Launch of ‘a new approach to financial regulation: judgement, focus and stability’
Thank you all for coming today and many thanks especially to Xavier Rolet and all at the London Stock Exchange for hosting this morning’s launch event.
We are here to launch the Government’s consultation on the future system of regulation for financial services and markets.
In my first speech as Financial Secretary, in Brussels in early June, I said that if we were to restore trust and confidence in financial services we had to go further than the reforms introduced by the previous Government.
Whilst we support reforms like the Banking Act 2009, which provides a statutory toolkit for resolving failing banks and building societies, I said that our package of reforms would not only focus on the cure for when things go wrong, but would also focus on prevention.
I said that we would launch a banking commission to challenge the current assumptions about the structure of the UK banking system, rigorously examining the existing business models for UK banks to see if there is a better and safer way to meet the needs of businesses and households.
And I said that to improve the regulation and supervision of the sector we would give control of macro-prudential regulation, with oversight powers of micro decisions, to the Bank of England.
Less than two months later:
- The banking commission has been set up under the leadership of Sir John Vickers; and
- We have not only set out our plans for regulatory reform, but we are today launching a consultation on a detailed set of proposals.
I believe our programme of reforms will build the foundation of renewed trust and confidence in the financial system.
The financial system would simply not be able to survive and would certainly not be able to flourish without good regulation. Because good regulation creates the transparency and accountability that produces trust in the system and the confidence to invest.
Of course a better regulation is not a silver bullet.
That is why the Government is also releasing a paper today on access to finance. Just as excessive lending contributed the financial crisis, we are concerned a shortfall in lending to business could undermine the recovery.
We will look at all the options in order to ensure that businesses can access the finance they need to grow.
If trust and confidence are the ground that holds up the financial system, then good regulation is the bedrock that prevents that ground from caving in.
Getting the design of the regulatory system right is vital to the long-term stability and sustainability of the financial system - and therefore vital to the task of rebuilding a sound economy based on production and investment, rather than speculation and excessive borrowing.
And it needs to be a design that fits within the broader architecture of the regulatory reforms being drawn up at the European and international levels whilst recognising the particular interests of London as a global financial centre.
The importance of building on solid ground may not be immediately obvious when you start to build, but when the pressure is on, the quality of the foundations are exposed.
The failure of the tripartite system
And to say the least, there has been a fair degree of pressure in the global financial system over the past three years.
Nowhere has felt the pressure more acutely than Britain and under that pressure, the regulatory foundations that the previous government laid were tried and found wanting.
In the wake of the crisis, the inherent weaknesses and contradictions of the tripartite system are plain to see:
- How could a single, monolithic financial regulator in the form of the FSA be expected to simultaneously deliver on multiple conflicting objectives, micro and macro prudential regulation, and conduct and prudential regulation, all at once?
- How could the Bank of England have responsibility for financial stability, when it lacks the tools to carry out this role?
- And perhaps most obviously, how could we expect stability when no single institution has the responsibility, authority or powers to monitor the system as a whole, identify destabilising trends, and respond to them with concerted action?
The FSA have made a good start to improving financial supervision, but the reform of the UK’s regulatory system would be insufficient and incomplete without thorough institutional reform.
It falls to the new Government to ensure that we prevent the failures of the old tripartite system from ever happening again.
Let me be clear - we are not advocating a return to the pre-FSA style of regulation.
We want to create a new supervisory approach that takes into account the lessons of the past but that is also designed for the future - a future in which supervisors should have greater discretion to use their own judgement, and to take a more risk-based approach to their work.
And a future where new European Supervisory Agencies will play a pivotal role in rule setting and where the many of the firms overseen by the PRA are the subsidiaries of overseas companies. I’ll say more about Europe later.
The Government’s proposed model
In his Mansion House address last month, the Chancellor set out the broad sweep of the changes that we intend to make.
