Articles - Regulation- All change

 By Karen Brolly, Risk Management Actuary, Hymans Robertson

 Throughout the financial crisis, the UK regulatory regime did not escape blame and many have questioned the scope and impact of the Financial Services Authority’s (FSA’s) role. As a result, the Chancellor announced in his Mansion House speech in June 2010 that there would be wholesale changes to the financial services regulatory regime and that there would be a separation of duties between prudential and conduct regulation.

 This means that two new regulatory authorities will be established in lieu of the FSA. The Financial Conduct Authority (FCA) which will be the on-going legal entity of the FSA and will be concerned with consumer protection.

 The Prudential Regulatory Authority (PRA) which will be concerned with ensuring that financial institutions are solvent enough to meet their obligations. In addition, a Financial Policy Committee (FPC) will be created which, as part of the BoE, will have a macro-prudential role i.e. it will be focussed on the overall stability of the UK’s financial system.

 The FSA’s Andrew Baily has been quoted as saying that he is confident that the framework would allow judgement to be applied more consistently and accountability for judgements to be more transparent.But what will this new system mean in reality?

 It is worth considering the relationships involved. The FCA will be accountable to HM Treasury and Parliament and will have an on-going co-operative and co-ordinated relationship with the PRA. The PRA will be a subsidiary of the Bank of England (BoE).

 An initial view of the relationship between the PRA and the FCA is outlined in a draft Memorandum of Understanding (issued on 27th January 2012). Note that the PRA will have the power to veto any FCA action that they feel may threaten financial stability.

 Dual regulated firms are all banks (including building societies and credit unions), all insurers (including mutuals, friendly societies and Lloyds) and major investment firms i.e. the large majority of financial institutions in the UK.
 The distinction in purpose between the FCA and the PRA is best understood if you consider the example of their roles in with-profits business. There is a large degree of discretion involved in the setting of bonus rates and it will be the responsibility of the FCA to check that with-profits customers are being treating fairly in terms of the level of bonuses they are awarded. However it will be the role of the PRA to ensure that the agreed levels of bonuses are affordable by the with-profits firms.

 The FPC will have powers of direction and recommendation in relation to financial stability and as such may interact with both the PRA and FCA (and in principle, can issue recommendations to anyone).

 After the legal cutover (LCO), the FSA Handbook will be split to form two new Handbooks. This also means that supervisory reviews will be carried out by both teams and dual regulated firms will need to respond to queries from both the PRA and FCA and will have to address two separate sets of mitigating actions, of equal importance.

 Each regulator could, separately or together, investigate and discipline and although Martin Wheatley has said that the FCA would consult with the PRA before taking action against a dual-regulated firm, the intention of the new set–up is that supervisory activity would not normally be conducted jointly.

 It is also worth noting that prudential supervision will continue to have dedicated resources supervising firms; and conduct supervision will focus more on thematic work, and less on firm-specific work.

 The general expectations are that firms will spend more time with their regulators and that they will be subject to a greater degree of challenge. However, the question of whether the benefits will stack up against the costs of all this change won’t be known for several years to come.

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