Written evidence submitted by Berwin Leighton
1. This memorandum is submitted by Berwin
Leighton Paisner LLP in response to the Treasury Select Committee's
call for evidence in relation to the government's proposals for
reform to financial regulation in the United Kingdom.
2. We have consulted with our clients very
widely within the financial services industry, spanning the banking,
investment and insurance sectors. The views expressed to us may
be summarised as follows:
The industry strongly welcomes the proposed
new powers and responsibilities of the Bank of England in relation
to macro-prudential regulation. It was a failing of the previous
regime that this responsibility was not clearly allocated. The
Bank of England is the best body to fulfil this function, given
its economic responsibilities and its stature both in the UK and
The industry believes it is sensible
to have a single body responsible for the investigation and prosecution
of economic crime. Some concerns have been expressed about the
fact that investigation and prosecution of civil market abuse
may be split from the investigation and prosecution of criminal
insider dealing and market manipulation. This is viewed as undesirable
due to the duplication that it would create, and potential disagreement
between the CPMA and the ECA as to whether a civil or criminal
sanction is appropriate in a particular case. Further, concerns
were expressed about whether the ECA would be able to attract
sufficient calibre of staff if it were to be publicly funded rather
than via an industry levy (as is the case for the FSA) and therefore
unable to pay sufficiently attractive salaries. If the ECA is
not able to pay at competitive rates, there is a concern that
it will be destined to fail as an institution.
Clients have universally expressed the
view to us that abolishing the FSA and replacing it with two new
regulatory bodies would result in a less effective and more costly
system of regulation. The various reasons for this are discussed
in detail below. Clients felt that the proposed changes were being
made for purely political reasons and that the new system would
be weaker than the current system. Moreover, there was a sense
that making representations on the negative impact of the new
structure would be pointless given the Conservative Party's pre-election
pledge to abolish the FSA. It is therefore widely considered that
making representations on the fundamentals of the new structure
would be a waste of time.
3. The reasons why we and our clients view
the new PRA/CPMA structure as a retrograde step include the following.
4. The various reasons given by the government
for abolishing the FSA and splitting its role between the PRA
and CPMA are incorrect, as they are based on misconceptions about
the current regulatory regime, or are illogical.
5. The Financial Secretary to the Treasury,
Mark Hoban MP, set out the government's rationale for abolishing
the FSA in a speech on 26 July 2010. The four principal reasons
given are each addressed below.
(a) Supervisors need greater discretion to
6. The current system of supervision by
the FSA was described as a tick-box approach. Mr Hoban explained
that he wished to see the financial regulator have much greater
discretion to require firms to take action that the regulator
This statement suggests a lack of understanding of how the current
regulatory system operates.
7. In fact, the FSA certainly does not operate
a tick-box approach but rather exercises very wide discretion
in its oversight of authorised firms. In view of the wide powers
and broad discretion that the FSA has, it is, in practice, able
to get firms to take virtually whatever action it deems appropriate.
8. These powers include:
the ability to require firms to hold
additional regulatory capital to reflect perceived additional
operational risk if the firm does not take steps that the FSA
wishes it to take;
the power to require firms to commission
costly "skilled person reports" on particular areas
of a firm's business regarding which the FSA has concerns;
the threat to remove a firm's regulatory
permissions (ie its ability to continue some or all of its regulated
activities) via its "Own initiative variation of permission"
broad high-level obligations on firms
(the breach of which results in unlimited fines for firms and
members of senior management);
the discretion to raise the firm's risk
assessment level, resulting in more frequent (and, in some cases
"close and continuous") regulatory attention;
the power to object to individuals being
appointed as members of senior management, on the basis that the
FSA is not satisfied that they are fit and proper;
the threat of negative publicity emanating
from the FSA if a firm does not act in a way that the FSA wishes;
the wide discretion to commence formal
disciplinary investigations into firms and/or members of senior
management, if it appears to the FSA that there are grounds to
believe that one or more of the FSA's very high-level Principles
or other widely-drawn rules may have been breachedresulting
in significant management time and legal costs being incurred,
and (if a case is proven or a settlement secured) an unlimited
fine against the firm and/or the relevant individuals.
9. These powers are discussed in more detail
in Compliance Monthly.
