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

Written evidence submitted by Intellect


  Intellect is the UK trade association for the IT, telecoms and electronics industries. Our members account for over 80% of these markets and include blue-chip multinationals as well as early stage technology companies, and play a crucial role in virtually every aspect of our lives. In the UK these industries together generate around 10% of GDP and 15% of trade, directly employing over one million people.

  We are a trusted partner for Government, both in terms of policy development and policy implementation across numerous sectors. We look to ensure that all relevant engagement of policymakers and regulators with industry is both easy and as valuable as possible in order that the technology industry may play the fundamental role it merits in the success of UK plc.


  Intellect believes that the changes to the regulatory system of financial services in the UK must be supplemented by a greater understanding within the new regulatory bodies of the role that technology plays in the functioning of this critical industry.

  Technology and financial services are inextricably linked in the 21st Century. A durable and effective regulatory system that learns from the problems of the last crisis in order to prepare for the next one must be able to understand and analyse that which underpins the entire financial services industry—technology.

  Developments in recent years have presented the retail-banking sector in particular with information technology challenges of a new, complex and demanding nature. Intellect's experience of the current regulatory system is one that has found a knowledge gap relating to the role of technology within financial services; a knock-on effect being that proposals are brought forward that are cumbersome, ill-informed and demonstrate the lack of a joined-up approach within the existing financial regulator. Consequently Intellect believes that:

    — There should be a formal recognition of the role of technology within the Government's planned reforms through a commitment to develop better expertise and knowledge amongst the regulators' staff.

    — The new regulatory bodies should learn from the mistakes that the Financial Services Authority has made in the past in failing to use the neutral expertise that is available to them outside of the traditional financial services interest groups.

    — More formal lines of communication should be established with the technology industry to each of the regulatory bodies to ensure that advice is available quickly when needed and to ensure greater stability, smarter regulation and improved implementation.

    — There should be more focus on the importance of flows of information within the financial services system—between banks, from banks to regulators and on an international scale. Regulators will not be able to perform their functions if they are not able to receive and analyse accurate information from the system. The downfall of Northern Rock in 2007 was the first major event in recent years to highlight the need for financial institutions to have responsive, up-to date IT systems so that information can be shared, evaluated and acted upon.

    — The regulation of infrastructure provision, whilst necessary, should be refined to avoid discouraging smaller, innovative suppliers from being involved.

  With the establishment of the Prudential Regulatory Authority (PRA), the Consumer and Market Practice Authority (CMPA) and the Financial Policy Committee (FPC) there is an opportunity to address these issues and ensure that the new regulatory authorities are fully equipped to tackle the problems that a rapidly changing financial services system will face.


  1.1  Intellect's Financial Services Programme brings together over 150 suppliers of information systems, services and consultancy to the financial services sector. After the public sector, the financial services industry represents the largest market place for many of Intellect's members. From software companies to service providers, enabling trading platforms and payment processing, technology is crucial to the sector. As such, the industry's regulatory regime is a key issue as, in many cases, it will be our members working with the financial institutions to ensure compliance. Global IT service providers sit alongside many specialised smaller companies and all play an active role in imparting their expertise and experience to better inform the development of financial services policy at a cross roads in the industry's development.

  1.2  Many of Intellect's members are heavily involved in providing the fundamentally important technology platforms upon which the UK's financial services industry is built. For example, these members help facilitate the 5.7 billion automated payments that are made through the banking system on an annual basis. Indeed, through Intellect our members are working with the Payments Council to develop the future technology that will afford consumers and businesses alike more convenient, secure and efficient ways to conduct their transactions. Similarly, the 40 million online bank accounts that are registered in the UK would not function without the technological capability that our members design and supply.


  2.1  The relationship between the financial services industry and the technology sector is one of fundamental importance. Technology not only plays a critical role in the functioning of the financial services industry, it is a hugely important factor in ensuring that the individual institutions within it can operate more responsibly and remain competitive in the global marketplace.

