The Financial Conduct Authority: A Fresh Approach to Regulation
Sarah Jane Leake | Bloomberg Law
On 13 January, the House of Commons Treasury Committee (Committee)1 published a report on the Financial Conduct Authority (FCA), the conduct of business regulator in the coalition Government’s new regulatory framework for financial services.
Given the wave of criticism levelled at the Financial Services Authority (FSA) for its overly bureaucratic, box-ticking culture, and for failing to sufficiently protect consumers from regulatory failure, the Committee views the creation of the FCA as an opportunity to create something better. “If we are not careful,” cautions Committee chairman Andrew Tyrie MP, “the FCA will become the poor relation among the new institutions. But it is the one that will matter most to millions of consumers.”2
The Committee stresses the importance of ensuring that the FCA does not carry over the FSA’s shortcomings through new legislation. To this end, the report sets out a number of recommendations for the Government to consider before finalising the Financial Services Bill3 (FS Bill). The key issues arising out of the report are outlined below.
— Promoting Competition
The FS Bill gives the FCA three operational objectives: (1) to secure an appropriate degree of protection for consumers; (2) to protect and enhance the integrity of the financial system; and, (3) to promote efficiency and choice in the market for certain types of services.
The Committee considers that competition must be put at the heart of the new regulatory framework and, to this end, urges the Government to legislate to give the FCA an explicit primary objective to promote competition across financial services markets for the benefit of the consumer.
— Protecting Confidence
In addition to the three operational objectives outlined above, the draft FS Bill also gives the FCA an overarching strategic objective of protecting and enhancing confidence in the UK financial system.
The Committee notes the complexity and confusion arising out of the interplay between the FCA’s strategic and operational objectives. In its view, this is a “complicated arrangement” that merely nullifies the Government’s initial intention to have a simple objective. Criticism is also made about the nature of the strategic objective, in that confidence in the markets may, at times, be misplaced. The Committee urges the Government to reconsider the need for a strategic objective, in order to simplify the FCA’s objectives, and avoid a “complex hierarchy of purposes.”
In the Committee’s view, the draft FS Bill fails to provide for adequate accountability, transparency, or scrutiny of the FCA. Drawing on the recent failings of the FSA and the Bank of England4 (BoE) in this regard, the Committee urges Government to revise the current legislative proposals to ensure that the FCA is properly accountable to Parliament and that the requisite tools are available to facilitate effective scrutiny. In particular, the Committee recommends that:
- The board of the FCA publish full minutes of each meeting;
- The FCA chief executive should undergo pre-appointment scrutiny by the Committee; and
- A statutory obligation be placed on the FCA board to respond to Parliament’s requests for information, including retrospective views of the regulator’s work.
A higher level of accountability will, according to Tyrie, “help provide better quality regulation and avoid the problems that have plagued the FSA in recent times.”5
The Wider Picture
— The PRA & The Financial Policy Committee
In the Committee’s view, the current tripartite system of regulation (comprising the FSA, HM Treasury, and the BoE), governed by a Memorandum of Understanding (MoU) has proven an “unsatisfactory experience.”
Learning from the mistakes of the past, the Committee recommends that the relationship between the future three regulators (comprising the FCA, the PRA, and the Financial Policy Committee) be set out in more detail in both primary and secondary legislation. This should, argues the Committee, “limit the scope for institutional bickering about obligations under the MoU” and, in consequence, help avoid regulatory gaps or overlap. Given the fast-paced nature of the sector, the relationship between the new tripartite bodies must be kept under review.
— PRA Veto
As drafted, the FS Bill gives the PRA a veto over the FCA where, in the PRA’s view, an action by the FCA may threaten the stability of the UK financial system or result in the failure of a PRA-authorised firm.
The Committee expresses serious concern over this issue, and does not believe a case for a veto over the FCA’s powers has yet been made. It urges the Government to publish persuasive evidence in support of the need for such a power and to set out in more detail in legislation the circumstances in which a veto would be used. In its view, the veto power should lie with the FPC, not the PRA, and then should only be used in exceptional circumstances.
