Moving the deckchairs? UK regulation in flux again (Part 2)

HM Treasury has now closed consultation on the proposal document for returning the UK to a twin peaks system of financial services regulation.

The key issues, summarised in our previous note on this subject, are:

• Separation of regulatory functions into two organisations, the Prudential Regulation Authority (PRA) and the Consumer Protection and Markets Authority (CPMA).
  
• Creation of a Financial Policy Committee (FPC) within the Bank of England to take oversight of macro-prudential risks as they emerge.
  
• Possible transfer of criminal prosecutions from FSA to a new Economic Crime Agency
  

It was clear from the consultation document that all of the headline decisions had been taken and were not up for debate. What was available for debate were the proposed mechanics of how the agencies would operate – and cooperate – and the relative powers of each.

Focus on the PRA

This new Prudential Regulation Authority (PRA), a subsidiary of the Bank of England, will be responsible for prudential regulation of all deposit-taking institutions, insurers and investment banks. This will include building societies and credit unions, broker-dealers dealing as principal, and friendly societies.

HMT estimates that PRA will be responsible for prudential authorisation, supervision and enforcement for between 1,500 and 2,000 of the 20,000 firms currently authorised by the Financial Services Authority. These ‘PRA firms’ will also continue to be regulated by the new CPMA for conduct of business issues, effectively answering to two masters.

The PRA will operate using a predominantly judgement-based, rather than rules-based approach, basing its judgments on information received and gathered as part of the supervisory process, and being willing to challenge firms’ business models. The Government generally expects that, as part of its new judgement-based approach, the PRA will seek to reduce and simplify the rules and guidance contained in the existing FSA handbook.

The PRA will collect and provide information to the new Financial Policy Committee which will form the basis for the Committee’s monitoring of developing macro-economic risks. The FPC will then take decisions about whether to deploy macro-economic tools and levers, and instruct the PRA accordingly – which will in turn pass on those requirements to the relevant groupings of firms and institutions and monitor their delivery, resorting to new enforcement powers where necessary.

Focus on the CPMA

The HMT paper describes CPMA both as a strong consumer champion, and as responsible for ensuring market integrity throughout the wholesale financial markets in the UK. Recognising the entirely different challenges posed by these two elements, the paper is clear that there will be two clearly-defined parallel functions or divisions within CPMA to address them.

In addition to the focus on policing retail and wholesale conduct issues, CPMA will also be responsible for the prudential regulation of the 18,500 or so firms that do not cross the PRA threshold, from authorisation to enforcement.

Consequently, the CPMA will effectively be the FSA under a new name, but without responsibility for prudential supervision of the institutions and firms with the largest or most complex balance sheets. For the 18,000 or so non-PRA firms, there will be no structural change in regulation: it does, however, appear that the CPMA will be operating to a much more aggressive retail-focused agenda.

Duplication and cost

The Consultation paper was clear that the PRA would have responsibility for:

• Authorisation and permissions
• Rule-making
• Exercising judgment about the safety and soundness of firms
• Supervision and where necessary, enforcement
• Approving individuals to perform Controlled Functions
• Raising levies to fund the PRA (to be collected by the CPMA)

The CPMA has the same responsibilities in relation to the 18,000 firms under sole regulation, and is also responsible for conduct and market regulation for both PRA and CPMA firms.

Consequently there will be parallel organisations within the new regulators dealing with authorisation and permissions, approving individuals, and enforcement – with enforcement activity also overlapping with the proposed new Economic Crime Agency.

Further, the FSA’s information technology assets will be split, but more likely duplicated (or binned for redevelopment) as will the entirety of the COO functional line.

This is wasteful, at a time when the country can not afford waste.

The consultation recognises that there will have to be close cooperation and coordination between the PRA and the CPMA given the degree of duplication, and indeed does ask whether it would be preferable to have a degree of integration, giving – for instance – one authority the responsibility for authorisation and removal of permissions across the piste.

A more elegant solution?

The key differentials between the PRA and CPMA are around the focus of rule-making and supervision – it is acknowledged that prudential and conduct regulatory models require different rules and supervisory skillsets.

We would argue that all other functions of the Authorities should be hived down into a unitary service company providing services to both the PRA and the CPMA, to avoid wasted resource in duplication and confusion and mess for regulated firms. Such an approach would also maximise consistency between the two organisations in all of the areas beyond rule-making and supervision where this is desirable.

Legally it would not appear to be particularly challenging to create legislative provisions to allow PRA/CPMA safely to delegate activities to a service provider to be conducted in their names and under their powers and control, whilst retaining authority and accountability.

The government has said that it will produce a further paper, including draft legislation, early in 2011, with the intention of passing the new legislation within 24 months. We await the results with interest.

Nick Gibson, Editor
nick.gibson@chasecooper.com