- The Government’s Proposals for Regulatory Reform - The Story So Far
- May 17, 2012
- Law Firm: Norton Rose Canada LLP - Montreal Office
In January 2012, the Government published a third consultation document on its proposed regulatory reforms. The consultation document was entitled A new approach to financial regulation: securing stability, protecting consumers (the Consultation Document).
This briefing note is in two parts:
- Part 1 examines the Consultation Document.
- Part 2 reviews the passage of the Financial Services Bill (the Bill) so far.
This briefing note should be read in conjunction with our other briefing notes on the Government’s proposals for UK regulatory reform.
Part 1 - The Consultation Document
The Consultation Document builds on a fairly extensive consultation process which the Government has already carried out. It builds on:
- Two earlier consultation documents (A new approach to financial regulation: building a stronger system and A new approach to financial regulation: judgement, focus and stability).
- Recommendations made in pre-legislative scrutiny of the draft Bill conducted by the Joint Committee on the draft Financial Services Bill from July to December 2011.
- Three separate Treasury Select Committee enquiries into issues relating to regulatory reform.
The Consultation Document accompanies the introduction of the Bill into Parliament. The Bill itself is not an easy read because it consists in the most part of amendments to other legislation, mainly changes to the Financial Services and Markets Act 2000 (FSMA). Hence, many of the clauses are difficult to understand except in the context of that Act. Recognising this fact the Treasury has produced a version of FSMA, incorporating the changes proposed in the Bill. This can be found on the Treasury’s website.
Financial Policy Committee
The Government intends to bring together all aspects of financial stability within the Bank of England (BoE) group. To this end the Bill provides that:
- The new Financial Policy Committee (FPC) will be responsible for macro-prudential oversight of the UK financial services system as a whole.
- The Prudential Regulation Authority (PRA) will be the prudential regulator of banks and other deposit takers, insurers and certain investment firms.
- The BoE itself will be responsible for the regulation of systemic infrastructure.
The Consultation Document states that the Government has accepted a recommendation made in pre-legislative scrutiny that amendments should be made to clarify the types of risk that the FPC should focus on. The Government has amended the Bill by inserting a new section 9C into the Bank of England Act 1998 (the BoE Act) which requires the FPC to look at “systemic risks attributable to structural features of financial markets, such as connections between financial institutions”. The new section clarifies that for the purposes of the definition of systemic risk it is immaterial whether the risks involved arise in the UK or elsewhere.
The Bill provides for the Treasury to set a remit for the FPC, in the form of recommendations regarding how the FPC should, in general, interpret and pursue its objective, or suggestions as to other factors the FPC might consider in the exercise of its functions. The Government acknowledges discussions in pre-legislative scrutiny that the FPC should not have complete discretion to disregard the Treasury’s remit. The Bill has 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.
The Government also acknowledges the comments made in pre-legislative scrutiny that the macro-prudential tools to be used by the FPC are of considerable importance. In the Consultation Document the Government confirms that there will be a public consultation on the FPC’s initial set of macro-prudential tools, before the draft order is laid in Parliament. The Government has also amended the Bill inserting a new section 9L of the BoE Act which requires the BoE to maintain a statement of policy for all its macro-prudential tools, except where the FPC needs to use a tool for the first time as a matter of urgency.
The BoE has primary operational responsibility for financial crisis management. The BoE, together with the PRA, will be responsible for the identification of threats to financial stability, and developing and implementing a response to those threats. In the Consultation Document the Government makes it clear that responsibility for any decisions requiring the use of public funds will fall to the Chancellor. Once it is clear that public funds may be put at risk, the Governor of the BoE will have a statutory duty to notify the Chancellor. The Government believes that this means that the Chancellor will have the power of direction when there is a real risk to the public purse, but that the BoE will continue to have operational autonomy when managing threats to stability where public funds are not at risk. A crisis management memorandum of understanding (MoU) will underpin the 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. A draft of the crisis management MoU is set out in the Consultation Document.
