by:Investment Management and Private Investment Funds Practices
The Financial Conduct Authority and the Prudential Regulation Authority begin work as the two new regulators in the wake of the long-heralded abolition of the Financial Services Authority.
On 1 April, as the Financial Services Act 2012 (the 2012 Act) came into force, the UK coalition government delivered on its 2010 promise to dismantle the prevailing tripartite architecture responsible for financial stability in the UK, due to its failure during the 2007/2008 financial crisis, with the Financial Services Authority (FSA) bearing the brunt of the blame and being abolished. The tripartite architecture comprised HM Treasury, the Bank of England, and FSA. In its place, the 2012 Act establishes a new financial regulation architecture with separate regulators responsible for macro-prudential regulation generally, micro-prudential regulation of systemically important authorised firms, and conduct regulation of all authorised firms.
The 2012 Act contains the core provisions for the government's structural reforms. The original bill was published on 27 January 2012 and, after parliamentary scrutiny, received Royal Assent on 19 December 2012. The 2012 Act largely amends existing legislation, making extensive changes to the Financial Services and Markets Act 2000 (FSMA), as well as to the Bank of England Act 1998 and the Banking Act 2009. It is worth noting that the 2012 Act did not repeal FSMA. The government decided to amend FSMA, rather than repeal, redraft, and reenact it, to minimise the impact.
The focus of this LawFlash is the new UK financial regulation architecture. A summary of the other significant changes to financial services regulation wrought by the 2012 Act appears below. We will issue further guidance on certain areas of change under the 2012 Act, with particular focus on those affecting corporate and finance practitioners.
The new architecture is structured as follows:
- The Financial Conduct Authority (FCA) has inherited the majority of FSA's former roles and functions and will be responsible for the conduct regulation of all authorised firms and the micro‑prudential regulation of all firms that are not systemically important firms.
- The Prudential Regulation Authority (PRA), a subsidiary of the Bank of England, will be responsible for the micro-prudential regulation of systemically important authorised firms.
- The Financial Policy Committee (FPC), a committee of the Bank of England, will be responsible for assisting the Bank of England in achieving its financial stability objective and will be given powers of recommendation and direction over FCA and PRA to address systemic risks.
- The Bank of England will have overall responsibility for financial stability, be the regulator of recognised clearing houses, and have the power to direct a UK clearing house in certain circumstances.
Firms regulated only by FCA will number approximately 23,000 and will include independent financial advisers, investment managers, most investment firms, insurance brokers, mortgage brokers, other brokers, non-deposit-taking lenders, corporate financiers, wholesale firms, custodians, professional firms, investment exchanges, collective investment schemes, managing agents, and others.
A relatively small number of firms will be required to be dual-regulated by FCA and PRA—an outcome that has been dubbed "twin peaks regulation". Dual-regulated firms will number approximately 1,700 and will include banks, building societies, investment banks, credit unions, friendly societies, life insurers, general insurers, wholesale insurers, commercial insurers and reinsurers, Lloyd's and Lloyd's Agents, and a small number of "significant" investment firms.
FCA will have a single strategic objective to ensure that markets for financial services work well and three operational objectives: (i) to secure an appropriate degree of protection for consumers, an objective that was not conferred on FSA; (ii) to protect and enhance the integrity of the UK financial system; and (iii) to promote effective competition in the consumer interest.
FCA will be responsible for the regulation of standards of conduct in retail and wholesale markets, supervision of trading infrastructures that support these markets, and prudential supervision of firms that are not PRA regulated. FCA will also undertake the function of the UK listing authority under Part 6 of FSMA, a role previously undertaken by FSA.
Under FCA, supervision will be more judgement based, starting at the firm's business model and strategy and leading to early intervention on the basis of conduct risk assessment rather than crystallised issues assessment. The 2012 Act equips FCA with a range of new powers that FSA did not possess and that will enhance its intervention and enforcement capabilities and, potentially, its reputation as a conduct regulator. These new powers include the authority to do the following:
- Ban investment products, subject to a consultation process.
- Where prompt intervention is required, ban investment products that pose unacceptable risks to consumers for up to 12 months, without consultation.
- Remove misleading financial promotions immediately from the market, without resort to any formal enforcement process.
