Blog: Financial services reform (insurance)

October 2012

On 16 October 2012, the Bank of England and the FSA published a joint paper entitled The PRA’s approach to insurance supervision. The paper outlines how the PRA will advance its objectives in relation to insurers, recognising the inherent difference between the risks insurers face in comparison to banks. The paper makes it clear that it is not the PRA's role to ensure that no insurer fails. Rather, the regulator will seek to ensure that when insurer failure does occur, it is managed in an orderly way thereby minimising disruption to the financial system and adverse affects on policyholders.

The PRA's objectives

The paper explains that the PRA will have two statutory objectives in its supervision of insurers: promoting the safety and soundness of firms; and securing an appropriate degree of protection for policyholders. The PRA will focus on ensuring that policyholders have an appropriate degree of continuity of cover for the risks they are insured against.

The PRA will assess the significance of an insurer in terms of its potential to adversely affect the PRA’s objectives by failing, coming under stress, or by the way it carries on its business. An insurers’ potential impact on the stability of the financial system will depend on its size, complexity, business type and interconnectedness with the rest of the system. Insurers will fall into one of five categories of impact ranging from category 1 (insurers with capacity to cause very significant disruption to the UK financial system) to category 5 (insurers with almost no capacity individually to cause disruption to the UK financial system). A firm will be assessed against the other firms within its category. Comparing insurers in this way marks a significant shift from FSA supervision, however, the PRA believes that categorising insurers according to risk will help to determine the intensity of supervision and focus the supervisory strategy.

The PRA’s new threshold conditions set out the minimum standards that insurers must meet and will be crucial to the operation of the new regime. Insurers will be required to have appropriate financial resources, monitor and manage risk, to be fit and proper, to conduct their business prudently, and be capable of being effectively supervised by the PRA. Firms should familiarise themselves with the more specific threshold conditions to understand what additional requirements will be expected of them. Boards and senior management will be responsible for upholding the PRA’s objectives and embedding a culture of safety and soundness within their firms.

Forward-looking supervision

In terms of supervisory activity, the PRA will adopt a forward-looking, judgement based approach to supervision. The PRA’s supervisory judgements will be based on evidence and analysis, recognising the different risks inherent in the business models of life and general insurers. Insurers will be assessed not only in terms of current risks, but also those risks that could plausibly arise in the future. The PRA will aim to develop a rounded, robust and comprehensive view of an insurer, in order to judge whether it is being run in a safe and sound manner.

All firms will be subject to a baseline level of supervisory monitoring, which will involve ensuring compliance with prudential standards for capital, liquidity, asset valuation, provisioning and reserving. However, under the PRA, supervision will be tailored to different firms and sectors and consequently, those firms posing the greatest risk can expect more intense supervision including evaluation of a firm’s business model, desk-based analysis of a firm’s financial strength and stress testing. Supervisors will assess a firm’s governance arrangements; its risk management policies and procedures; and its possible recovery options and exit strategies.

EU and international regulation

It is noted throughout the paper that various EU and international regulatory developments are closely aligned with the PRA’s objectives. Significantly, in a number of areas, the PRA’s aims are reflected in the Solvency II requirements. The PRA’s method of categorising insurers according to risk, for example, is consistent with the central principle of Solvency II that actions taken by supervisors should be proportionate to the risk inherent in the insurers’ business. Given this overlap, firms may find that their work for Solvency II is useful when preparing for PRA regulation.

For further information:

The PRA’s approach to insurance supervision

October 2012

On 16 October 2012, the FSA published a paper entitled Journey to the FCA. The paper sets out the FSA’s current thinking on the transition to the FCA and how the new regulator will operate once it is established in April 2013. Under the Financial Services Bill, the FCA will have a statutory objective to ensure that relevant markets work well. In addition, the regulator will have three operational objectives that focus on the integrity of the UK financial market, consumer protection and promoting competition. The key issues covered in the paper include:

• The FCA's new powers and responsibilities in relation to product intervention, financial promotions, markets regulation and super-complaints. The FCA will have a clear mandate to make rules banning products that pose unacceptable risks to consumers. Where quick intervention is necessary, the FCA will be able to ban a product without consultation for a maximum of 12 months. In addition, the FCA will have powers to ban misleading financial promotions and remove them immediately from the market.
• Regulatory processes, including authorisations and threshold conditions, approved persons, changes in control, waivers and passporting. The paper clearly points out that FSA regulated firms and individuals will transfer to the new regulators immediately after legal cutover, and will not need to reapply. Significantly, the FCA will have a new business model threshold condition. Firms will need to put forward an appropriate, viable and sustainable business model and make clear to the FCA how it meets the needs of its customers. The FCA plans to consult on this new threshold condition in November 2012. The FCA is currently consulting on changes to the approved persons regime and authorisations process and will publish the final rules after the regulators acquire their legal powers in April 2013.
• Its competition objective and duty, including the steps it will take to promote competition and to embed competition in its regulatory approach. To fulfil its competitive objective the FCA will need to expand its analysis of markets which includes conducting sound and thorough market studies and, where possible, designing pro-competitive remedies. The FSA is in the early stages of deciding the FCA’s approach to competition and has invited feedback on its current thinking. Amongst other things, views are sought on which financial services markets where competition is working well in the interests of consumers and in which ones it is working poorly and the reasons for this.
• Supervisory approach and strategy for intervening to ensure the fair treatment of customers. The new approach will be underpinned by judgement-based supervision. The FCA will carry out in-depth, structure supervision and take action on the biggest conduct risks. The regulator will be looking for firms to base their business model, their culture, and how they run the business on a foundation of fair treatment of customers. Firms will be categorised according to level of risk, with those firms posing the greatest risk to consumers or market integrity will be subject to more intense supervision. Senior management can the expect a more open, engaged and challenging style of supervision as the new regulator seeks identify and address problems more quickly than in the past.

In addition to the questions in relation to the FCA’s new competition role, the FSA is also consulting on gathering and receiving information. The deadline for comments is 14 December 2012, with the FSA expected to publish feedback in early 2013.

For further information: 

Journey to the FCA

October 2012

On 3 October 2012, the FSA published a consultation paper setting out its proposals for splitting the approved persons regime between the PRA and the FCA. The paper focuses on the rules contained within chapter 10 of SUP and proposes some additional requirements within APER. Both regulators will be able to specify functions that enable the person concerned to exercise a significant influence over the conduct of a firm’s affairs, known as significant influence functions (SIFs). In addition, the FCA will be able to specify functions that involve a person dealing with the customers of a firm, or with the property of these customers, known as customer dealing functions. 

The FCA and PRA Handbooks will include certain provisions in relation to dual-regulated firms including that:

• The FCA and PRA must consult each other before specifying SIFs.
• The PRA must obtain the FCA’s consent before approving a PRA SIF application. In certain cases, the FCA may arrange with the PRA that FCA consent is not needed.
• Either regulator may withdraw approval from a person who is carrying on a SIF, regardless of which regulator gave approval. If withdrawing an approval given by the other regulator, it must consult that other regulator first.
• Both regulators can discipline an approved person who has breached a statement of principle that it has issued.

