FSA: Regulatory Reform.

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1 FSA: Regulatory Reform.

2 FSA: Regulatory Reform Introduction Largely as a result of the FSA s failing performance during the financial crisis in 2008, it was announced in June 2010 that the FSA would be abolished in its current form and that three new regulatory bodies would be established with effect from 1 April 2013: (i) the Financial Policy Committee (FPC); (ii) the Prudential Regulation Authority (PRA); and (iii) the Financial Conduct Authority (FCA). The PRA and the FCA will inherit the majority of the existing functions carried out by the FSA, with the result that the FSA Handbook will be split between the PRA and FCA to form two new Handbooks, one for the PRA and one for the FCA. Financial Policy Committee (FPC) The FPC will be a committee of the Bank of England (BoE) and will monitor the financial system as a whole. It will be responsible for macro-prudential regulation and will focus on identifying and managing macroeconomic and other risks to the stability of the financial services sector as a whole or to a significant part of the sector. It will respond to any such issues which arise by directing the PRA (and the FCA where appropriate) to take necessary action, which may include the use of new macro-prudential tools. The FPC will not have direct regulatory responsibility for any particular type of firm. Prudential Regulation Authority (PRA) The PRA, which will be a subsidiary of the Bank of England, will be responsible for the micro-prudential regulation and supervision of systemically important firms i.e. banks, building societies, insurers, credit unions and certain investment firms with systemic importance. These firms are commonly known as dualregulated firms, as they will also be regulated by the FCA for conduct purposes. The general objective of the PRA is to promote the safety and soundness of regulated firms. Financial Conduct Authority (FCA) The FCA will adopt the legal corporate identity of the FSA and will inherit most of the roles and functions of the FSA. It will responsible for: (i) the conduct of business regulation of all firms, including dual-regulated firms; (ii) the prudential regulation of firms not regulated by the PRA (i.e. FCA-authorised or FCA-only firms); and (iii) it will inherit the majority of the FSA s market regulatory functions, including the role of the UK listing authority (although responsibility for settlement systems and recognised clearing houses will be transferred to the BoE). The strategic objective of the FCA is to ensure that relevant markets function well, while its three operational objectives are to protect consumers, to protect the integrity of the UK financial system and to promote effective competition in the interests of consumers. The FCA will be the prudential and conduct regulator for all other firms currently regulated by the FSA, which will generally include fund managers. It will be independent from the BoE. The regulatory principles of the PRA and FCA The FCA and PRA will have a shared set of eight regulatory principles which the regulators must take into account when exercising their regulatory functions in pursuit of their objectives, as follows:

3 Principle 1 (the efficiency principle): the need to use the resources of each regulator in the most efficient and economic way. Principle 2 (the proportionality principle): the imposition of a burden or restriction should be proportionate to the benefits. Principle 3 (the sustainable growth principle): the desirability of sustainable growth in the economy of the UK in the medium or long term. Principle 4 (the consumer responsibility principle): the general principle that consumers should take responsibility for their decisions. Principle 5 (the responsibilities of senior management principle: the responsibilities of the senior management in relation to compliance with those requirements. Principle 6 (the recognition of business differences principle): each regulator should recognise differences in the nature of, and objectives of, businesses carried on by different persons. Principle 7 (the openness and disclosure principle): publishing information, or requiring persons to publish information, as a means of contributing to the advancement by each regulator of its objectives. Principle 8 (the transparency principle): the regulators should exercise their functions as transparently as possible, as well as be more open and accessible to both the regulated community and the general public. These principles are not intended to impose burdens or requirements on firms or consumers, but are matters which the regulators much have regard to when exercising their general functions. Co-ordination between the FCA and PRA The decision to split the majority of the FSA s current functions between the FCA and PRA will require the two regulatory bodies to coordinate their activities closely and they have a statutory duty to do so, including where one of the regulators is considering action which may have an adverse material affect on the other s achievement of its objectives or in connection with the exercise of their functions under FSMA. The FCA and PRA must agree and publish a memorandum of understanding on how they will deliver their statutory duty to co-operate and this MoU has to be reviewed annually. Further, each of the chief executives of the FCA and PRA will sit on the other regulator s board, although they will not be able to vote on firm-specific issues, and there will be a general obligation to share information with each other and arrangements must be put in place for regulatory data collection under the memorandum of understanding to avoid duplication. It is envisaged that the FCA and PRA will also need to co-operate with the BoE more generally on certain issues, such as the gathering and sharing of information. New FCA interventionist approach Important philosophical changes will be embedded in the FCA s supervisory model, which will include moving away from the FSA s retail conduct philosophy and going beyond the buyer beware principle to ensure integrity of the wholesale markets, the five main elements of which are as follows: (i) being more forward-looking in its assessment of potential problems; (ii) earlier intervention when it sees problems; (iii) attacking the underlying causes of problems, not just the symptoms; (iv) securing redress for consumers if failures do occur; and (v) taking meaningful action against firms that fail to meet FCA standards through fines. It will also adopt a pre-emptive approach to supervision which will be based on making forward-looking judgements about firms business models, product strategy and how they run their businesses, to enable the FCA

