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.
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.
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