Firms will need to submit an application to the PRA in relation to the following SIFs:

• CF2 - PRA Non-executive director
• CF3 - Chief executive
• CF12 - Actuarial
• CF12A - With-profits actuary
• CF12B - Lloyd’s actuary
• CF28 - Systems and controls

Applications for the following SIFs should be submitted to the FCA:

• CF1 - Director
• CF2 - FCA Non-executive director
• CF4 - Partner
• CF5 - Director of an unincorporated association
• CF6 - Small friendly society
• CF8 - Apportionment and oversight
• CF10 - Compliance oversight
• CF10a - Client assets
• CF11 - Money laundering reporting
• CF29 - Significant management
• CF30 - Customer function

Notably, the rules create two new non-executive director functions, one PRA and one FCA. The CF2 (PRA) function will cover anyone who falls within the current definition of CF2 and performs the role of chairman, senior independent director, member of the Society of Lloyd’s or chair of the audit, remuneration or risk committees. Anyone taking up these roles that is already approved to perform another of the CF2 functions will be required to notify the PRA. The CF2 (FCA) function covers all other aspects of the current non-executive director function. The FSA is still deciding on its approach to the approval of people who sit on with-profits committees and therefore, neither the PRA nor the FCA functions currently cover this area. This new approach to the non-executive director function means that a person moving from one regulator’s CF2 function to the other will need to make a new application.

The consultation paper addresses those situations in which a person is applying for two functions (for example CF1 and CF3) within the same firm at the same time. The FCA is required to minimise the duplication of approvals, not to eliminate the possibility entirely. The FSA proposes that, in situations where there is a likelihood of a combination of two functions being performed frequently, firms will only be required to apply to the PRA. For example, the FSA expects that a significant number of chief executives will also be performing the apportionment and oversight function therefore firms will only need to apply to the PRA for approval, which will effectively expand to cover the FCA function as well. However, firms will still need to seek dual approval for combinations of controlled functions that will arise less frequently.

In addition, the consultation paper includes proposed changes to APER. The PRA will be able to issues statements of principle for people it has approved to perform a controlled function and people in dual-regulated firms whom the FCA has approved to perform a SIF. The FCA will be able to issue statements of principle for the conduct of persons approved by either regulator. Perhaps most significantly, the FSA proposes extending the scope of APER to include activities outside of a person’s controlled function. The standards in the PRA’s APER will, therefore, apply to the performance of any activity which could be a SIF, insofar as it relates to the carrying on of a regulated activity by a firm. The FSA makes it clear that they expect individuals to apply the same standards of behaviour to aspects of their role that fall outside of their controlled function.

Finally, the consultation paper does not provide details on the treatment of people who are already approved, or how those approvals will be transferred to the new regulatory system. The Government is yet to publish details of its proposed legislation in this area, however, the FSA expects that approvals currently held by individuals will be transferred to one of the new regulators without the need to make any new application.

In preparation for the split to the PRA and FCA, firms should familiarise themselves with the proposed changes to the approved persons regime. It is particularly important to note which controlled functions will be designated to each regulator and the procedure for submitting applications where dual approval may be required. 

The deadline for comments is 7 December 2012. The final rules will be issued by the PRA and FCA when they acquire their legal powers in April 2013.

For further information:

The PRA and FCA regimes for approved persons

September 2012

In September 2012, the FSA published a consultation paper proposing changes to the existing FSA Handbook on aspects of the future PRA and FCA authorisation and supervision regimes. In preparation for legal cutover, the FSA is consulting on how the existing Handbook will be “designated” to the PRA, the FCA, or both regulators. In order to align the new rulebooks with the objectives and functions of the PRA and FCA under the Financial Services Bill (the Bill), however, some more substantive changes to the current Handbook will need to be made. Insurers will be particularly interested in the proposals relating to the procedures for permissions, portfolio transfers, waivers and skilled person reports. The FSA’s approach to designation between the new authorities in relation to each of these issues is considered below.

Part VIIs

The Bill revises the current process for transfers of insurance business under Part VII of FSMA. The responsibilities of each regulator for transfers will be covered in a MOU between the PRA and the FCA. A draft MoU, published on 27 January 2012, provides that the PRA will lead the transfer process and consult with the FCA throughout. In light of the changes in the Bill, the FSA proposes amending Chapter 18 of SUP to reflect the division of responsibilities. The consultation paper indicates that SUP 18 will be adopted in both the new PRA and FCA rulebooks.

Aside from the changes to reflect the new regulatory structure, and among other amendments, the FSA proposes the following rules for Part VIIs:

• Removing guidance that may place inappropriate constraints on the decision making of either regulator, to be replaced with high level references to the PRA and FCA assessing Part VII transfers in light of their respective statutory objectives.
• Improving the outline of the regulators’ expectations of the information that should be provided by firms, for example, in relation to a proposed Independent Expert.
• Additional guidance to reflect the practice which has developed whereby the regulator(s) will provide a report to the Court regarding the proposed transfer.
  The revised SUP 18 requires the PRA to lead the Part VII process and to have responsibility for aspects such as the provision of certificates. However, the PRA must consult with the FCA "at the outset and throughout" the process. Furthermore, both regulators are entitled to be heard in court.

It is anticipated that the involvement of two regulatory bodies in the Part VII process will lead to more complex negotiations between the transferring parties and the regulators particularly in relation to issues such as notification, given the different objectives of the PRA and FCA.

Another issue that has been raised is whether the FCA’s objectives to promote efficiency and choice in the market for financial services will affect its approach to business transfers that reduce competition, economic efficiency and consumer choices. In response, the FSA has indicated that this is unlikely on the basis that competition law already prevents transfers that result in a significant lessening of competition.

Waiver and modification of rules

The FSA proposes that SUP 8 be amended to reflect that the PRA can waive or modify rules in the PRA Handbook as it applies them to dual-regulated firms. The FCA will have the power to waive or modify rules in the FCA Handbook as it applies them to dual-regulated and FCA-only regulated firms. Before deciding whether or not to publish a waiver which relates to a PRA authorised person, the FCA will have to consult the PRA.

Finally, when considering whether it is appropriate or necessary to publish a waiver, both regulators must consider whether publication of the waiver would be detrimental to the UK financial system.

Part IV permissions

The Bill replaces Part IV FSMA with a new Part 4A detailing the requirements for permissions to carry on regulated activities. Accordingly, ‘Part 4A permission’ will be the new term for a Part IV permission.

From legal cutover the position concerning the variation or cancellation of permission will be as follows:

• Already regulated firms do not need to re-apply. Their existing permission will continue to apply.
• Insurers must apply to the PRA to vary or cancel its Part 4A permission.
• The PRA may determine an application to vary permission only with the consent of the FCA.
• The FCA may request any additional information from the firm it reasonably considers necessary to decide whether to give consent. The PRA is required to consult the FCA when determining an application to cancel permission.
• An FCA-only regulated firm (i.e. intermediaries) will have to apply to the FCA to vary or cancel its Part 4A permission except where it seeks to vary its permission to include a PRA-regulated activity, in which case it must apply to the PRA.
• Where an application for the variation or cancellation of permission is made to the FCA by an applicant that is a member of a group that includes a dual-regulated firm, the FCA must consult the PRA as part of its consideration of the application. This would apply for example to a broker in a group containing an underwriter.
• Before imposing a new requirement or varying an existing requirement of a dual-regulated firm the PRA must consult the FCA.
• Before the FCA imposes a new requirement or varies an existing requirement, relating to a firm that is or will be (on the granting of its application for permission) dual-regulated, or a firm that is a member of a group that includes a dual-regulated firm, it is required to consult the PRA.

In addition, the FCA and the PRA will each be responsible for their own set of threshold conditions. When granting a firm’s application to vary permission, imposing or varying requirements on a firm, or consenting to a variation, both regulators will need to ensure that the firm concerned will satisfy, and continue to satisfy, the threshold conditions for which that regulator is responsible.

