Financial Regulation

Written evidence submitted by the Financial Services Practitioner Panel

EXECUTIVE SUMMARY

1. This submission is from the Practitioner Panel, a body set up under FSMA 2000 as an independent Panel to represent the interests of practitioners to the FSA. Details of the role and remit of the Practitioner Panel are at Appendix 1.

2. This submission answers to the questions as set out by the Committee. The key points which we would draw out from our answers are:

a. Overall we do see clear benefit in the establishment of an FPC to address macro-prudential risks, but we believe that this could have been achieved as an addition to the current regulatory structure.

b. The move from a single integrated regulator to a "twin peaks" model risks losing some of the good work done by the FSA since the crisis and has an inherent risk of lack of communication and coordination between the various regulatory bodies (in this case the CPMA, PRA and FPC) and potential cost, duplication, overlap or underlap.

c. The proposals recognise the need to minimise the risks of splitting the regulator, but with insufficient detail to be assured of their effectiveness. There must be a system of coordination at every level, as changes in the conduct and prudential areas within firms are inextricably linked.

d. There is a significant risk of increased costs, not only in the transition, but also in the structure of the separate regulatory bodies and the inevitable introduction of additional requirements such as for macro prudential regulation.

e. None of the proposed bodies map directly onto the relevant EU bodies, on which the UK has only one vote. The scope for dilution of the UK’s voice in Europe is therefore very significant.

f. There is much power vested in the Bank of England via the FPC and PRA, and potentially with fewer checks and balances than the present regulatory regime. All the regulators must be transparent and accountable, with the appropriate consultative mechanisms. As part of this, we are advocating an increased role for the independent panels across the regulatory structure.

g. The new regulators must all retain an objective to take account of the impact of their actions on the competitiveness and innovation in the financial services industry. We are opposed to the CPMA being positioned as a "consumer champion", as this is too emotive and ill defined as a role for a regulator.

h. Although we do not object to a ‘judgement led’ approach for the PRA, the Treasury Consultation does not indicate the principles on which such judgements will be based. Judgement led regulation is only acceptable on the basis of clear and transparent principles which are applied on an equal basis.

i. The proposed tripartite approach to markets regulation, with the separation of primary markets, secondary markets and post-trading is unlike the approach in any other jurisdiction. We are not convinced that the CPMA is the best location for markets regulation. We recognise the difficulties of this decision, but believe that Markets regulation, including the UKLA, should be a standalone function, or with the PRA.

j. We await the specific proposals on enforcement, which has been an important component of the existing regime.

TREASURY COMMITTEE QUESTIONS

3. Will the Government’s financial regulation proposals improve the framework for financial stability in the UK? Will they work in a crisis? Do the Government’s proposals get the balance right between tackling the problems of the last crisis and preparing the UK financial system for the next one?

4. We think that the creation of the FPC has the potential to improve the effectiveness of financial services regulation in the UK. However, the FSA has progressed far since the last crisis, and other aspects of the changes introduce additional complexities which create the need for additional safeguards and coordination. This therefore may reduce the effectiveness of the regulatory framework in preventing or tackling a crisis.

5. The transition process itself creates a risk of the erosion of the effectiveness of the regulator, at a time when there is a need for the regulator to be focused on other issues. We believe the implementation risks are very significant, especially at the current time:

a. We have already seen a significant loss of senior FSA personnel.

b. Whilst the crisis may have lessened in intensity, the FSA is dealing with major regulatory change and supervisory issues. To overlay a protracted period of fundamental organisational upheaval raises a material risk of management distraction.

c. We perceive there to be a considerable risk of dilution of focus on the international agenda at a time when such focus is imperative.

6. The potential problem of coordination is clearly recognised in the Treasury Consultation, but there is little detail on the effective mechanisms for ensuring coordination throughout the regulatory system. The prudential and conduct aspects of a firm’s business are inextricably linked, and so it is difficult to see how the regulators will act independently of each other.

7. How do the Government’s proposals dovetail with initiatives currently being undertaken at European and the global level?

8. There is recognition in the Treasury Consultation of the need to link in to initiatives at European and global level. We want the UK to be in a strong position to negotiate, both at Government level and at regulatory level. We do not want the fragmentation of the UK regulator to dilute the UK’s voice. We have urged the FSA to take a high profile role, and would not like the FSA’s initiative in appointing a Director dedicated to European and International issues to be lost.

9. The new UK structure does not dovetail into European structures any better than the current system, and risks fragmentation and dilution of the UK’s messages with the split of regulatory responsibilities. This is particularly pronounced in the proposed division of markets regulation which does not tally with ESMA.

