APPENDIX
Letters of Understanding between Chancellor
and FSA Chairman
Sir Howard Davies
Chairman
Financial Services Authority
Dear Howard
THE NEW
FINANCIAL REGULATION
FRAMEWORK
The Government has a responsibility to ensure
that the UK's financial sector is effectively regulated and supervised.
In response to the failures of the past, and in recognition of
the rapidly changing nature of financial markets, we have established
a new consolidated regulatory body, operating—for the first
time—within a single legislative structure.
The Financial Services and Markets Act came
into force at midnight on 30 November, providing the legal underpinning
for the FSA to act as the UK's sole financial regulator and supervisor.
The FSA is independent of Government, and separate from the conduct
of monetary policy by the Bank of England. There is a comprehensive
new framework to ensure that the FSA and its Board is properly
accountable to Ministers, Parliament and the wider public, and
that it takes into account the interests of all its stakeholders—authorized
firms and consumers alike.
In this letter, I want to set out how I propose
to use my powers under the new arrangements to ensure that the
accountability process works as effectively as possible. I also
want to clarify the circumstances in which sensitive information,
perhaps relating to individual cases, might flow between the FSA
and Ministers.
The new framework
Under the new Act, the FSA will regulate compatibly
with achieving four statutory objectives:
— maintaining market confidence in
the financial system;
— promoting public understanding of
the financial system, including awareness of the benefits and
risks of different kinds of investment or other financial dealing;
— securing the appropriate degree of
protection for consumers, while having regard to the general principle
that consumers should take responsibility for their decisions;
and
— reducing the extent to which it is
possible for a business carried on by a regulated person or body
to be used for a purpose connected with financial crime, such
as money laundering, fraud and insider dealing.
The Government will remain responsible for:
— the legal and institutional framework
within which regulation is carried out, including the core corporate
governance structure of the FSA;
— appointing the executive and non-executive
members of the FSA Board, and judging their overall performance
in relation to the FSA's statutory responsibilities;
— ensuring the boundaries of FSA regulation
are correct;
— directing the FSA on additional matters
to be included in its public Annual Report;
— mounting investigations in cases
of possible major regulatory failure, and also to assess value
for money; and
— directing implementation of international
obligations.
Accountability
Under the new legislation, the FSA will set
the detailed regulatory rules, and make its regulatory decisions,
independently. In recognition of this, there will be a new, strong,
framework to hold the FSA Board to account.
As you will know, the main elements are:
— the four statutory objectives;
— a requirement also to have regard
to principles of good regulation, notably to regulate proportionately;
— extensive consultation requirements
when the FSA makes new rules, including an examination of proportionality,
backed up by statutory consumer and practitioner panels. The Director
General of Fair Trading must also keep the regulating provisions
and the FSA's practices under review;
— in respect of individual cases, accountability
is supported by the Complaints Commissioner and (where the Act
provides) the Financial Services and Markets Tribunal, together
with the possibility of judicial review;
— and each year, the FSA must report
to the Treasury on "the extent to which, in its opinion,
the regulatory objectives have been met". The Treasury can
also direct you to cover particular issues in the report. It submits
this Annual Report to Parliament; and
— the non-executive directors must
also report on the discharge of their functions, which include
whether the FSA is using its resources in the most efficient and
economic way.
It will be the general responsibility of Ministers
to reassure themselves that the FSA is meeting its objectives.
Without in any way compromising the FSA's statutory
independence, I propose to use my powers as follows:
— directing the FSA to cover particular
issues in its public Annual Report, so that, over time, the Reports
will establish an important public information base, through which
Parliament and others will hold the FSA and its Board to account.
I will encourage Parliament and the Treasury Select Committee
to consider the Report carefully. The Treasury Committee may also
want to take evidence on it;
— the reports will need to cover the
FSA's performance against its statutory objectives. I know reports
under the interim arrangements have made great progress in this
direction. They will also need to set out (subject to any statutory
restrictions on disclosure and any market sensitivities) how the
FSA has dealt with major regulatory cases, or regulatory issues,
which have arisen during the year;
— in making any directions, I shall
endeavour to take into consideration the views of other stakeholders;
— establishing whether the FSA is providing
value for money (under Section 12 of the Act) through periodic
independent review as necessary;
— periodically reviewing the panoply
of statutory instruments which sit under the FSMA. Ministers (and
Parliament) will also want to consider whether the boundaries
of regulation (ie which activities are subject to the FSA's jurisdiction)
remain appropriately drawn. In doing that, they will want to take
into account your views on whether there are any problems of scope
or powers which are hindering achievement of the statutory objectives;
and
— finally, under Section 14 of the
Act, I have the power to launch a statutory inquiry into possible
serious regulatory failure, which I discuss further below. Of
course, it is important to emphasise that failures of individual
firms are not, in themselves, evidence of regulatory failure by
the FSA. The Government believes that it is right for the FSA
to set the maintenance of confidence in the financial system as
its target, rather than the avoidance of failure of firms per
se.