It is likely that firms will incur some extra compliance costs when dealing with these new procedures. Most likely these will be associated with understanding and adjusting to the new PRA and FCA processes, particularly where a firm is dual regulated. The key issue will be the consultative aspect between the PRA and FCA and whether this slows down the process. Reluctant to address this point, the FSA has stated that it is “too early to say at this stage” whether the authorisation process would take more time. However, it did add that it understood the need to “strike the right balance between taking the time to make the right decision and not holding decisions up for too long.”

Skilled person reports

The FSA proposes a number of changes to SUP 5 in relation to the use of ‘skilled person’ reports under section 166 of the Bill. Both regulators will be authorised to commission skilled person reports via section 166 notices. For insurers, the most significant change will be the regulator’s power to appoint and contract directly a skilled person. Under the current system, the FSA sends a notice to the firm concerned nominating, or asking the firm to nominate, a skilled person. The firm then contracts with the skilled person to produce the report. Where the skilled person is appointed directly by either the PRA or FCA, a new rule in FEES 3 enables the appropriate regulator to levy a fee on the firm concerned. Prior to the work commencing, the regulator will provide an indication of the costs likely to be incurred. An additional rule grants both regulators the power to appoint a skilled person to collect, update and report information where an authorised person is believed to have breached regulatory requirements to do so.

Skilled person reports are expected to be an effective way of delivering intensive supervision without sacrificing limited resources, and will enable the PRA and FCA to get on with the day-to-day supervision of firms. The use of skilled person reports is expected to increase under the PRA, however, it will only use this tool where it is the most appropriate way to address a particular risk. It has been suggested that requests for skilled person reports carry a certain degree of stigma, and the FSA is keen to stress that this should not be the case. Indeed, this type of regulatory action looks likely to become an increasingly routine part of supervision under the new regime.

The regulator’s power to contract directly with the skilled person has raised some concerns in the market. In the years since the financial crisis, there has been a significant increase in the number of reports commissioned with a particular focus on systems and controls, capital adequacy and corporate governance. The cost of skilled person reports varies according to the nature and complexity of the matter being reviewed. In 2011/2012, for example, the FSA commissioned 111 skilled person reports, with a total cost to firms of just over £31 million. By contrast, 2007/2008 saw firms spend less than £6 million on 30 reports.

Whilst the PRA and FCA will take into account the costs to firms of any regulatory decision, they are likely to be far less concerned about costs than the firm under review. It is anticipated that the regulator will seek to directly appoint the skilled person in the most important cases, thereby eliminating any conflicts of interest between the skilled person and the firm. Where the regulator decides to directly appoint a skilled person, firms will lose the ability to control costs, the selection process and the scope of a report. The areas of investigation will come under closer scrutiny and firms should consider appointing advisors to shadow the work being done by the skilled person to ensure that the report remains with the terms of the appointment.

Prior to the new rules coming into force, firms might consider reviewing their internal processes and ensuring they have in place adequate systems and controls, particularly in light of the FSA’s increased focus on this area in recent times. Firms can take steps to reduce the likelihood of being served with a section 166 notice by demonstrating compliance with their regulatory obligations and ensuring that corporate governance is effectively monitored.

Next steps?

Firms should review the proposed Handbook changes and consider the likely impact of the new regulatory structure. Most importantly, firms should ensure they understand the split of responsibilities between the two regulators to avoid delays to applications and minimise disruption to their business at legal cutover.

Those wishing to comment on the FSA’s proposals should respond by 12 December 2012. The PRA and FCA will issue finalised rules and guidance, once they acquire their legal powers, currently expected to be around April 2013.

For further information: 

CP12/24 Regulatory Reform

January 2012

On 27 January 2012, the UK Parliament published the text of the Financial Services Bill, together with explanatory notes. In addition, HM Treasury published A new approach to financial regulation: securing stability, protecting consumers. The document summarises the key policy decisions taken on the new regulatory structure and sets down the Government’s response to recent reports by both the Joint Committee and Treasury Select Committee. It also includes the proposed Memorandums of Understanding on crisis management and international organisations. The following issues will be of particular interest to insurers and intermediaries:

The PRA’s insurance objective

The HM Treasury paper confirms that the insurance objective of the PRA was supported by a range of respondents to the June 2011 consultation, including insurance companies and their representatives. In relation to with-profits policies, the draft Bill supplemented the insurance objective to confirm that the PRA will be responsible for ensuring that the reasonable expectations of policyholders are protected. According to the paper, this provision was also broadly welcomed.

However, the Joint Committee suggested that the phrase “reasonable expectations” of policyholders should be replaced. The Government has now amended the Bill to focus on “decisions by insurers relating to the making of payments under with-profits policies at the discretion of the insurer (including decisions affecting the amount, timing or distribution of such payments or the entitlement to future payments)”. In addition, the Bill now requires the FCA and the PRA to enter into, and maintain, arrangements for the FCA to provide the PRA with information and advice in connection with the regulation of with-profits policies.

It should be noted that a number of respondents to the June 2011 consultation questioned whether the reference to protecting “future policyholders” in the PRA’s insurance objective could prove to be ambiguous. Respondents also queried whether the insurance objective would be consistent with the full implementation of Solvency II.

Influencing EU and international decisions

In response to the Government’s proposals, many have expressed concern that the ESAs regulatory responsibilities are divided based upon subject area, whereas the new UK regulatory bodies will be split into prudential and conduct regulation across all subject areas. This means that the PRA will hold the UK’s voting seat in EIOPA. Additionally, the PRA will represent the UK in the IAIS.

This creates the risk of the UK not speaking with one voice on the international stage and one body may have to represent the UK’s position on a subject where it is not the national expert. The Memorandum of Understanding on international organisations sets out a framework for consultation and cooperation amongst the relevant authorities in order to ensure that the UK takes a coherent position internationally and a consistent line in discussions with its international partners. Amongst other things, the Memorandum of Understanding confirms that where not all the UK authorities are represented in international organisations and bodies, the UK authorities that are represented shall, in a timely manner, consult with and keep the other UK authorities informed in relation to any matter of common interest. It also provides for the establishment of an International Coordination Committee, which will be responsible for ensuring that the UK authorities act in accordance with the principles set out in the Memorandum of Understanding.

Early publication of disciplinary action

As previously reported, the Bill will amend FSMA to relax the general prohibition against the publication of warning notices. In its recent report (published on 19 December 2011), the Joint Commission argued that the requirement to consult the firm or individual subject to the notice ahead of disclosure should be removed. Conversely, industry respondents were either opposed to the power in principle or called for it to be subject to additional safeguards.

The Government believes that the proposal detailed in the June 2011 consultation strikes the right balance between making the power useable and providing appropriate safeguards for those affected. The Government has, therefore, not made any changes to this power.

Next steps

The Financial Services Bill had its second reading in the House of Commons on 6 February 2012. It will now make its way through Parliament, and the Government has confirmed that it is firmly committed to securing passage of the Bill by the end of 2012, so that the changes can be implemented in 2013.

For further information:

Financial Services Bill

Financial Services Bill - Explanatory Notes

A new approach to financial regulation: securing stability, protecting consumers

January 2012

In September 2011, the House of Commons Treasury Committee announced an inquiry into the proposed FCA. The inquiry posed a number of questions. For example, it considered whether the current objectives of the FCA were clear and appropriate and asked whether it had suitable powers.

