Financial regulation reform: too many cooks?

Prudential regulation will be the sole responsibility of the BoE, with macro- and micro-prudential regulation split between two entities under the BoE's control:

The Financial Policy Committee. The Financial Policy Committee (FPC) will be responsible for macro-prudential supervision. In practice, its main roles will be:

The FPC will also be given control over specific macro-prudential tools. These are not yet identified, but the majority are likely to involve micro-prudential levers (such as capital requirements and leverage limits).

The FPC will be able to require the Prudential Regulation Authority (PRA) (and, if relevant, the new Consumer Protection and Markets Agency (CPMA)) to take regulatory action in pursuit of macro-prudential policy (for example, to apply new capital requirements to all firms) (see below).

The FPC will be responsible for monitoring the boundaries of regulation. It will also oversee the division of responsibilities between the various regulatory bodies.

Prudential Regulation Authority. The PRA will be responsible for the authorisation, regulation and day-to-day supervision of all firms which are subject to significant prudential regulation; that is: banks and other deposit-takers; broker-dealers (or investment banks); and insurers (including friendly societies) (see box "PRA's key functions").

Neither the FPC nor the BoE will have any formal power of direction over the PRA in relation to firm-specific matters.

The CPMA will regulate:

The CPMA will have the core regulatory function of making the rules which govern the conduct of financial firms, in both the retail and wholesale spheres. It will also grant and amend permissions to carry on "non-prudential" regulated activities.

Further, the CPMA will supervise and, where necessary, enforce compliance with conduct of business rules, and the prudential activity that sits within its remit (that is, in relation to firms not prudentially regulated by the PRA (see above)).

The CPMA will be responsible for approving individuals to perform conduct-related controlled functions for firms which are also prudentially regulated by the PRA, and for approval of all controlled functions where the firm is solely regulated by the CPMA.

CPMA oversight. The CPMA will oversee the Financial Ombudsman Service, a new Consumer Financial Education Body and the Financial Services Compensation Scheme (FSCS) (the government is consulting on different operating models for the FSCS going forward).

UK Listing Authority functions. The government proposes merging the FSA's functions in its capacity as the UK Listing Authority with the corporate functions of the Financial Reporting Council.

The government will consult separately on the following issues:

Economic crime. Whether to transfer responsibility for prosecuting criminal offences involving insider dealing, market abuse and other criminal law breaches to a new Economic Crime Agency.

Consumer credit. Whether to transfer responsibility for consumer credit regulation from the Office of Fair Trading to the CPMA. The government will also consider whether consumer credit regulation should be simplified.

Lloyd's of London. How the regulated activities relating to Lloyd's of London should be allocated within the PRA and CPMA.

The main area of uncertainty in the proposals is the division of responsibilities between the regulatory bodies, arising in particular out of the fact that some activities will be regulated by the PRA and others by the CPMA. This division of activities will determine, among other things:

It is not clear which specific activities will be regulated by each body, except that the consultation states that the activities of accepting deposits, effecting and carrying out contracts of insurance and dealing as principal will be the responsibility of the PRA.

It is difficult to see how certain controlled functions or the SYSC rules could be allocated to a particular regulated activity, as opposed to applying to the firm as a whole. The proposal has the potential to cause duplication of regulation; for example, a director of a bank which both accepts deposits and provides investment management services may need to be approved as an approved person by both the PRA and the CPMA. This will need to be clarified.

The consultation closes on 18 October 2010. The government then intends to bring a Bill forward in mid-2011 and to enact the necessary primary legislation within two years.