Prudential Regulation Authority
In line with recommendations made in pre-legislative scrutiny the Government has amended the Bill to place an explicit duty on the PRA to supervise firms. The Government felt that giving the PRA a specific “duty to supervise” would 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 also noted the comment made in pre-legislative scrutiny that the judgement-led approach to supervision could be further strengthened by reviewing the threshold conditions. However, it felt that conducting a radical overhaul of the threshold conditions at this time would be complex and potentially disruptive. In light of this the Government removed from the Bill those provisions which made specific amendments to the threshold conditions. However, the Government states that it would conduct a detailed and comprehensive review of the threshold conditions before making any changes. The FSMA currently gives the Treasury power to add additional threshold conditions or amend the existing threshold conditions. The Bill now extends this power to enable the Treasury to modify the existing threshold conditions to provide clear and separate sets for the PRA and the Financial Conduct Authority (FCA), and to add additional conditions if needed.
The Government also agrees with the comments made in pre-legislative scrutiny that there would be merit in providing a mechanism for the regulators to set out in more detail what is required of firms to meet the threshold conditions. The Bill now gives the PRA and FCA the power to make “threshold condition codes” that will elaborate on the conditions and how they will apply to different classes of firm. The codes will be stronger than existing FSA guidance in that they will be binding on firms.
In relation to the PRA’s scope the Government noted the question that was raised in pre-legislative scrutiny as to whether this should be extended to investment firms that do not pose stability risks as individual firms but could be “systemic as a herd”. However, it rejected making changes to the Bill arguing that the draft legal framework already provided sufficient flexibility for changes to be made through secondary legislation.
The Government accepted the recommendation made in pre-legislative scrutiny that the PRA be given more comprehensive powers to regulate holding companies to ensure a consistent regulatory approach. The Government has now bolstered the PRA’s powers in relation to holding companies by strengthening the supervisors’ powers to monitor emerging risks at the holding company level, including:
- Providing a new power for the PRA (and the FCA) to make rules requiring classes of parent undertakings of authorised persons to provide information on a regular basis.
- Widening the trigger for use of the power of direction, to enable the regulator to act in instances where it considers that acts or omissions of the parent undertaking have or may have a material adverse effect on the effectiveness of consolidated supervision.
- Providing an enforcement mechanism for the power of direction that enables the regulator to issue a statement of censure or to fine where the parent undertaking fails to comply with the requirement.
Financial Conduct Authority
In pre-legislative scrutiny it was argued that the strategic objective of the FCA should not be focused on confidence but rather on making markets work well. In particular, it was recommended that “the FCA’s strategic objective should be amended to focus on promoting fair, efficient and transparent services and markets that work well for users”. In the Consultation Document the Government accepts the need for greater clarity and has amended the FCA’s strategic objective to one of “ensuring that the relevant markets function well”.
In recognition of the important role the FCA has in promoting competition the Government has also recast the FCA’s efficiency and choice operational objective as “promoting effective competition in the interests of consumers”. This new competition objective will be complemented by a set of factors to which the regulator may have regard in deciding what constitutes effective competition. The Bill also retains the competition duty on the basis that the Government recognises the important effect this will have in driving the FCA to seek competition led solutions to conduct issues more generally and in pursuit of its “consumer protection” and “integrity” operational objectives. The Government hopes that the overall effect of these changes is that the FCA’s competition mandate is much stronger and more explicit.
The Government has also amended the FCA’s consumer protection objective. First, it has added a new “have regard” so that, in deciding what degree of protection is appropriate, the FCA will be required to have regard to the general principle that those providing regulated financial services should be expected to provide an appropriate level of care. Second, the Government has replaced the current “have regard” covering the need for accurate information with one setting out explicitly consumers’ need for advice and information that is accurate, timely and fit for purpose.
The Government agreed with the recommendation made in pre-legislative scrutiny that there would be significant benefit in transferring responsibility for consumer credit to the FCA. The Bill therefore now includes provisions enabling the transfer of consumer credit regulation to the FCA, with the retention of substantive provisions from the Consumer Credit Act 1974 (CCA).