10. The reference to the PRA using its ‘judgement’ in many parts of the consultation could conflict with European and global initiatives unless the judgement is against clear standards. International firms operating in the UK cannot be expected to conform to judgement decisions which are not based on clear policy statements and procedures, and UK firms should not be disadvantaged by any arbitrary application of judgement.

11. What costs will the regulatory structure place on consumers?

12. Consumers, through increases in fees and charges, ultimately pay for all the costs of the regulatory structure. There are potentially significant costs in the transition to the new system as a one-off cost. The new system itself is likely to cost more in regulatory fees and in the resources of firms in dealing with two regulators.

13. There may be further consumer costs if the CPMA’s role as consumer champion is interpreted too narrowly. If it restricts firms from developing new products and working the market effectively, there may be less choice available, with consumers paying more for products which are less suited to their requirements. One example of this is the Retail Distribution Review, which may improve standards, but it will also reduce the availability of advice for consumers.

14. Do the Government’s proposals appropriately assign roles and responsibilities between the different regulatory institutions?

15. The roles and responsibilities of the different regulatory institutions seem generally to be appropriately assigned. We have a number of specific considerations, as follows.

16. Location of markets. We have found it difficult to identify what the government is trying to achieve with the changes proposed for markets. It seems it would be better to have Markets in a stand alone regulator, or as part of the PRA, rather than the CPMA.

17. Confidence in the markets is fundamental to the strength of London and those institutions that trade there: a failure in the markets would have an immediate effect on the UK’s financial stability. We note that within the FSA, the regulation of markets does not take place within the Supervision Directorate of the FSA, but is located in the Risk Division, indicating its strategic importance to overall risk in the financial system. In many other European countries, markets are regulated by a separate authority. If the current FSA Markets Division, with all its responsibilities, was transferred to a separate markets regulator, the firms affected would only be supervised by the new regulator, so it would not cause further fragmentation for practitioners.

18. Whilst we appreciate that there are pros and cons, we also believe that the UK Listing Authority (UKLA) should stay with the rest of Markets regulation and not be moved to the FRC as suggested in the Treasury Consultation. If the UKLA moved to FRC, it would be too far away from financial services regulation, and so insufficiently aware of the competitiveness and wider pressures of the financial markets. Splitting the UKLA off from the rest of Markets would also weaken our voice in Europe.

19. Governance. We are concerned about the accountability mechanisms for effective challenge and consultation in the regulatory system. Overall, there is much power vested in the Bank of England, with little external accountability, whilst its actions will have an increased impact on how firms operate and the UK economy as a whole.

20. The FPC is extremely powerful and yet does not seem to have enough external checks and balances. One option is that the FPC has a majority of independent members so that the industry and consumer viewpoint is fully taken into account, although we recognise this might not be practical. An alternative might be for an advisory and consultative body similar to the previous Bank of England Board of Banking Supervision, which gave industry input before FSMA replaced the Banking Act. Another alternative would be to establish a Practitioner Panel for the PRA, perhaps with additional powers for the Practitioner Panel, or a sub group of it, to interact with the FPC.

21. Independent Panels. The current system of the Independent Panels (Financial Services Practitioner Panel, Smaller Businesses Practitioner Panel, Financial Services Consumer Panel) providing guidance and checks and balances in the development of policy is important. It should be maintained, not only in the structure of the CPMA, but in the PRA as well, with possible input into the FPC.

22. These changes also present an opportunity to strengthen the powers of all the Panels. Currently the only onus on the FSA is to explain why they are not responding to challenges from the Panels. We would welcome more formality in the responsibility of the regulator to consider our views, with less discretion to ignore representations without evidence that the opinions have been fully taken into account. We would like all the Panels to have the right to raise major concerns about the impact of regulation on financial stability with the FPC.

23. Decision making and crisis management. We do not believe that there is enough clarity of ultimate authority and escalation of conflicts in the current proposals. For instance, if the PRA cleared a change of ownership of a major UK financial institution to a company based in a country with whom the UK had a difficult political or economic relationship, would the FPC be able to step in on financial stability grounds to stop such a takeover?

24. Costs and benefits of regulation. There is not enough reference in the Treasury consultation to the need for any new developments in regulation to be challenged on the basis of costs versus benefits. This is an area where we have criticised the FSA for not paying enough attention to cost benefit analysis (CBA), or not always undertaking a rigorous CBA when changing procedures. We will urge that all parts of the new regulatory system must adhere to strict cost benefit analysis for implementation of new regulatory requirements.