In practice, we have seen the FSA use these powers to get firms
to agree to take steps they were arguably under no obligation
to take, such as to stop selling certain products entirely, to
replace individuals on the Board of firms and requiring other
individuals to be promoted to the Board, and blocking acquisitions
of other regulated entities.
10. The FSA uses these powers as part of
its new "intrusive approach" to supervision
and we have seen no evidence to suggest that the FSA currently
has insufficient powers in order to pursue this more intrusive
11. In summary, it is difficult to imagine
a situation in which the regulator could have greater discretion
in the way that it supervises firms than that currently exercised
by the FSA.
(b) Prudential and conduct of business regulation
result in irreconcilable conflicts
12. Second, as a rationale for abolishing
the FSA and replacing it with the PRA and CPMA, Mr Hoban stated
prudential regulation of individual firms
(ie ensuring that they are soundly and prudently managed, with
adequate financial resources); and
conduct of business regulation of individual
firms (ie ensuring that the day-to-day conduct of their business,
including customer and counterparty dealings, are conducted fairly),
were inherently in conflict and therefore needed
to be split out to two separate regulators.
13. We believe that this contention is misconceived
for a number of reasons.
14. We consider that it is debatable whether
there are in practice real conflicts of interest between prudential
and conduct of business regulation of individual firms. However,
regardless of the view taken on this issue, it would plainly be
much more desirable for any such conflicts to be resolved by the
regulatory body itself, rather than to place upon authorised firms
the unfair burden of having to follow the wishes of two different
regulators who may well be requiring the firm to take mutually
inconsistent actions. This is of fundamental importance in assessing
how the new regime is to be structured.
15. Furthermore, the very significant majority
of authorised firmsnamely all those who are not retail
or investment banks or insurerswill under the new regime
continue to be both prudential and conduct of business regulated
by a single regulator, the CPMA. If the government genuinely believes
that prudential and conduct of business regulation of individual
firms presents irreconcilable conflicts, why does it propose to
retain this approach for the vast majority of firms (including
some very significant global businesses)?
16. Finally, one of the core lessons to
be learnt from the various reviews of the regulation of Equitable
Life Assurance Society prior to its closure to new business
was that it was undesirable for prudential and conduct of business
regulation to be undertaken separately, and that the much better
model was for prudential and conduct of business regulation to
be fully integrated. It would be wrong for these important findings
on how to improve regulation to be ignored.
(c) Need for dedicated "consumer champion"
17. The third reason given by Mr Hoban for
abolishing the FSA and replacing it with the PRA and the CPMA
is that in recent years the FSA has focused far too much on prudential
regulation of individual firms and not enough on consumer protection.
As a result, Mr Hoban suggests, it is necessary to have a dedicated
"consumer champion" as regulator of retail financial
18. The statement that the FSA has historically
focused far too much on prudential regulation and not enough on
consumer protection is simply incorrect. In fact, as frequently
stated publicly and as accepted by the FSA, the opposite is true.
Since the onset of the financial crisis the FSA has been widely
criticised for having devoted far too much resource to its "Treating
Customers Fairly" initiative (designed to ensure that consumers
were being properly protected) and accompanying enforcement actions
in the retail sector, at the expense of resource it should have
been devoting to identifying what events may cause authorised
firms to fail (ie core micro prudential regulation).
19. We believe there is sufficient evidence,
as highlighted above, to support the proposition that the FSA's
Supervision and Enforcement divisions have worked together very
effectively to ensure that, in particular, ordinary customers
of retail products have received far greater focus and protection
over the past few years than ever before. We do not believe that
a dedicated consumer protection and markers agency is necessary
in order to achieve the desired outcomes of the present government
and we have not seen any evidence to suggest that a separate consumer
protection body will achieve better results than the FSA.
20. Furthermore, it should be noted that,
under the government's proposals, the CPMA will not in fact be
a dedicated "consumer champion" at all. Rather, contrary
to the statement that the CPMA will be a "strong consumer
champion in pursuit of a single objective", it will have
a wide range of regulatory responsibilities, of which consumer
protection will be just one. Other responsibilities of the CPMA
Micro-prudential regulation of thousands
of financial services firms, including fund managers, corporate
finance advisory houses and commercial insurance brokers;
Conduct of business regulation of wholesale
financial services, ranging from complex commodity derivatives
and global insurance programmes to advisory work on takeovers
and acquisitions; and
Oversight of listed stock exchanges and
regulation of listed companies.
