MiFID II: A Regulator’s viewpoint
On 30 January 2012, the FSA published a speech by David Lawton (Acting Director, FSA) entitled MiFID II: A Regulator’s viewpoint.
At the start of his speech Lawton stated that generally the Markets in Financial Instruments Directive (MiFID) had been a success for the trading environment, increasing competition and reducing trading costs and therefore there was no need for a radical re-think. However, some important changes are needed to address certain areas so that the framework continues to foster market integrity, enhance market transparency while promoting market liquidity and deliver market stability.
In relation to fostering market integrity Lawton made the following points:
- Regulators need to have appropriate powers to properly supervise markets and their participants, and take action where necessary.
- Regulators need access to information that is comprehensive, accurate, focused on important risks, provided on a timely basis and in a format that can be easily used for analysis.
- Regulators need to be given the appropriate authority to consider the interaction between financial markets and any underlying physical markets.
- That the extension of the transaction reporting obligations to over-the-counter derivatives is long overdue.
- Improvements to the content of transaction reports sent to regulators are also necessary to facilitate surveillance.
In relation to transparency Lawton stated that currently there are shortcomings in the quality, standardisation and consolidation of equity post-trade data. Whilst acknowledging that some important details still need to be fleshed out the FSA believes that the Commission’s approach in this area is heading in the right direction and it welcomes the involvement of the European Securities and Markets Authority in the calibration of the regime.
Lawton stated that the big question is whether the transparency regime for equities should be applied to other asset classes and that here pre- and post-trade requirements need to be considered separately. Lawton further stated that the FSA believes that there is a case for greater post-trade transparency but that it will need to be carefully calibrated.
In the final part of his speech Lawton touched on third countries. He stated that the FSA welcomes the granting of passporting rights to branches of third country firms under a single branch authorisation procedure. However, it fears that the current scope of access restrictions will curtail investor choice and competition.
View MiFID II: A Regulator’s viewpoint, 30 January 2012
In the Treasury paper A new approach to financial regulation - securing stability, protecting consumers the Government stated that payment, settlement systems and central counterparties each have a primary role of managing and reducing systemic risk, making the Bank of England the appropriate regulator. Regulation by the Prudential Regulation Authority (PRA) would only be appropriate for recognised clearing houses that are central counterparties.
The Government believes that it is more appropriate for trading infrastructure to be regulated by the Financial Conduct Authority (FCA) which will be responsible for regulating the conduct of authorised persons who use recognised investment exchanges or multilateral trading facilities to deal for their own account or the account of their customers.
On 25 January 2012, the FSA published a speech by Clive Adamson (Director of Supervision, Conduct Business Unit, FSA) entitled FCA supervision. In his speech Adamson gives an insight into how the FCA will supervise firms.
He began by discussing conduct strategy and mentions that one of the building blocks is the FSA’s revised conduct strategy which was launched in 2010. This, in essence, set out the key change in approach which was to move from a primarily reactive to a pre-emptive style of retail conduct supervision. The FCA’s approach will build on this and will emphasise five main elements to:
- Be more forward looking in its assessment of potential problems.
- Intervene earlier when it sees problems including earlier intervention in the development or marketing of retail products.
- Attack the underlying causes of problems it sees, not just the symptoms, on the basis that this will be more effective and efficient in the longer term for consumers and firms.
- Secure redress for consumers if failures occur.
- Take meaningful action against firms that fail to meet standards through fines that will have a deterrent effect.
Adamson then turned to the supervision model that is being developed to deliver more intensive conduct supervision. The key components of this model are:
- A clearer sector-based approach.
- Greater use of forward looking analysis to understand what is happening in particular sectors and to help in determining risks.
- More focus on intelligence and data.
- Greater use of thematic reviews.
- Continued, but more focused, programme of firm level assessments.
- More responsive and flexible use of resources with fewer firms having a fixed team facing off against them.
Adamson also touched on the firm assessment aspect of the supervision model. At the moment this is conducted through the ARROW process for large firms and through the Revised Approach to Small Firm Supervision for smaller firms. According to Adamson the intention is to keep a firm assessment framework across the firm population but to replace the ARROW framework with a new process that is easier to communicate to the senior executives and boards of firms so that they can align good business practice with good regulatory practice.