FCA is also empowered for the first time to do the following:
- Announce publicly that it is taking disciplinary action against a firm or individual.
- Regulate and sanction investment exchanges, sponsors, and primary information providers.
- Exercise a power of direction in relation to certain unregulated "qualifying parent undertakings" that are the parent entities of UK-regulated firms. A power of direction is a rulemaking power for information gathering and supports enforcement powers to fine or censure for breach. A "qualifying parent undertaking" must be the parent of a UK dual-regulated person or investment firm, must be incorporated in the UK or have a UK place of business, must not be an authorised person, and must be a prescribed financial institution. In relation to parents of authorised persons, the prescribed financial institutions are insurance holding companies, financial holding companies, and mixed financial holding companies.
- Take over responsibility for the regulation of consumer credit in April 2014 from the Office of Fair Trading (OFT).
FCA will sort its constituency of authorised firms into four conduct supervision categories, based on risks posed to customers and the market, broadly as follows:
- C1 banking and insurance groups with very large numbers of retail customers and universal/investment banks with very large client assets and/or trading operations. For C1 firms, proactive supervision by FCA will be on a one-year cycle.
- C2 firms across all sectors with substantial numbers of retail customers and/or large wholesale firms. Proactive supervision by FCA will be on a two-year cycle.
- C3 firms across all sectors with retail customers and/or significant wholesale presences. C3 firms will be assessed by FCA on a four-year cycle and subject to interim reviews by FCA where information indicates that the risk they represent is significantly changing.
- C4 smaller firms, including almost all intermediaries. C4 firms will be subject to a "touch point" by FCA once every four years.
C1 and C2 firms will have a nominated supervisor within FCA. C3 and C4 firms will not have a nominated supervisor but will be supervised by an FCA team of sector specialists.
In relation to FCA-only firms where FCA will be the prudential regulator as well as the conduct regulator, FCA will deploy the following four prudential supervision categories, based upon the impact a firm would have on the financial markets should it fail:
- P1 (prudentially critical)
- P2 (prudentially significant)
- P3 (prudentially insignificant)
- P4 (firms requiring a differentiated approach, e.g., a firm in administration or insolvency)
There is no necessary correlation between conduct and prudential categories.
FCA will have 2,848 staff members in place for 2013–2014 and require total funding of £432.1 million by its constituency of authorised firms. In contrast, FSA employed roughly 4,000 staff members in 2012–2013, and its budget for that period was £578 million.
PRA will have two objectives: (i) to promote the safety and soundness of all the firms it regulates, focusing primarily on the harm firms can cause to the stability of the UK financial system and, (ii) specifically for insurers, to contribute to securing an appropriate degree of protection for those who are, or may become, policy holders. PRA will be responsible for the authorisation of banks, building societies, insurers, and certain "significant" investment firms in conjunction with FCA and will itself be responsible for the prudential regulation of the same, with FCA being responsible for conduct regulation. PRA's powers have not changed significantly from FSA's. PRA will sort all deposit takers, investment firms, and insurers it supervises into the following five categories:
- Category 1 for the most significant firms with capacity to cause very significant disruption to the UK financial system or, in the case of insurers, the interests of a substantial number of policyholders
- Category 2 for significant firms with capacity to cause some such disruption
- Category 3 for firms with capacity to cause minor such disruption
- Category 4 for firms with very little capacity individually to cause any such disruption
- Category 5 for firms with almost no capacity individually to cause any such disruption
PRA will make forward-looking judgments on the risks posed by firms to its statutory objectives, aiming to identify and respond to emerging risks at an early stage. Those institutions and issues that pose the greatest risk to the stability of the financial system will be the focus of its work. PRA, as supervisor, will conduct its assessment work on a continuous cycle, and its focus on the key risks means that its supervisory activity will depend on a firm's particular circumstances. It will take into account how close a firm is to failing when considering supervisory actions, and its judgment about a firm's proximity to failure will be captured in that firm's position within PRA's Proactive Intervention Framework (PIF).
Broadly, there will be the following five PIF stages:
- Stage 1: Low risk to viability of the firm
- Stage 2: Moderate risk to viability of the firm
- Stage 3: Risk to viability of the firm absent action by it
- Stage 4: Imminent risk to viability of the firm
- Stage 5: Firm in resolution or being actively wound up
Every firm's PIF stage will be reviewed at least annually and in response to relevant, material events.
