After 15 years at the helm of financial regulation and supervision in the UK, the Financial Services Authority (FSA) bowed out on 1 April 2013, making way for the new ‘twin peaks’ model. Well, sort of new. Prudential regulation reverts back to the Bank of England in a new subsidiary, the Prudential Regulatory Authority (PRA). This time round, the Bank of England/PRA is not just supervising banks, but also credit unions, building societies, insurers, large investment firms, central counterparties and other systemically important institutions.
Supervising all these entities under one roof probably has some merits. Lehman Brother’s disorderly failure in 2008 demonstrated the tight interconnectiveness and interdependency of systemically important financial institutions. The differences between these entities’ businesses are also fading as non-banks jump into traditional banking activities and vice versa.
The PRA is supported by the Financial Policy Committee (FPC), the UK’s macroprudential regulator, which is housed within the Bank of England’s superstructure. The FPC will chip-in and direct the PRA and other regulators on financial stability issue. Giving some teeth to a financial stability authority is a significant departure from the previous regime where macroprudential supervision wasn’t given much attention other than the production of annual financial stability reports. In the context of sluggish economic performance and tight lending conditions, the FPC came out fighting, directing the PRA to require UK banks to raise £50 billion in additional capital in light of increasing bad loan provisions and estimated future redress costs.
The Financial Conduct Authority, a separate and independent agency, will prudentially regulate all other regulated entities (23,000+). It is also responsible for conduct regulation of all financial institutions operating in the UK. So like in pre-FSA times, many firms are now dual-regulated. Dual -regulation will present a number of challenges because both regulators will have different objectives and regulatory judgements, and the coordination is likely to happen more at a policy level than a practical level, especially for firms that are not relationship managed by the regulators’ supervisory teams.
The FCA will focus on protecting consumers and promoting confidence in financial services and markets. The PRA’s approach to prudential supervision of banks and investment firms will be based on one objective – to promote the safety and soundness of all firms it supervises. In some areas the delineation between prudential and conduct of business matters may be clear-cut. But in other areas, such as authorisation or assessment of governance arrangements, it is clear that the interests of the PRA and FCA will overlap. Where firms are dual-regulated (or a part of a dual-regulated group) regulators will not normally conduct supervisory activity jointly. But the PRA and FCA will routinely share information on the outcome of supervisory activity that could be relevant to the other regulator.
In terms of the supervisory approach, both regulators will be more proactive in identifying and reacting to market risks. The FSA’s judgement focused and risk-based approach in the past few years will be extended and reinforced. The PRA team will have dedicated supervisors for systemically important firms while the FCA team will have fewer firms for which it has dedicated supervisors. The FCA will favour more flexible resourcing and make more interventions on a thematic basis. The FCA will have a clear pivot towards conduct risk and business model supervision (for more information on Conduct Risk you can view our recent webinar here).
Financial stability will trump consumer protection when push comes to shove. The PRA can veto a regulatory move by the FCA where it believes the proposed exercise of powers may threatens the stability of the UK financial system or could result in the failure of a PRA-authorised person in a way that would adversely affect the UK financial system.
The UK government believed it was necessary to start again and re-think the financial regulatory institutional structure following the crisis. However, academic research doesn’t fully support institutional restructuring as a way of reducing systemic crisis in the financial system. Looking at the last 78 financial crises, research results have shown very little correlation between the type of institutional structure (i.e. single, entity monetary and financial supervision, multiple etc.) and either the frequency or the scale of systemic crises.
Other factors such as higher capital levels, enforcement practices and the levels of resources at regulators will be much more important in reducing the frequency and severity of financial crises. How CRD IV, Solvency II, EMIR, and other big ticket EU reforms are implemented will also be a huge factor in determining how successful the PRA and FCA will ultimately be. Some of these changes are largely out of their hands, but the UK regulators still have an important role to play in shaping the regulatory agenda in the EU.
