Breaking Down the new FCA and PRA Regulatory Regimes
The Financial Services Act 2012, which came into force 1 April 2013 (a date known as the ‘legal cutover’), represents the abolishment of the Financial Services Authority (FSA). This is, in large part, due to a perceived lack of effective control in its handling of the recent financial crisis and its inability to look after the interests of consumers. In place of the FSA is a new regulatory architecture, which aims to adopt a different culture and approach to supervision of the UK financial services industry, ultimately ensuring that the industry as a whole is better equipped to handle any future financial crisis.
As readers will be aware the FSA has been replaced by a ‘twin peaks’ model, which has seen the introduction of two new regulatory bodies: the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA). The FCA now acts as watchdog for the conduct of all regulated and authorised firms and individuals alike, whilst the PRA, under the watchful eye of the Bank of England (BoE) and Financial Policy Committee (FPC), will be responsible for prudential matters ensuring financial stability of the larger organisations. It is important to note that not all firms will be regulated by the PRA.
This comment piece looks specifically at the new regulatory architecture of the PRA and FCA.
It is important to understand the differing functions of the PRA and FCA. The FCA website lists its three main aims as follows:
In October 2012 the PRA, which now sits under the BoE, highlighted that it has the statutory objective to “promote the safety and soundness of firms”. In other words, its aim is to avoid adverse effects on financial stability through prudent management of a firm’s business.
What are the changes?
On top of all the regulatory change in the past few years, legislators understand that imposing an entirely new system of financial regulation would be too much for the UK financial services industry to cope with. Therefore changes, in particular to the handbooks, have been kept to a minimum in order to avoid hindering the progress being made by firms looking to comply with international regulations such as Basel III and International Financial Reporting Standards (IFRS 9).
The stand-out difference between the new regulatory model and its predecessor is that firms and authorised persons can be dual regulated. This is fundamental to understanding the attitude and approach of the new regime. The two regulators will have different principles and different remits, while looking at different areas, as well as having increased resource and means to analyse and interrogate a firm’s business model. All firms will be regulated by the FCA while banks, mutual societies, building societies and some larger trading organisations will have dual regulation from the PRA also.
As expected, the newly-published handbooks of the PRA and FCA represent very little change and will require firms to submit the same reports, which have been established for some time, in accordance with European Union (EU) and international bodies. Despite the focus that the UK has placed on developing the new regulatory architecture, ensuring that firms meet international regulatory standards such as Basel III, will continue to be at the forefront of its priorities. Both the PRA and FCA will be increasingly engaged in the need to implement, enforce and supervise EU and international standards.
Differing Approaches of the PRA and FCA
Due to the shift in regulatory philosophy, firms will need to undertake substantial changes. In the case for the FCA the regulator will bring more enforcement cases, press for tougher penalties for infringement of rules, pursue more cases and continue to seek criminal prosecutions for insider dealing and market manipulation. The FCA will ultimately impose a far greater level of transparency, in order to look after consumer interests while in pursuit of a well-functioning market.
The PRA intends to be more judgement-led, much tougher on scrutinising each firm’s business model in terms of prudential risk, intervene more quickly than the FSA where needed and to demand more in terms of explaining and understanding from a firm’s senior management. It will also expect a firm’s risk processes towards capital, leverage and liquidity to be responsive to the risks they face. The PRA has an impressive list of sanctions that can be applied in the event of deviation from the rules or if firms fail to meet their prudential obligations, such as:
However the PRA will still need to seek FCA approval to take enforcement action in certain cases.
What effect will the changes have?
We cannot expect an immediate change and it is recognised that the handbooks have stayed more or less the same. The FCA has set itself a transparency objective and, as a result, consumers should become more aware about the actual risks being taken when engaging in certain important financial transactions. In addition the expectations of suppliers and consumers of financial service products may well be altered and in fact become fairer and more realistic. Ideally, the regulators are pushing for a situation where external information mirrors what is seen internally within a firm.
The establishment of the PRA and the implementation of the Basel III reforms should make the system safer, as there will be increased capital and liquidity in the financial system. The most important contribution to safety will come from better analysis and understanding, resulting in better decision making. As such, we will have to see if this new structure will deliver a better process than the previous one.
While the new architecture is still in its very early days of operation, it will feel in the main feel much as before for many firms. However, there will be a focus on the more systemically important factors. During its final couple of years the FSA became far more intrusive, asked a wider range and depth of questions, and challenged firms with more conviction. As mentioned previously, due to the new ‘twin-peak’ structure allowing the regulators to home in on areas and issues increased intrusion, focus and required transparency, should be the very least that firms can expect from the PRA and FCA regimes.
It would be a mistake to assume that the new regimes will not be accompanied by a substantial cost increase for firms. More resource and management time will be needed to address the regulators’ concerns and to respond to ad-hoc requests. Currently, it is difficult to accurately measure how much increase in cost this will involve, as every firm is different. In terms of the annual levy, it is estimated that the PRA and FCA regimes will be approximately 15% more expensive to run, equating to £646.3m according to a recent FCA announcement.
Tackling the new regulatory structure
A key aim of the new regulatory architecture is to move away from a ‘tick-box’ compliance culture, into a more desirable approach of applying far greater attention to a firm’s risk and regulatory obligations, thus allowing them to meet and even exceed the regulator’s requirements. The regulator’s “shoot first, ask questions later” stance emphasises their desire for this approach to compliance to be adopted universally.
The messages clearly being portrayed is that it is an outdated view to simply act passively towards compliance in the belief that if requirements are met then the regulators will be satisfied. This is not the case, as the new bodies are making it clear that if they have reason to investigate a firm, even if on the surface all seems well, then they have the power and resource to do so. It is therefore essential that firms embrace a pro-active culture towards compliance.
As with everything, those firms which are best prepared for the new regimes are at a distinct advantage over those that haven’t reacted. Best practice would be for them to delve deep into the official documents published, and gain a strong understanding of how the dual regulatory architecture will operate and what is being required.