PRA has yet to announce its budget, but it will be funded by its constituency of systemically important firms, which will also be funding FCA. PRA will have around 1,300 staff members.
To view a diagram depicting the roles of the Bank of England, FPC, FCA, and PRA in the new UK regulatory architecture, visit page five of the HM Treasury's February 2011 "A new approach to financial regulation: building a stronger system," available here.
On 1 April 2013, the former FSA Handbook of Rules and Guidance was split between FCA and PRA to form two new handbooks, one for FCA and one for PRA. Most provisions in the FSA Handbook have been incorporated into the FCA Handbook, the PRA Handbook, or both, consistent with each new regulator's set of responsibilities and objectives. Publication of the new handbooks commenced in March, and changes to the FCA and the PRA Handbooks will continue to be made by instruments, which will be published online.
The following can be accessed online:
- The FCA Handbook, displaying conduct provisions that apply to all regulated firms and the provisions that apply to firms prudentially regulated by FCA.
- The PRA Handbook, displaying provisions that apply to firms prudentially regulated by PRA.
- A clearly labelled combined version, displaying the provisions of both handbooks.
Regulatory Status Disclosure
An FCA-only firm's statutory status disclosure can now read "Authorised and regulated by the Financial Conduct Authority". A dual-regulated firm's statutory status disclosure can now read "Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority". Firms have a 12-month transitional period to make the necessary changes to relevant business stationery, websites, and electronic communications.
Use of the FCA Logo
Hitherto, firms had the option of using the FSA logo under a general licence to assist with their statutory status disclosure obligations. This general licence has now been removed. FCA may grant an individual licence to a firm or its representatives for the use of the FCA logo. Firms must not use the FCA logo in any communication with a client. Use of the "old" FSA logo is subject to the 12-month transitional period.
Provided below is a list of answers to a range of practical queries that have arisen frequently in response to the reforms.
- Firms and individuals already regulated by FSA were automatically transferred to the appropriate regulator on 1 April 2013.
- Firm reference numbers and individual reference numbers remain the same.
- Gabriel and Online Notifications and Applications System (ONA)—FSA's online systems for reporting, applications, and notifications—will continue to be used.
- FCA and PRA will not have separate registers of their authorised firms. There will be one register maintained by FCA.
- Change-in-control applications for firms regulated by FCA only will be assessed by FCA.
- Change-in-control applications for dual-regulated firms will be assessed by PRA.
- Non-UK European Economic Area (EEA) firms wishing to passport into the UK must notify FCA.
- FCA will be responsible for client money and asset regulation for all firms it regulates, including dual-regulated firms.
- FCA and PRA will maintain the existing regime of regulatory returns.
- Dual-regulated firms can expect assessments from both FCA and PRA separately and at different times, with each regulator pursuing its own mandate.
- The new regulators have their own new websites. The following are some useful links and information:
Summary of Other Changes
Although the majority of the 2012 Act's provisions concern amendments to other primary legislation, the 2012 Act does include freestanding provisions on mutual societies; collaboration between the HM Treasury and the Bank of England, FCA, or PRA; inquiries and investigations; investigation of complaints against regulators; and offences related to financial services.
The government also deployed the 2012 Act to make significant other changes, including the following:
- Implementing the recommendations of the recent Wheatley review of the London Inter-Bank Offered Rate (LIBOR), in which regard the 2012 Act achieved the following:
- Repealed section 397 of FSMA (misleading statements).
- Restructured and extended the scope of the law relating to market manipulation.
- Introduced new provisions relating to regulated activities requiring authorisation connected with setting benchmarks.
- Ensuring that fines paid by the financial services industry to regulators go to the UK Exchequer, rather than being used to reduce the annual levy imposed on other financial institutions.
- Extending the scope of the special resolution regime (SRR) to apply it to systemically important investment firms and central counterparties.
If you have any questions or would like more information on the issues discussed in this LawFlash, please contact the following Morgan Lewis lawyer:
. For more information, view our 11 March 2013 LawFlash, "UK Financial Services Authority Releases Draft Handbooks for New Regulators", available here, and our 14 June 2012 LawFlash, "UK Financial Services Regulatory Structure Facing Major Reforms", available here.