Financial Regulation

Written evidence submitted by the Smaller Business Practitioner Panel

EXECUTIVE SUMMARY

1. The Smaller Businesses Practitioner Panel was set up by the Financial Services Authority in recognition of the need to have a specific Panel to represent the interests of smaller firms to work alongside the Practitioner Panel and Consumer Panel. We are pleased that the importance of our Panel’s work is recognised in the Treasury Consultation, with its proposal to set our Panel on the same statutory footing as the other two independent Panels. More details of our role and membership are at Appendix 1.

2. The key points made in our submission are as follows:

a. Smaller firms represent around 90% of regulated businesses by number, and yet the Treasury Consultation does not refer to the impact on smaller firms;

b. The Government’s proposals will have a significant cost and burden impact on small firms. These firms are already dealing with regulatory changes such as the Retail Distribution Review, and wider trading pressures from the economic downturn; The disruption involved in regulatory change itself is disproportionate to the benefits:

c. These changes are seeking to solve problems which have essentially been resolved through changes at the FSA and Tripartite system. The changes will be disruptive and costly and seem not to offer any commensurate benefit in regulation;

d. A new weakness in regulation will be introduced in the divide between prudential and conduct, as the business models of small firms are not split in that way, so hazardous patterns could be missed by supervisors;

e. We do not believe there is enough external accountability in the new system. Significantly more power is being given to the Bank of England, and the powerful new FPC has few checks and balances. The PRA only has tentative proposals for the current FSA level of accountability;

f. We are against any type of ‘judgement-based’ regulation which is not based on clear and transparent principles;

g. The impact of the regulators’ actions on the industry’s competitiveness and firms’ ability to do business must be a key consideration;

h. A role of "consumer champion" is not an appropriate role for a regulator.

INTRODUCTION

3. It is vital to recognise that smaller firms represent around 90% of all regulated firms – some 15,000 businesses, providing financial advice and other services in towns and cities throughout the UK. Despite this importance, there is little reference in the Treasury Consultation to the likely consequences of the proposals on the smaller firms sector.

4. These proposals could have a seriously adverse impact on the viability of smaller firms. We are already preparing for regulatory changes resulting from the Retail Distribution Review and Mortgage Market Review, as well as initiatives from Europe such as Solvency II. On top of this, the Government’s wider plans to reduce the deficit are expected to lead to a contraction of business, as likely increases in unemployment and cuts in public spending reduce consumer spending to immediate and essential purchases.

5. This added regulatory burden at a time when trading conditions will be difficult is unwelcome.  Smaller firms might reasonably expect help and support from the Government to lessen the burden of bureaucracy during difficult economic times, rather than any suggestion that it might increase. We believe the Department for Business Innovation and Skills (BIS) should be asked to comment on the impact of this increase in regulatory requirements on smaller firms.

6. The Government’s proposals, in so far as they relate to smaller businesses, are seen as trying to introduce solutions that have already been identified and resolved by the FSA within its existing "unified" structure. Indeed, the added regulatory burden with its associated costs, will be seen as a backward step.

TREASURY COMMITTEE QUESTIONS

7. 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?

8. The Government’s proposals seem essentially focused on the last crisis, and so the proposals, although flexible, do not necessarily create a framework capable of responding to the future threats posed by all financial markets. The vast majority of the regulated community are smaller firms who played no part in the last crisis. Nevertheless, smaller firms are potentially set to pay a high price, both regulatory and financial, for the actions of a relatively small number of larger firms.

9. The formation of the FPC, to consider systemic or macro-economic risk should assist in obviating future crises at that level. However the change in regulatory structure will not, and may indeed prove to be an impediment. A weakness of the FSA before the crisis was that it did not interrogate firms’ business models adequately. The FSA’s approach tended to be reactive, responding to problems that had already arisen, and giving inadequate attention to the structure and business models of firms. However, this has been addressed by the FSA in its restructuring in response to the crisis, with the Risk Division now performing that function.

10. The Government’s proposed regulatory divide introduces a new weakness into the regulatory analysis: business models are influenced both by prudential issues such as capital structure and liquidity, and also by the products sold. Having these two aspects in two different regulators makes an overall view of a firm more difficult, and may impede the regulators’ ability to anticipate problems arising at firm level.

11. In addition, from a firm’s point of view, there is not always a natural dividing line within a firm’s culture between its moral duties relating to prudential risks and conduct risks. It will therefore be more difficult to hold conversations with regulators who want to see that split. Issues could fall down the cracks between regulators: actions taken in one area of any business will have an impact on other areas, and supervisors must be aware of this.

12. The micro prudential regulation of smaller institutions may become less effective and the macro consolidated impact of systemic prudential issues within sectors such as stockbroking (which controls highly material amounts of retail client assets) will be more likely to be missed. The prudential regulator will not be looking for them and the consumer regulator will not be geared up to identify or deal with them.

13. Under the current proposals, a significant proportion of smaller firms will be only regulated by CPMA although they have some prudential risks. There must be skills within the CPMA to ensure prudential safeguards are adequate within firms regulated solely by them.

