Written evidence submitted by the Investment
and Life Assurance Group
1. EXECUTIVE
SUMMARY
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.
2. OVERALL
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.
3. POWER, ROLES
AND RESPONSIBILITIES
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.
4. THE FINANCIAL
POLICY COMMITTEE
(FPC)
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.
5. THE PRUDENTIAL
REGULATION AUTHORITY
(PRA)
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.
6. THE CONSUMER
PROTECTION AND
MARKETS AUTHORITY
(CPMA)
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.
7. OTHER ISSUES
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
| 
