Hector Sants speech on Regulatory Reform to the City Week Conference February 2012 (12/10)

17 February 2012

Introduction

Early in February 2012 Hector Sants addressed the City Week conference on the issue of regulatory reform. His task was to provide an update on the UK regulatory reform programme and to raise awareness of the key issues on the European regulatory agenda.

Update on the regulatory reform agenda

Next major milestone the introduction of a “twin peaks” model operating from 2 April within FSA.
- Financial Conduct Authority focusing on consumer protection and market regulation.
- Prudential Regulation Authority focusing on banks, insurers and major investment firms.
The expectation is that the new structure will be in place by early 2013
Responsible bodies here are the Bank of England and the FSA
The Bank is also planning the third leg of the structure namely the Financial Policy Committee responsible for macro-prudential supervision.

Twin Peaks Supervision

there will be two independent groups of supervisors for banks, insurers and major investment firms covering prudential and conduct (all other firms (i.e. those not dual regulated) will be solely supervised by the conduct supervisors);
the supervisors will make their own, separate, set of regulatory judgements against different objectives; they will coordinate internally to maximise the exchange of information which is relevant to their individual objectives, but to be clear, they will act separately when engaging with firms. The FSA have termed this ‘independent but coordinated regulation’; and
FSA will retain the principle of seeking to ensure that regulatory data is only collected once. In other words we will retain our common, current data infrastructure.

The above principles reflect that each group of supervisors has a different objective and will act independently. Sants refers to this as “independent but co-ordinated decision making.” The objectives of the prudential group will align with those of the PRA. in seeking to ensure the safety and soundness of firms and avoid disorderly failure. Additionally it will seek to protect policy holders by ensuring that insurers have sound financial management.

The conduct group’s key objective will align with that of the FSA, in ensuring that markets work well and with integrity. This means:

Ensuring customers get a fair deal
Ensuring markets are fair and resilient
Ensuring that firms minimise the possibility of their being used for financial crime
The FCA should have greater powers in the new structure in relation to competition and the proposal to include consumer credit within its remit.

The new conduct group within the FSA will not, however, be required to take into account the new responsibilities and powers that the Bill is proposing for the FCA. The most noteworthy are the proposed greater powers for the FCA in relation to competition and the proposal to widen its scope to include consumer credit.

The key changes to the supervisory model under twin peaks

From a firm’s perspective the key operational change will be that the existing ARROW risk mitigation programme will be discontinued and any outstanding actions will be split between those relevant to the conduct supervisory groups’ objectives and those that relate to the prudential supervisory group. From 2 April onwards, the two supervisory units will run their own risk mitigation programmes and firms will have two separate sets of mitigating actions to address.

In the remaining lifetime of the FSA, however, FSA will retain the current ARROW review cycle. So if a firm is due to complete an ARROW assessment before spring 2013, it will still be subject to a supervisory review. It will, however, now consist of two supervisory teams assessing the risks against their new objectives.

Impact on Firms

Each supervisory group may ask similar questions but for different purposes. For example issues of corporate governance may be reviewed by the prudential supervisors to ensure that the risks to the firm’s stability are being well managed. The conduct supervisors on the other hand will be looking to see that the firm’s customers are being fairly treated.
The two groups of supervisors will not prioritise between prudential and conduct risk.
Sants sees the twin peaks as an opportunity that must not be missed. “We must crystallise the change from the ‘old style reactive approach’ to the ‘new style proactive approach”.
However, changes to the behaviour of supervisors alone will not be enough. If this approach is to work effectively firms will also need to change the way they think about regulation. Firms will be expected to:
recognise the importance of aligning their goals with those of the supervisors and society as a whole;
show a greater willingness to comply proactively with supervisory judgements and
recognise that this new approach will require greater resources and expertise and thus costs.

The Challenge of Europe

Engaging with the European regulatory process is central to delivering financial regulation in the UK. Increasingly the rules will be made by Europe and the roles of the PRA and FCA will be ones of supervision and enforcement. Truly effective reform of the regulatory system will thus only be achieved if Europe delivers on the implementation of the Basel III framework.

The financial crisis demonstrated that an effective single European market place requires coordinated regulation delivered to a consistent standard across Europe. The FSA therefore supports the concept behind the ESAs and the necessity of them being strong and independent organisations. The foundation for that strength and independence lies in their members, the national supervisory authorities. The role of the ESAs is to deepen the single market, raise supervisory standards and help mitigate crises through the following key tools:

exercising powers in an emergency;
developing a single rule book;
investigating breaches of EU law;
settling disagreements between supervisors;
enhancing colleges of supervisors; and
undertaking peer review.

In future the FSA’s policy function will focus on two core activities: pure policy analysis and influencing.

Sants believes that the crisis has provided the opportunity to raise standards across the European market place but if in doing so if we remove the ability of supervisors to make judgements, then we will have created a new set of risks.

The full text of the speech can be found here.

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