UK Government announces abolition of FSA as part of sweeping Financial Services Regulatory Reform Proposal
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On the evening of 16 June 2010, the UK Chancellor of the Exchequer, George Osborne, set out high level details of the shake-up to the UK financial regulatory system at his first annual Mansion House speech at the Lord Mayor’s Dinner for Bankers and Merchants of the City of London. The Chancellor expressed his “profound doubts” about the current tripartite system under which the UK Treasury sets legislation, the Bank of England (the “Bank”) oversees financial stability and the Financial Services Authority (the “FSA”) regulates financial institutions and markets. Mr Osborne said that, under this system, the Treasury drifted into a “backwater”, the Bank focused only on “consumer price inflation” and the FSA “became a narrow regulator, almost entirely focussed on rules based regulation.” When the financial crisis hit, “no one knew who was in charge.” The Chancellor stated that “the cry has gone out: this time is different” and declared that the reform proposals represented a new settlement between the banks and society.
This update sets out some of the key reform proposals.
The Chancellor stated that the UK should demand rigorous standards for capital, liquidity and leverage requirements on banks, which are to be set at the next meeting of G-20 Finance Ministers and Central Bank Governors in Seoul in November 2010, even if that means UK banks have to transition to such standards.
In relation to the proposed new framework for financial supervision currently progressing at the European Union level, which includes proposals for the creation of pan-EU regulatory authorities, the Chancellor agreed that there should be strong mechanisms to underpin the EU single market, stronger cooperation between supervisors of EU member states and strict enforcement of the law. However, the Chancellor also emphasised that supervisory decisions that have an impact on national budgets will remain at the national level.
New regulatory framework
The current tripartite system allocating responsibilities among the UK Treasury, the Bank, and the FSA will be abolished. The FSA will cease to exist in its current form. The Bank will be given sweeping powers and will play a pivotal role in supervising the entire UK financial services industry. The Bank will be responsible both for macro-economic supervision and for micro-prudential regulation of financial institutions in the UK. This is based on the view that the Bank in its role as macro supervisor and lender of the last resort needs to be familiar with every aspect of the institutions that it may have to support in times of crisis. The Governor of the Bank, Mervyn King, in his speech at the same event, stated that, in approaching the Bank’s new responsibilities, the Bank will look more closely on “common features” across the UK banking industry that may threaten stability and will avoid an “overly legalistic culture with its associated compliance-driven style of regulation.”
An independent Financial Policy Committee (“FPC”) will be created at the Bank to carry out the Bank’s macro supervision function and will be provided with tools to exercise its powers. The FPC will have responsibilities to “look across the economy at the macroeconomic and financial stability issues that may threaten stability.” It will also have the power to require the PRA (see below) to implement its decisions by taking regulatory action across all UK financial institutions. The following persons will serve on the FPC: the Governor of the Bank as its chair, the Deputy Governors of the Bank for monetary policy and financial stability, a new Deputy Governor of the Bank for prudential regulation, the chair of the CPMA (see below), other external members and a UK Treasury representative. An interim FPC will be set up by autumn 2010 in advance of legislation for its official creation.
A new prudential regulator, the Prudential Regulation Authority (“PRA”), which will be a subsidiary of the Bank, will be created to carry out the Bank’s micro-prudential regulation function. The PRA will be responsible for the prudential regulation of all financial institutions in the UK. Although details of how the PRA will operate are to be finalised in the coming months, the Chancellor suggested that regulation should be more about exercising of judgement than “box-ticking”. Also, given that the Chancellor has accused the FSA of being a rules-based “narrow regulator”, notwithstanding that the FSA has always held itself out as a “principles-based” regulator, the more intrusive supervisory approach adopted by the FSA following the financial crisis is most certainly here to stay.
The Governor of the Bank will be the Chairman of the PRA and a newly created Deputy Governor of the Bank for prudential regulation will be the PRA’s Chief Executive (this will be the FSA’s outgoing Chief Executive Hector Sants who has agreed to stay on to lead the transition). The Deputy Governor of the Bank for financial stability will also be a board member.
While the PRA will be responsible for prudential regulation, supervision of the conduct of business of UK financial institutions will be the responsibility of a new Consumer Protection and Markets Authority (“CPMA”). The CPMA will be responsible for ensuring that UK retail and wholesale financial institutions conduct their activities in accordance with certain standards.
The UK Government will ensure that the CPMA has a tough, proactive approach to regulating the conduct of financial institutions. The CPMA will retain the FSA’s existing responsibility for the Financial Ombudsman Service and oversee the newly-created Consumer Financial Education Body. It will also have responsibility for the Financial Services Compensation Scheme.
The current powers of the FSA, the Serious Fraud Office and the Office of Fair Trading to fight financial crime will be handed over to a new, as yet unnamed, single agency which will be responsible for tackling serious financial crime.
These changes will be completed in 2012. The consultation process will start soon and the UK Government aims to publish a detailed policy document for public consultation before the UK Parliament’s summer recess (from late July to early September 2010).
The UK Government plans to introduce a bank levy and impose further restraints on pay and bonuses by banks and investment banks. The UK Government is also establishing an independent commission on the banking industry which will review the structure of banking in the UK and the state of competition in the UK banking industry. The Independent Commission on Banking (the “Commission”) will also review the separation of investment banking and retail banking. The Commission will produce a final report to the UK Government by the end of September 2011; the UK Government will then decide what measures are to be taken.
Following on from the Chancellor’s speech, the Financial Secretary to the UK Treasury, Mark Hoban, delivered his statement on the following day to the UK Parliament setting out further details of the proposed reform. Mr Hoban echoed the Chancellor’s remark that the current regulatory system has failed “spectacularly”. In his statement to the UK Parliament, Mr Hoban set out four principles to be followed during the transition period: (1) minimising uncertainty and transitional costs for firms; (2) maintaining high quality, focused regulation during the transition; (3) balancing swift implementation with proper scrutiny and consultation; and (4) providing as much clarity and certainty as possible for FSA, Bank and other staff affected during the transition period.
Impact on regulated firms
In spite of these stated principles, there will no doubt be uncertainties for regulators and regulated firms alike as the process of reform proceeds. These broad proposals will require not only new legislation but significant amendments to existing legislation. Another concern is whether the UK will continue to be able to take a leading role, or at least successfully promote its own position, in respect of ongoing EU regulatory reforms while undertaking such sweeping changes at home. Clearly, banks, investment firms and other regulated entities should start thinking about how they should best monitor and become involved in the coming changes. Those considering establishing new businesses in the UK during this time are also likely to experience longer lead times for regulatory approvals.
If you have questions about any of these items, please contact your regular Sidley Austin LLP contact.
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