March 4, 2013
The Financial Services Act 2012 (the "Act"), which comes into force on 1 April 2013, contains the UK government’s reforms of the UK financial services regulatory structure and will create a new regulatory framework for the supervision and management of the UK’s banking and financial services industry. The Act gives the Bank of England macro-prudential responsibility for oversight of the financial system and day-to-day prudential supervision of financial services firms managing significant balance-sheet risk. Three new bodies will be formed under the Act: the Financial Policy Committee ("FPC"), the Prudential Regulatory Authority ("PRA") and the Financial Conduct Authority ("FCA"). While the Act mainly contains the core provisions for the UK government’s structural reforms and will therefore make extensive changes to Financial Services and Markets Act 2000 ("FSMA"), as well as to the Bank of England Act 1998 and the Banking Act 2009, it also includes freestanding provisions in Part 3 ("mutual societies"), Part 4 ("collaboration between Treasury and Bank of England, FCA or PRA"), Part 5 ("inquiries and investigations"), Part 6 ("investigation of complaints against regulators") and Part 7 ("offences relating to financial services"). With respect to the last of these, it should be noted that:
section 397 of FSMA, which relates to misleading statements, will be repealed;
three separate offences relating to financial services will be introduced, namely the offences of misleading statements, misleading impressions and statements, and misleading impressions relating to benchmarks (including, for example, LIBOR); and
new provisions relating to regulated activities connected with setting benchmarks will also be introduced.
Amendments to banking legislation (in Part 8), apart from the regulatory structure, are mainly focussed on an extension of special resolution regime to systemically important investment firms and central counterparties and the Bank of England’s stabilisation powers to apply to parent undertakings of investment firms and deposit takers.
The Act also contains a series of miscellaneous legislative changes (in Part 9), including provisions that:
will enable the UK government to transfer consumer credit regulation from the OFT to the FCA; and
ensure that fines paid by the financial services industry to regulators go to the Exchequer, rather than being used to reduce the annual levy imposed on other financial institutions as at present.
New Regulatory Structure
The Act will bring about the establishment of the FPC which will be responsible for macro-prudential regulation and charged with monitoring the stability and resilience of the UK financial system as a whole, as well as supporting the government’s economic policies and identifying, monitoring and removing or reducing systemic risks. The FPC has the power to give directions to the PRA and FCA in respect of macro-prudential matters, make recommendations to the Bank of England, PRA and FCA, and prepare financial stability reports. The FPC will be a committee of the Bank of England.
The PRA will be the micro-prudential regulatory authority responsible for ensuring effective prudential regulation of deposit takers, insurers and a small number of significant investment firms. The statutory objective of the PRA will be to promote the safety and soundness of firms. The PRA will be required to pursue this objective primarily by seeking to avoid adverse effects on financial stability and seeking to minimise adverse effects resulting from disruption to the continuity of financial services that can be caused by the way firms run their businesses or upon their failure. The PRA will be a part of the Bank of England.
The FSA will be abolished and replaced with the FCA, a new conduct of business regulator, which will be charged with the strategic objective of ensuring that relevant markets are functioning well. The strategic objective differs from the original proposed objective in the draft Financial Services Bill (the "Bill"), which was expressed as being the protection and enhancement of confidence in the UK financial system. The "relevant markets" are defined as:
the financial markets (although this term itself is not defined in the Act);
markets for regulated financial services (as defined in a new section 1(H)(2) of FSMA); and
the markets for services that are provided by unauthorised persons in carrying on regulated activities without contravening the general prohibition.
The FCA will have three operational objectives:
to secure an appropriate degree of protection for consumers (the consumer protection objective) (new section 1C, FSMA);
to protect and enhance the integrity of the UK financial system (the integrity objective) (new section 1D, FSMA); and
to promote effective competition in the interests of consumers in the markets for regulated financial services and services provided by recognised investment exchanges in carrying on certain regulated activities (the competition objective) (new section 1E, FSMA).
Matters to which the FCA must have regard when considering the consumer protection objective include factors such as the differing expectations that consumers may have in relation to different kinds of investment or other transaction.
The competition objective replaces the third objective set out in the Bill which was the promotion of efficiency and choice in the market for certain type of services (referred to then as the "efficiency and choice objective"). Following a recommendation in the Independent Commission on Banking’s final report, the UK government decided to recast the efficiency and choice objective in terms of promoting effective competition in the interests of consumers.
