Publications

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On 27 January 2012, the Financial Services Bill ('FS Bill'), together with explanatory notes, was published by UK Parliament. The FS Bill had its first reading before the House of Commons on 26 January 2012.

The FS Bill will implement the government’s proposals to reform the financial regulatory structure in the UK. The legislation will fundamentally reform the current regulatory system, which divides responsibility for financial stability between the Treasury, the Bank of England (BoE) and the Financial Services Authority (FSA).

The government is reforming the UK regulatory architecture by: 

• Establishing 'a strong and expert' macro-prudential authority, the Financial Policy Committee (FPC) within the Bank of England to monitor and respond to systemic risks 
• Transferring responsibility for micro-prudential regulation of firms that manage complex risks on their balance sheets to a focused new regulator, the Prudential Regulation Authority (PRA), established as a subsidiary of the BoE 
• Providing for a focused new conduct of business regulator, the Financial Conduct Authority (FCA)

The government is confident that each of these bodies will have "clarity of responsibility and the necessary powers to ensure the stability of the financial sector and the protection of consumers." The government’s primary objective in reforming financial regulation in the UK is to fundamentally strengthen the system by promoting the role of judgement and expertise. The government said that tick-box compliance with rules has been shown to be of limited use as a model of supervision and that regulators must be empowered to look beyond compliance, to supervise proactively and to challenge.

The government has made some notable changes to the FS Bill since it published a white paper in July 2011 in response to specific recommendations made by a joint committee of the House of Commons and the House of Lords ('joint committee') report which was published on 19 December 2011.

FPC

Objectives

The FS Bill has been amended to make clear the types of risk the FPC should focus on in line with the joint committee report's recommendations. The FPC is required to look at “systemic risks attributable to structural features of financial markets, such as connections between financial institutions.” This language incorporates an explicit reference to the global interconnected nature of the financial sector, as recommended by the joint committee. For the purposes of the definition of systemic risk it is immaterial whether the risks arise in the UK or elsewhere.

Ensuring democratic accountability

The government has accepted the joint committee’s suggestion that where the FPC does not agree with the treasury’s recommendations about how the FPC should fulfil its objectives, or factors it should consider in pursuing those objectives, it should make its concerns public and explain why it does not intend to act in accordance with those recommendations. The FS Bill has therefore been amended to require the FPC to respond publicly to the treasury’s remit, setting out how it intends to comply with the recommendations and, where appropriate, setting out its reasons why it does not intend to act in accordance with the remit. This is to ensure greater democratic accountability of the FPC to parliament through the treasury.
PRA

A 'duty to supervise'

The FS Bill has been amended to include an explicit requirement on the PRA to maintain arrangements for the supervision of PRA-authorised persons. The government believes that the PRA should be explicitly empowered and required to go further than making rules and ensuring that authorised persons comply with them. Giving the PRA a specific 'duty to supervise' will ensure an enduring statutory commitment for the PRA to take a judgement-led approach to supervising individual firms through engagement, scrutiny of business models and forward-looking assessments of risk. The government believes it will allow the PRA’s supervisors to exercise judgement on aspects of a firm’s business that affect safety and soundness and to take action where they are of concern.

Scope of regulation

The joint committee raised the question of whether the PRA’s scope should extend to investment firms who do not pose stability risks as individual firms but could be 'systemic as a herd,' including those investment firms conducting 'rehypothecation' of their client’s assets. However, no change has been made to the provisions of the FS Bill, as the government feels that the legal framework already provides sufficient flexibility for changes to be made through secondary legislation. This includes the Regulated Activities Order and the order made under new section 22A (designation of activities requiring prudential regulation by the PRA) which permits changes to be made to the boundary between the PRA and FCA regulation of firms dealing in investments as principal.

The draft designation order sets out the criteria which the PRA will apply when considering whether it should designate individual firms dealing in investment as principal for PRA regulation:

• The applicant must hold or be seeking to hold permission to deal in investment as principal
• The applicant must be required to have initial capital of at least €730,000, which has the effect of excluding smaller investment firms

The decision to designate will involve the exercise of judgment. For example, a firm might only meet the designation criteria because of temporary factors. The PRA will consider periodically, or in response to a merger or acquisition, whether the conditions for designation are satisfied. To guard against 'designation volatility,' the criteria will be applied based on an average value of assets over a specified period of time. Where the investment firm does satisfy the criteria and is designated, there will be a minimum period over which it will remain supervised by the PRA. As required by the designation order, the PRA will consult the FCA before designating an investment firm.

FCA

Objectives of the FCA

The FS Bill adopts changes to the strategic and operational objectives of the FCA in response to two concerns of the joint committee. First, that the overall remit of the FCA should focus on making sure that financial services and markets that work well for those who use or participate in them and second, that the FCA should have an operational objective to promote effective competition in financial services in the interests of consumers.

Regulation of Consumer Credit

The FS Bill includes provisions enabling a full transfer of consumer credit regulation to the FCA, with retention of substantive Consumer Credit Act provisions. The exercise of these powers will be subject to impact assessment and the approval of both Houses of Parliament. This follows the recommendation by the joint committee that consumer credit regulation should be transferred from the Office of Fair Trading (OFT) to the FCA. The OFT issued a public statement on 27 January 2012, declaring its commitment to working with the government and the FSA to help to design a model of FCA regulation that enhances strong protections for consumers in the credit market.