According to Adamson the new framework will focus much more on the main drivers of conduct risk at the firm level, but the overall assessment, which will continue to be in the form of a letter to the board, will be based on all the work that has happened on the firm, including thematic work. At the most intensive end of the spectrum the firm’s business model and strategy will be reviewed to see whether these deliver good outcomes for consumers.
The key message is that the FCA will be a conduct focussed regulator to ensure that firms do not trade consumer treatment off against financial performance or prudential strength. The FCA will look at product design and delve into sales to see whether firms have appropriate systems and controls in place to ensure the delivery of fair outcomes to consumers. The FCA will also look to firms’ boards and other governing bodies to set, put in place and maintain a culture that will bring about good outcomes for their customers.
Adamson also discussed wholesale conduct and the FCA’s focus here will be to ensure the integrity and resilience of wholesale markets rather than to seek to introduce concepts of detriment and redress that it will use in the retail markets. However, the FCA will place more emphasis on three areas where:
- Wholesale products filter down or are distributed to retail consumers.
- Certain behaviours in wholesale markets can cause damage to market integrity.
- Market structures can result in participants being disadvantaged or the market being inefficient.
In the final part of his speech Adamson discussed the transition from the FSA to the FCA. A key milestone for the FSA occurred last April with the creation of the Conduct (CBU) and Prudential business units within the FSA. At that time the FSA moved all firms that will be solo regulated in the future into the Supervision Division within the CBU. The next milestone is the splitting of conduct and prudential supervision of firms that will be dual regulated in the future and the move of these into CBU Supervision for conduct purposes.
View FCA supervision, 25 January 2012
Delivering twin peaks within the FSA
On 6 February 2012, the FSA published a speech given by Hector Sants (Chief Executive, FSA) entitled Delivering twin peaks within the FSA.
At the start of his speech Sants stated that implementing a twin peaks model is the next stage in the FSA’s reform process and that such model will be introduced from 2 April 2012.
The FSA intends to move as close as possible, subject to the framework imposed on it by the Financial Services and Markets Act 2000, to the new style of regulation outlined by the Government. Namely, that firm-specific supervision for banks, insurers and major investment firms will be carried out by two separate entities, one for prudential and one for conduct regulation.
Sants then discussed some of the general principles of the new model noting its high level operating characteristics:
- There will be two independent groups of supervisors for banks, insurers and major investment firms covering prudential and conduct supervision. All other firms (i.e. those not dual regulated) will be solely supervised by the conduct supervisors.
- The supervisors will make their own, separate, set of regulatory judgements against different objectives.
- They will coordinate internally to maximise the exchange of information which is relevant to their individual objectives, but to be clear, they will act separately when engaging with firms. The FSA has termed this “independent but coordinated regulation”.
- The FSA will retain the principle of seeking to ensure that regulatory data is only collected once. It will retain its common, current data infrastructure.
Sants also mentioned that the move to twin peaks is an opportunity to drive home and further embed the move to forward-looking, proactive, judgement-based supervision.
Sants then discussed some of the operational changes. From a firm’s perspective the key operational change will be that the existing ARROW risk mitigation programme will be split between those actions which are relevant to the conduct supervisory group’s objectives and those that relate to the prudential supervisory group. From 2 April 2012 onwards, the two supervisory units will run their own risk mitigation programmes and firms will have two separate sets of mitigating actions to address. Sants also stated that in the remaining lifetime of the FSA, it will retain the current ARROW cycle so that if a firm is due to complete an ARROW assessment before spring 2013 it will still be subject to a supervisory review.
However, there will be two particular consequences of the new approach. First, each supervisory group may ask similar questions, but it needs to be understood that the purpose will be different. Second, in the twin peaks world there will not be a consolidated list of the required actions arising from the two supervisory groups. Firms will be expected to address each set of actions arising from the prudential and conduct reviews with equal focus.
In addition, the supervisory models of each group will diverge in a number of ways particularly in terms of allocation of supervisory resource and in the mechanism that each supervisor will use to reach judgements. In relation to the latter prudential supervisors will introduce the concept of a set of questions, which will be focused on ensuring the institution is minimising the risk of disorderly failure. In the conduct area, ARROW will be replaced by a more focussed assessment of conduct risk. In addition in the conduct space there will be more focus on thematic work.