Alerting the Government to problems
The Government has no power to interfere with
how the FSA regulates in individual cases. And, ordinarily, I
would not expect you to consult Treasury Ministers, or officials,
in respect of such cases. However, there will be circumstances
in which individual cases bear on wider responsibilities which
I, or other Government Ministers have, where you will want to
share information, and where it would be appropriate to do so.
I appreciate that you will of course need to respect requirements
of confidentiality in the Single Market Directives—as will
the Treasury and the Government more widely in relation to any
information you pass to us.
Specifically, such circumstances may arise where:
— there may be implications for the
stability of the financial system as a whole, or for a particular
sector. On occasion, there might be a need for a support operation.
Normally, all these instances will be discussed by the tri-partite
Standing Committee on Financial Stability (which brings together
you, me and the Governor of the Bank of England). These meetings
usually take place at deputy (ie official) level;
— it appears that serious regulatory
failures or gaps in the regulatory regime allowed events to occur
which posed, or could have posed, significant damage to the market
confidence or consumer protection objectives. In such cases, where
it is in the public interest to do so, I may want to use my power
to launch a statutory inquiry;
— we have agreed that you will formally
write to Ministers as soon as circumstances or issues arise which
you and your Board judge are serious enough to be likely to prompt
me to consider launching a statutory inquiry at some point in
the future. Your letter will set out the details of the problem,
and how you are dealing with it in regulatory terms. It will also
be helpful to know at that stage whether you think an inquiry
is warranted, or whether some other action (such as a fuller FSA
report) is appropriate. I will obviously want to take account
of what you say in deciding whether, and how, to respond.
— There could also be cases where:
diplomatic or foreign relations problems might arise; or where
there could be hardship or losses to a significant number of retail
customers. More generally, there may be cases which could lead
to broader questions to, or debates for, Ministers in Parliament
on matters for which we answer.
I suggest that the most serious of these circumstances—as
they arise from time to time—would also be best dealt with
through formal correspondence. There may be a case for making
these letters public, but I would expect that most of your letters
would contain market-sensitive or other confidential information
which could not be made public. Of course, Treasury Ministers
may also write to you on occasion to raise particular issues,
and the separate Standing Committee process might also require
you to write from time to time (for example, in relation to a
support operation).
Under such arrangements, I will have a basis
on which to take an appropriate view on the wider public policy
issues, which I may then wish to discuss with you, and others.
However, I stress again, I have no statutory authority to direct
your regulatory actions in any case, except where the FSA may
be in contravention of European Community law or other international
obligations.
I believe that this framework provides the right
incentives for the FSA to succeed, to operate in the interests
of all its stakeholders, and to explain and be accountable for
its actions.
Yours sincerely
Gordon Brown
Chancellor of The Exchequer
13 December 2001
Rt Hon Gordon Brown
Chancellor of the Exchequer
Dear Gordon
Our Ref: BG/2058
THE NEW
FINANCIAL REGULATION
FRAMEWORK
I am writing on behalf of my Board to confirm
the basis on which, as you propose, our independence and accountability
should be secured under the new framework for financial regulation
which has just come into effect. As we take up our new responsibilities,
it is helpful to have this framework comprehensively set out in
your letter.
We welcome your commitment to the FSA's independence
from Government. This is, we believe, clear in the statutory framework
which Parliament has put in place, which gives the FSA its own
self standing regulatory objectives. It is also, we believe, vital
to the long-term credibility of the Authority, both domestically
and internationally.
We also recognise and welcome the accountability
which justifies this independence. In particular, we believe it
is right that ministers should seek to reassure themselves that
the FSA is meeting its regulatory objectives, as well as to consider
how they should exercise their own specific statutory powers under
the legislation, and their more general responsibility for the
legislative framework within which we operate, both domestically
and in Europe.
Our annual report is a key mechanism for delivering
our accountability, and it is sensible as you propose that the
Government should provide a framework setting out what it should
cover in more detail than is done in the Act itself.
In addition, I confirm that we will write to
you as you request, as soon as circumstances or issues arise which
we judge are serious enough to be likely to prompt you to consider
launching a statutory enquiry at some point in future, and to
deal with the other cases you have specifically identified.
Howard Davies
Chairman
Financial Services Authority
13 December 2001
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