Separate from the competition objective, the FCA will also be obliged to discharge its general functions in a way that promotes competition in the interests of consumers (new section 1B(4), FSMA). While this general obligation was included in the Bill, the final provision in the Act includes additional wording requiring the promotion of competition in "the interests of the consumer".
The scope of the FCA’s activities will include:
Conduct of business regulation for all firms in both retail and wholesale markets. The FCA will be responsible for the conduct of business regulation of all regulated firms, including PRA-authorised firms and firms passporting into the UK.
Acting as the lead regulator for those firms currently regulated by the FSA other than PRA-authorised firms, including in respect of prudential supervision. The Act refers to these firms as FCA-authorised firms.
The FCA will inherit the FSA’s existing roles relating to markets regulation under Part XVIII of FSMA, with the exception of the FSA’s current responsibilities for settlement systems and recognised clearing houses ("RCHs") which the FSA will transfer to the Bank of England. Institutions that provide both exchange services and central counterparty clearing services will be regulated by the BoE with respect to their activities as RCHs and by the FCA as RIEs.
The FCA will inherit the FSA’s responsibilities for the regulatory oversight of client assets and countering financial crime.
The FCA will also inherit the FSA’s existing responsibilities for certain institutions operating outside the FSMA regulatory perimeter, including:
payment service providers; and
In its October 2012 Journey to the FCA paper, the FSA stated that the FCA will be the conduct supervisor for approximately 26,000 firms across all industry sectors and the prudential supervisor for approximately 23,000 firms not regulated by the PRA.
Following the September 2012 Wheatley Report into the regulation of the London Inter-Bank Offered Rate (LIBOR), the government decided to amend the Bill to bring certain activities relating to the setting of benchmarks within the regulatory scope of FSMA and these are set out in section 7 of the Act. HM Treasury intends to amend the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (SI 2001/544) (RAO) to create two new activities: "providing information in relation to a regulated benchmark" and "administering a regulated benchmark". At least initially, the only regulated benchmark in the UK will be LIBOR. As the government has decided against making these new regulated activities PRA-regulated activities, the FCA will be the lead regulator for LIBOR (and, in future, potentially other benchmarks).
The FCA will not be responsible for:
preventing all conduct or prudential failure;
handling individual complaints on financial services (this will remain the responsibility of the Financial Ombudsman Service (FOS));
acting as an economic or price regulator, such as Ofcom or other utility regulators in the sense of prescribing returns for financial products or services; however, in performing its new competition role, it will be interested in prices because prices and margins are key indicators of whether a market is competitive;
intervening in areas where it does not have a statutory responsibility; the FCA does not intend to provide kite-marking or product approval for financial services products, although it will have additional product intervention powers; or
setting social policy, which will be a matter for the government, rather than the FCA.
In addition, the FCA will take on most of the FSA’s market regulatory functions, including the FSA’s acting as the UK Listing Authority ("UKLA").
Other key amendments to the FSMA include:
as well as integrating the UKLA into the new FCA, applying the general FCA objectives to the listing regime;
extending the powers of the FCA to impose sanctions on sponsors for breaches of UKLA rules and requirements imposed on sponsors (section 18 of the Act). This will include the ability to impose financial penalties and to suspend a person’s approval as a sponsor or restrict their activities; such sanctions will be subject to the normal enforcement and appeal mechanisms in FSMA;
extending the limitation period for taking action for breaches of Part 6 of FSMA (relating to listings) from two to three years (section 20 of the Act);
giving the FCA power to regulate primary information providers ("PIPs") (organisations which channel information from issuers to the UKLA and announce information to the market) (section 19 of the Act); the Act amends the FSMA to give the UKLA powers in relation to PIPs’ continuing obligations, their supervision and to impose sanctions on them;
giving the FCA power to direct a firm to withdraw a financial promotion that the FCA considers is likely to breach its rules concerning financial promotion, subject to certain safeguards;
allowing the FCA to discontinue or suspend a listing at the request of an issuer without following the warning notice and decision notice procedure (section 17); the UK government regards the warning notice and decision notice requirements as onerous and unnecessary when the FCA is agreeing to an issuer’s request; and
giving the FCA power to disclose the fact that a warning notice has been issued in relation to proposed disciplinary action against a firm or individual.