  2.2  By facilitating greater, more accurate flows of information within and between banks, technology can diminish the threat of bank failure and systemic risk. The downfall of Northern Rock in 2007 was the first major event in recent years to highlight the need for financial institutions to have responsive, up-to date IT systems so that information can be shared, evaluated and acted upon. In 2008, the demise of Bradford and Bingley was, in part, because of antiquated information technology; the bank's senior figures did not have access to the company's up-to-date financial figures.

  2.3  In the event of such a failure, the processes that will be in place to ensure that customers are guaranteed to get their money back, are technology enabled. It is these systems, when implemented, that will play a significant role in increasing customer confidence in their banks, tapering fear for the safety of their money and reducing the chance of another run on a bank.

  2.4  By allowing new entrants to go to market with technology-enabled banking products and services, there is also the prospect of greater competition and choice for consumers. Indeed, technology can tread where regulation dare not—by helping to make it commercially viable for banks to lend to a wider cross section of suitable SMEs by allowing them to paint a more accurate picture of which SMEs are sound investments and which are not (as opposed to classifying all SMEs as undesirable "risks").

  2.5  However, there are also technology-based risks that equally need to be understood so that, where possible, they can be mitigated. The "Flash Crash" of May 2010, where the Dow Jones Industrial Average plunged 600 points and then recovered in the space of 15 minutes demonstrated how a system that relied upon technology to function could potentially be destabilised by this very reliance, with knock on effects for the economy. Similarly, the intertwined legacy IT systems that many established banks' business-critical operations are built upon, represent an obstacle to business change to meet ever-evolving regulatory, consumer and market pressures.

  2.6   Consequently, if the UK's banking sector is to be reformed to meet the challenges posed in recent years and provide the backdrop to economic recovery, policy not only needs to reflect what technology can facilitate today, but what it will enable in the future. Regulation will only be effective and durable if it takes into account how it will be implemented and how the application of technology can be complementary. For an industry like financial services that relies so heavily upon technology, it is essential that policy is developed at all stages with a full understanding of it.


  3.1  Please note: Intellect has not responded to all the issues set out in the Inquiry's Terms of Reference. Answers that are given to questions below are based upon Intellect's Members' expertise in the field of financial services.

  3.2  As the consultation on some of the Government's proposals for reform of the regulatory system are still ongoing, there are only some issues that Intellect can give its views on at this time as consultation with Members is ongoing,


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?

  4.1  Intellect welcomes the vigour with which the Government is addressing the issue of reform of the financial services industry. Its multi faceted approach to issues ranging from competition; to the structure and focus of regulators; to the availability of finance for business, amongst others, are necessary if the problems that caused and resulted from the last crisis are to be resolved. However, there are a number of issues that Intellect has identified.

  4.2  Potential lack of technology expertise within regulators

  Intellect believes there is a significant omission in many of the recent regulatory and policy proposals from a number of Government departments, regulators and executive agencies specifically relating to the technology expertise and knowledge of staff.

  4.2.1  There is a general failure to recognise the importance of the technology that underpins the UK financial system, and the individual institutions within it, to its stability, prosperity and ability to deliver customer and economic benefit. This lack of understanding will translate into a negative effect on the durability and effectiveness of the regulatory regime as the development of technology outstrips the ability of regulation to develop as well. This will have the effect of restricting the evolution of the financial services industry as innovation is stifled, and/or it will fail to take into account the new regulatory challenges that the development of new technology poses.

  4.2.2  HM Treasury's consultation "A new approach to financial regulation: judgement, focus and stability" suffers from a similar oversight. Whilst it does focus upon the traits and expertise that the Prudential Regulatory Authority; the Consumer Protection and Markets Authority; and the Financial Policy Committee will require if they are to be able to tackle the problems of the last crisis and prepare for the next one, it does not focus upon the need for these bodies to have any technology expertise or experience. If regulators are to play an effective, but not unnecessarily restrictive role in the financial services sector, they must have an understanding of how these institutions (eg the banks) operate. It is now fundamentally impossible to do this without appreciating the technology that not only underpins existing banking institutions, but will drive changes to their operations and strategies in the future. An example would be a lack of understanding amongst regulators how the bank's existing legacy IT systems (ie the multiple layers of intertwined IT platforms within banks that have been built upon over many years, are at the heart of established banks' operations, and to alter them would require significant operational risk and cost) are actually having an impact upon these banks' abilities to alter their behaviour and business strategies.

