HM Treasury: A New Approach to Financial Regulation

27 July 2010

The Government intends to reform the tripartite model to address macro-prudential regulation, prudential regulation of individual firms, and regulation of conduct towards retail consumers and in wholesale markets. It proposes to set up:

A Financial Policy Committee (FPC) within the Bank of England.

  • This will have statutory responsibility for maintaining financial stability.
  • As such it will undertake much monitoring of the system and take action on identified vulnerabilities
  • It will have access to macro-prudential tools to ensure that systemic risks can be addressed, such as directing the PRA/CPMA (see below) to take action on firms
  • The toolset at its disposal will include items such as ability to impose fresh capital requirements and leverage limits on firms, and to impose loan to value limits where it is felt necessary to restrain lending
  • It will work with similar international authorities to ensure a co-ordinated policy.
  • It will publish six-monthly Financial Stability Reports (that sound fairly similar to the FSA's annual Financial Risk Outlook) and minutes of its meetings (at least quarterly)
  • It will be subject to scrutiny by the Treasury Select Committee, and directly accountable to the Treasury

A Prudential Regulation Authority (PRA) as a subsidiary of the Bank of England.

  • This will take over operational responsibility for prudential regulation and supervision from the FSA, across deposit takers (banks, building societies and credit unions), insurers/friendly societies and investment banks.
  • Its board will be chaired by the Governor of the Bank of England
  • It will gather market information to support evaluation of emergent risks
  • The emphasis will be on a 'judgment'-based rather than rules-based approach (criticised as 'tick box compliance')
  • FSMA may well be used as a template for the legal operation of the PRA
  • However, not all the principles which currently apply to the FSA under FSMA will necessarily apply to the PRA - especially in respect of competitiveness and innovation in financial services
  • Credit rating agencies may also in future fall under PRA supervision depending on international developments

A Consumer Protection and Markets Authority (CPMA)

  • This will be responsible for promoting confidence in the integrity and efficiency of financial markets and protecting consumers
  • The Government believes that combining prudential and consumer regulation in the FSA in the past detracted from the focus and protection that retail consumers should have received.
  • The CPMA will have "arms-length oversight" of the Financial Ombudsman Service (FOS), the Consumer Financial Education Body (CFEB), and the Financial Services Compensation Scheme (FSCS)
  • It is intended that the CPMA will build on progress made recently by the FSA to a more "interventionist and pre-emptive" approach to regulating retail conduct
  • It will continue with the Retail Distribution Review and Mortgage Market Review and "work on responsible lending"

The Government states that it intends to legislate so that:

"the CPMA will have responsibility for the conduct-of-business regulation of all financial institutions, whether they are prudentially regulated by the PRA or not."

However, it states it will consult separately in the autumn on whether responsibility for consumer credit should be transferred from the OFT to the CPMA in due course. It signals that, if so, a longer timetable would then be likely to be adopted to ensure extensive engagement on this. Some comfort is given in a statement that change would need to "deliver real and justifiable benefits" for consumers and will be genuinely dependent on this secondary consultation's outcome.

How the PRA and CPMA should work together:

  • The PRA and CPMA will each be responsible for authorising respective regulated activities and for approving persons to hold significant influence functions.
  • They will each have to 'have regard' to the other's objectives
  • Cross membership of boards and Statutory Memoranda of Understanding are to ensure coherence of approach
  • Legal provision for gateways to share supervisory information

The full consultation paper can be read here. The Government intends to publish more detailed proposals and draft legislation for consultation in early 2011, and then to see the changes enacted within two years.

In the meantime, as well as the separate consultation on consumer credit regulation, a consultation will also be forthcoming on reforming the approach to economic crime, including the creation of a new Economic Crime Agency.

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