14. Overall, we remain to be convinced that splitting up a single body into two or three will improve regulation, particularly in a crisis. A particular concern is the need for formal cooperation mechanisms which could easily slow down the system.

15. In addition, it seems there will be little change in staff from the FSA to the new regulators: it will therefore be the same staff doing similar jobs under a different title so unlikely to be a fundamental change in effectiveness.

16. We believe the disruption of regulatory change is totally disproportionate. The few problems in regulatory structure that arose within smaller firms have been identified and resolved.

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

18. Apart from the top level European stability body, the new European bodies are sector specific, with more emphasis on understanding the various sectors of the market. This means the proposals for UK regulation do not mirror Europe, and yet it is crucial for the UK to have a strong voice in European negotiations.

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

20. The costs of all the changes will ultimately be borne by consumers. The Treasury Consultation acknowledges that it will be more expensive to run two smaller regulators than one larger one. There will be costs for the new regulators having to split back-office services such as IT and HR, as well as costs for firms in changing reporting methods to deal with different regulators and their methods of operating to adhere to any changes to the rules.

21. For those firms who are regulated by both the PRA and CPMA, there will be the cost of responding to more than one regulator. This will be in an increased burden of hosting visits from two regulators and providing information to more than one regulator. On top of this, there is the danger of the two regulators placing conflicting demands on the behaviour of firms.

22. An example of the increased burden of dual regulation is that on the credit union sector. Credit unions have prudential and conduct risks and so are likely to be regulated by both. This will increase the cost of borrowing to those more vulnerable in society, and reduce dividends to those being encouraged to save for the future with more meagre resources than the majority involved in the financial services sector.

23. Ultimately, these regulatory changes represent yet another cost which small firms have to bear. We already have hugely unpredictable costs in supporting the Financial Services Compensation Scheme. The levy on firms is decided on an annual basis, depending on how many firms have gone into default and the consequent compensation payments required to consumers. At the moment, with large payments expected, it is extremely difficult to predict the size of the likely costs, and yet firms have to devise a fee structure to cover this. It is likely that firms required to fund this will err on the side of charging too much rather than too little – in order to try to ensure their survival.

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

25. If the split is to occur as outlined, the key divide between prudential and conduct seems sensible. However, we refer to our concerns as outlined in answer to the first questions, that this change is unnecessary and will neither improve the regulation of smaller firms, nor definitely prevent any future crises.

26. We believe that a regard to competitiveness and viability of the financial services industry should be a responsibility of all of the regulatory institutions, and not be reconsidered for the PRA as suggested in paragraph 3.9 of the Treasury Consultation. It is untenable that a regulator should have the power to act in ways which could undermine the stability of such an important sector of the UK economy without considering the consequences of their actions.

27. As there will be fewer smaller firms regulated by the PRA compared to the CPMA, we are concerned that the smaller firm voice may become lost within the PRA.  We will urge that there is a specific facility created, similar to the FSA's Smaller Firms Division, in both the CPMA and the PRA, to protect and promote the interests of smaller firms.

28. It is inappropriate for the CPMA to be a ‘champion for consumers’, especially in relation to smaller firms. A better approach would be to ensure a reasonable and fair balance between the interests of consumers and the impact of those interests on firms seeking to provide quality services to consumers.

29. The FPC and Bank of England will be very powerful influencers of regulatory policies, and ultimately, the whole business environment in the UK. We are concerned at the low level of external accountability proposed in the new structure, with no input from practitioners specified. For the PRA, there is only a consideration of possible current accountability mechanisms of the FSA being transferred to the PRA (HMT Consultation, paragraph 3.38). We would advocate an increased role for all three of the FSA’s current independent panels interacting with the CPMA, PRA, and FPC. From the smaller firms’ point of view, it is crucial that the perspective of 90% of firms by number is taken into account at all levels of the regulatory structure.

30. It is unclear how the future structure of enforcement will work. This is an important aspect of regulation, which we want to see working effectively, and with appropriate appeal mechanisms.

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

32. The new prudential regulator must be flexible enough to recognise the differences between banks and non-bank institutions. It is a concern that paragraph 3.34 of the Treasury Consultation refers to the supervision of financial firms having the benefit of the expertise, experience and credibility of a central bank, without reference to the possible need to expand that expertise and experience to those sectors not previously covered by the Bank.

33. It is already predicted that a large number of small advisory firms will go out of business as a consequence of the implementation of the FSA’s Retail Distribution Review in 2012. The regulatory changes proposed in the Treasury consultation will lead to yet more costs in changing systems for dealing with a new regulator. The consequence of this will be to encourage more small firms to give up, so denying consumers access to financial advice, and employees access to work.

34. For small firms overall, these regulatory changes represent an additional burden for which there seems to have been no cost benefit analysis. We believe, in the case of smaller firms, that the cost of the regulatory changes will be disproportionate as there are no perceived benefits.

