After FSA – the new regulatory landscape

Simon Morris

Partner - CMS Cameron McKenna LLP

5th April 2011

What is proposed?

– Financial Policy Committee … “create the focus for macro-prudential regulation that

is missing from the current framework”.

– Prudential Regulation Authority … financial stability of banks and insurers.

– Financial Conduct Authority … conduct of business and market regulation for all

firms, and prudential regulation for non-PRA firms

– “put appropriate consumer outcomes at the centre of the regulatory process”

– “centre of excellence for market regulation”.

– Bank of England … directly supervise settlement systems, payment systems and

recognised clearing houses … co-ordinate crisis management, with the Treasury

responsible for deciding on the use of public funds.

What is the objective?

– To prevent a recurrence of the last financial crisis

– Recognise firms’ assumption and management of risk determines stability

– Regulators will have central policies – eg FCA will provide intrusive and

judgemental regulation

Operational targets

– Retain a competitive, world-leading financial services industry

– Have a rigorous and effective regulatory framework

– For regulators to provide firms with sufficient certainty of expectations and actions

– For unnecessary regulatory burdens to be minimised or eliminated

What is the timetable?

– A White Paper and draft Bill to enact these changes will be published around May

2011

– The Bill to be enacted by mid-2012

– FSA being currently remodelled

– Enactment planned for the end of 2012

What are the main features?

– Similar drivers to the Turner Report of 2009

– FSA was “all things to all men”

– Institutionalises the different functions of UK regulation

– Gives the Bank of England explicit oversight of UK regulation

– Co-ordination between the three bodies will be critically important

The international aspects

– G20 and the international forums drive financial services regulation

– EU directives

– More about the style than content of regulation

– National areas are principally authorisation, supervision and enforcement

Will this make a real difference for firms?

– Clearer “economic connectivity”

– FPC is being given tools and levers to bridge the economics/regulation gap

– A credible and intrusive prudential regulator

– A judgemental and effective consumer regulator

The Financial Policy Committee

– Financial stability “fell between the gaps”

– FPC puts the Bank of England at the heart of the financial system

– Judgement-led approach to achieving financial stability

Financial markets have structural features that make a system vulnerable to shock …

a) Information problems – a lack of information or transparency

b) Misaligned incentives – decisions that appear rational but cause problems

elsewhere in the market

c) Market illiquidity

d) Contagion where innovative products or practices increase the network of

interconnections between financial institutions

e) The existence of numerous systemically important financial institutions

f) Inadequate market infrastructure

g) Narrow distribution of risk exposures, such as sub-prime mortgages

h) Cyclical risks such as cycles of risk and appetite

The FPC’s objective

– The Bank’s financial stability objective …protect and enhance the stability of the

financial system of the UK

– The FPC objective …to contribute by identifying, monitoring and minimising

systemic risks …

– These include … structural features …the distribution of risk …and unsustainable

levels of leverage, debt or credit growth

The FPC’s functions

The FPC will use levers and tools to address these risks:

• to seek to influence

• to make recommendations

• to give directions

a) Creating a counter-cyclical capital buffer

b) Varying risk weightings applied to a firm’s asset exposures

c) Limiting leverage

d) Enhancing liquidity requirements

e) Require a firm to provide against prospective future lending losses

f) Increasing collateral requirements

g) Adding to disclosure requirements

h) Requiring stress tests to be conducted

The Prudential Regulatory Authority

“…The PRA should be judged by the avoidance of failures which incur a cost to the

economy and in particular to individual tax payers and customers. This objective

contrasts with the situation the FSA found itself in, namely no acceptance from the

media or politicians that the FSA was not a “Zero failure” institution. ……”

Extract from Hector Sants’ speech of 13 December 2010

PRA

Grand plan – bringing macro- and micro-prudential regulation together

The PRA’s proposed objectives are:

– Strategically promoting the stability of the UK financial system (= Bank’s & FPC’s

strategic objective)

– Operationally promoting the safety and soundness of each firm that it authorises,

minimising the adverse effect of its failure on the UK financial system

PRA scope

The PRA will regulate:

• Deposit takers

• Insurers

• Lloyd’s

• Other firms – principal dealers/BIPRU 730k

PRA style

– The PRA will “take a judgement-led supervisory approach”

– It will adopt a principles-based rulebook

“A particular focus of our initial thinking has been around establishing whether a

slimmer, more purposive and accessible rule book can be produced for the PRA.