  4.2.3  If the current regulatory focus on the financial services industry is about ensuring that no more avoidable crises befall it; that consumers are adequately protected; yet ensuring the City remains competitive on a global scale and able to contribute to the UK's economy, there needs to be 360 degree consideration of all relevant issues and factors. Policy needs to not only reflect how technology can facilitate better policy today, but also what technology will empower the financial services industry to do for its customers and investors tomorrow.

  4.2.4  Intellect believes that to assume that these three bodies will take on an element of technological understanding to complement their own specific remits under their own volition is to leave the regulatory system open to ill informed decisions and will reduce its effectiveness. Consequently Intellect believes that there should be a formal recognition of the role of technology within the Government's planned reforms through a commitment to develop better expertise and knowledge within this area and to establish and maintain lines of communication with industry.

  4.2.5  As a trade association a key part of Intellect's remit is stakeholder engagement, to ensure a two-way exchange of information between members and stakeholders within a particular market area. One of the key shortfalls of the FSA in recent years has been a general reluctance to engage in a two-way dialogue with stakeholders outside "the usual suspects" within the financial services industry. This is both a result of, and a catalyst for a lack of awareness of the role that technology, and the technology industry, plays within the financial services industry.

  4.2.6  Across other market areas, regulators have a strong relationship with Intellect, as they appreciate that the knowledge and expertise within our membership is critical to meeting challenges that they have. For example, Intellect hosts a regular forum with Ofcom—providing a high level opportunity to discuss issues of strategic importance such as spectrum allocation, Digital Britain and the digital switchover. Similarly, Intellect has a strong relationship with Ofgem on important issues such as Smart meters and Smart Grids. Indeed Intellect is a chosen partner for many Government departments (eg Cabinet Office, HM Treasury, Home Office, plus others) in terms of assessing the feasibility of many initiatives by mapping them to technology capability within industry—Concept Viability.

  4.2.7  It is common sense that if a particular industry or utility is based upon the application of technology, as indeed most now are, the regulator needs to have a two-way relationship with industry. This is so that it can seek advice in areas where it does not have definitive answers, ascertain what challenges are on the horizon and work towards solutions that are not only possible, but are forward-looking. To do so is not a concession of fallibility, quite the opposite, it demonstrates a willingness to take on board the views of experts and increase the regulator's potential for its outputs to be beneficial for consumers, industry and the economy. Crucially, as this response also outlines below, it will allow decisions to be made that will minimise the potential for wastage of public money.

  4.2.8  Intellect provides an ideal source of neutral expertise for policy makers and regulators to tap into, representing the aggregated expertise of the companies that provide the IT platforms which underpin much of the financial services industry and as outlined above it provides this expertise within numerous other sectors that are critical to the running of the UK's infrastructure and services. However, over recent years, it has been unable to build this relationship with the FSA.

  4.2.9  The FSA has demonstrated a reluctance to attend Intellect meetings and engage in a meaningful dialogue that could assist their task of regulating such a critical (ie to the UK economy) and technology-dependent industry. When stating their reasons, the FSA have displayed a lack of awareness of the role that technology plays within and between financial institutions, and the technological impact of the various regulatory initiatives that are announced. We hope a reformed regulatory regime would address this and that appropriate expertise, and lines of communication to the technology industry, can be implemented.

  4.2.10  Therefore Intellect believes that there are two possible solutions to this scenario that should both be integrated into plans for the forthcoming regulatory structure for financial services:

    (i) The employment of technology-knowledgeable individuals within the Prudential Regulatory Authority and the Consumer Protection and Markets Authority. This will allow meaningful and beneficial dialogue to take place between regulators and the technology industry.

