice that they did not, at the same time, give some consideration to the impact of such measures on different sectors.


Should the FPC have a statutory remit? If so, what should that remit be?

How should the success of the FPC, both in and out of crisis, be measured?

Given the international regulatory framework, what macro-prudential tools should be granted to the FPC?

Has enough been done to mitigate the risk of conflict between the FPC and the Monetary Policy Committee (MPC)?

Is the FPC appropriately structured in terms of:

  —  the balance between internal and external members? and

  —  the size of the Committee?

What characteristics, experience and qualities should the Government look for when appointing external members of the FPC?

  4.1  We do believe that the FPC should have a statutory remit in order that, at all times, it acts within its recognised boundaries and is accountable for all its actions. As proposed, its primary remit is focused on preserving financial stability and we feel that its terms of reference should be extended to include secondary factors to take account of wider socio-economic considerations in much the same way as the MPC does.

  4.2  In a business sense any measurement of success must be linked to its objectives but, in reality, the FPC will be judged by the actions it takes in either responding to or preventing the next crisis in the UK. If such decisions prove effective then it will be deemed a success but anything less may call into question its fitness for purpose. That apart, it is difficult to quantify how success should be measured on a formulaic basis as crises will vary in type, origin and impact. Certainly in its day-to-day operations, the FPC should adopt the procedures of the MPC and publish minutes and reports on a regular basis to aid transparency and public scrutiny.

  4.3  In managing the exercise of its macro-prudential functions upwards, it should have the means and authority to communicate swiftly with corresponding international bodies ie. G20 Financial Stability Board (FSB) and ESRB, and be able to take unilateral measures consistent with any action taken on an international level. In managing downwards, it should, in emergency situations, have the power to direct both the PRA and CPMA to take action without due consultation although in an operational sense some prior notice will need to be given.

  4.4  It is difficult at the drawing board stage to visualise how direct conflicts could arise between the MPC and FPC in the exercise of their duties as within the BoE their objectives are linked in relation to the workings of the whole economy. Both bodies should have secondary responsibilities to take into account these wider considerations though in practice it is difficult to predict the resultant effects elsewhere eg. actions by the MPC to raise or lower interest rates and its immediate or measurable effect on financial stability, and equally any actions by the FPC in closing financial markets in triggering sudden changes in price stability.

  4.5  It is important, however, that where actions have direct or indirect consequences the relationships between the two committees are underpinned by a "memorandum of understanding"-type document to ensure a formal process of engagement and co-ordination. Additionally, within the Bank of England, a similar document should be prepared to define the relationships between the Court of Directors and the FPC (presumably on similar lines to the MPC).

  4.6  On the size, composition and character of the FPC, we agree that the numbers proposed are of the right order and fully endorse the need for balance of membership to reflect a cross-spread of interests and abilities in financial sevices. As proposed, and against the background of the recent crisis, there is a danger that the FPC Board will be bank-issue orientated and it is important that the non-Bank appointees provide the necessary breadth of knowledge in other areas. These appointees should have a sound understanding of strategic and systemic risk and also occupy positions of prominence within their own financial sectors to be able to draw on vital, practical experience. Thus the ideal remit in terms of appointing external members is to ensure that other sectors, particularly the insurance and securities markets, are adequately represented, rather than filling the extra places with regulatory and academic-based persons.

  4.7  Above all, we believe that the external appointees should be of senior NED-type quality bringing independence, diversity and challenge to all the FPC's activities.


Should the PRA be the lead authority over the Consumer Protection and Markets Authority (CPMA)?

Is it appropriate for the PRA (and CPMA) to adopt a judgements-based approach to financial regulation and supervision?

  5.1  We believe that the PRA should be the principal regulator of financial firms and have authority over the CPMA. Otherwise, firms will suffer from uncertainty and confusion as to which body is in charge and potentially be faced with having to carry out different edicts that may be in apparent conflict with each other eg having to increase capital reserves at the same time as being instructed to allocate more resources to monitoring financial promotions. It is vital that the two bodies operate as closely as possible in order to ensure that the whole regulatory regime is seamless and runs as smoothly and cost-effectively as possible.