The Government rejected comments made to the earlier consultation documents that there should be greater safeguards concerning the FCA’s use of its new product intervention power. The Government believes that the Bill as drafted strikes the right balance in terms of giving the FCA sufficient flexibility to act while providing the right framework to ensure that the power is used in an appropriate way. The Government has made clear in the Consultation Document that it does not expect the FCA to use the new product intervention power routinely in its work, but rather where possible, to look to greater transparency, disclosure and competition to promote better consumer outcomes. Further clarification on the making of temporary product intervention rules is to be provided in a statement of policy that the FCA will be required to produce.
In relation to the new power to disclose the fact that a warning notice in respect of disciplinary action has been issued, it was recommended in pre-legislative scrutiny that the requirement to consult the firm or individual subject to the notice ahead of disclosure should be removed. However, the Government has rejected this argument and has made no changes on the basis that the Bill strikes the right balance between making the power usable and providing appropriate safeguards. In particular the Government states in the Consultation Document that the requirement to consult does not mean that the regulator must seek the consent of the firm or individual in question, but considers that pre-disclosure dialogue to be crucial to allow the regulator to determine whether disclosure is appropriate in the circumstances.
The Government confirms that the FCA will be the UK competent authority for listing under Part 6 of FSMA. The Bill includes reforms to the listing regime which were discussed in the previous consultation documents with the exception of the proposal to extend the scope of the power in section 166 FSMA (to require “skilled persons reports”) to cover persons subject to rules made under Part 6 powers.
In its earlier consultation documents the Government consulted on specific proposals to help ensure that the FCA could take the lead in dealing with issues that were causing mass consumer detriment. The proposal was that where mass detriment was already occurring, designated interested parties (such as consumer groups) would be able to raise the issue with the FCA and require a response within 90 days. In pre-legislative scrutiny it was argued that the proposed mechanism was not broad enough for consumer issues to be brought to the attention of the FCA. This was on the basis that designated consumer bodies should be able to make “super-complaints” to the FCA, as well as the Office of Fair Trading (OFT). The Government accepted this proposal and the Bill now provides that consumer representatives will be able to make super-complaints to the FCA.
Where mass detriment is already occurring the FCA will have a range of powers that it can draw on, such as issuing new rules or guidance or using powers under section 404 FSMA to deliver an industry wide redress scheme, or the adoption of a single-firm redress scheme. In the Consultation Document the Government proposes that on the occurrence of mass detriment firms and the Financial Ombudsman Service (FOS) should be able to refer the issue to the FCA and require a response within 90 days.
Regulatory processes and coordination
The Government has agreed with the point made in pre-legislative scrutiny that the FCA should be required to give its consent over the approval of key individuals conducting significant influence functions in firms where supervision is shared between the PRA and the FCA and the Bill now makes provision for this.
The Government has also made a small number of amendments to the authorisation regime, requiring that the regulators should consult each other prior to withdrawing permission, but they do not need to obtain each other’s consent.
The Government has not amended the proposed changes to the appeals process which appeared in the earlier consultation documents. The Bill leaves the Upper Tribunal’s scope of review of supervisory decisions unchanged, but limits the course of action available to the Tribunal in the event that it chooses not to uphold the relevant regulator’s decision. With the exception of disciplinary matters and those involving specific third party rights, the Tribunal will not be able to substitute its opinion for that of the regulator. The Tribunal will instead be required to remit the decision back to the regulator with such directions as it considers appropriate in relation to a range of findings.
Part 2 - The passage of the Bill
Public Bill Committee
The Bill was introduced into the House of Commons on 26 January 2012 and received its second reading on 6 February 2012. The Bill was considered in Public Bill Committee between 21 February to 22 March 2012. The Public Bill Committee stage was held over 16 sittings and the only amendments made were a few technical Government amendments. The Government’s reason for opposing most of the amendments was that the contentious issues in the Bill had already been considered in pre-legislative scrutiny and public consultation.
The general theme of the debates in the Public Bill Committee stage was concern on the part of the Opposition to try and ensure that the right “wiring was in place”. Much of the Bill covers the powers and responsibilities of the new authorities and how they interact with one another. This inter-connectability was described as the “wiring”. In broad terms, the aim of many of the Opposition’s amendments was to introduce extra points of contact between authorities and to increase the level of concern each should have for the activities of the other. However, the Government opposed these amendments arguing that one of the identified problems of the current system was that different authorities were unsure of their respective responsibilities and that the new system prioritised clarity.