He announced that we will place the Bank of England in charge of macro-prudential regulation by establishing a Financial Policy Committee. And we will also create two new, focused regulators:
- a new prudential regulator under the Bank of England, headed by a new Deputy Governor; and
- a new Consumer Protection and Markets Authority (CPMA), established as a single integrated conduct regulator.
There is still much to be done to make these new arrangements a reality.
As a Government we recognise that we rely on the input of everyone who has an interest, including regulators and the regulated community, to ensure that we get the detailed design right.
The great designer and inventor Alexander Graham Bell has said that, “Great improvements invariably involve the cooperation of many minds.”
And it is in the spirit of cooperation that we are launching this consultation today. Without going into the full detail of the consultation document, I would like to outline the shape of our proposals.
First, in order to equip the Bank of England to carry out the role of a marco-prudential regulator, we will create within it the Financial Policy Committee.
It will have the responsibility to look across the economy at the macroeconomic and financial issues that may threaten the stability of the financial system and it will be given the tools to address the risks it identifies.
The majority of the FPC’s members will be Bank executives, it will also have a strong independent voice, with four external members appointed by the Chancellor.
The FPC will meet at least four times a year and will publish a record of its deliberations and decisions after every meeting, providing important transparency and accountability.
Prudential regulation of individual firms
Second, the regulatory architecture has to ensure that macro-prudential regulation of the financial system is effectively co-ordinated with the regulation of individual firms.
That is why we will transfer responsibility for prudential regulation from the FSA to a new subsidiary of the Bank of England, and we will create a standalone Consumer Protection and Markets Authority.
Both will become centres of excellence in their own right, recognising that effective conduct and prudential regulation require very different skills.
These changes will enable supervisors to build on the changes the FSA has put in place and take a more risk-based and judgement-led approach to prudential regulation, freeing supervisors from the ‘tick-box’ approach that typified supervision prior to the financial crisis.
The supervisors will have greater discretion to interrogate firms’ business models and strategies and minimise the risk that they pose to the system as a whole.
The new Prudential Regulation Authority will be responsible for prudential regulation of all deposit-taking institutions, insurers and investment banks.
The FPC will be able to require the PRA to take regulatory action with respect to all firms for macro prudential reasons. But the PRA will be independent in the supervisory decisions it takes, so the FPC will have no power of direction over the PRA on individual firms.
Consumer protection and markets regulation
Thirdly, in the new consumer protection and markets authority we will establish a single, focused regulator that regulates conduct in financial markets.
Prudential and conduct of business regulation require different approaches and cultures.
The combined remit of the FSA meant that participants in financial services and markets, particularly ordinary consumers of retail products, did not always get the degree of regulatory focus or the protection they may have expected or required.
We are committed to changing this. The new body will have the required focus, and will regulate the conduct of all authorised firms, whether they are prudentially regulated by the PRA or not.
The scope of firms regulated by the CPMA will range from those offering a simple product on the high street, to investment banks dealing with sophisticated counterparties in wholesale markets.
The CPMA’s primary objective in regulation will be to ensure confidence in financial markets. In pursuing this objective it will focus on the twin aspects of consumer protection and market integrity.
It will build on the FSA’s recent progress towards a more proactive and interventionist approach to retail conduct regulation, backed by tough enforcement to ensure credible deterrence.
The CPMA will be a strong consumer champion in pursuit of a single objective - there will be no in-built tensions between different objectives, and a dedicated focus on the importance of appropriate conduct.
This will provide greater clarity and ensure that the interests of consumers and participants in financial markets is placed at the heart of the conduct regulatory system and given the right degree of priority
But if we are going to restore confidence in financial markets we also need to provide security in the knowledge that there is help when things go wrong.
So the Financial Ombudsman Service and the Financial Services Compensation Scheme will continue operating as a safety net, and will have an arm’s-length relationship with the CPMA.
And to make sure we have informed and capable consumers that are able to make sound financial choices, the Consumer Financial Education Body will also operate at an arm’s length from the CPMA.