    (ii) An objective for all three bodies (the the PRA, CPMA and FPC) to seek industry advice on specialist issues of importance to the functioning and regulation of the financial industry (within the context of their own specific remit), and to set up channels of communication with industry (ie through forums, councils etc) that ensure that advice can be easily and quickly sought.

  4.2.11  These are "quick-win" solutions to problems that have been significant obstacles to the effectiveness of the FSA in the past and, as proposals stand, will continue to detract from the ability of the new regulators to perform their functions. It is critical that lessons are learned from the FSA in this regard and the same path is not followed.

4.3  Ensuring information sharing between the regulators

  Intellect welcomes the Government's statement that there will be a review of the applications required by the new regulatory system in its entirety. However it is crucial that in this review the Government considers the lessons that have been learned from the recent banking crisis in terms of ensuring that accurate and relevant information can be shared between all relevant bodies. The review should have this theme at its centre.

  4.3.1  As outlined above the downfall of Northern Rock in 2007 was the first major event in recent years to highlight the need for financial institutions to have responsive, up-to date- IT systems so that information can be shared. The application of appropriate technology can reduce systemic risk and supplement the regulatory focus that is currently cast upon the banking industry. If counterparty risk cannot be assessed because of deficiencies in the flow of information within and between individual banking institutions, the effectiveness of the PRA, and consequently the FPC will be reduced.

  4.3.2  Similarly, if the CPMA is to fulfil its role of identifying potentially significant consumer protection or market integrity issues it is anticipated that it also will need to have access to accurate and comprehensive flows of information from banks, so that it can evaluate and advise the FPC.

  4.3.3  In a submission to Lord Sasoon's 2009 consultation on the Tripartite system of financial services regulation, Intellect highlighted some of the challenges that exist between the sharing of information between a number of regulatory bodies and indeed with the financial services institutions within the system. These challenges will continue to exist under the proposed system. All three regulatory bodies will need to have flows of information from the banks and with each other that allow them to fulfil their individual roles, in a co-ordinated manner.

  4.3.4  Consequently, developing appropriate and uniform data standards that are universally accepted and adhered to by all actors within the banking system is critical to ensuring that data can be shared accurately and can be analysed by banking institutions and regulators to spot the build up of systemic risk. A key challenge is that information standards and formats differ from institution to institution and finding a means of standardising this information (and facilitating its sharing and analysis) is complicated by the legacy systems (see below) that are in place across most of the established, larger and most systemically important banks.

  4.3.5  If the accuracy and flow of data is not treated as a priority by the new regulatory authorities, it could have the effect of undermining their effectiveness.

4.4  Implementing crucial information systems

  As part of the IT systems required for the new regulatory system, Intellect would also urge the Court of the Bank of England and other relevant bodies responsible for ensuring that value for money is achieved in the procurement and implementation of IT systems for the new regulatory environment, to involve industry as early as possible to seek advice and work with those suppliers that will ultimately be rolling out the required systems anyway.

  4.4.1  The case of the FSA's approach to implementing the Single Customer View (SCV) as part of the Financial Services Compensation Scheme (see Annex A—below) is an example of how not to do this. Ernst & Young, who carried out the feasibility study for the FSA, estimated that the cost of adapting the bank's IT systems to accommodate this new regulation was in the region of £1 billion. A commercially-focused SCV has been the goal of established banks for some time now, in order to manage individual customers' "touch-points" and allowing a more personalised service. There is a strong argument that if the FSA had sought to involve industry at an early stage to determine how to its own SCV, the result would have been quicker and easier to implement; and significantly less expensive. At a time when there are two state owned banks that need to deliver value for money, it makes little sense for regulation to "re-invent the wheel" when there are systems already in place within banks that can be adapted to achieve the same result.

  4.4.2  Intellect already partners with the Office of Government Commerce, HM Treasury and the Cabinet Office to ensure that such situations are avoided and it would seem logical that the Bank of England consider this path as well.

  Please see Annex A for a Case Study on the Financial Services Compensation Scheme.