New disciplinary powers

Under the current sponsor regime the FSA cannot impose a financial penalty for infringement of the sponsor rules. Under its new powers, the FCA will be able to issue fines to sponsors and primary information providers. This represents a significant change to the disciplinary powers of the regulators. The BoE and the FCA will also be able to take disciplinary action, including the imposition of financial penalties, on recognised clearing houses and recognised investment exchanges. The BoE, PRA and FCA will also be able to take disciplinary action in relation to auditors and actuaries, including disqualifying an auditor or actuary from working with a financial services company, imposing a financial penalty and publicly censoring them.

Referrals to the FCA

The Financial Ombudsman Service (FOS), authorised persons or certain other financial institutions will be able to make references to the FCA. A reference can be made where it appears that there may have been regular failure by one or more regulated persons to comply with requirements which apply to them and as a result consumers have suffered. A reference can also be made where it appears that one or more regulated persons has on a regular basis acted in such a way that, were it referred to the FOS, and where the compulsory jurisdiction applies, an award would be made in the complainant's favour. There may be a range of responses open to the FCA. The FCA could indicate that it proposes to consult on making rules on a particular matter or that it is still considering the matter and proposes to carry out further analysis of the matter referred to in the complaint or reference. The FCA may also wish to set out a timetable for taking action, allowing the FOS to consider how to proceed with complaints which have been made to it which relate to the subject matter of the reference. Alternatively, it may be that having examined the issue, it does not consider that it merits detailed investigation. These new powers reflect concern about there being inadequate mechanisms in FMSA for dealing with issues arising before the FOS which had 'wider implications' for the new regulatory regime (eg, PPI mis-selling and bank charges complaints).

Competition powers

The Joint Committee Report thought that the FCA's role in promoting competition should be clarified and it should be given greater competition powers to achieve its competition objective. In particular, it should be given concurrent powers, alongside the OFT, to make market investigation references to the Competition Commission. Also, designated consumer bodies should be able to make super-complaints to the FCA, as well as the OFT. There has been little movement on this by the government. The FCA is able to ask the OFT to consider whether a feature of the UK market for financial services may prevent, restrict or distort competition. However, the OFT is not required to take any specified action in response to the request. The OFT has given its support to the government's position on the FCA's competition powers and objectives and declared its commitment to build on its close working relationship with the FSA over the coming months to "implement a new FCA framework that works well for consumers and the markets alike."

Does FCA have power to announce investigations?

The FCA will have the power to publish its enforcement investigations at an earlier stage under the FS Bill. Currently, the FSA is only able to publish details of its enforcement cases once it has completed its investigation and issued a decision notice. However, the FCA will be able to publish details of firms and individuals at the warning notice stage. The draft bill required the FCA to consult the firm that was subject to the investigation before publishing details of the enforcement investigation. The Joint Committee Report backed the FSA's view over removing the requirement to consult. However, the government has rejected the joint committee's argument, stating that "the right balance has been struck between making the power usable and providing appropriate safeguards for those affected."

The FS Bill also gives FCA regulated firms less time to represent themselves to the regulator before their case is progressed. This period is reduced from 28 days to 14 days although the FCA may extend this period on a case-by-case basis.

Product intervention powers

One of the most controversial new powers is the FCA's powers to intervene in the contractual dealings of authorised persons under the product intervention rules. The FCA is able to make general rules including prohibiting authorised persons from entering into specified agreements or doing anything that would or might result in the entering into of specified agreements, if it is necessary for the purpose of advancing the consumer protection objective, competition objective or integrity objective. The FCA can also intervene in the terms and conditions to be, or not to be, included in specified or other agreements and limiting invitations or inducements to enter into specified or other agreements to those made to specified persons. The competition objective was included after the Joint Committee Report stated that the FCA should be mindful of the potential impact of product intervention on competition and innovation. In relation to the FCA's product intervention powers, the joint committee felt that the potential risks and benefits of products must be properly understood. It is not evident that the FCA would necessarily understand a new product better than a firm. The joint committee supports the need for judgement-led product intervention by the FCA but recommends greater communication between the regulator and the firm concerned, which should reduce the need for such intervention.

Crisis management 

The Treasury Select Committee (TSC) carried out a comprehensive review of the current framework around crisis management as part of its recent inquiry into accountability of the BoE, and made a number of important recommendations.

A key recommendation is that the responsibility of the treasury for protecting public funds needs to be more clearly recognised in the statutory framework for crisis management. The government has accepted the TSC’s recommendation (which the joint committee backed) to establish a new targeted power of direction over the BoE, which the Chancellor may deploy following a notification by the Governor of a material risk to public funds. Essentially, responsibility for any decisions requiring the use of public funds will fall to the Chancellor. The amendment is an attempt to ensure that ultimate responsibility for the use of public money falls clearly with the treasury and therefore accountable to the wider public through parliamentary scrutiny. Once it is clear that public funds may be put at risk, the Governor will have a statutory duty to notify the Chancellor. A crisis management Memorandum of Understanding will underpin this process, setting out how the decision to notify will be made and the steps that will be taken by both the BoE and the treasury to resolve the threat.

Next steps

The government had made significant changes to the FS Bill in response to the Joint Committee Report which increases democratic accountability of the FPC and gives greater powers to the PRA and the FCA. Undoubtedly, the FS Bill could still change significantly as it makes its way through the parliamentary process and as amendments are proposed. The FS Bill is scheduled for a second reading in parliament on 6 February 2012. The government has stated it is firmly committed to securing passage of the FS Bill by the end of 2012, so that the changes can be implemented in early 2013.