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.