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Reorganising the Regulation of Financial Services in the UK: The Financial Services Act 2012

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On 1 April 2013 new legislation comes into force that will radically change the regulation of financial services within the UK. These changes will be made by the Financial Services Act 2012 (“Act”), which will abolish the FSA, replacing it with the Prudential Regulation Authority and the Financial Conduct Authority. The existing functions of the FSA, as well as some additional powers, will be separated out across this ‘Twin Peaks’ system.

While these new regulatory bodies will interact with individual firms on a practical level, a third body, the Financial Policy Committee (a statutory committee of the Bank of England), will seek to identify and monitor systemic risk across the UK financial system.

The following provides a brief explanation of the roles of the PRA and the FCA and considers some issues to which the changes may give rise.

Prudential Regulation Authority (PRA)

The PRA will be a subsidiary of the Bank of England and the Governor of the Bank will chair its Board. It will be the ‘prudential’ regulator for banks, building societies, credit unions, insurers (including Lloyd’s of London) and certain investment firms which would pose a significant risk to the stability of the UK financial system were they to fail. The PRA-Regulated Activities Order details the conditions and criteria that must be satisfied in order for the PRA to subject an investment firm to its prudential regulation.

In the words of the Managing Director of the FSA’s ‘shadow’ Prudential Business Unit:

“The PRA will have two statutory objectives:

  • To promote the safety and soundness of firms; and
  • Specific to insurers, to contribute to securing an appropriate degree of protection for policyholders.

The PRA’s approach to supervision will be clearly based on judgment rather than narrowly rules-based. Supervisory judgments will be forward-looking, taking into account a wide range of possible risks to the PRA’s objectives”.

The PRA will have supervisory, disciplinary and enforcement powers. As explained below, PRA-authorised firms will be subject to dual regulation in that the FCA will be responsible for the regulation of their conduct of business.

Financial Conduct Authority (FCA)

The FCA will be the conduct regulator of all firms. It will also act as prudential regulator for non-PRA regulated firms (known as FCA-authorised or FCA-only firms).

The operational objectives of the FCA will be to protect consumers, protect and enhance the integrity of the UK financial system and promote effective competition.

In order to meet these objectives, the FCA will be given a number of additional powers, which were not covered by the FSA under the old structure. These include:

  • To make temporary product intervention rules (including the power to block an imminent product launch or to stop an existing product);
  • To require firms to withdraw or amend misleading financial promotions;
  • To publish details of disciplinary actions related to rule breaches or compliance failings (a power also to be held by the PRA); and
  • To impose a requirement upon certain unregulated parent undertakings that exert influence over authorised persons (a power also to be held by the PRA).

These changes are focused on advancing the well-being of consumers and promoting good behaviour, attitudes and motivations in business practice.

The FCA will also inherit many of the FSA’s current responsibilities, including:

  • Market regulatory functions;
  • Enforcement of rules and imposing sanctions for breaches of them;
  • Regulatory oversight of client assets and countering financial crime;
  • Acting as the UK Listing Authority;
  • Responsibility for e-money firms, payment service providers and mutual societies.

Practical issues on transition

In order to smooth the transition upon ‘legal cutover’ on 1 April 2013, the FSA has, for some time, been operating a ‘Twin Peaks’ structure.

In the long term, the FCA and PRA will adopt new separate handbooks, but for the being they will split the relevant parts of the existing FSA handbook between them.

There will be a single register, maintained by the FCA, which will reflect the position of both the PRA and the FCA.

The FSA has stated that those firms which are already regulated by the FSA will be ‘grandfathered’ into the new regime, i.e. will not need to re-apply to the FCA or the PRA for re-authorisation.

Redress when things go wrong

In recent years, the FSA enforcement section has added “bite” to its “bark” and one might expect the FCA to maintain that approach. Indeed, the changes give it more teeth to pursue rigorous enforcement action.

Where losses are suffered as a result of, for instance, misselling:

  • Consumers may still complain to the Financial Ombudsman Service (“FOS”) and request compensation, albeit that the FOS is, in some quarters, seen as under-resourced and in need of substantial change;
  • Breaches of the FSA (soon to be FCA) principles and conduct of business rules may be evidence of negligence in a court action brought by an investor or other party for negligence or other breach of duty;
  • The section of the Financial Services and Markets Act 2000 which gives private persons the right to bring court actions to recover losses resulting from contraventions of FSA rules (section 150), will be replaced by a new provision (section 138D) which, essentially, restates that right with regard to FCA rules. As to contraventions of PRA rules, power is given to the PRA to make provision within its rules for contraventions of them to be actionable by private persons who suffer loss.

Whether those rights to bring court actions will remain of any practical use to consumers is placed in doubt by other legislative changes that also come into effect on 1 April 2013, namely to the costs regime in litigation in England and Wales (featured in recent issues of this newsletter and still available to read on the GD website). One ‘school of thought’ is that those changes are likely to make it difficult or impossible for ordinary people who have suffered loss as a result the advice or actions of banks, insurers, financial advisers and the like, to pursue court actions for sums of less than about £200,000. Only time will tell.

Is the “Twin Peaks” structure prudent (or indeed ‘prudential’)?

Arguably, there are currently “Three Peaks”: the FSA, the Bank of England and the Treasury. That division has been said to have been a significant factor in the failure to foresee and forestall the near-meltdown of the UK banking and financial system (with the UK being only hours away from the present Cypriot situation, in which the public cannot extract its money from cash machines).

The 1 April 2013 changes keep that “Three Peaks” division, with:

  • The FCA being the FSA under a changed name, with some powers added; and
  • Responsibility for the ‘prudential’ regulation of more significant ‘players’ being transferred from the FSA to the Bank of England’s new PRA subsidiary.

A cynical view is that the term “Two Peaks” is used so that the Treasury can stand on its peak and blame those on the other peaks if it should all go horribly wrong again.

Focussing, however, on the “Twin Peaks”:

  • The return to the Bank of England, ‘trading as’ the PRA, of supervisory and regulatory powers over banks, as well as other financial ‘big fish’, may be seen by many in the City as a welcome move;
  • On the other hand, to subject PRA-authorised firms to conduct of business regulation by the FCA and thereby giving rise to the potential additional costs and confusion of dual regulation, might be thought to be an inherently flawed arrangement. Again, only time will tell.

The FSA has stated the following as to how the PRA and FCA will work together:

“The draft Memorandum of Understanding (MoU) between the FCA and the PRA sets out a high level framework for how the two regulators will work together within the new regulatory system provided for by the Act. It will be vital that the two authorities pursue their own mandates, respecting the UK’s Twin Peaks supervisory system. But it will also be essential that they coordinate activities in some areas, and cooperate in others. The MoU sets out these arrangements to help ensure they are effective and efficient”.

That may set some minds at rest. Others may think that ‘Sir Humphrey’ would have regarded it as a model of governmental reassurance.

This article was written by Jonathan Haydn-Williams, Senior Counsel, with assistance from Emily Kozien-Colyer and Chris Smith.

This guide is for general information and interest only and should not be relied upon as providing specific legal advice. If you require any further information about the issues raised in this article please contact the author or call 020 7404 0606 and ask for your usual Goodman Derrick contact.