  5.1  As outlined above, Intellect believes that the FPC should be able to call upon a number of experts, either individuals or Groups that can assist them in their work. There is a strong argument for the FPC being able to call upon the expertise of the technology industry as and when it is required. The right application of technology (specifically the flows of accurate information within the financial system) can assist the FPC in identifying the build up of systemic risk. It is foreseeable that the FPC, in its capacity to suggest changes to make the financial system more resilient, will need to draw upon the expertise of the technology industry to evaluate weaknesses in the system, identify areas where their oversight is limited and be made aware of how rapidly developing technology within the financial services system could also affect the stability of the financial services system.

  5.2  Intellect would welcome the opportunity to work with the FPC to define such an advisory group.


  6.1  If the PRA is to adopt a judgements-based approach to financial regulation and supervision of individual operators within the system, it will not only need access to relevant information from these individual operators (as outlined above, there is currently no standard format for this data amongst the banks—a challenge in itself), but it will also need to be able to understand the technology platforms that these individual businesses are built upon. It is therefore also foreseeable that the PRA will need to call upon the expertise of the technology industry in an advisory capacity (to supplement its own technology-knowledgeable staff—as outlined above).

  6.2  As with the FPC, Intellect would welcome the opportunity to work with the PRA to define such an advisory group.


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

7.1  Regulation of infrastructure provision

  Intellect does believe that there should be a balance between transparent and appropriate auditing of suppliers to potential entrants in the retail banking market, and unnecessary and costly oversight that prolongs the licensing process (extending "go to market" time for the entrant) and which ultimately will in itself act as a barrier to competition within the marketplace.

  7.2  The role that the FSA currently plays, whilst necessary, should be evaluated and refined where appropriate to ensure that the role that the CPMA takes ownership of to this end, does not suffer from "mission-creep". A specific issue is the FSA's "adopted" role of scrutinising the contractual relationships between the market entrant and its service suppliers—especially ICT suppliers that supply its systems and infrastructure. This could potentially cause a barrier to entry if the CPMA (like the FSA) does not have the necessary level of technical expertise to adjudge what ICT technology is appropriate, what represents a satisfactory level of risk and what is in the consumers' best interests with regards to ICT provision.

  7.3  In the current regulatory system this prolonged time frame, as a result of increased FSA scrutiny, could eventually have the effect of discouraging smaller ICT providers from forming commercial relationships with prospective and new entrants to the retail banking sector. It is simply not as profitable for smaller ICT providers to be involved in such projects as it would be for them to be involved in other, less scrutinised markets. Intellect believes (and has submitted to consultation responses to the Office of Fair Trading and the Treasury Select Committee to this end) that innovative IT-enabled customer services and infrastructure are important to new entrants' entry and expansion in order to differentiate themselves from incumbents. A reduced field of suppliers to choose from will harm this ability. The public sector has, in recent years, seen a similar problem where smaller, innovative suppliers were discouraged from tendering for government contracts because of the costs of embarking on a time consuming and administration-heavy process. There is a danger that through increased regulatory scrutiny of ICT suppliers, the financial services industry could be sleep-walking into a similar situation.

  7.4  Intellect believes there is an unnecessary degree of oversight on aspects of a potential entrant's undertakings that will not have a direct bearing on its ability to undertake deposit-taking activities. The CPMA should still be responsible for ensuring that prospective entrants are suitable and have appropriate capital and liquidity measures in place, but should look to streamline the process of scrutinising new and prospective entrants' ICT suppliers.


  8.1  There is no avoiding the fact that the financial services industry is now, and indeed has been for a

  number of years, reliant upon the technology that facilitates almost every activity and transaction within it. As this response will have hopefully illustrated, technology drives the industry, it sets its parameters, it is the next success story and potentially the cause of the next market crisis.

  8.2  If the reform of the regulatory structure that governs the industry is to be successful (ie ensuring stability, protecting consumers, contributing to the economy, but not being unnecessarily restrictive) Intellect believes that the new regulators have a duty to understand how technology influences the market and how it can help the market develop. Regulators need to understand how the market is underpinned by technology so that future regulation is not left redundant at best; and harmful to industry at worst by technology developing at a quicker pace.