The PRA will not do away with rules altogether, but an important change in focus for

the PRA will be in ensuring that it is clear to all what purpose its prudential rules

are intended to achieve. We expect to review the prudential aspect of the current

FSA Handbook with a view to achieving this end, subject to constraints imposed by

EU directives - as well as in making the material shorter and easier to navigate.”

Extract from Hector Sants’ speech of 13th December 2010

– The PRA will establish a proactive intervention framework

The Financial Conduct Authority

“The CPMA is being set up with the clear intention of securing better outcomes for

consumers. This will mean it will engage with consumers, their representative

bodies and consumer intelligence earlier than has been the case with the FSA –

being prepared to intervene as soon as potential concerns begin to emerge and

having a willingness to take a greater risk of being overturned on appeal if it

thinks that early intervention is warranted … the CPMA will pursue a more

aggressive consumer protection agenda,

[but] the CPMA will not always assume that the consumer is right, or that

consumers have no responsibility to look after their own interests when dealing

with financial firms…”

Extract from Hector Sants’ speech of 13th December 2010

FCA’s objectives

– The core purpose of the FCA will be to protect and enhance retail and wholesale

consumer confidence with focus on developing a new model of retail regulation

using early and proactive intervention to protect retail customers – a

fundamental shift from focusing on the sales process and seeking to ensure

adequate disclosure

– Strategically – protecting and enhancing confidence in the UK financial system

– Operationally – facilitating efficiency and choice in the market for financial services;

securing an appropriate degree of protection for consumers; and protecting and

enhancing the integrity of the UK financial system

FCA’s functions

The FCA will have five principal functions

– Fighting financial crime

– Prudentially regulating non-significant firms

– Regulating conduct of business

– Promoting competition

– Overseeing wholesale business and markets

1. Fighting financial crime

Seeking to reduce the extent to which a financial firm can be used for financial crime

2. Prudentially regulating non-significant firms

– Prudential regulator of some 18,500 fund managers, non-bank mortgage lenders, and

personal investment firms and insurance/mortgage intermediaries

– The key focus of FCA’s prudential regulation will be in preventing consumer

detriment

– To require adequate capital resources to achieve an orderly wind-down

3. Regulating conduct of business

FCA will regulate the conduct of business of some 27,000 firms

– Firms regulated by PRA, mainly banks and insurers

– Firms only regulated by FCA

– Inwardly passporting EEA firms

– And possibly consumer credit providers

A new approach to conduct regulation

“… in contrast to the FSA, it is likely that there will be a shift towards more detailed prescription.”

“…the consumer objective for the CPMA … emphasises early and proactive intervention, a braver approach to enforcement and redress, and a willingness to improve the consumer experience. However, in order to achieve this goal the CPMA will need to be given more powers of intervention and disclosure than the FSA currently has...”

Hector Sants’ speech of 13th December 2010

1. Have a lower risk appetite than FSA

2. Be less prepared to see detriment occur

3. Be readier to act to prevent losses

Product intervention

– Earlier identification of risks through gathering intelligence from wider sources

– Placing requirements on products and product features to remedy a problem –

perhaps disclosure of a specific feature or prohibiting a limitation

– Mandating minimum product standards where a problem is perceived

– Restricting product sales to certain classes of consumer

– Halting a product launch or continuing sales for up to 12 months, for example when

this is not already covered by existing rules.