Despite ongoing uncertainty, asset managers are progressing full steam ahead with their preparations for the Alternative Investment Fund Managers Directive (AIFMD). EU Member States have until 22 July 2013 to implement AIFMD into national law, with alternative investment fund managers (AIFM) offered a further year to become fully compliant. However, fund managers will be unable to market their products in other EU countries if they are not authorised under AIFMD by their home state regulator. So many AIFM are considering applying for authorisation under AIFMD and becoming AIFMD-compliant much earlier.
It is not clear whether all Member States will be ready for AIFMD by July. The Level 2 Delegated Regulation, setting out much of the detail that underpins AIFMD, will not come into force until 11 April. Key guidelines from the European Securities and Markets Authority (ESMA), that define what structures are actually in scope of AIFMD, are outstanding. Meanwhile, AIFMs and other firms impacted by AIFMD have little time left in which to make crucial strategic and operational decisions related to implementing AIFMD requirements into their business before the new regime goes live.
Given the frustration experienced by many in the asset management industry over the AIFMD legislative process, the Q&As published last week by the European Commission (EC) are welcome. They address a number of important issues. Following common practice, the EC will periodically update these Q&A based on questions received. The Q&As covers issues such as:
Whilst the Q&As have no legal basis, they serve as a good guide towards regulatory thinking over a number of aspects of AIFMD. It will be interesting to see how much of the EC’s guidance is reflected in the regulatory approach across Member States in the coming months.
CRD IV is starting to pick up steam as it enters the final stages of the EU legislative process. On 21 March 2013, the Commission published a press release announcing political agreement in trialogue negotiations on the remaining key issues, based on the provisional agreement reached with the European Parliament (EP) on 27 February. On 27 March 2013, the EcoFIN Council announced that agreement with the EP and the EC had been reached on the overall package. The texts (dated 26 March 2013) of the agreed CRD IV Directive and Capital Requirements Regulation were then published, together with a comprehensive overview of the new prudential regime, CRD IV/CRR – Frequently Asked Questions, from the EC.
The EP is expected to adopt the final text in plenary session on 17 April, which will be followed by a legal/linguist expert review, prior to final adoption by the EcoFIN Council (possibly in May) and then publication in the Official Journal. The text must be published in the Official Journal before the end of June for the new regime to go live on 1 January 2014 (otherwise, the start date will be 1 July 2014) due to an agreement in the Council for Member States to transpose CRD IV in an unprecedented six months.
The European Banking Authority (EBA) is not waiting for the legislative process to finish before continuing its preparations for the draft regulatory technical standards (RTS) underpinning CRD IV. It needs to submit draft RTS and ITS covering issues in some 35 articles to the EC (according to the original 2011 proposal) before CRD IV can take effect. Last year the EBA undertook preparatory work covering a number of the key issues. In March 2013, it published a number of draft RTS and ITS providing us with a first glimpse of how it intends to flesh-out the new prudential regime in relation to:
The EBA also published an updated version of the templates, instructions, validation rules and data point model for ITS on supervisory reporting (COREP and FINREP) on 15 March 2013.
These draft RTS are quite narrow in focus and do not necessarily give us a good picture of how the EBA is going to tackle CRD IV overall. Other RTS, particularly on eligibility of capital instruments and remuneration, will be more contentious and insightful.
Assuming CRD IV applies from 1 January 2014, full implementation will be phased-in by 1 January 2019. The supervisory reporting regime using the harmonised COREP and FINREP will also start from 1 January 2014. The EBA will address questions about the practical application of the supervisory reporting requirements in a Q&A tool for the Single Rule Book which is currently being developed. This tool will also cover EBA technical standards and guidelines once they are finalised and adopted.
The EBA cannot truly finalise its work until after the CRD IV text is published in the Official Journal and comes into force (20 days later) which will be sometime in July, if all goes according to plan. The Level 1 text of CRD IV, although definitive in itself, needs to be supplemented for firms to understand the full detail of what they must operationalise. The EBA has an overview of RTS/ITS proposals that are published and already in the pipeline, but the industry will have to wait a few more months to get the complete picture.