Sants then discussed behavioural changes stating that it is not just supervisors but also firms that need to adopt a new approach. If the new approach is to work Sants argued that firms should also:
- Recognise the importance of aligning their goals with those of the supervisors and with society as a whole. Firms are encouraged to avoid gratuitous regulatory arbitrage.
- Show greater willingness to proactively comply with supervisory judgements.
- Recognise that there are times when both firms and the regulator will make judgements which in hindsight are wrong.
- Recognise that this new approach will require greater resources and expertise than the previous reactive model.
Sants also reminded firms that one of the key messages relates to the importance of boards managing their institutions responsibly.
In the final part of his speech Sants mentioned that the FSA and the Bank of England will publish, later this year, two further documents setting out in more detail the functionality of the supervisory regimes of the Prudential Regulation Authority (PRA) and Financial Conduct Authority (FCA). He also mentioned the principal areas of focus for further work over the next 12 months:
- Threshold conditions need to be recast to align them with the twin peaks model.
- Both the FCA and the PRA need to commence work on designing a new operating platform to support their new approaches to supervision.
- Both need to complete the detailed design work on their supervisory risk framework which will replace ARROW. For the PRA this includes documenting the detail of the new “proactive intervention framework” and for the FCA the “firm systematic framework”.
- The draft memorandum of understanding laying out how the FCA and PRA will coordinate has been published but the detailed procedures need to be agreed.
- The rulebook will need to be split between the responsibilities of the PRA and the FCA.
- Work needs to be undertaken to ensure that staff are effectively equipped to deliver the new model.
The FSA has also published a press release concerning the speech.
View Delivering twin peaks within the FSA, 6 February 2012
View Delivering a twin peaks regulatory model within the FSA, 6 February 2012
Update on the transition to the new regulatory structure: Implementing ‘twin peaks’ within the FSA
On 6 February 2012, the FSA published a Dear CEO letter which provided an update on the transition to the new regulatory structure and the implementation of ‘twin peaks’ within the FSA.
The Dear CEO letter repeated many of the comments that Hector Sants (Chief Executive, FSA) made in an earlier speech entitled Delivering twin peaks within the FSA. In particular, Sants made the same points concerning the supervisory changes firms will see.
The Dear CEO letter also reminded firms that in the twin peaks world there will not be a consolidated list of the required actions arising from the two supervisory groups. Central to the concept of genuine twin peaks is that both sets of regulatory objectives are different and determined by Parliament to be of equal importance. Firms will be expected to address each set of actions arising from the prudential and conduct reviews with equal focus.
View Update on the transition to the new regulatory structure: Implementing ‘twin peaks’ within the FSA, 6 February 2012
Update on the regulatory reform agenda
On 7 February 2012, the FSA published a speech by Hector Sants (Chief Executive, FSA) entitled Update on the regulatory reform agenda.
In the first part of his speech Sants discussed the UK’s reform programme and the move to twin peaks supervision. Much of the discussion repeats the comments Sants made in an earlier speech entitled Delivering twin peaks within the FSA.
In the second part of his speech, Sants discussed the challenge of Europe. He started by stating that engaging with the European regulatory process is central to delivering financial regulation in the UK. He also stated that it needs to be recognised that, in respect of prudential regulation, and increasingly over the longer-term in respect of conduct regulation, the rules will be made by Europe and the role of the Prudential Regulation Authority and the Financial Conduct Authority will primarily be one of supervision and enforcement. Essentially, the UK is moving to become a ‘supervisory arm’ of Europe.
Sants then turned to the European Supervisory Authorities (ESAs) and discussed how they will operate and how this will impact on the FSA. He started by stating that the FSA supports the concept behind the ESAs and the necessity of them being strong and independent organisations. He added that the ESAs will also bring profound changes for both the policy function and firm supervision.
In terms of policy function Sants referred to the shift in the FSA’s rule making authority to European bodies and that this trend has increased with the Commission opting to use Regulations as opposed to Directives and the further increase of detail through ESAs issuing binding technical standards.