On 13 January 2012, the Treasury Committee published its report (dated 10 January 2012). The report opens with a section describing how the FCA fits into the proposed regulatory structure, and also considers the objectives of the FCA. It reviews the proposed lines of accountability for the FCA and makes recommendations on how these might be improved. It also outlines the FCA’s place in the wider regulatory architecture (specifically discussing how the FCA should coordinate with the PRA and the European Union). Finally, the report discusses the FCA’s proposed new powers including early warning notices, product intervention and the pre-approval of some financial products. The following issues will be of particular interest to insurers and intermediaries:

The FCA’s strategic and operational objectives

The draft Bill currently sets out a strategic objective for the FCA, three operational objectives, a requirement for the FCA to discharge its functions in a way which promotes competition, and a number of “have regard” duties. This creates a hierarchy of four tiers of objectives and duties. As the promotion of competition ranks below the strategic and operational objectives, it is given a lower level of significance, and the Treasury Committee believes that the FCA should have competition as its primary objective. On 19 December 2011, Chancellor of the Exchequer, George Osborne, announced that in legislation, due to be published this year, one of the objectives of the FCA will be to promote effective competition in the interests of consumers. In the report, the Treasury Committee welcomes the Chancellor’s assurances and suggests that competition should be central to the culture of the FCA.

Under the draft Bill, the requirements that the regulator considers the desirability of facilitating innovation and maintaining the competitive position of the UK will no longer be included in FSMA. The financial services industry makes a major contribution to UK GDP and employment. Recognising that an effective regulatory system can attract business, the Treasury Committee states that it is important that the new regulatory bodies do not ignore the impact of their actions on the competitiveness of the UK. According to the Treasury Committee, the relationship between competitiveness and the means by which the Chancellor’s assurances that competition will be an objective of the FCA are implemented will need to be carefully scrutinised, and they may return to the issue.

Accountability of the FCA

The report accepts that the membership and functioning of the FCA’s board will be important to the success of the regulator as a whole. Evidence received on the issue suggested that the selection process for appointing members to the FCA board should be clear and transparent and that the process should aim to ensure that the board’s expertise covers all financial sectors supervised by the FCA, including insurance. The Treasury Committee believes that the FCA’s accountability to the industry should be supported by a duty applicable to both bodies requiring a high level of engagement and exchange of information. The Treasury Committee makes a number of other recommendations regarding accountability. For example, it suggests that the board of the FCA should publish full minutes of each meeting and that legislation should provide that the Chief Executive of the FCA is subject to pre-appointment scrutiny by the Treasury Committee.

The FCA’s place in the wider regulatory architecture

There is a concern that a regulatory structure made up of three separate bodies, the FCA, PRA, and FPC will not be efficient and that it may be difficult to maintain strong relationships among the different bodies.

It is suggested that the FCA will need to form and maintain close relationships with the Bank of England. The FPC’s work on macro-prudential measures will impact substantially on the FCA and it must ensure that it is fully involved with the FPC’s work. Coordination between the FCA and the PRA is equally crucial, as there will be 2,000 “dual regulated” firms (including insurers). The Memorandum of Understanding between the regulators will, therefore, be an important document and the Chancellor recently explained that it has not yet been published as he wanted to first consider the recommendations made by this report and those given by the Joint Committee in their report on the accountability of the Bank of England. Given previous unsatisfactory experience of regulators operating within a Memorandum of Understanding, the Treasury Committee recommends that the relationship between the FCA, PRA and FPC should be set out more explicitly in primary and secondary legislation in order to avoid regulatory gaps or overlap.

The Treasury Committee also discusses the Government’s proposal that the PRA should be given a veto over the FCA where, in the opinion of the PRA, an action by the FCA may either threaten the stability of the UK financial system or result in the failure of a PRA-authorised person in a way that would adversely affect the UK financial system. The Treasury Committee does not believe that the case for a veto over the FCA’s powers has yet been made and states that, if it wishes to proceed with the proposal, the Government should publish persuasive evidence to support the need for it. If the Government does maintain its commitment to a veto, the Treasury Committee contends that the draft Bill should be amended so that the power lies with the FPC (even then it should only be used in exceptional circumstances).

The report accepts that the “twin-peaks” model of financial regulation does not align directly with the EU model of three regulatory authorities. Particular concerns have been raised by the insurance industry, as insurance intermediaries will be regulated by the FCA for both conduct and prudential matters, but representation at European level is through the PRA (who will sit on EIOPA). According to the Treasury Committee, the proposed Memorandum of Understanding is unlikely to be an appropriate method for establishing the basis of co-ordination between the PRA and FCA in respect of the UK’s seat on EIOPA. Accordingly, the Government should consult on the appropriate level of coordination and set this out in secondary legislation.

The FCA’s new powers

The draft Bill sets out the specific powers of the FCA in relation to product intervention. A number of firms have suggested that the FCA’s more interventionist approach is not appropriate and that it should not be involved in product design or stipulating mandatory minimum standards. The Treasury Committee believes that it is crucial that the potential risks and benefits of the approach are properly understood. The FCA will not necessarily understand a new product better than a firm and this could pose risks to competition and innovation. Having said this, the Treasury Committee does support the need for judgement-led product intervention by the regulator. It recommends, however, that such powers should be used sparingly and that clear guidance should be issued to firms whenever an intervention is made.

The Government also proposes to give the FCA the power to disclose the fact that a warning notice has been issued to a firm. Firms have objected to the proposal citing the potential reputational impact of an early warning notice and worries about consistency with natural justice. The Treasury Committee is also concerned that a general rule permitting the FCA to publish early warning notices in respect of specific firms, which in some cases could subsequently prove to be unfounded, risks unreasonable reputational damage to which there may be inadequate redress. Therefore, the Government should continue to consult on the proposed power.

The Government is due to publish the Financial Services Bill early in 2012, and the Treasury Committee reports that it will return to some of the issues discussed in light of the revised proposals.

For further information:

House of Commons Treasury Committee: Financial Conduct Authority

December 2011

On 16 June 2011, the Government published a consultation document and white paper entitled A new approach to financial regulation: the blueprint for reform. The paper, which included draft legislation, set out the details of the proposals for regulatory reform and stated how the Government intends to give them legislative effect. A joint committee of both Houses of Parliament was appointed to conduct pre-legislative scrutiny and, on 19 December 2011, it published its much anticipated report. The following issues will to be of particular interest to insurers and intermediaries:

The PRA’s insurance objective

In A new approach to financial regulation: the blueprint for reform, the Government accepted that the distinct nature of insurance business ought to be recognised in the regulatory framework and confirmed that it would insert a new section into FSMA. The PRA’s insurance objective requires it to contribute to the securing of an appropriate degree of protection for those who are or may become policyholders. The objective is designed to recognise the correlation (especially in with-profits policies) between the management of risk and consumer outcomes. In its report, the committee indicates that it would prefer the imposition of new cross-sectoral objectives for the PRA. Notwithstanding this, it lists its concerns with the drafting of the insurance objective.

Clause 5 of the draft Financial Services Bill, gives the PRA specific responsibility for securing an appropriate degree of protection for the reasonable expectations of policyholders as to the distribution of surplus under with-profits policies. According to the committee, there is legal uncertainty regarding the definition of “reasonable expectations” and much of the Equitable Life litigation revolved around the problems of defining the term. The committee states that using a phrase of this kind makes it difficult for the PRA to be clear on the meaning of its duties, and near to impossible for consumers and Parliament to hold the PRA to account for its actions. HM Treasury should, therefore, redraft the Bill to exclude the problematic phrase “reasonable expectations”. In relation to with-profits policies, HM Treasury has stated that the FCA should advise the PRA on matters relevant to achieving an appropriate balance between the interests of policyholders and the prudential position of the firm. Under current provisions, this arrangement will be established under the Memorandum of Understanding (which will govern co-ordination between the PRA and FCA). However, the committee suggests that the PRA should be subject to an explicit duty to consult with the FCA on matters affecting with-profits customers.

