Financial Regulation

Written evidence submitted by the Association for Financial Markets in Europe

1. Introduction and executive summary

1.1. The Association for Financial Markets in Europe (AFME)1 welcomes the Treasury Committee’s (the Committee’s) inquiry into Financial Regulation, which will consider the Government’s proposals to reform the UK system of financial regulation, as articulated in the HM Treasury consultation document: A new approach to financial regulation: judgement, focus and stability.

1.2. AFME believes – at least in principle – that a "twin peaks" model can deliver effective regulation for both consumers and markets and we welcome, in particular, the emphasis on a more judgement-led style of regulation. However, in moving from a single regulatory authority to multiple authorities and in freeing regulators to make individual judgments, the precise design of the framework will be crucial to its success and the challenges of achieving a successful outcome must not be understated. Hence, given the fundamental nature of the reforms proposed by the HM Treasury consultation – which must be viewed within the context of the wider reforms at both an EU and international level – AFME is reviewing the proposals with particular focus on their potential impact on firms, markets and wholesale financial services business in London. We hope that summarising the issues upon which our Members have asked us to concentrate will assist the Committee.

2. AFME’s approach

2.1. In preparing its response to the HM Treasury, AFME is conscious of the fact that much of the detail surrounding the proposed framework will be provided in subsequent consultations. Although further clarity is needed to understand fully the proposals, we stand ready "not only to answer the questions that remain but also to question the answers that we have put forward" and help "ensure we get the detailed design right."2 We are embarking on a major restructuring of financial regulation in the UK and hence, while AFME recognises the reasons and momentum for reform, we believe that the process needs to be conducted thoughtfully, collaboratively and openly.

2.2. In view of the ongoing nature of our work on the proposals and the fact that we are at the beginning of a long process, AFME believes that it would be most appropriate, at this stage, to set out the areas in respect of which we have open questions and issues (rather than respond to all of the specific questions to which the Committee may have regard during its inquiry). We trust that this approach will prove helpful to the Committee.

3. Areas of focus

3.1. Regulation of markets in London (including the Market Authority): it is crucial that the current, robust regulation of markets and the expertise of the FSA’s Markets Division are not diluted in the new framework.

3.2. In particular, we strongly oppose the proposed removal of the UK Listing Authority (UKLA) from the Consumer Protection and Markets Authority (CPMA), which would dislocate primary and secondary market regulation. We also believe that the implications of the proposal to regulate clearing in the Bank – which would divide the regulation of exchanges from the regulation of their clearing and settlement operations – will need careful consideration, particularly given market developments such as the ‘verticalisation’ of exchanges (i.e. adding integrated clearing capabilities) and the moves to create pan-EU clearing solutions. Given the wider changes, e.g. at the EU level, it is vital that the new UK authorities have the maximum heft – expertise, authority, resources, and breadth of competence – to enable them to exert the necessary influence.

3.3. More generally, we would note that the customer protection element of the CPMA does not capture the breadth of the CPMA’s role, which would include the conduct of business regulation of wholesale market firms and complex groups. We are also concerned that a ‘strong consumer champion’ and a financial markets regulator do not naturally sit comfortably within one authority. We, therefore, suggest that the final name (and organisational structure) of this authority (the CPMA being a "working title") encapsulates its broader, conduct of business regulatory role.

3.4. Finally, we await with interest the forthcoming consultation on the proposed new Economic Crime Agency (ECA); AFME will, in particular, be responding on the question of whether responsibility for prosecuting criminal offences involving insider dealing, other forms of market abuse and other criminal law breaches which the FSA currently prosecutes should be transferred to the ECA.

3.5. Accountabilities: given the considerable powers that will be vested in the Bank of England (the Bank), we believe that the proposed accountabilities to HM Treasury and Parliament, particularly for the Financial Policy Committee (FPC), should be strengthened.

3.6. Independence: we have questions (and possibly concerns) around, for example, the multiple roles of the Governor and - although we recognise that this is intended to strengthen co-operation - the executive cross-membership of the FPC, MPC, Prudential Regulatory Authority (PRA) and CPMA Boards by a limited number of key individuals. We believe there is a serious risk that this arrangement will lead to a significant concentration of decision making powers in the hands of a few, over whom there is limited oversight. As discussed in 3.5 above, we believe the arrangements for oversight and scrutiny of these bodies should be strengthened. We also have questions around the degree to which there will be information barriers within the Bank to protect the confidentiality of firm-specific information.

3.7. We also believe that independent, non-executive directors should have an active role in all the work of their Boards, including decisions appertaining to specific firms (c.f. the FSA Board) and that the process for selecting non-executives with the appropriate skills, knowledge and experience, should be effective, robust and transparent. We also question whether independent non-executive directors should be in the minority on the Board of the FPC.