25. Structure of regulators. At this stage, we do not have the details of the proposed structures of the PRA and CPMA, but they must have a breadth of sector representation which will be critical for ensuring appropriate resources are employed. There must be equal standing between the CPMA and the PRA, and a chief executive should be appointed to lead the CPMA as soon as possible. We are also concerned about the lack of clarity on the future of parts of the enforcement function. This is a key part of the regulatory system, and must be strong, but with appropriate appeals mechanisms.

26. Consumer champion role for CPMA. We do not believe that the CPMA’s main role should be as a consumer champion and have indicated the cost implications in paragraph 13. We are particularly concerned about such an emotive and ill-defined description which may allow undue bias into the role of regulator.

27. Will there be unintended consequences of the Government’s proposals for regulation on the prospects for non–bank financial institutions

28. We note that paragraph 3.34 of the Treasury Consultation refers to the PRA benefitting from the expertise, experience and credibility of the central bank, but it is unclear that this will help the regulation of companies in insurance and other sectors. It is essential that senior staff with non-banking expertise are appointed at the PRA. There should also be a consideration of specifying certain independent members of the FPC are from non-banking backgrounds to counter-balance the banking members.

29. In addition the FSA in response to the banking crisis has tended towards a read-across of policy proposals from different sectors with a seeming preference for ‘one-size-fits all’ approach. Once the PRA is part of the Bank of England there is a danger that this will increase with banking driven interests taking over the agenda.

30. Should the FPC have a statutory remit? If so, what should that remit be?

31. We would welcome a statutory remit for the FPC which would give it clear accountability. We advocate that the remit should be to maintain financial stability, with due regard to maintaining the competitiveness of the financial services industry in the UK.

32. We also believe that there should be some statutory challenge to the FPC’s opinions on behalf of industry practitioners. There must be practitioner membership within the independent members and an external monitoring/advisory role for part of the Practitioner Panel or another independent practitioner dominated grouping.

33. How should the success of the FPC, both in and out of crisis, be measured?

34. The measure of financial stability which will guide the FPC needs to be defined. With that in place, the transparency of decisions and six monthly reports as recommended in the consultation paper should allow the success of the FPC to be measured.

35. However, the MPC is dealing with more measurable objectives and a narrower range of clearly defined tools than the FPC will have. Therefore the FPC will need to base its views on judgements and so will need a greater level of transparency, scrutiny and challenge, with publication of measures taken to avoid any crisis after an appropriate interval.

36. We would argue that the FPC should be measured on the basis of regulatory stability in addition to maintaining financial stability. It is important for the industry and for consumers that the regulatory agenda does not lurch between policy priorities, and provides a consistent and certain regulatory environment.

37. Given the international regulatory framework, what macro–prudential tools should be granted to the FPC?

38. The detail of macro-prudential tools is not within our expertise, but we would urge that any implementation of macro-prudential requirements from the FPC which impact on firms should still be subject to full consultation through the PRA and CPMA.

39. Has enough been done to mitigate the risk of conflict between the FPC and the Monetary Policy Committee (MPC)?

40. The MPC has a clear inflation target, whereas the FPC’s more general objective of financial stability is less easy to measure. We would not support any proposals where the MPC’s views could over-ride that of the FPC, with regulation of financial services firms potentially manipulated via the FPC to help achieve inflation targets.

41. Is the FPC appropriately structured in terms of the balance between internal and external members and the size of the Committee?

42. We are concerned about the balance of FPC membership. As well as 6 out of 11 members from the Bank of England, the chief executive of CPMA is counted as an external member. This means 7 out of 11 are officials from the regulatory structure. This committee must be seen as independent, and also in tune with current industry practices. The FPC will have such an impact on the financial services industry, that one option would be to have a majority of independent members on the FPC or a specialist advisory body (see paragraph 20).

43. Independent membership of the FPC must be seen as a substantial role which requires time commitment between meetings. Members will need to be provided with resources and back up to ensure they operate with credibility and their opinions are not ignored.

44. What characteristics, experience and qualities should the Government look for when appointing external members of the FPC?

45. There must be people with detailed knowledge of the financial services industry as external members of the Committee. Most people currently working in a regulated firm will have conflicts of interest. Instead, independent members could work alongside the industry, or be only recently retired and be well regarded and of high standing in the financial services industry.

46. There should also be members of the Committee with wider experience than that of banking to ensure that the interests of the whole financial services industry, and particularly that of other firms regulated by the PRA, are taken into account.

47. Should the PRA be the lead authority over the Consumer Protection and Markets Authority (CPMA)?

48. Although we understand the need to resolve potential conflicts, it is essential that the CPMA is seen as being as important as the PRA. If the CPMA is seen as junior, it could harm how the CPMA is regarded by firms, and the CPMA’s position in EU and international negotiations. It could also damage its ability to attract the highest quality staff. We would not want this to happen. There is already an imbalance in the appointment of Hector Sants as Chief Executive of the PRA, but no appointment to the head of the CPMA – who must be a credible person of similar standing to Hector Sants.