Transparency

Two specific new powers proposed are for FCA to publicise that

• A firm has been required to amend or withdraw a misleading advertisement or

sales practice

• It has commenced disciplinary action against a firm

4. Promoting competition

The FCA is to have a “credible and effective role in competition”

5. Overseeing wholesale business and markets

Key FCA focus – monitoring market conduct

• Assume FSA’s current powers in respect of market abuse

• The UK Listing Authority will become part of the FCA with minor alterations

• Responsibility for the conduct and prudential regulation of UK recognised

investment exchanges and multilateral trading facilities

Further retail protection

– FSCS

• Jointly overseen by PRA and FCA

• Each making rules for levies and funding.

– FOS will be overseen by FCA.

• FOS will retain its role as a quasi-regulator because of the wider implications rule.

• The Government also wants FOS to be able to publish its determinations

Operating under dual regulation

There are six regulatory principles:

1. To use resources efficiently and economically

2. The imposition of a burden or restriction should be proportionate to the resulting

benefits

3. Consumers should take responsibility for their actions

4. A firm’s senior management is responsible for compliance

5. A regulator should seek to make information public

6. A regulator should operate transparently

Operational issues

Some specific instances for dual-regulated firms are:

1. Firm authorisation

2. Variation of permission

3. Individual approvals

4. Passporting

5. Making rules

6. Supervision

Making sense of the new UK and EU regulatory

landscape

Paul Edmondson

Partner - CMS Cameron McKenna LLP

Europe

– HMT’s message about greater EU and international engagement

– But what about

• The march of maximum harmonisation and the single rulebook and…

• ….the restraint of EU law on domestic policy and the new roles of PRA and FCA

• The Icelandic bank issues and the more/less Europe debate

The agencies and their roles – ESRB and ESA

European Systemic Risk Board (ESRB)

– The EU equivalent of the FPC

European System of Financial Supervision (ESFS)

– Comprises a network of three new European Supervisory Authorities (ESAs) –

• CEBS, CEIOPS and CESR transformed into…

• EBA (Andrea Enria), EIOPA (Gabriel Bernardino) and ESMA (Steven

Maijoor)

ESFS – European System of Financial Supervision

– ‘Supervising the supervisors’

– Detailed harmonisation

• The single rulebook and technical standards

• e.g. EBA intends to use the “true power” of a single set of rules – Andrea

Enria

– Staffing up

• Staffing at the three ESAs will rise to 150 people in 2011 and to 300 in

2015

– Coordination of supervision of firms/groups across borders

• Collection of information (e.g. for stress testing)

• Common supervisory culture (e.g. by peer reviews)

ESFS powers

– Tie-breaker powers

• Mediating and settling disputes between national supervisors

– Home/host supervisor of RBS Insurance

– Group/subsidiary supervisor

– Power to revise standards of national supervision

– Temporary restriction of ‘high-risk’ financial activities based on sectoral legislation

• e.g. the proposal on short-selling

– Enhanced ESA powers for emergencies and crisis management

– Ability of ESA to issue instructions to FSA and/or to individualinstitutions to comply with ESA rulings

EU work legislation and rulemaking

– See our EU legislation checker (in pack & RegZone)

– Solvency II

• MiFID II

• MAD II and energy market transparency

• Post-crisis measures – Basel III/CRD IV, EMIR

• Long list!

– Less national discretion on local rules and policy

• Legislation by regulation (eg EMIR)

• Maximum harmonization eg MiFID

• Less gold plating

• = the single rulebook with common technical standards

The new agenda to promote competition

Susan Hankey

Partner – CMS Cameron McKenna LLP

Too much for one morning

– Roles of FCA and PRA

– Reports from HMT, TCS, ICB (11 April)

– BIS consultation

– So look at a selection

• “promoting competition”

• Transparency

• TSC and market development

• Market investigations and concurrency

– More questions than answers

Promoting competition: a more interventionist approach?