21. As a consequence the CPMA would appear
to be little better placed to be a "strong consumer champion"
than the FSA is currently able to achieve.
22. Finally, it should be noted that the
FSA has already adopted a change in approach to retail financial
services products, with the intention of acting more proactively
to review and assess new products to seek to ensure that risks
are properly disclosed to consumers and problematic products are
prevented from coming to market.
23. Accordingly, the role that the government
is seeking to create for the CPMA closely resembles the role that
is already undertaken by the FSA under the current regulatory
(d) Alignment of UK and EU regulatory structures
24. A further basis for reforming regulatory
bodies in the UK put forward by Mark Hoban MP is the expressed
desire to mirror in the UK the regulatory structures that are
being implemented at EU level.
25. However this statement appears to be
based on a misunderstanding of the changes to EU regulation that
are being implemented with effect from 1 January 2011. In particular,
three new EU-wide regulatory bodies are being created, as follows:
The European Banking Authority, to be
based in London;
The European Insurance and Occupational
Pensions Authority, to be based in Frankfurt; and
The European Securities and Markets Authority,
to be based in Paris.
26. As their names indicate, these three
bodies will each be focused on overseeing regulation of specific
sectors. Their role will encompass both prudential and conduct
of business regulation in each of those sectors.
27. As a result, the UK regimewhich
is not at all to be based on sector areas but rather which will
split regulation of banking and insurance between the PRA and
the CPMAwill operate very differently to the EU regime
that the government believes it would be desirable to mirror.
28. A number of our clients, particularly
those in the insurance sector, have expressed the view that a
new regulatory structure with supervisory bodies focused on specific
sector areas would be more effective than that proposed by the
government. This would also have the benefit of directly mirroring
the three new supervisory bodies at the EU level.
29. We believe that there are a number of
further inherent weaknesses in the proposed new regulatory structure.
These are summarised briefly below:
(a) The new structure will result in significantly
higher compliance costs for banks and insurers (and therefore,
indirectly, their customers), as they have to deal with two different
regulators with potentially inconsistent objectives and which
are unlikely to be closely integrated. Spending time with supervisors
to ensure that they understand your business and the products
that you sell can take a significant amount of time; this will
now need to be duplicated. Overall the regulatory burden on firms
will be much greater.
(b) The new structure will be more costly from
the supervisors' perspective. The PRA and the CPMA will collectively
require more staff than the FSA currently requires, due to the
duplication of activities that will be unavoidable under the new
regime. It is likely that each body will have its own authorisation
process, its own supervision teams and its own enforcement functions,
as well as other specialist groups necessary to enable each regulatory
body to fulfil their statutory role. This will require a materially
higher levy on the financial services industry, a cost which will
ultimately be passed on to customers.
(c) We anticipate that the PRA will be housed
within the Bank of England while the CPMA will be housed in the
FSA's offices in Canary Wharf. The distance between the two offices
will make it much more difficult for the two bodies to be properly
integrated and share information and resource in an effective
(d) We have some concerns about the PRA being
established as a subsidiary of the Bank of England. While there
will be some Bank of England ex-officio representation on the
Board of the PRA, and the PRA will have its own independent statutory
duties, there is a risk that the PRA will feel compelled to consult
the Bank of England each time that there is a difficult regulatory
judgement call to make. This would severely hamper the PRA's ability
to operate as an effective supervisor of banks and insurers.
(e) The Chancellor of the Exchequer has been
vocal in criticising the tripartite structure of HM Treasury,
the Financial Services Authority and the Bank of England, observing
that important responsibilities fell between the cracks and that
"when the crunch came no one knew who was in charge".
This is also what the FSA's Chairman Adair Turner referred to
as "underlap" in the regulatory architecture.
However, the prospect of issues falling between the cracks as
a result of either uncertainty or division of responsibility is
almost certain to increase under the proposed new structure, in
which four bodies (HM Treasury, the Bank of England, the PRA and
the CPMA), rather than three, will have supervisory responsibilities.
30. If the proposed new regulatory framework
is implemented, we believe that much careful thought will need
to be given to the coordination of the separate authorities with
one another and streamlining processes to overcome the operational
challenges highlighted above. We envisage several structures being
established in order to facilitate an appropriate level of communication
and collaboration between the authorities. In particular, consideration
should be given to establishing a body to allow members to share
information about emerging risks and mutual concerns and to discuss
issues where responsibilities overlap.