49. One could argue that the CPMA should be the lead regulator, as under the current arrangements, all firms will be regulated by the CPMA, but a smaller number of firms will be regulated by the PRA.

50. Is it appropriate for the PRA (and CPMA) to adopt a judgements–based approach to financial regulation and supervision?

51. Any judgements-based approach must be referenced against clear principles, with consistent application across sectors, groups and firms, and with reference to the requirements in other jurisdictions. It is unclear in the Treasury Consultation what transparency and accountabilities are proposed around the adoption of a judgement-based approach.

52. We disagree with paragraph 3.9 of the Treasury Consultation that excessive concern for competitiveness was the cause of regulatory failure leading up to the recent crisis. The regulator must take account of the need for financial services firms to operate successfully in the market place.

53. We believe that PRA rule-making must be subject to similar requirements to the current FSA consultation requirements.

54. Do the reforms and the creation of the CPMA provide adequate protection for the consumer?

55. The CPMA’s proposed role as ‘consumer champion’ is too emotive, too ill-defined, and fundamentally inappropriate for a regulator to hold. We advocate a role for the CPMA to ensure that the market works effectively for consumers. Consumers must take some responsibility for their own decisions and we welcome the reference to consumer responsibility in paragraph 4.25 of the Treasury Consultation.

56. The remit of the CPMA must also guard against any inadvertent extension of consumer protection measures into the wholesale market, where such restrictions would stifle the market.

57. At the moment the balance between product and sales regulation for the CPMA seems unclear. If greater product regulation is introduced, there should be a commensurate reduction in the regulation of sales practices.

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

59. There are significant increases in the costs of the new model, both in direct regulatory fees and for firms who will have to deal with two rulebooks, two sets of requirements, and two teams of supervisors coming to visit. There may also be unnecessary duplication and potentially conflicting regulatory demands from the two bodies.

60. As overall support costs are likely to increase, with a corresponding pressure to contain costs, we would not like this to result in a reduced effectiveness of supervision.

61. Should any of the proposed bodies be given responsibility for promoting competition in the banking and financial services sector?

62. We believe it is vital that all the new proposed bodies should have to pay regard to the need to maintain competitiveness in the banking and financial services sector. It is not a regulator’s role to promote competition.

63. Should any of the proposed bodies have a role in promoting the City of London?

64. We believe the regulator has a role to promote the effectiveness of the UK in its EU and international relations, but not in promoting London.

September 2010

APPENDIX 1

ROLE AND REMIT OF THE PRACTITIONER PANEL

1. The role of the Practitioner Panel is to advise the Financial Services Authority on its policies and practices from the point of view of the regulated community. It has statutory status under the Financial Services and Markets Act 2000 (FSMA). As such, the Practitioner Panel is given access to the FSA’s plans for new regulatory policies, and so is able to provide an important sounding board for the FSA before the ideas have been made public.

2. Members of the Practitioner Panel are drawn from the most senior levels of the industry, with the appointment of the Chairman being formally approved by the Treasury, to ensure independence from the FSA. The members are chosen to represent the main sectors of the financial services industry as regulated by the FSA. The Panel currently has senior practitioners from the retail and investment banks, building societies, insurance companies, investment managers, financial services markets, custodians and administrators.

3. The Chairman of the FSA’s Smaller Businesses Practitioner Panel (SBPP) sits ex officio on the Practitioner Panel to ensure co-ordination, but debate on issues specifically affecting smaller firms are covered by that Panel. The SBPP is submitting separate evidence to this Inquiry.

4. The names of the members of the Practitioner Panel as at 20th September 2010 are as follows.

Panel Member Position

Iain Cornish (Chairman) Chief Executive, Yorkshire Building Society

Richard Berliand Head of Global Cash Equities & Prime Services, JP Morgan Securities Ltd

Simon Bolam Principal, E H Ranson & Co (Chairman, SBPP)

Russell Collins Head of Deloitte UK Financial Services Practice

Mark Hodges Chief Executive, Aviva UK

Simon Hogan Managing director, Institutional Equity Division,

Morgan Stanley

Roger Liddell Chief Executive, LCH.Clearnet Group Limited

Helena Morrissey Chief Executive Officer, Newton Investment Management

Xavier Rolet CEO, London Stock Exchange Group

Andrew Ross Chief Executive, Cazenove Capital Management Limited

Malcolm Streatfield Chief Executive, Lighthouse Group plc

Helen Weir Group Executive Director Retail, Lloyds Banking Group plc