– FCA to “discharge its general functions in a way which promotes competition”

• The ability to make rules that will have beneficial competition outcomes

– PRA to have major role “in key regulatory areas potentially impacting on competition”

• Rule making even where potentially contrary to classic competition

prohibitions?

– BIS considering whether CMA to have primary duty to promote competition

• Notes must not compromise independence and impartiality in specific

cases

BIS consultation

– Aims to improve in terms of cost, speed of processes and effective decision making

– UK competition regime and authorities world class, but still relatively inexperienced

– All about £? “flexible allocation of scarce resources”

– Themes for improvement:

• Formation of CMA

• Better pursuit of breaches of the prohibitions

• Other procedural issues (including market investigations)

• Merger control

• Concurrency regime

• Obtaining more cartel offence convictions

Transparency – the answer to everything?

– TSC 2 April Report

• Lack of price transparency and comparability in the personal current

account market

• Personal current account gateway effect

– Implications for other products: cross subsidy

– TSC attempting social engineering?

• 10 years post Cruickshank “problem remains acute”

• Government can do more to prioritise competition in the way it regulates

the industry

• FCA should have competition as a primary objective

If transparency is the answer, how will it be achieved?

– The old market investigation way won’t do – PPI took 57 months to publication of CC Order on 24/3/2011

– Updated market investigations? (see later)

– FCA promotion of competition

• how would/could this work?

– ICB and OFT

• TSC “calls on the banks to make cooperating a priority”

• how would/could this work?

TSC and the development of the market

– New entrants

• Disadvantaged where no access to extensive branch network

• Government should “examine carefully where it can help to improve conditions for effective competition”

– Regulation and competition

• ICB should not shirk from “proposing radical changes to the market as a whole”

• “case for further structural reforms….to reduce concentration and promote competition”

• Solve the “too big to fail” problem

• FCA should have competition as a central operational objective – we’ve told you this before and we’re telling you again

Market investigations – the BIS view

– Onerous process OFT and CC – long and duplicative

• Store Credit Cards 31 months

• Home Credit 29 months

• NI Personal Banking 31 months

• PPI 57 months

– Favours two stage approach – process options

– Will look at time frames

– Queries whether CMS should deal only with competition, not consumer-focused MIs

Market investigations – Treasury suggestions

– In context of powers for FCA:

• Competition mandate would have been useful in PPI

• Could have used regulatory tools to intervene more swiftly e.g. to

unbundle sale of PPI from sale of loans

– So should FCA have powers to keep FS markets under review and decide whether to refer a market investigation to the CC?

If FCA deals with market investigations, why not further concurrency?

– HMT to take BIS report into account, but considering:

• Market investigation powers

• Or FCA could decide where more appropriate to use regulatory powers

• Agree legally binding commitments with industry in lieu of referral to CC?

– No need to stop there

• FCA could have concurrent powers to hear super-complaints in FS sector

• Or FCA’s Consumer Panel could have power to make super-complaints

to OFT

And what has BIS said about concurrency?

– BIS generally likes concurrency because:

• Allows integrated application of regulation and competition law

• Concurrent regulators have industry expertise

• Regulated businesses have only one beast to deal with

– But not much evidence to date of use of competition powers

– Perception that regulatory powers easier to enforce than Competition Act ones

– Considering obligation on regulators to use competition powers as preferred option and role of CMA as central resource

Implications for the financial services sector?

– Concurrent regulators deal with networked industries and price regulation

– Licence conditions often reflect competition concerns e.g. fair trading

– Financial services sector is different

• BIS recognises current FSMA position = the old world

• HMT options

• What next?

Making it easier to prosecute

– Whatever the changes in roles and procedures, the key competition prohibitions remain

– Cartel offence: criminal sanctions where individual dishonestly agrees that company will participate in hardcore cartel activities

– Imprisonment <5years/unlimited fines

– But since 2002 only one successful case (and that started in the US)

– BIS considering how to make it easier to get convictions

• Remove concept of dishonesty

• Options for change

Any questions?