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

Written evidence submitted by Berwin Leighton Paisner LLP


  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.[16]

  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 internationally.

    — 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 direct firms

  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 deems appropriate.[17] 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" (OIVoP) powers;

    — 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; and

    — 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 breached—resulting 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.[18] 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[19] and we have seen no evidence to suggest that the FSA currently has insufficient powers in order to pursue this more intrusive approach.

  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 that:

    — 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.[20]

  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 firms—namely all those who are not retail or investment banks or insurers—will 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[21] 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" regulatory body

  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.[22] As a result, Mr Hoban suggests, it is necessary to have a dedicated "consumer champion" as regulator of retail financial services.

  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).[23]

  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 will include:

    — 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.[24]

  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 structure.

(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]

  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 regime—which 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 CPMA—will 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 way.

    (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".[26] This is also what the FSA's Chairman Adair Turner referred to as "underlap" in the regulatory architecture.[27] 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 proposed regime.

  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 reform".

22 September 2010

16   HM Treasury's consultation paper entitled A new approach to financial regulation: judgement, focus and stability, July 2010. Back

17   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

18   An article by the authors, published in the October 2009 edition. Back

19   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

20   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

21   See the Baird Report The Regulation of Equitable Life an independent reportBack

22   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

23   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

24   See Hector Sants' speeches of 12 March 2010 and 24 June 2010. Back

25   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

26   Mansion House speech, 16 June 2010. Back

27   Speech to the FSA Annual General Meeting, 24 June 2010. Back

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