Influencing EU and international decisions

The committee notes that the ESA’s regulatory responsibilities are divided based upon subject area, whereas the new UK regulatory bodies will instead be split into prudential and conduct regulation across all subject areas. For example, the PRA will hold the UK’s voting seat in EIOPA. This creates the risk of the UK not speaking with one voice on the international stage and one body may have to represent the UK’s position on a subject where it is not the national expert. Given these concerns, the committee states that it is vital that the international co-ordination Memorandum of Understanding establishes a committee responsible for ensuring that the UK authorities agree consistent objectives and exercise their functions in a way that is effective. This committee should report to the Chancellor and include representatives of the PRA, the FCA, the Bank and HM Treasury.

Early publication of disciplinary action

The draft Bill will amend FSMA to relax the general prohibition against the publication of warning notices. The industry has been critical of this relaxation and argues that it could cause reputational damage to firms that are subsequently not found to be in breach. The Government suggests that it has taken these concerns into account by implementing a series of safeguards. Under the safeguards:

• the regulator will have the opportunity to consider the case for publication on a case-by-case basis, rather than being required to publish;
• the regulator must consult the person to whom the notice is given before making any disclosure; and
• the FCA may not publish if, in its opinion, it would be unfair to the person against whom action is being taken, it would be prejudicial to the interests of consumers, or it would be detrimental to financial stability.

According to the committee, these safeguards may significantly reduce the effectiveness of the power to publish early warnings of disciplinary action. Early publication of disciplinary action is common practice amongst regulators in other sectors, and the committee sees no reason why financial services firms should be granted dispensation from public disclosure. Accordingly, the committee recommends that the requirement to consult before disclosing the fact that a warning notice has been issued should be removed from the draft Bill.

The committee also considers other issues pertinent to insurers. For example, it suggests that membership of the FPC must include experts from across the financial services industry, including insurance, and that the PRA’s board must have at least one member with specialist expertise in insurance.

For further information:

Joint Committee on the draft Financial Services Bill - first report

June 2011

On 27 June 2011, the FSA published a document entitled The Financial Conduct Authority: Approach to Regulation, setting out how the FCA will deliver its objectives. The document outlines the FSA’s initial thinking which will be refined between now and the end of 2012.

The FCA will have the single strategic objective of protecting and enhancing confidence in the UK financial system and three operational objectives, namely:

• securing an appropriate degree of protection for consumers;
• promoting efficiency and choice in the market for financial services; and
• protecting and enhancing the integrity of the UK financial system.

The document confirms that the FCA will focus more closely on wholesale conduct and that it will adopt a more issues and sector-based supervisory approach than the FSA. The new approach will build on changes which the FSA has already made, or to which it has signalled commitment. The document states that the essence of the new approach can be illustrated by considering the FSA’s response to the mis-selling of PPI. Whilst the FSA intervened robustly to secure redress of consumer detriment, in the future the FCA will look to ensure that fewer such problems develop in the first place.

The actions of the FCA will need to be based on judgemental trade-offs between different desirable objectives. Consequently, the FCA will need to consult widely about how it should strike these trade-offs, explain clearly the basis for its judgements and be clearly accountable.

The document considers how the FCA will work effectively with the PRA and recognises that coordination will need to be particularly close in respect of with-profits insurance business. The Government is currently considering whether further legislative provision may be necessary to ensure that coordination will be efficient and effective. The document also states that the FCA will support the PRA in representing UK interests in EIOPA. This will be particularly important as conduct issues fall within the scope of EIOPA.

For further information:

The Financial Conduct Authority: Approach to Regulation

June 2011

On 20 June 2011, the Bank of England and the FSA published a joint paper entitled The Bank of England, Prudential Regulation Authority - Our approach to insurance supervision. The paper recognises the particular nature of insurance contracts and business models, and confirms that the PRA’s supervision of insurers will be framed in a different way to its supervision of banks.

The PRA will have two complementary objectives for insurance supervision. It will seek both to secure an appropriate degree of protection for policyholders and to minimise the adverse impact that the failure of an insurer, or the way it carries out its business, could have on the stability of the system. The PRA’s insurance objective is designed to complement its contribution to the promotion of the stability of the financial system.

Policyholders will be protected by the PRA and FCA. Essentially, the PRA will look to ensure that an insurer is likely to have sufficient financial resources to meet its obligations to policyholders as they fall due. This will include assessing an insurer’s governance processes and financial strength. The FCA’s role as conduct regulator will be to ensure that consumers are treated fairly in all engagements with insurance firms. As stated in HM Treasury’s White Paper, arrangements will be put in place to ensure close co-operation between the PRA and FCA, which will take particular account of insurers’ liabilities arising from with-profits policies.

While insurers are not systemic in the same way as banks, their behaviour or failure has the potential to pose risk to the stability of the financial system. For example, the combination of insurance and banking in a single group may give rise to system-wide risk if the failure of the insurer threatens the financial condition of the bank. Furthermore, the investment decisions of insurers can accentuate movements in asset prices and groups containing an insurer may undertake non-insurance activities that bring risk to the system. The PRA will seek to identify those insurance companies likely to individually pose risk and will supervise those firms in a way that reduces their potential impact. Assessment of system-wide risks, such as risks arising because insurers are providers of funds to the banking system, will be the responsibility of the FPC and the Bank of England. The insurance supervisors of the PRA will work closely with the FPC in support of its macro-prudential remit.

The paper also accepts that firm failure is always a possibility and the PRA will not guarantee that policyholders are protected in all circumstances and will not seek to ensure that no insurer fails. Given the PRA’s objectives, it will be important that there are mechanisms by which all types of insurer supervised by the PRA can exit the market in an orderly manner.

The paper confirms that the PRA’s supervisory approach will recognise the different risks inherent in the business model of life and general insurers and states that across its entire portfolio of firms, the PRA’s style of supervision will be judgement-based. Practically, this means that the nature and intensity of the PRA’s supervisory approach will be commensurate with the level of risk a firm poses to policyholders and to the stability of the system. Therefore, there will be a baseline level of monitoring for all firms but resources will be focussed on those institutions and issues which have the greatest impact on the PRA’s objectives. Amongst other things, the intensive supervisory approach will include an evaluation of a firm’s business model, desk-based analysis of a firm’s financial strength and stress testing against a range of possible future states of the world. The paper states that a Proactive Intervention Framework (PIF) will be introduced, which will clearly set out both the recovery actions expected to be taken by a firm as its financial position deteriorates, and the actions expected to be taken to prepare for firm failure, should that become necessary. Whether a special resolution regime akin to that introduced for banks will be implemented remains undecided. Finally, in relation to supervision, the PRA expects firms to consider the underlying purpose of its rules when managing their business.

The PRA’s policies and supervisory actions will take place within an international context and much of the PRA’s proposed approach will be achieved through the application of Solvency II. The paper states that the PRA will play an active and constructive role in shaping the development of the common framework for regulation and supervision at a global level and in the EU. Many international insurers operate in the UK and the PRA will collaborate with other organisations including EIOPA and the IAIS to ensure that it is able to address risks that non-UK insurers may pose to its statutory objectives.