4 to identify and intervene earlier to prevent problems crystallising and to be robust when things do go wrong. The FCA also intends to address the root causes of problems by seeking to obtain a deeper understanding of underlying commercial and behavioural drivers and the causes of poor outcomes for consumers. With regard to regulation, the FCA will take a risk-based approach, which means the FCA will make decisions and take action based on the risks to the FCA in meeting its objectives. The FCA will not seek to, or be able to, prevent or control everything that causes harm to consumers or financial markets. The FCA also intends to take a more assertive and interventionist approach to risks caused by wholesale activities and, if necessary, will act to protect a wider range of client relationships than the FSA does at present. Its wholesale role will also apply to exchangeoperated markets and over-the-counter (OTC) dealing. New FCA powers As part of its new interventionist approach, the FCA will be given a number of powers additional to those currently held by the FSA, including powers to: (i) make temporary product intervention rules, allowing it to block an imminent product launch or to stop an existing product; (ii) require firms to withdraw or amend misleading financial promotions; (iii) impose requirements on certain unregulated parent undertakings which exert influence over authorised persons; and (iv) publish details of the start of enforcement proceedings against a firm for rule breaches or compliance failings (although the PRA will also have this power). The FCA will also have additional powers to enhance its operational objective to promote competition. Categorisation Conduct supervision categorisation The FCA will categorise all regulated firms into four categories for their conduct supervision: C1, C2, C3 and C4, with C1 firms subject to the most intensive supervision and C4 firms the least. The following firms are likely to fall within each category: (i) C1 firms: Banking and insurance groups with a very large number of retail customers and universal/investment banks with very large client assets and trading operations. (ii) C2 firms: Firms across all sectors with a substantial number of retail customers and/ or large wholesale firms. (iii) C3 firms: Firms across all sectors with retail customers and/or a significant wholesale presence. (iv) C4 firms: Smaller firms, including almost all intermediaries. (v) The vast majority of firms will be categorised as C3 or C4 and the FCA s approach will be similar to the FSA s current approach to small firms, as they will be supervised by a team of sector specialists. The FSA will contact firms in early 2013 to let them know how they will be categorised by the FCA. Prudential supervision categorisation The FCA will categorise all the firms for which it has prudential responsibility into three categories: CP1, CP2 and CP3, with CP1 firms subject to the most intensive prudential supervision and CP3 firms the least. The categories can be described as follows: (i) Prudentially critical firms (CP1): firms where a disorderly failure would have a significant impact on the market in which they operate. This might be the case because a particular market is highly concentrated or where there are significant client assets and money holdings. The FCA will work closely with these firms to reduce the probability of their failure.