On consumer credit, the CPMA’s role as a strong consumer voice presents an ideal opportunity to look again at the style and location of consumer credit regulation.
We want to make sure that we have the highest possible standards for consumer protection, with more certainty and transparency for both consumers and businesses.
So we want to consult in the autumn on whether the responsibility for consumer credit should transfer from the Office of Fair Trading to the new CPMA.
My last point on the CPMA is that we will establish within it a strong markets division to lead on market conduct regulation and in representing the UK in the new European Securities and Markets Authority, to ensure that the right outcomes are delivered for London.
The CPMA markets division will also be responsible for regulating exchanges and trading platform providers, reflecting their key role in securities and derivatives markets and their importance for market conduct regulation.
And we will consult on whether the UKLA should be merged with the FRC, bringing together primary market activity alongside company reporting, audit and corporate governance.
The Bank of England will take responsibility for overseeing central counterparty clearing houses and settlement systems - sitting alongside its existing responsibilities for overseeing payment systems.
For the first time this brings together the regulation of systemically important infrastructure and prudentially significant central counterparties.
Taken together, these reforms will create a robust regime for responding effectively to emerging risks to financial stability.
But we must make sure that where these risks crystallise, as they did in the financial crisis, the response is effectively coordinated. The crisis taught us that we need to be clear about who does what.
Crucially, wherever crisis management decisions are taken that could impact on public funds, the Chancellor must have the final say. And the Chancellor will be accountable to Parliament and the wider public for the strategy that is adopted.
To this end, we will put in place formal obligation for the Governor to notify the Chancellor as soon as it becomes clear that there is a potential call on public funds.
Ensuring smooth transition
I recognise that changes on the scale I have outlined will bring temporary disruption and uncertainty both to the regulated community and to those charged with the vital task of continuing the work of regulation in the meantime.
To limit this disruption, we have committed to put the necessary primary legislation in place within two years.
The Treasury, Bank of England and FSA are already working hard on the transitional arrangements for the current and new authorities.
We are delighted that Hector Sants has agreed to become the Chief Executive of the PRA, with Andrew Bailey as his Deputy. Both they and their wider staff will bring vital skills and experience to the new PRA.
Working with Europe and the G20
Finally, I would like to say a few words about our engagement with Europe and the G20.
As a Government we want to have a strong voice in the dialogue around international reforms to help ensure stability in the global system and to ensure that London remains a global financial centre.
We believe that the new European supervisory authorities should reinforce the single market, ensure consistency in supervision and the application of rules across the jurisdiction, but should not regulate institutions directly.
I am pleased to be working with the CityUK’s International Regulatory Strategy Group to develop a stronger EU agenda.
And at the G20 level we are particularly keen to work towards certainty about an end point to the debate on capital and liquidity.
As we work at the international level to strengthen and stabilise the financial system, we are committed to preserving maximum discretion for the UK to act in its own interests where necessary and to provide our banking system with the support it needs in the event a future crisis.
The Bank, PRA and CPMA will work closely with the Treasury in representing the UK’s interests in European and international fora.
We have every reason to be positive about the future. But we need to act now to get the design of the new system right.
Today we are putting forward our answers to the question of what the exactly the new system should look like and how we think it should work.
But we rely on the full range of firms and interested groups that are impacted by these changes not only to answer the questions that remain but also to question the answers that we have put forward.
I started this morning by comparing our regulatory system to the foundation on which the whole architecture of the financial system stands or falls. And I have argued that we need to design that foundation together.
We sit here, a stone’s throw from St Paul’s Cathedral, and we should take inspiration from the epitaph on the tombstone of its architect Sir Christopher Wren “Reader, if you seek his monument, look around.”
I believe that in the decades ahead, when people look around, they will see a flourishing financial sector, built on the foundations of the reformed regulation structure that together we are laying today.