For further information:

The Bank of England, Prudential Regulation Authority - Our approach to insurance supervision

June 2011

In opening the conference, Hector Sants, FSA Chief Executive, confirmed that whilst the paper on the PRA’s approach to insurance supervision is not a formal consultation document, the FSA invites comments which will allow it to proceed to the detailed design and implementation stage. Sants also commented positively on the reforms made by the FSA to the insurance framework in 2003 and suggested that these will inform the future PRA approach.

According to Sants, the effectiveness of the PRA will rest heavily on its ability to deliver a judgement-based model. To equip the PRA to make the best possible decisions it is imperative that it employs the right individuals with the optimal experience and technical ability. The history of the FSA demonstrates the difficulty of achieving this goal and the PRA will need to employ an imaginative and dynamic approach to the recruitment and retention of staff. Finally, Sants stresses the importance of the PRA being accountable to Parliament and there must be no suggestion of “regulatory capture”.

Julian Adams, FSA Director of Insurance, also gave a speech setting out in more detail the PRA’s approach to insurance supervision. Adams considers that the PRA’s tightly-defined objectives will mean that the PRA’s execution will be clear and focussed concentrating on matters that go to the heart of the financial viability of firms. He confirms that the PRA will be replacing the FSA’s ARROW process with a new framework for assessing the risks posed by individual firms and states that the PRA is conscious of the limitations inherent in models.

The PRA will also implement a new framework for proactive intervention with a set of trigger points at which regulatory action will be presumed. Adams contends that this degree of proactive intervention will mean that “after the event” enforcement actions are likely to be relatively rare. To conclude, Adams discusses the PRA’s co-ordination with other authorities and confirms that more clarity will be provided on the interaction between the PRA and FCA when it becomes available.

For further information:

Hector Sants, the PRA Insurance Conference

Julian Adams, the Supervisory Approach of the Prudential Regulation Authority

June 2011

On 16 June 2011, the Government published a consultation document and white paper entitled A new approach to financial regulation: the blueprint for reform. The paper, which includes draft legislation, sets out details of the proposals for regulatory reform and states how the Government intends to give them legislative effect. It also contains a summary of responses to the previous consultation and highlights areas where the Government’s position has been informed by these responses. The following issues are likely to be of most interest to insurers and intermediaries:

The statutory objectives and governance of the PRA

Respondents to the February consultation paper were supportive of the PRA’s strategic and operational objectives. However, some were concerned that the emphasis on financial stability could result in a lack of focus on “non-systemic” firms. Notably, respondents from the insurance sector stated their concerns that the specific regulatory requirements of insurance business might not be reflected in the generic financial stability approach proposed in the February consultation.

The Government has recognised that the distinct nature of insurance business ought to be reflected in the regulatory framework and has revised the objectives of the PRA. A new section will be inserted into FSMA stating that the PRA’s insurance objective is contributing to the securing of an appropriate degree of protection for those who are or may become policyholders. This amendment also complies with the Solvency II Directive which requires regulators to have the protection of policyholders as an objective of supervision.

The new set of objectives is drafted in order to retain a strong emphasis on financial stability whilst allowing for a flexible approach under which the PRA can focus on the specific needs of particular types of firms. They are designed to address the concerns raised by some respondents that insurance regulation would have a lower priority than the regulation of deposit-takers in the PRA.

Respondents were also generally in favour of the proposed governance framework for the PRA. However, some respondents were keen that there should be insurance expertise represented on the PRA board. The Government accepts that it is essential that the board has the right balance of expertise and expects the Bank of England to ensure that this will be the case.

The regulation of with-profits insurance business

The Government has considered how to achieve the necessary balance in insurance regulation between policyholder expectation of future return and balance sheet soundness with respect to with-profits insurance business. Respondents to the February consultation suggested that the regulation of the reasonable expectations of policyholders should be carried out by the PRA.

Consequently, the Government has inserted a section into FSMA which provides for the PRA to have sole responsibility for securing an appropriate degree of protection for the reasonable expectations of policyholders in regards to their returns under with-profits policies. The Government recognises that this is a complex area and emphasises that the PRA will need to consult with the FCA on matters relevant to achieving an appropriate balance between the interests of policyholders and the prudential position of the firm.

The Government is also considering whether explicit legislative provision is necessary to ensure efficient and effective consultation between the PRA and FCA, or whether current provisions, such as the Memorandum of Understanding, are sufficient.

Lloyd’s

Only a small number of respondents commented on the Government’s proposals for the future regulation of Lloyd’s. The respondents supported the proposals to make the PRA the lead regulator for Lloyd’s as a whole and the prudential regulator for the Society of Lloyd’s and Lloyd’s managing agents. Some respondents suggested that the PRA should also be the prudential regulator for Lloyd’s members’ agents.

The Government confirms its intention to legislate to make the arrangements for Lloyd’s as set out in the February consultation. The Society of Lloyd’s and Lloyd’s managing agents will be dual regulated firms whilst Lloyd’s members’ agents and brokers will be regulated by the FCA. The relevant regulatory arrangements will be adapted to match the unique way in which Lloyd’s operates by allowing the PRA to regulate the prudential aspects of Lloyd’s operations despite the fact that Lloyd’s names are not authorised persons.

Passporting

Respondents supported the proposals in relation to passporting and the Government has, therefore, retained its proposals for outward passporting. For firms passporting out of the UK, the PRA will be responsible for issuing all relevant notices.

However, it is clear that the PRA needs to oversee the entire financial system in the UK, including the parts made up of branches passporting in from other countries. To achieve this, the PRA will need to build close working relationships with overseas regulators and supervisory colleges supervising large firms passporting into the UK. Therefore, notifications from overseas regulators in relation to the Reinsurance Directive, the Consolidated Life Assurance Directives and the First, Second and Third Non-Life Insurance Directives will go to the PRA, in order to mirror its responsibilities on a domestic basis. Notifications in relation to all other directives will go to the FCA.

Membership of the FPC

A number of respondents to the previous consultation supported the Treasury Select Committee’s view that the membership of the FPC was too heavily weighted towards the Bank. The Government will gather views on this issue over the period of pre-legislative scrutiny. Conversely, respondents welcomed the Government’s views on the importance of ensuring that external members of the FPC have recent and relevant financial sector experience, including experience in non-bank areas like insurance.

The Government stresses that itself and the Bank are committed to ensuring an appropriate balance and breadth of experience for both the interim FPC and the permanent body that will replace it.

The draft Bill will now be subject to pre-legislative scrutiny. Responses from all stakeholders are welcomed during the consultation period which runs until 8 September 2011.

For further information:

A new approach to financial regulation: the blueprint for reform

May 2011

On 4 May 2011, the House of Commons Treasury Committee published Financial Regulation: a preliminary consideration of the Government’s proposals: Government response to the Seventh Report of the Committee. The document sets out the Government’s response to the Committee’s report on financial regulation reform which was published on 3 February 2011.

The Committee’s report expressed concern that the Government’s current proposals say relatively little about some of the key segments of the financial sector, such as insurance. The Government responds that as the lessons of the financial crisis have predominantly focussed on the micro and macro-prudential regulation of the banking sector, it is inevitable that the presentation of proposals for improving regulation should focus on banking. However, the Government states that it recognises the importance of effective regulation in all sectors of the financial services industry. To this end, the Government will ensure that external members of the FPC are able to offer insights from direct experience as financial market practitioners, not only in banking but also other sectors such as insurance and investment banking.