  8.3  As part of its inquiry into financial regulation, Intellect would recommend that the Treasury Select Committee ponder three key questions that it may find useful in its deliberations over whether or not the Government is approaching regulatory reform in the right way:

    (i) What are the circumstances in which a regulator (or regulators) does not have to understand how the organisations and the wider industry it regulates, operates?

    (ii) What is the current financial services regulator's justification for not sufficiently understanding the role of technology within its industry focus, and for not seeking to do so?

    (iii) How could the new regulators go about addressing this knowledge gap?

  8.4  The importance of access to accurate and up-to-date information is crucial and could be a factor in the survival or demise of a financial institution and on a wider scale, the stability of the system. The simple fact is that if the new regulatory bodies do not have access to full and accurate information that originates from the financial services operators and is shared around the financial services ecosystem, it will not be able to make informed decisions on potentially critical issues. There is a significant challenge ahead for both regulators and Government to ensure that flows of information of a sufficient standard can be shared within the system. Currently this is a challenge that has not been met; has not been treated as a priority in the Government's regulatory proposals as they stand; and which could be the difference between the new regulators being able to discharge their functions effectively, and not.

Annex A

A.1  Case study: Financial Services Compensation Scheme Reform

  (This case study was taken from Intellect's response to Sir James Sassoon's Review of the Tripartite System of financial regulation)

  The FSA's consultation on FSCS Reform, published in January 2009, is an excellent example of the—or lack of awareness—displayed by the regulator towards the technology supplier industry. It raises a number of issues that a new regulatory regime should consider:

A.2  Engage with industry early and comprehensively

  The consultation was published jointly with a feasibility study, produced by E&Y. This study, which estimated the costs of the FSA's proposals, was apparently produced without consultation with IT firms—the very companies on whom the deposit taker would be reliant to implement the proposals. If a similar study were repeated for another regulatory initiative, particularly one with such a focus on IT (for example, a chapter in the consultation was called `Changes to the IT infrastructure of deposit takers and the FSCS), Intellect would early engagement with the IT industry.

A.3  Demonstrate awareness of procurement best practice

  has extensive experience of working with public sector bodies to help ensure an effective procurement process with information technology suppliers. Based on this experience, and consultation with our members, Intellect believes the timescales set out in the aforementioned consultation are impracticable in their nature. This could result in significant procurement and implementation difficulties.

A.4  In its response to the FSCS consultation, Intellect expressed concern that the proposals did not meet with the best practice guidelines set out by the National Audit Office in its publication "Delivering successful IT-enabled business change", published in November 2006. In this report, the NAO identified three key and recurring themes in successful programmes and projects:

    (i) The level of engagement by senior decision makers of the organisations concerned;

    (ii) Organisations' understanding of what they needed to do to be an "intelligent client"

    (iii) Their understanding of the importance of determining at the outset what benefits they were aiming to achieve and, importantly, how programmes and projects could be actively managed to ensure these benefits were optimised.

  Like other public bodies, the FSA should follow this best practice.

A.5  Concept Viability: the benefits of engagement

  Regulatory change can present a massive task for the financial institutions and the FSA, and in this case study, the FSCS itself. However, because of the issues that are being dealt with and the number of bodies involved, there is great value in encouraging a wider dialog with other stakeholders, who will be able to assist the relevant institutions by helping to develop innovative solutions to problems that may be raised via the new regulatory regime.

A.6  A means to achieve this might be through Concept Viability, a service that Intellect has successfully that allows both public and private sector clients to take market soundings to test the practicability of their ideas at the earliest stage. Flaws in proposals can be highlighted without competitive issues being compromised, and innovative solutions through emerging technologies can be discussed alongside frank dialogue about the risks incurred. This is a service supported by the Office of Government Commerce, the Cabinet Office, HM Treasury and other departments and executive agencies.

September 2010

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