The Committee considers that a MoU is “unlikely to be the appropriate method” to establish co-ordination between the FCA and the PRA in respect of their seats on the new European Supervisory Authorities (comprising the European Securities and Markets Authority, the European Banking Authority, and the European Insurance and Occupational Pensions Authority). To ensure adequate scrutiny and legal certainty, details of co-ordination arrangements should be set out in secondary legislation.
— Tailoring the FCA’s Approach
Since the FCA will be responsible for the micro-prudential supervision of some 24,500 firms and the conduct supervision of over 27,000 firms across a wide spectrum of sub-sectors, the Committee considers that the Government could better tailor the FCA’s regulatory approach, for example, by distinguishing between the FCA’s mandate and powers for retail financial services, services for professional clients, and wholesale financial services.
— Costs & Benefits
While financial services regulation undoubtedly yields many benefits, the cost of regulation is a major concern to the financial sector. Seeking to balance benefit and cost, the Committee stresses that existing FSA practices should be challenged, and recommends once more that the FCA and the PRA should, once established, review the tools used to examine the costs and benefits of regulation. The costs should, argues the Committee, be investigated at an early stage in policy development, and subsequent reassessment should not be treated as a mere box-ticking exercise.
In the Committee’s view, the FS Bill needs to be amended to include requirements for more extensive cost-benefit analysis and consultation prior to the introduction of new legislation.
— Communication Issues
According to Tyrie, the FSA has too often been described as “aloof and unapproachable and that, in any case, firms are nervous about approaching them.”6Lines of communication between the FCA and the firms it regulates must therefore improve. To this end, the FCA must take greater steps to ensure that formal regulatory material makes it clear to firms what is expected of them and discourage “regulation by speech.” In a similar vein, regulated firms also need to engage with the FCA in a more positive and constructive fashion.
Much criticism was made of the FSA’s recent document summarising the proposed approach for the FCA,7 in particular because it “outlines an inappropriate culture for the FCA, one that may allow some old and inappropriate practices and culture from the FSA to be replicated.” In the Committee’s view, this document was lacking in detail and substance. It therefore calls on the Government to publish a more detailed consultation paper setting out its intended approach for FCA regulation/supervision, together with full supporting explanations.
— Product Intervention
The Government proposes giving the FCA power “in product intervention [and] to direct firms to withdraw or amend mis-leading financial promotions with immediate effect.”8
The Committee expresses concern that the FCA may not necessarily understand a new product better than a firm, and is wary of the potential impact of product intervention on competition and innovation. While it supports the need for judgement-led product intervention, the Committee stresses that such powers should be used sparingly, with careful consideration given to the merits of each case before intervention. Moreover, firms must be given clear guidance when these powers are exercised.
While the FCA will be given product regulation powers, its role in price regulation needs further clarification. Given the competition law repercussions of making the FCA a price regulator, further consultation on this issue is essential.
To prevent the FCA’s power to pre-approve simple products from stifling innovation, and in effect causing consumer detriment, the Committee recommends that the FCA should conduct and publish a review of the merits and costs of a pre-approval scheme for financial products. Moreover, it should seek to distinguish in regulation between simple products that can be pre-approved for basic needs, and more complex products targeted at sophisticated investors, that cannot.
— Early Warning Notices
The Committee generally supports the Government’s proposal to give the FCA the FSA’s current ability to issue public warning notices about specific products. It is, however, concerned that a general rule allowing the FCA to publish early warning notices in respect of specific firms risks “unreasonable reputational damage” should the allegations contained therein prove to be unfounded. Moreover, allowing the FCA to act as investigator, judge, and jury poses a serious threat to natural justice. To address these concerns, the Government should continue to consult on this issue.
In view of the recommendations made by the Committee, much work still needs to be done before the draft Bill is presented to Parliament, scheduled to take place within the next four months. Further public consultation on a wide array of issues needs to be undertaken, and publication of the Government’s proposals on the co-ordination of the FCA and the PRA, originally expected during the summer of 2011, is still awaited.
If all goes to plan, the Bill should receive Royal Assent before the end of the year, and the new regulatory architecture implemented in full by end-2013.
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