In its report, the Committee also discussed the suggestion that the PRA will focus on what it considers to be medium and high-impact firms and its concern about an implicit acceptance that any failure of a high-impact firm should be avoided. The Government states that although the PRA will focus with great intensity on firms whose failure could cause the greatest risk to the financial sector it accepts that the failure of smaller firms can cause disruption and cost to regulated firms, customers and taxpayers. The Government also indicates its agreement that no firm should be too important to fail and states that it is committed to embedding this approach in the legislation. For example, the PRA will be under a duty to ensure that the cost and disruption arising from a potential firm failure is minimal. This objective makes clear that, to strengthen market discipline and avoid moral hazard, the regulatory system should allow firms to fail.

The Government notes the Committee’s concerns about the description of the FCA as a “consumer champion”. The Government stresses, however, that the term “consumer champion” should be viewed in the context of the FCA’s role as a focussed and proactive conduct regulator that is entirely independent and impartial. The distinct objectives of the PRA and FCA should reduce the risk of overlap and the Government discusses the need to coordinate so that both regulators can focus on their core remit.

The Committee discussed the need for the UK to secure appropriate representation on the EU regulatory bodies. The Government is in agreement and explains that the three ESAs will each have a voting member from the UK. The PRA will represent the UK in the ESAs for banking and insurance, while the FCA will be a member of the securities authority. The PRA and FCA will work together to ensure that the other regulator and any other relevant authorities are kept fully informed of any matters due to be discussed that fall within their sphere of responsibility. When another body has an interest, the relevant UK member may bring along a non-voting representative of that national body. The Government is proposing legislation which will put the regulators under a duty to coordinate and they will be required to agree a Memorandum of Understanding which will state how they will manage their engagement with foreign regulatory bodies.

For further information:

Financial Regulation: a preliminary consideration of the Government's proposals: Government response to the Seventh Report from the Committee

February 2011

On 17 February 2011, HM Treasury published a consultation paper entitled A new approach to financial regulation: building a stronger system. The paper expands on the proposals announced by the Government in its July 2010 consultation paper and, wherever possible, reflects and responds to the Treasury Select Committee’s report, which was published on 3 February 2011.

The Government’s reforms focus on three key institutional changes:

• A new FPC will be established in the Bank of England, with responsibility for macro-prudential regulation. The Government proposes that the FPC should have a number of macro-prudential tools available to address systemic risk including capital and collateral requirements and liquidity tools.
• The PRA will be responsible for micro-prudential regulation of financial institutions that manage significant risks on their balance sheets. The PRA will take a “judgement-led” supervisory approach. While this approach will focus on forward-looking analysis, it will also consider firm failure and the impact that this would have on the financial system as a whole and the possible use of public funds.
• The FCA (previously known in proposals as the CPMA) will have responsibility for conduct of business regulation across the entire spectrum of financial services. The FCA will take a proactive, interventionist approach to conduct regulation, so that actual or potential risk is acted upon before it crystallises into significant detriment.

These reforms will be implemented through primary legislation amending FSMA. The approach will involve modifying, adapting, supplementing and, in some cases, amending the current legislative framework. This will allow the Government to implement changes with greater speed, while minimising the cost and disruption to firms that would arise from repealing FSMA and starting with an entirely new bill. The following issues are likely to be of most interest to insurers and intermediaries:

Effective regulatory coordination between authorities

In the paper, the Government recognises that effective coordination between the FCA and PRA will be a vital part of the new framework. The Government will legislate for a variety of general coordination mechanisms:

• a statutory duty to coordinate the exercise of their functions;
• an obligation to prepare a Memorandum of Understanding;
• cross-membership of boards; and
• a veto mechanism for the PRA to reduce the risk of regulatory actions threatening financial stability or the disorderly failure of a firm.

The statutory duty to coordinate will allow each regulator to benefit from the expertise of the other without duplication or confusion, through appropriate consultation mechanisms and, where necessary, specific mechanisms to allow shared regulatory processes to operate efficiently.

In its report the Treasury Select Committee cautioned that the reforms should not be concerned exclusively with banking and that it will be important to avoid confusion as to which firms will be regulated, or part regulated, by which regulator.

The paper confirms that the general principle underpinning the Government’s model of dual regulation (that conduct of business and consumer protection issues are the preserve of the FCA, while the PRA will focus on the soundness of firms and the stability of the system) will also apply to insurance regulation. The FCA will be responsible for supervising the day-to-day conduct of insurance firms in dealing with their customers and clients whilst the PRA will look to promote their long-term soundness and stability. In fulfilling these responsibilities, the PRA will recognise that insurance business models are different to those of banks, especially in terms of liquidity risk and the systemic importance of a firm’s failure. Practically, this means that effective supervision may be achievable through a less intensive supervisory approach when compared to banks.

The paper recognises that the PRA and FCA will need to consider how their supervisory approaches should reconcile the conflicting issues of policyholder protection and the expectation of future return, and balance sheet soundness (particularly in relation to with-profits business).

Lloyd’s

Given the importance of prudential supervision in ensuring that the claims of Lloyd’s policyholders are met, the PRA will be the lead regulator for Lloyd’s as a whole. However, the FCA will play a role by regulating conduct in relation to certain activities of Lloyd’s, its members and other participants in the Lloyd’s market including the dealings with policyholders, customers and investors.

The division of responsibility will largely follow the division of interests in relation to insurance business or activities, as described above, but will also have regard to the unique nature of Lloyd’s, including the way it operates as a specialist financial market and the distinctive roles played by certain participants in the market. The Government proposes that the Society of Lloyd’s and Lloyd’s managing agents should be dual-regulated firms with the PRA responsible for prudential regulation and the FCA responsible for conduct regulation.

Part VII Transfers

The process currently detailed in Part VII of FSMA sets out a framework to enable the transfer of insurance and banking business. Under the current Part VII mechanism, the courts are ultimately responsible for approving or rejecting an application for a business transfer, while the FSA has the right to make representations to court and is responsible for approving the necessary documentation. The paper confirms that the Government does not intend to alter the substance of the current framework.

The PRA will be primarily responsible for the process. However, the FCA has an interest and will need to satisfy itself that, as a minimum, the transfer will not adversely affect the customers of the firms involved in the transfer. Both authorities will be able to make representations to the court during the transfer process.

Insolvency of a Life Insurer

The FSA is currently required to agree to any voluntary winding-up of a life insurer. The original aim of this provision was to protect policyholders. However, there are clear prudential and possible financial stability implications associated with the winding up of a life insurer. Given these considerations the Government has confirmed that it will consider the most appropriate division of responsibilities between the PRA and FCA in this area.

Early publication of an enforcement action

The Government has confirmed that it will legislate to allow for publication of the fact that a warning notice has been issued, and of a summary of the notice. This power will apply to both the PRA and FCA. The Government recognises the need for appropriate safeguards for this power, given that the publication of such information could cause reputational damage where enforcement action is later discontinued. Consequently, the new power will include a safeguard to ensure procedural fairness.

Fees and Levies

Within the new regulatory structure the Government believes that it is essential for the PRA and FCA to use their resources efficiently in order to keep their costs down. The Government states that fees will need to be considered thoroughly, this will be especially important for those firms which will be subject to regulation by both authorities, and so will have to pay two sets of fees.

The paper also includes more detailed proposals in relation to authorisations and variations to permissions, approved persons, passporting and change of control and supervision of financial groups.

The Government has invited comments on the paper and the consultation period will remain open until 14 April 2011. The Government has reiterated that it intends to introduce legislation to implement its proposals in mid-2011 and that the new regulatory framework is expected to be in place by the end of 2012.

