It is now a full year since the Financial Services Authority was abolished and its responsibilities split between two new UK regulators - the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA).
The new “twin peaks” system, under which banks and insurers are subject to supervision by both the PRA for prudential issues, and the FCA for conduct risks, has now bedded in and firms subject to dual regulation have begun to get to grips with what to expect from each regulator.
Integrated within the Bank of England, the PRA aims to have an in-depth understanding of the banks and insurers that it oversees, challenging firms on their business strategy, risk appetite, risk management framework and governance processes as well as ensuring that the firm has adequate capital and liquidity resources.
The FCA has also committed to a new approach to regulation, aiming to adopt a more proactive system under which risks are identified and managed at an early stage rather than allowed to develop into significant problems. The core focus has moved away from the FSA’s historical approach of targeting customer-facing activities, to challenging product providers on how they design and reassess their products, to seek to ensure that consumers are buying products that closely match their needs.
Both the PRA and the FCA have promised to adopt a more judgement-based, forward-looking approach to regulation, second-guessing decisions of management and taking a more interventionist role in how firms are being run. They accept that the extent to which they are able to achieve this depends in large part on having the right calibre of staff engaged in supervision activities.
Another key uncertainty when the new system was launched a year ago was how the PRA and FCA would interact with each other – would the regime operate seamlessly or would there be a large amount of overlap (or underlap) between the areas of activity of the two new bodies?
To assess how the new regulators are performing in this new role, and how the PRA and FCA could perform better in the future, we canvassed opinions from general counsels, heads of compliance and senior management at many of the largest financial institutions. Our sincere thanks to all of you who participated in the survey. The range of institutions represented by the respondents is indicated in the chart below.
Figure 1: Responses by Sector
What you've told us
We set out below the views expressed in the survey. Perhaps the most noticeable theme emerging was the disparity of experience between those in the banking sector (who felt that the regulators had a good understanding of their businesses and the risks faced) and those in the insurance sector.
Regulators’ relatively poor understanding of the insurance industry
Most respondents consider that their PRA and FCA supervisors have an adequate or good level of understanding of their businesses. However, a minority are very unhappy with their supervisors’ level of understanding of their firm. This criticism was not entirely sector-specific, but the majority of criticism in this area came from insurers. This suggests to us that the regulators may not yet be as familiar with the insurance markets as they are with some of the other markets they regulate.
Most respondents consider that the regulators are focusing on the right areas in their supervisory approach, although there is some concern (again, from the insurance sector) that the FCA needs to think through the longer-term implications of its approach for consumers before deciding upon costly interventions in the markets.
The majority of respondents feel that they are being treated fairly by their regulatory supervisors. Those who don’t are almost all insurers or insurance intermediaries. We wonder, therefore, whether the shortfall in sector-specific knowledge that our insurance sector respondents have highlighted is introducing an unnecessary level of tension into the regulatory process for insurers.
I was seconded to the FSA shortly after it took over responsibility for general insurance in 2005. Whilst a lot has obviously changed at the regulator since then, I sense that there is still an element of the ‘dreaming spires’ in the regulators’ perception of the insurance industry – it’s seen as remote, inaccessible and a little bit stuck in the past. I think that’s unfortunate, and I feel it contributes to the increased level of enforcement activity that we are currently witnessing. More needs to be done to get insurance companies and their regulators onto the same page, to make the supervisory relationship more fruitful.
--- Polly James, Senior Associate, Financial Services Investigations
Attestations and skilled person reviews
As we expected, a number of respondents had seen requests from the regulators for attestations within the past year. Subjects covered included conflicts of interest; sales of derivatives products; completion of tasks agreed in relation to a Risk Mitigation Programme or Skilled Person Review; product governance; client money processes; and Solvency II implementation.
We are seeing the regulators use the attestation tool increasingly frequently. They are making no secret of their motivation in doing so – this is clearly meant to be a tool for enforcing personal accountability further down the line. Individuals need to take great care when signing a regulatory attestation. The personal consequences of signing an attestation which turns out to be wrong are potentially very significant.
--- Sidney Myers, Partner, Head of Financial Services
A significant number of respondents told us that delivering “judgement-based supervision” is proving challenging for the regulators. They pointed to a wide variation in the quality and experience levels of supervision staff, with some supervisors much more willing than others to move away from process concerns and make a judgement call.
This concern is borne out by the recent National Audit Office report on dual regulation, which remarked that “supervisors now spend considerable time writing papers for senior staff exercising judgements and some have become demotivated because they do not have individual decision-making responsibility”.
Clearly, the new ‘judgement-based’ regulatory approach will take a while to bed down, but in the meantime it seems clear that the regulators need to do more to reinforce their internal messaging and achieve more consistency in their supervisors’ approach.
We continue to hear concerns from our clients that the supervisors they are dealing with at the PRA and FCA do not have enough hands-on experience in the relevant markets to enable them to understand the key risks, and therefore to reach proper judgements on the best way forward. Both regulators need to continue to recruit from industry at a senior level to ensure they are properly equipped to do their jobs in a constructive and positive manner.
--- Jacob Ghanty, Partner, Funds and Financial Services
Co-ordination between the PRA and FCA
Another key concern was about the lack of communication between the PRA and FCA, both in terms of co-ordinating their information requests and sharing between them their existing knowledge of your firms.
Again, these survey responses chime with the findings of the National Audit Office report, which pointed to uncertainty within the PRA as to what data is allowed to be shared with the FCA, and when.
This is clearly adding to firms’ already significant regulatory burden. Whilst recognising that the PRA and FCA have different roles to play and cannot be expected to liaise with each other in relation to every matter, there is clearly more that can be done to increase information sharing and co-ordination between the two regulators and to reduce the need for duplicative work by firms.
Although we all anticipated that banks and insurers would be subject to a greater regulatory burden in having to deal with two regulators rather than one, the approach of the PRA and FCA in defining the scope of their own responsibilities has been disappointing. In particular we are seeing the FCA taking an extremely wide view of its own remit, which goes well beyond what Parliament envisaged when it created the twin peaks structure. Frequently the FCA is challenging dual regulated firms on core prudential issues, which are more properly the domain of the PRA. Similarly, the FCA has adopted a broad view of its jurisdiction in relation to conduct issues outside the UK where dual regulated firms operate through branches in the EEA. In the future a clearer demarcation of responsibilities on the part of each regulator would be helpful for all concerned.
---Nathan Willmott, Partner, Financial Services Investigations, Head of Commercial Dispute Resolution
We will be discussing these views of the industry with each of the PRA and the FCA. We are keen to represent the interests of the regulated community in pressing for improvement in the standard of regulation in the UK markets: this is your chance to make a confidential contribution to this effort, so do get in contact if there are additional points that you would like us to convey.