3.8. Objectives: we believe that the FPC, PRA and CPMA should have clear objectives - where possible auditable and accountable to Parliament - that reflect fully the multifaceted nature of their roles, even if the inter-relationships are complex.

3.9. As growth in the financial markets will aid economic recovery and offer better choice and availability to consumers, we believe strongly that the new authorities (but at the very least both the FPC and the CPMA), should have, as one of their high-level objectives, due regard to the UK’s competitiveness as an international financial centre and how it may be enhanced by effective regulation.

3.10. As discussed at 3.24 below in relation to the PRA and CPMA, in order to achieve consistency, we also believe that the authorities’ objectives should be cross-referenced.

3.11. The Principles of Good Regulation: we see no reason why any committee or authority (e.g. the PRA) should be able to operate without regard for the Principles of Good Regulation. We strongly believe that the PRA and the CPMA should be subject to the Principles of Good Regulation, including consultation and cost benefit analysis (subject to emergency over-ride as found in the Financial Services and Markets Act).

3.12. Powers and functions: the powers of the FPC, PRA and CPMA will be limited by EU regulation and constrained by the new EU supervisory architecture. It is important that the impact of such constraints is recognised fully, given the likely impact on the extent to which, for example, judgements can be made or unilateral action taken.

3.13. We support a more judgement-led approach to regulation, which we agree should be facilitated through the legislative framework. However, the success of more judgement-led regulation will ultimately rest on the quality and competence of the staff that take individual, firm-specific decisions. To ensure consistency and fairness, the authorities will need to have streamlined and clearly articulated procedures, which are transparent, provide reasons for a decision and give firms wishing to challenge a decision a fair hearing.

3.14. EU and International relationships: it is crucial that the UK maintains a strong, credible and coherent voice in the EU and internationally and continues to help shape regulatory developments. For example, by ensuring that experts are trained for placement in the new ESAs through a revival (including in the current FSA) of a process akin to the European Fast Stream programme that operated in Whitehall for many years and through the provision of high-quality thought-leadership (while not ‘front-running’ policy initiatives requiring EU and international accord).

3.15. Given the importance of the UK’s financial markets, the PRA and, in particular, the CPMA could have a target for preparing high quality, senior candidates to work in the ESAs. In addition, as discussed in 3.2 above, it is vital that the new UK authorities are staffed with individuals who have the expertise, experience and authority to negotiate effectively with EU and international bodies.

3.16. The reform process needs to focus on how the proposed UK structure will fit into, and work with, EU and international bodies. In particular, the structure and relationships between the proposed authorities must take into account fully the new EU supervisory structure; e.g. how the multiple UK authorities will align with the new European Supervisory Authorities (ESAs); and how the UK representatives on the ESAs will ensure there is co-ordination between UK stakeholders. For example, under the proposals both the Bank and the CPMA will have responsibility for regulating market infrastructure but only the CPMA will have a seat on the European Securities Markets Authority. The design of the PRA and CPMA must aim to eliminate these gaps, or risk a serious loss of heft and influence at the EU table

3.17. The process also needs to consider how incoming EEA firms, that establish branches in, or provide services into, the UK under a single market directive, will fall within the new framework, particularly as fundamental questions regarding Home and Host State still remain open at an EU level.

3.18. It will also be important, particularly for internationally active UK authorised firms, to ensure that the territorial application of the CPMA’s conduct of business rules to firms’ business activities outside of the EEA is appropriate and respects ‘local’ regulations.

3.19. Macro-prudential regulation: while AFME welcomes the proposal to enshrine macro-prudential regulation, we have questions around how the FPC will operate given the global nature of markets and the need for strong linkages to the new European System Risk Board (ESRB), third country regulators such as the Federal Reserve and the US Financial Oversight Council and international bodies such as the International Monetary Fund and the Financial Stability Board.

3.20. The proposals - as set out currently - also appear to take a narrow view of financial/macro-economic stability; we are uncertain how they would address fully the potential impacts of other policy areas, notably monetary and fiscal policies. To be effective, a consistent and coordinated approach across all policy areas will need to be pursued. However, as the mechanisms for achieving consistency and co-ordination in the new framework appear to be limited to executive cross-membership of the FPC and MPC and sequencing of meetings, we believe that they should be developed further. AFME will also be considering issues such how the FPC’s powers of direction over the PRA will link macro-prudential regulation to the micro-supervision of individual firms (i.e. through a ‘Pillar 2’ process) and the more general use of macro-prudential tools.