For further information:

A new approach to financial regulation: building a stronger system

February 2011

On 9 February 2011, Hector Sants, Chief Executive Officer of the FSA, gave a speech on the future of insurance regulation. In his speech Sants focuses on the key regulatory issues facing the UK insurance industry, namely the imminent change to a new pan-European set of regulatory rules and a new supervisory structure in the UK. He also discusses the new European regulatory structure.

The supervisory structure in the UK

Last year the Government announced plans for changes to the structure of regulation in the UK. Specifically, the Government plans to create three new bodies, the PRA, FPC and CPMA. In his speech Sants discusses the progress made to date on the design of the supervisory approach which will be applied by the PRA and the CPMA in regulating insurers in the future.

Sants describes the PRA as a focussed prudential regulator, equipped with the philosophy, systems and skills to deliver its single statutory objective: to promote the soundness of firms and minimise the adverse impact that the failure of firms can have on the financial system. In Sants’ view the PRA should not be perceived as a “no failure” institution.

Sants reassures his audience that he understands the important distinctions between regulating banks and insurers. Insurers differ to banks in two key respects. Firstly, their business model is different and secondly, the failure of insurance firms is not as likely to be as systemically significant as that of banks. According to Sants, the main risk posed by insurer failure is the resulting market concentration and disruption caused by the loss of a market participant. Sants believes that insurers pose the greatest systemic risks when engaging in “bank like” activities, rather than when undertaking traditional insurance business.

To minimise disorderly failure the PRA needs to recognise the importance of policyholders’ reasonable expectations. It is a regulator’s responsibility to seek to ensure that firms’ balance sheets are set up to deliver these expectations. To surmise, there should be greater emphasis on going concern issues for insurers as opposed to “gone concern” issues pertinent to banks. Despite these comments, Sants emphasises that the PRA will base its supervisory interventions for both banks and insurers on a similar judgement-based risk assessment framework.

Sants moves on to discuss the creation of the CPMA, its interaction with the PRA and what this means for the insurance industry. The CPMA’s objectives and scope are wide-reaching, covering responsibility for the regulation of conduct in wholesale, retail and financial markets and the infrastructure that supports these markets to ensure integrity, stability and efficiency. The CPMA has a particular focus on protecting consumers but Sants plays down the idea that the CPMA will be a “consumer champion”. Rather, Sants views the consumer objective as one which emphasises early and proactive intervention, a braver approach to enforcement and redress, and a willingness to improve the consumer experience. The CPMA’s regulatory approach will be delivered using a risk model which puts a premium on early risk identification and prioritisation.

Sants states that the PRA and CPMA will liaise regularly on prudential and conduct supervision issues. He believes that this interaction will be particularly important for with-profit insurers, given the high degree of connectivity between prudential and conduct issues. The FSA envisages addressing this connectivity though a number of mechanisms including:

• a high level Memorandum of Understanding, with detailed annexes covering potential high risk areas;
• domestic colleges for joint working on the supervision of individual firms;
• cross representation on policy boards; and
• legal provision for information gateways.

The new European regulatory structure

Finally, Sants outlines the changes to insurance regulation from a European perspective. He discusses the formation of EIOPA. In the future, Sants believes that, the FSA and successor authorities will essentially be a supervisory arm of an EU policy setting body. With this in mind he underlines the need for the UK to effectively influence decision making, not just in EIOPA, but also in the wider European framework.

Sants pledges that the FSA will invest significant effort into fully engaging with the issues facing the insurance sector at a European level.

For further information:

The future of insurance regulation, speech by Hector Sants, Chief Executive, FSA

February 2011

In July 2010, HM Treasury published a consultation document entitled A new approach to financial regulation: judgement, focus and stability. The report proposed major changes to financial regulation in the United Kingdom which would signal the end of the tripartite system, in which the Treasury, the Bank of England and the FSA work together. Instead a new regulatory framework will be developed which follows a “twin peaks” model, under which prudential regulation of financial institutions is separated from the oversight of consumer protection and markets conduct.

On 3 February 2011, the House of Commons Treasury Committee set down its preliminary responses to the proposals in Financial Regulation: a preliminary consideration of the Government’s proposals.

The Government plans to introduce a Bill to implement its proposals by the middle of 2011 and intends to ensure its successful passage into law by the end of 2012. In the report the Treasury Committee states that the Government should take the time required to gets its reform of financial regulation right. Whilst the Treasury Committee appreciates the need to keep uncertainty to a minimum during a period of administrative upheaval it cautions against abiding by an arbitrary timetable, as it is more important that the reforms are carefully thought through. Accordingly, the report recommends that the legislation should be subject to pre-legislative scrutiny, over a reasonable timescale. Even with proper pre-legislative scrutiny, once introduced, the Treasury Committee believes that the timetable for the Bill should be generous enough to allow proper parliamentary consideration, using carry-over if necessary.

The Government’s consultation has previously been criticised for an overemphasis on the banking sector. The Treasury Committee considers how too much focus on the banks may adversely affect other areas of financial activity. For example, the creation of two new regulators, the PRA and the CPMA, may lead to confusion about which firms will be regulated, or part-regulated, by which regulator. Most large insurance firms have asset management arms and it is not clear whether the PRA or CPMA will be the lead regulator for such organisations. The Treasury Committee also believes that Lloyd’s merits more focus than the consultation document provided. The Treasury Committee concludes that inappropriate regulation of non-banking sectors could cause serious and unintended damage to companies within those sectors, and to the UK more widely. The report also discusses the FPC and cautions that there must be no room for accusations that it is overly focussed on banking nor that it lacks the expertise to look at other important sectors, such as insurance.

The FPC will be given lead responsibility for securing financial stability and the Treasury Committee stresses the need for clarity about what such stability means. In the Treasury Committee’s view the overall stability of the financial system should not mean that no firm will ever fail. The report criticises the view of Hector Sants that the PRA will have a low tolerance for the failure of the so-called high impact firms. According to the Treasury Committee the assumption that certain firms cannot be allowed to fail results in market distortion, entrenches the market power of large incumbents and thereby stifles competition. They are also concerned by the PRA’s focus on medium and high-impact firms. The report cites the case of Northern Rock as evidence that the failure of a low-impact firm can engender a systematic loss of confidence.

There is also criticism of the Government’s determination to brand the CPMA as a “strong consumer champion”. The Treasury Committee feels that this would be inappropriate, confusing and potentially dangerous. There are other organisations which campaign for consumers. The report suggests that the promotion of a regulator as a consumer champion may lead consumers to falsely believe that all financial products are risk free, creating moral hazard. This is clearly inconsistent with the regulators task which is to be alert to abuse and to ensure that consumers are appropriately protected in an open and fair marketplace with a minimum of moral hazard.

The Government’s current proposals include a suggestion that FSMA could be revisited in its entirety. In the report the Committee urges the Government to ensure that this is done. It believes that the Government should present a new Bill only after full consideration has been given to responses to initial consultation. Drafting the legislation will then be likely to secure a more coherent final product and may be quicker, given the complexities involved in the comprehensive amendment of FSMA.

For further information:

Financial Regulation: a preliminary consideration of the Government's proposals

The Conservative Party first set out its plans to reform the regulation of financial services in the UK in July 2009 and the Financial Services Bill finally received its first reading in the House of Commons on 26 January 2012. It will now make its way through Parliament, and the Government has confirmed that it is firmly committed to securing passage of the Bill by the end of 2012, so that the changes can be implemented in 2013.

The proposed reforms have been criticised for failing to pay adequate regard to the regulation of the insurance industry. This blog will provide regular updates on insurance related developments.