In relation to firm supervision Sants made two points. Firstly, that there is pressure to harmonise the way that supervision is carried out. Secondly, the by-product of seeking to have common standards, which underpins the concept of the single financial market, runs the risk of removing supervisory discretion in terms of the measures supervisors can take to address firm-specific risk.
Sants acknowledged that there is momentum to have a common supervisory procedure manual and supports the importance of the ESAs having a role in maintaining standards and in doing so they need to be able to participate in peer reviews and have a full understanding of the way a supervisor assesses risk. However, he argued that supervision needs to be delivered locally and be tailored to a particular set of circumstances. Good supervision needs to be based on forward-looking judgements and a deep understanding of firm-specific circumstances. He warned that care needs to be taken to ensure that the philosophy of harmonisation does not undermine this principle. Sants did, however, make clear his strong support for colleges and data sharing. In particular, he states that cooperation is crucial to establishing effective recovery and resolution regimes.
View Update on the regulatory reform agenda, 7 February 2012
The Consultation Paper sets out proposed implementing Orders and amendments to existing financial services legislation to implement elements of the EU regulatory framework applicable to certain bidders in Government auctions of aviation and phase III EU emissions allowances under the EU Emissions Trading System (EU ETS).
Implementing the changes will result in the creation of a new regulated activity under the Financial Services and Markets Act 2000 (FSMA). In most cases this will lead to the FSA having to authorise relevant persons who wish to bid in auctions of emissions allowances irrespective of the permissions or exemptions that they current hold. This will involve amending secondary legislation made under FSMA and some minor additions to the Act itself.
The deadline for responding to the Consultation Paper is 10 April 2012.
On 23 February 2012, the FSA published a speech given by Tracey McDermott (acting director of the Enforcement and Financial Crime division, FSA) entitled An update on the FSA’s investigations and enforcement regime.
In her speech McDermott looked at recent FSA enforcement action and then discussed the proposed enforcement responsibilities of the Financial Conduct Authority (FCA).
In particular McDermott stated that credible deterrence is here to stay. The FCA will carry on the enforcement work of the FSA, maintaining and strengthening its outcomes. Where it does not see improvements from its action, the FCA will be willing to take tougher action just as the FSA has done in prosecuting insider dealing.
McDermott also stated that the FCA will be clear on expectations. Consumers can expect it to be more accessible and to communicate proactively, so they understand what they can expect from firms and the regulatory system. The FCA will seek to view issues through the eyes of consumers and understand the drivers of their behaviour as well as that of firms. Firms can expect more challenge from the FCA and more willingness to intervene.
In addition McDermott explained that central to the FCA’s approach will be a focus on early intervention, looking to take action before risk crystallises. She noted that early intervention can take many different forms including the proposed power for the FCA to ban products where it considers the risk of mis-selling those products significantly outweighs any benefit. However, early intervention will also include a willingness to take action - supervisory or enforcement - earlier in the cycle. Consumers might expect to see the FCA take action, including enforcement action, where its judgement is that a particular aspect of the firm’s business model - its product selection, its remuneration practices, its training or recruitment, for instance - is likely to give rise to poor consumer outcomes.
McDermott further stated that the FCA will have a lower tolerance for firms bumping along at the bottom - firms that only fix things when the FCA tells them to, and then do only enough to fix the specific problem. The FCA will be swifter and more willing to take action to restrict, or even prevent, such firms from doing business.
The Bank of England and the FSA have co-produced a note which responds to the Government’s request for an explanation as to how the proposed Prudential Regulation Authority (PRA) will consult. The note will be reviewed by the board of the PRA once the PRA has been established.
The PRA’s general approach to consultation will be to give the firms it regulates, their representatives and other interested parties the opportunity to express views. In particular, it will look to expert practitioners to offer technical and detailed feedback on the different means to achieve the PRA’s aims. The PRA will want to seek from the consultation process informed views from firms as to how the proposed means of achieving its objectives on particular fronts will affect their particular business.
The PRA will not establish a standing practitioner panel comprising a fixed group of practitioners. However, the PRA will on occasions draw together temporary groups, comprising practitioners and other experts, where it judges that a focussed discussion of technical points will be helpful.