31. Our final point relates to concerns
we have in relation to the government's proposals to extend OIVoP
powers under the new regime, supposedly for the purposes of enhancing
the CPMA's ability to provide effective consumer protection.
32. As a result of changes brought in by
the Financial Services Act 2010, the FSA's OIVoP powers have already
been significantly widened, removing some of the restrictions
which were previously in place and allowing the FSA to use its
powers if it appears that this would be "desirable"
in support of any one of the FSA's statutory objectives.
33. We believe that this power is currently
very wide and at risk of being used improperly by the FSA to get
firms to take steps for which there may be no genuine regulatory
obligation. We do not consider that there is any good reason to
extend the power.
34. The government has stated that the aim
of its proposed programme of reforms is to build the foundation
of renewed trust and confidence in the financial system by creating
transparency and accountability. Whilst we agree that the reasoning
behind the reforms is important, we do not believe that the government
has presented sufficient evidence to demonstrate that this cannot
be achieved under the current regulatory system, or that there
is a better chance of these objectives being realised under the
35. Whilst it is widely accepted that mistakes
were made by the FSA in relation to the recent financial crisis,
under the auspices of the previous government the FSA has been
proactive in implementing a programme of improvements which has
resulted in a radically different approach to supervising the
largest financial services firms. It is our view that the new
government has not given due consideration to improving the current
system of regulation in the UK and has been too quick to conclude
that the best, and only, way forward is to disband the FSA and
to implement reforms which themselves have no proven track record.
36. In summary, we do not believe that the
evidence put forward by the government to date supports Mark Hoban
MP's statement that "reform of the UK's regulatory system
would be insufficient and incomplete without thorough institutional
22 September 2010
16 HM Treasury's consultation paper entitled A new
approach to financial regulation: judgement, focus and stability,
July 2010. Back
Mark Hoban MP's speech stated: "We want to create a new supervisory
approach that takes into account the lessons of the past but that
is also designed for the future-a future in which supervisors
should have greater discretion to use their own judgement, and
to take a more risk-based approach to their work." While
recognising that significant improvements have been made by the
FSA in its approach to prudential regulation, Mr Hoban nevertheless
compared the proposed new regime with the FSA's approach before
the improvements had been implemented: "These changes will
enable supervisors to build on the changes the FSA has put in
place and take a more risk-based and judgement-led approach to
prudential regulation, freeing supervisors from the `tick-box'
approach that typified supervision prior to the financial crisis." Back
An article by the authors, published in the October 2009 edition. Back
The new approach of the FSA was outlined by chief executive Hector
Sants in a speech on 9 November 2009: "The FSA has moved
firmly into the realm of making `judgements on judgements'. This
is different from how we operated in the past... [Our new approach]
focuses on the risks inherent in a firm's business model and enables
us to be proactive and not reactive to the management of these
risks. Our outcomes-focused philosophy requires supervisors to
judge firms on the likely consequences of their decisions." Back
Mr Hoban described these two areas as having "multiple conflicting
objectives" leading to "in built tensions between different
objectives". He further states that "effective conduct
and prudential regulation require very different skills"
and "different approaches and cultures". Back
See the Baird Report The Regulation of Equitable Life an independent
Mark Hoban MP stated that "The combined remit of the FSA
meant that participants in financial services and markets, particularly
ordinary consumers of retail products, did not always get the
degree of regulatory focus or the protection they may have expected
or required". Back
This has been accepted at the highest levels within the FSA as
stated by Hector Sants in his speech of 12 March 2010: "The
TCF initiative has yielded some benefits, particularly with regard
to raising management awareness of the outcomes the FSA seeks
but it has not yet delivered substantial on-the-ground benefits
to consumers..." Back
See Hector Sants' speeches of 12 March 2010 and 24 June 2010. Back
Mark Hoban MP's speech explained that the new UK regulatory structure
"needs to be a design that fits within the broader regulatory
architecture of the regulatory reforms being drawn up at the European
and international levels whilst recognising the particular interests
of London as a global financial centre". Back
Mansion House speech, 16 June 2010. Back
Speech to the FSA Annual General Meeting, 24 June 2010. Back