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

36. We believe the FPC should be democratically accountable through a statutory remit. As well as financial stability, the statutory remit should also direct the FPC to consider the impact of their decisions on the viability, competitiveness and multiplicity of the financial services community.

37. We recognise that the FPC will not focus its attention on the activities of small firms, nevertheless, it must not make decisions which will unnecessarily penalise them.

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

39. In a crisis, the success of the FPC will be if UK financial institutions remain secure and markets continue to function. Out of a crisis the success should be on the basis that UK financial institutions remain internationally competitive, that the UK remains an attractive place to do business and that markets are liquid and transparent.

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

41. There is the prospect of some conflict in terms of the different remits requiring conflicting policy responses, but this should be minimised and managed through the mutual members of the MPC and FPC.

42. Is the FPC appropriately structured in terms of the balance between internal and external members and the size of the Committee? What characteristics, experience and qualities should the Government look for when appointing external members of the FPC?

43. We believe that there must be independent members with experience and understanding of the management of financial services firms; including smaller businesses. These people must also have experience of other regulated sectors beyond banking, particularly insurance as it is such a major part of the system.

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

45. We do not believe it is appropriate to have the PRA as the lead authority. If prudential and conduct are to be split, the regulators should have independence and equal authority. The CPMA must not be seen as a junior partner, as it could adversely affect the way it is regarded by regulated firms and in any negotiations on behalf of the UK.

46. Indeed, we would advocate the CPMA as the lead authority over the PRA: all firms are due to be regulated by the CPMA, and only a smaller number by the PRA.

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

48. The idea of judgement-based approach from the PRA (and possibly CPMA) without any agreed guidelines cannot be allowed to prevail when there are European legal structures which apply to the UK – much of it set through maximum harmonisation directives.

49. In today’s global economy, the UK cannot have a subjective and uncertain regulatory regime which could unfairly disadvantage UK firms, but must work within clear and transparent guidelines.

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

51. It is unclear that consumer protection will increase under the proposed system. Indeed, consumer protection could reduce if there is not sufficient information sharing between the PRA and CPMA. As with any new system, there is a danger of gaps developing between the new bodies.

52. However, if the activities of the two regulating authorities dovetail and firms do not suffer too much disruption in the changeover, consumer protection should persist at least at the current level.

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

54. The proposals indicate that the vast majority of smaller firms will only be regulated by the CPMA. Nevertheless, these firms are still likely to have additional burdens in revising systems to deal with a new regulator with possibly differing priorities.

55. For those firms having two sets of regulators, they will have two supervisors to whom they are accountable, with two sets of visits rather than one, and a need to notify two regulators of changes in the business. There may also be differing, possibly contrary requirements from two regulators which will cause frustration and delays.

56. For some small firms, for instance credit unions, the possibility of being regulated by two bodies will increase administrative and financial burdens on a sector which is, in the main, run by volunteers and with low financial resources.

57. We are also concerned that if the new regulators try to keep overall costs down to current levels, the quality of supervisors and supervision may deteriorate.

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

59. Market forces should be allowed to create healthy competition, but as the regulator is intervening in that market, it must have regard to the impact of its actions on competitiveness. However, we do not believe that it is the role of the regulator to actively promote competition.

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

61. All the proposed bodies should have a role in promoting the UK’s interests as a whole in EU and international relations.

September 2010

APPENDIX 1

ROLE AND REMIT OF THE SMALLER BUSINESSES PRACTITIONER PANEL

1. The Smaller Businesses Practitioner Panel (SBPP) was set up by the Financial Services Authority (FSA) to represent the views and interests of smaller regulated firms and to provide advice to the FSA on its policies and strategic development of financial services regulation. 

2. Our members are drawn from smaller firms operating across the main sectors of regulated business.

3. We consider several factors when deciding on the definition of "smaller" businesses and take a flexible approach to the application of criteria.  A firm may have – in relative terms – a minor market share or small number of employees in the context of its industry sector.  In addition, the firm’s financial position and whether the firm is owner-managed may be relevant.

4. We work to ensure that the interests of smaller financial services firms are taken into account and their importance to a healthy, successful and vibrant marketplace are properly reflected in the policies of the FSA.

5. The names of the members of the SBPP as at 22nd September 2010 are as follows.

Panel Member Position

Simon Bolam Principal, EH Ranson and Company

(Acting Chairman)

Guy Matthews Chief Executive, Sarasin Investment Funds

(Appointed Chairman from 1.11.10)

Clinton Askew Director, Citywide Financial Partners

Ian Dickinson Director, The Brunsdon Group

Paul Etheridge Chairman, The Prestwood Group

Peter Evans Chief Executive, Police Credit Union

Sally Laker Managing Director, Mortgage Intelligence

Fiona McBain Chief Executive, Scottish Friendly Assurance

Keith Morris Chairman and Chief Executive,Sabre Insurance

Andy Smith Special Projects Advisor, TD Waterhouse UK

Andrew Turberville Smith Chief Operating Officer and Finance Director, Weatherbys Bank Ltd