  5.2  The notion that both regulatory bodies should move to a judgement-based approach is both complex and far from straightforward. For example, in applying new rules based on EU regulations and directives, the scope for a judgements-based approach will be severely limited as in most cases adoption of such measures will be governed by prescription. Indeed, there are many smaller and medium-sized firms that prefer to abide by the (FSA) rulebook rather than having to operate under a principles-based regime which may provide less certainty and consistency.

  5.3  We appreciate that appointing an executive committee under the auspices of the PRA Board, to include non-executives, may help to instil a more judgements-based culture, but doubts will remain as to how this approach percolates down to actual officials responsible for day-to-day supervision of firms. From recent experience within the industry, there is an impression that supervisors are uneasy in dealing with firms that interpret and discharge the same rules in different fashions. If this is to be perpetuated, there is a continuing risk that firms may suffer from lack of consistency on the part of supervisors, either being too cautious or cavalier in what they allow firms to do. How one solves this conundrum can only be achieved by ensuring that all supervisors are sufficiently skilled and experienced in making such judgements and in giving the necessary confidence to firms.

  5.4  Thus in an ideal regulatory world, there should be room for both rules and judgements but whatever the final mix there must be a level of clarity and certainty that gives no grounds for dual or misinterpretation.


Do the reforms provide adequate protection for the consumer?

To what extent will the regulatory and administrative burden increase for those firms who now have to deal with two regulators?

  6.1  Setting up a dedicated body with the words "consumer protection" in its title would appear to confer the status of a consumer champion with an over-arching role to provide adequate safeguards. However, it is essential that such a body operates on an even-handed basis in discharging its functions taking into account the legitimate needs and interests of firms as well as consumers. A careful balance has to be struck between consumer protection and ensuring that the financial services sector is not unduly constrained in facilitating access to suitable products and services. Otherwise, there lies the danger of a cumbersome and costly conduct of business regime for firms that will then have unintended consequences for consumers in pushing up prices and involving layers of detailed and largely un-read documentation; thus leading to a widening of the already large savings and protection gaps.

  6.2  More fundamentally, the whole concept of firms having to report to two regulators takes the industry back over 10 years, before the FSA was formed, and which even at that time proved costly and burdensome to firms even though the rule book was at most half the current size. Returning to split regulation will be a real and significant issue for an estimated 1,500-2,000 firms, requiring new relationships to be established and imposing extra costs and resources both during transition and thereafter. If it is to work effectively, then the systems, processes and controls of the two organisations must be streamlined and inter-linked and the respective officials must communicate with each other on a regular, on-going basis.

  6.3.  Moreover, the Government's preliminary cost-benefit analysis, set out at the back of its consultation paper is threadbare in the extreme, based on only two options—"do nothing" or "proceed"—with nothing in between. It contains only a broad approximation of transitional costs for the new institutions and makes vague assumptions that firms will notice only minimal cost increases of a transitional and on-going nature. We firmly believe this will not prove to be the case and that further and more detailed assessments are required.


Should any of the proposed bodies be given responsibility for promoting competition in the banking and financial services sector?

Should any of the proposed bodies have a role in promoting the City of London?

  7.1  In neither case, do we see such an overt role for any of the proposed bodies in the new regulatory environment. Certainly, they should take care to avoid any measures that may have a direct, serious and adverse impact on competition and innovation in the industry but their prime responsibilities have to be to ensure efficient regulation and supervision and clean, fair and orderly markets.

  7.2  In any case in the City of London, a new purpose-made body—TheCityUK—has recently been created to undertake the task of actively promoting the City and UK financial services at home and abroad and duplication of effort should be avoided.

22 September 2010

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