5 (ii) Prudentially significant firms (CP2): firms where a disorderly failure would have a significant impact on the functioning of the market in which they operate, but there is a smaller client asset and money base or an orderly wind-down can be achieved. (iii) Prudentially insignificant firms (CP3): firms where failure, even if disorderly, is unlikely to have significant impact. The FCA s approach to prudential supervision will be based on managing failures when they happen, rather than on reducing their probability, on the basis that the a failure of an FCA-authorised firm (other than a CP1 firm) will usually not present a risk to the integrity of the financial system. New FCA and PRA Handbooks The FCA and PRA will each have a separate handbook of rules and the FCA will also have its own guidance. In the short term, both the FCA and PRA will adopt relevant parts of the FSA Handbook, with some parts being shared between them, and only minimal changes will be made to the current rules where necessary to reflect the new regulatory structure. Both regulators have stated, however, that they intend to review their handbooks once they are formally established. FCA Register The FCA will maintain a single register, the equivalent of the current FSA register, which will cover all FCA-authorised firms and dual-regulated firms, as well as approved persons, and Current details on the FSA Register will be carried across to the new FCA Register after legal cutover. The FCA Register will not include details of recognised clearing houses, as these will be regulated by the BoE, as mentioned above. The PRA will be required to provide information to the FCA to assist it in its obligations to maintain the register FCA online systems The FCA will continue to use the existing FSA systems, such as GABRIEL and ONA, and the way in which they are used will not change and the home pages for the FSA online systems will move to the FCA website with links also available on the PRA website. Firm reference numbers, individual reference numbers and user logins will stay the same and no systems are being replaced. The contact centre telephone number for firms will also remain the same. From 1 April 2013 most FSA systems will be updated to show the new FCA and PRA logos and branding. Impact on FSA-authorised firms The FSA will remain the UK regulator until the legislation is implemented on legal cutover, namely 1 April In its consultation paper CP13/3, published in January 2013, the FSA indicated that it was working on the assumption that existing Part IV permissions, controlled functions, rule waivers and modifications, passports, limitations and requirements would be grandfathered to the new regulator(s), which means that firms will not need to re-apply to the FCA or the PRA for their existing authorisations and regulatory approvals. According to CP13/3: (i) actions taken before legal cutover by firms, or other persons to whom the FSA rules apply, will remain effective after the FCA and PRA Handbooks come into force. Thus, if either Handbook requires a firm to submit a report that was submitted to the FSA before legal cutover, it will be treated as if it had been submitted to the new regulator; (ii) for FCA-only firms, existing approvals will be carried forward to the FCA and will be deemed to have been given by the FCA; and (iii) for dual-regulated firms, existing CF2s (non-executive directors) will be deemed to have been approved by the FCA. All

6 other significant influence functions will be transitioned according to the following principles: (a) each approved person will be deemed to have been given approval by the regulator that will in future specify that particular controlled function into rules; and (b) where there are changes between the FSA framework of controlled functions and the new PRA and FCA frameworks, firms will not be required to take action to switch existing people to the new framework of functions while they remain in their current role. Dual-regulated firms under the new regime will face the most disruption, as they will need to adapt to supervision by two regulators and the fact that regulatory processes such as the approved persons regime will be split between the FCA and the PRA. Firms which will be regulated by the FCA only will have a similar relationship with the FCA as they currently have with the FSA. As with the FSA, firms will be required to provide appropriate details about their regulatory status under the new regime, as follows: (i) for an FCA-authorised firm, it is proposed that the required disclosure is Authorised and regulated by the Financial Conduct Authority ; and (ii) for a PRA-authorised firm, the required disclosure will be Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and Prudential Regulation Authority. The FSA has stated that it intends to allow a transitional period of six months after legal cutover for firms to make the necessary changes to their relevant business stationery and to any electronic equivalents. However, in the long term, all firms will be affected by the new supervisory models that the FCA and PRA intend to introduce and the impact of the additional powers for the regulators being introduced by the reforms.

7 This document is for general guidance only. It does not constitute advice February Brook Street, London W1K 5DB Neuhofstrasse 3d, CH-6340 Baar Regulated by the Solicitors Regulation Authority

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