The UK government believes that credible and effective enforcement action should remain a key focus for the FCA. It therefore expects the FCA to continue the FSA’s existing credible deterrence policy. The UK government’s view is that the existing arrangements in FSMA relating to enforcement action have worked well to date and accordingly the Act does not make significant amendments to those arrangements (other than the change relating to the publication of information about warning notices). In its October 2012 Journey to the FCA paper, the FSA confirmed that the FCA would retain the FSA’s existing Regulatory Decisions Committee ("RDC"), which makes decisions on contested enforcement and certain supervisory and authorisation matters on behalf of the FSA. The FCA will retain the FSA’s current allocation of decision making between the RDC and senior executive and any decision to change the current procedures will be a matter for the future FCA Board following a public consultation.
In a recent speech made by Tracey McDermott, the director of the FSA’s Enforcement and Financial Crime Division, Ms McDermott emphasised that the FCA will continue the FSA’s policy of credible deterrence and also stated that the approach of the FCA’s enforcement division would include the following:
Focusing increasingly on those in senior management that fail to recognise and manage their firms’ risks, that fail to control the way that products are sold and that fail to ensure that consumers’ interests are prioritised when designing products.
Working in a more integrated way with supervisors and other FCA colleagues on thematic and firm-specific work.
Using existing tools such as own initiative variations of permission (OIVoPs) more readily as well as new tools, such as product intervention powers.
Having a low tolerance for repeat offenders. The FCA will be more ready to take action against firms that fix immediate problems but do not think about the underlying causes.
As noted above, the Act also enables the transfer of Consumer Credit regulation to the FCA (further information from HM Treasury regarding this transfer can be found here).
The existing FSA Handbook will be split into two new handbooks: one for the FCA and one for the PRA. The FSA has published a number of consultation papers detailing the proposed changes related to the creation of new rulebooks for the FCA and the PRA, including:
FSA Consultation Paper CP12/37 (December 2012) which sets out proposed amendments to the regulatory requirements needed to create the new rulebooks and policies for the FCA and the PRA, including:
amendments to the Listing Rules sourcebook arising from the new statutory powers that the FCA will acquire to supervise and discipline sponsors;
amendments to the Disclosure and Transparency Rules sourcebook (DTR) regarding the approval of primary information providers, their continuing obligations and supervision;
amendments to Recognised Investment Exchanges and Recognised Clearing House sourcebook; and
amendments to Decision Procedure and Penalties Manual arising from new statutory notice powers that the FCA will acquire;
FSA Consultation Paper CP12/39 (December 2012) which sets out the PRA’s proposed approach to enforcement policy and procedure under the Financial Services and Markets Act 2000 (FSMA);
FSA Consultation Paper CP13/3 (January 2013) which sets out general transitional provisions to facilitate the transition from the FSA Handbook to the new FCA Handbook; and
FSA Consultation Paper CP13/6 (February 2013) which sets out proposed amendments to certain provisions of the existing FSA Enforcement Guide.
It is intended that the proposed amendments set out in the consultation papers above will take effect on 1 April 2013.
Orders Implementing the Act
The Act will take effect on 1 April 2013 and be implemented through secondary legislation. To date, the following statutory instruments related to the Act have been released:
The Financial Services Act 2012 (Transitional Provisions) (Rules and Miscellaneous Provisions) Order 2013 (made 29 January 2013), which sets out certain transition provisions facilitating the coming into force of the Act; and
The Financial Services Act 2012 (Commencement No. 1) Order 2013 (made 23 January 2013), which is the first commencement order bringing into force certain provisions of the Act.
The most interesting changes brought about by the UK government’s reforms of the UK financial services regulatory structure pursuant to the Act are those related to the FCA. Its creation is seen to be an opportunity to reset conduct standards of the financial services industry which have been under a spotlight since the beginning of the 2008 financial crisis. There seems to be a focus on requiring firms, from the boardroom to the point of sale and beyond, to put the well-being of their customers at the heart of how they run their businesses and to promote behaviour, attitudes and motivations about good conduct above anything else. The new powers the FCA has, such as banning financial products, publishing details of misleading financial promotions and publishing information about taking disciplinary actions, are expected to enable to the FCA to step in earlier, and act faster, when problems are identified that risk harming consumers or markets. Although the vision and ambition of these reforms is clear, it remains to be seen how the new regulators, and in particular the FCA (with its new enforcement powers), will in practice approach regulation of the UK’s banking and financial services industry once the Act and its new regulatory structure is in force.
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