3.21. The scope of the PRA and the CPMA: we note that the PRA will be responsible for "all firms who are subject to significant prudential regulation." However, we believe that the current proposal, under which the PRA would be responsible for the "authorisation, regulation and day-to-day supervision" of specific regulated activities – namely, "taking deposits", dealing in investments as principal and effecting and carrying our contracts of insurance – would result in significant, unintended consequences, including:

· increasing the number (and types) of firms to be regulated by the PRA (e.g. by bringing within scope any firm with a Part IV permission that includes dealing in investments as principal, regardless of whether the firm undertakes that activity or, if they do so, the scale of the business);

· dividing the authorisation and regulation of wholesale firms’ trading activities between different regulatory authorities;3 and,

· adding unnecessary complexity to the vital gate keeping, authorisation and approvals (approved persons) processes.

3.22. Whilst references to specific regulated activities could form the starting point from which to define the PRA’s scope (i.e. to help determine which firms are, in principle, subject to prudential regulation) we believe strongly that the CPMA should still be responsible for the conduct of business regulation of these regulated activities. Since it is proposed that the CPMA regulate "all conduct" we assume – despite a degree of ambiguity in the consultation document – that this will be the case.

3.23. If it is considered necessary to give the PRA responsibility for authorisation of the specific regulated activities that are within its scope, we believe strongly that a single organisation should undertake authorisations, approvals (of approved persons) and other regulatory processes on behalf of the authorities or other authority (also on this see 3.26 et seq. below).

3.24. Co-ordination between the PRA and CPMA: given the significant overlaps between the scope of the PRA and CPMA (some of which, as noted in 3.21 et seq, could be resolved by redefining the scope of the PRA), the authorities must have clear objectives. We also believe that each authority’s decisions should be required to not be incompatible with the terms of reference of the other authority, unless to do so would conflict with its own terms of reference.

3.25. A procedure will need to be in place to ensure that individual regulatory decisions (whether concerning rule interpretations, a specific firm etc) taken by the authorities are compatible (for example, a CPMA enforcement penalty may impact on the solvency of a PRA regulated firm). A process should also be established to resolve differences between the authorities.

3.26. Regulatory processes and shared services: in respect of regulatory processes (i.e. authorisation and approval, supervision and enforcement), the new framework will need to deliver, amongst other things:

· efficient, shared, processes for authorisation, approval and other regulatory processes;

· co-ordinated and consistent supervision;

· co-ordinated reporting and data requirements (including an over-arching data integrity and standards programme and data warehousing that facilitates supervisory analysis without placing disproportionate burdens on firms); and

· clarity with respect to respective enforcement functions (and no risk of double jeopardy).

The increased costs and uncertainties for firms, when dealing with multiple UK regulatory authorities (in addition to exchanges and other regulators which may regulate group entities), must also be recognised.

3.27. Given the need for deep consistency and communality and to reduce administrative costs and undue bureaucracy, we believe that there should be a shared services organisation that performs regulatory processes and provides a common ‘back office’ for both the PRA and CPMA.

3.28. Transitional issues: the transitional period (from now until 2012, in the event that the ambitious timetable can be met), will present a number of significant challenges. To maintain confidence and reduce uncertainty, these challenges will need to be managed carefully and effectively. Matter of concern include:

· the appointment of a high calibre CEO to lead the move to the CPMA;

· the retention of key FSA policy experts and senior supervisors (who are essential for more judgement-led regulation);

· the abilities of the new authorities (particularly the CPMA which may be seen as the junior partner) to recruit the calibre of staff needed for judgement-led regulation; and

· maintaining focus on and influencing key EU and international regulatory developments.

3.29. Retention of ‘talent’ (in particular, wholesale market expertise) will be key throughout the whole process and FSA initiatives designed to enhance the training and competence of supervisory staff must be continued during the transitional period.

3.30. The new ESAs will also be established while there is uncertainty in the FSA. By the time the UK landscape is settled and the new UK authorities are fully operational, the ESAs may already be fully staffed and many policy issues and their strategic direction already resolved: hence the need for the UK to maintain focus, influence and involvement.

3.31. FSA ‘shadow structure’: we note that the FSA is developing a ‘shadow structure’ for Q1 2011. While we recognise the operational challenges this process is likely to entail, it is important that the reorganisation does not foreclose on aspects of the current consultation or pre-judge future (more detailed) consultations.

4. Conclusion

4.1. Although our ongoing discussions with Members may raise additional issues, we hope that this summary will inform the Committee by flagging some of the open questions, issues and concerns which AFME Members believe are of importance at this stage of the process. We would be pleased, of course, to provide further information about any of the matters which our Members have raised if that would be helpful.

22 September 2010