UK Government: Reforming Financial Markets (Part 1)

On 8th July the Chancellor of the Exchequer published the broad-ranging White Paper on Reforming Financial Markets, the UK government’s policy response to the banking crisis.

The paper principally builds on proposals around prudential supervision and systemic risk management carried in the Turner Review, but makes a number of interesting proposals beyond the scope of Lord Turner’s work.

The meat of the paper is split. First it offers consultation on proposed policy where the government is firm in its proposals, covering:

• Reforming regulatory institutions, and
• Competitive markets that work for consumers (some elements)

Secondly, it offers consultation on policy areas where the government wants further input before reaching a firm policy conclusion, covering:

• Managing ‘systematically significant firms’
• Competitive markets that work for consumers (some further elements), and
• Strengthening mutuals

Over the next few weeks Chase Cooper will be examining elements of these proposals in more detail, and trying to predict what some of the more interesting practical outcomes will be if the government’s ideas pass into law and regulation. We start with the areas where the government is firm in its thinking.

Proposed new powers for FSA

1. for FSA to suspend firms or individuals on the grounds of misconduct,
2. to give FSA the ability to penalise individuals carrying out Controlled Functions without the necessary approval from FSA, and
3. to allow FSA to exercise its powers of intervention against a firm in pursuance of any of its statutory objectives, including financial stability.

The government will also work with the FSA to assess whether FSA should be able to require information from additional participants in the financial markets – not directly regulated by FSA – where this is needed, for example, to carry out effective financial stability analysis.

Penalties for non-Approved Persons

Firms will need to ensure that they are rock solid in defining objective thresholds beyond which individuals will be carrying out Controlled Functions and so need FSA approval, with a very clear decision-making process where there are doubts. Individuals in senior roles will need to understand with clarity whether their role constitutes a Controlled Function – and if not, why not. We are therefore likely to see a material increase in defensive registrations.

FSA, through HM Treasury, is clear that this proposal is targeted at individuals who avoid or evade obtaining Approved Person status in order do business and make profits whilst staying beyond FSA’s reach, but there is a risk that in due course it could be used to target senior individuals at firms with less tight registration and compliance processes as a tool to bring about improved controls.

Use of intervention powers

This needs to be considered in the context of two other issues – the first is the new requirement for FSA to focus on understanding and challenging firms’ business models and strategies as well as their compliance with regulatory requirements, and the ability of FSA to amend firms’ Permissions – their permitted business activities – on its own initiative: the second is FSA’s exemption from liability for anything done in good faith in performance of its duties.

Clearly FSA is being asked to exercise judgment around the future impact of a firm’s current business model, and to take action where the business model in FSA’s view may have a detrimental impact on financial stability: however, this is a delicate judgment and it is difficult to see any material negative impact for FSA if they take action with which the target firm disagrees, which is subsequently demonstrated to be wrong, and has cost the firm significant funds, or prevented it from carrying on legitimate business, in part or in total.

Suspensions

Further, FSA may make Prohibition Orders against Approved Persons including a rider that the individual may apply for the order be revoked after a specified period of time has elapsed – as in the case of Christopher Headdon in 2004 – again, effectively a suspension.

Conclusion