On 23 April 2012, the House of Commons held the first day of the report stage of the Bill. On this day MPs considered a limited number of new clauses and amendments to the Bill. Most of these were defeated by the Government. Those that were agreed were minor amendments to clause 5 of the Bill and a new clause 4 was added that relates to the power to make further provision about the regulation of consumer credit.
The new clause 4 is intended to provide a framework for the implementation of the Government’s proposal to retain the rights and protections of the CCA. In the debate during the report stage the Financial Secretary, Mark Hoban MP, said that, for example, the Government was likely to retain section 75 of the CCA which provides for the joint liability of creditors for misrepresentation or breaches by suppliers.
Hoban added that the Government’s preferred approach to the implementation of the transfer of responsibility for consumer credit from the OFT to the FCA was to ensure that the protections under the CCA were replicated in the FCA’s consumer credit rule book, and that the relevant sections of the CCA were repealed. This was on the basis that the approach was in line with the intention to move to a more responsive, rules-based regime than the current statutory framework.
However, Hoban accepted that there were limitations to the type of rules that the FCA could make, which meant that it was not possible to replicate in its rules all the CCA protections that the Government wanted to retain, including protections that impose rights directly on consumers and those that affect unauthorised third parties. Hoban explained that the Government therefore intends to keep some of the CCA protections within the CCA itself, and that certain provisions of the CCA will need to remain in force following the transfer. As a result, the Government will be making a number of changes to both the CCA and the FSMA as part of the transition, to reflect the fact that the FCA will be responsible for regulating consumer credit and to ensure that the FCA, as well as local trading standards, can effectively enforce the retained CCA provisions.
Hoban further explained that the Government would need to apply certain features of the FSMA, such as references to the FCA’s objectives, statutory immunity and fee-raising powers, to the FCA’s new functions under the CCA, and enable the FCA to use the FSMA supervision and enforcement powers that would normally be used in relation to breaches of FCA rules for breaches of CCA requirements. Hoban felt that the new clause 4 enabled the Treasury to make those changes and other necessary amendments to the CCA and the FSMA by order.
A motion passed in the House of Commons allocated only one further day for the report stage and third reading of the Bill.
Bill reintroduced into Parliament
On 11 May 2012, the Bill was reintroduced to the House of Commons. The Bill had been reprinted to incorporate the changes that had been made. Revised explanatory notes to the Bill had also been re-printed.
The second day of the report stage and third reading of the Bill are scheduled to occur on 22 May 2012.
The cost of regulation
There is nothing in the Bill creating more financial discipline on either the PRA or FCA, e.g. cost benefit analysis does not apply to fees rules and also there is no overall Treasury control on costs.
There is arguably a general issue as to whether sufficient information on the secondary framework has been made available to enable observers to properly consider the new structure.
There are still many uncertainties - for example, the Government agrees that the risks posed by investment firms and the issues arising from the MF Global failure should continue to be subject to scrutiny by the authorities and this may change the boundary. This has now partly been addressed through a draft of the Designation Order which has now been published on the Treasury’s website which 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. However, some commentators have queried whether enough thought has been given to this issue as they note that some large hedge fund managers who only deal as agent, and so stay on the FCA side, arguably pose systemic risk.
The Government remains firmly committed to securing the passage of the Bill by the end of 2012, so that the changes can be implemented early in 2013. As a prelude to the changes since 2 April 2012 the FSA has been operating, as far as possible within the confines of the FSMA, a so called twin peaks regulatory model and in effect operating as two separate regulators within one organisation.
Further papers on the regulatory reforms will be published by both the FSA and the BoE further clarifying the powers and responsibilities of the FPC, PRA and FCA. There is likely to be further change at Parliamentary level and although further debate in the House of Commons may be curtailed given the limited time available at the report stage, it seems more than likely that there will be significant discussion and further amendment as the Bill passes through the House of Lords.