A new approach to financial regulation: June 2011Cm 8083 the blueprint for reform £56.75 Presented to Parliament by the Chancellor of the Exchequer by Command of Her Majesty June 2011 Cm 8083 A new approach to financial regulation: the blueprint for reform Official versions of this document are printed on 100% recycled paper. When you have finished with it please recycle it again. If using an electronic version of the document, please consider the environment and only print the pages which you need and recycle them when you have finished. © Crown copyright 2011 You may re-use this information (excluding logos) free of charge in any format or medium, under the terms of the Open Government Licence. 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This publication is also available for download at http://www.official-documents.gov.uk/ ISBN: 9780101808323 PU1142 Printed in the UK by The Stationery Office Limited on behalf of the Controller of Her Majesty’s Stationery Office Printed on paper containing 75% recycled fibre content minimum ID 2433277 06/11 Contents Page Foreword 3 Chapter 1 Introduction 5 Chapter 2 Policy overview 15 Chapter 3 Draft Bill 51 Chapter 4 Explanatory notes 279 Annex A Consultation questions and how to reply 367 Annex B Summary of responses to February consultation 371 Annex C Impact assessment 391 1 2 Foreword Over the past few years, a clear consensus has emerged that the shortcomings of the ‘tripartite’ model of financial regulation were a significant factor in the UK’s failure to predict, or adequately respond to, the financial crisis that started in 2007. The objective now is to learn from what went wrong and put these mistakes right, in order that Britain can be the home of stable and competitive financial services. So the Government is committed to introducing a new approach to financial regulation – one which is based on clarity of focus and responsibility, and which places the judgement of expert supervisors at the heart of regulation. A year ago, almost to the day, I launched a programme for radical reform of financial services regulation in my first Mansion House speech. Since then, the Treasury has been working with the Bank of England and the Financial Services Authority to make these reforms a reality. We have had the benefit of an immensely constructive contribution from financial and professional services firms, trade associations, consumer groups and other stakeholders. This white paper – which includes the core of a draft Bill – is an important milestone in this process. Responsibility for financial stability – both at the macro-level of the financial system as a whole, and the micro-level of individual firms – will rest within the Bank of England, in a new macro- prudential body, the Financial Policy Committee, and a new micro-prudential supervisor, the Prudential Regulation Authority. Responsibility for conduct of business will sit with the new Financial Conduct Authority, with the mandate and tools to be a proactive force for enabling the right outcomes for consumers and market participants, including through the promotion of competition. And responsibility for the overall regulatory framework, and the protection of the public finances remains with the Treasury, and the Chancellor of the Exchequer. Creating these centres of regulatory excellence will enable each part of the framework to focus on what it knows best. Sitting within the Bank of England, the Financial Policy Committee will make judgements about risks to the overall stability of the financial system, and offer advice, recommendations, or binding directions to ensure that these risks are dealt with. Also within the Bank of England, the Prudential Regulation Authority will make judgements about the safety and soundness of individual firms, and will take supervisory and regulatory action to ensure that firms take necessary steps. And the Financial Conduct Authority will make judgements about risks to consumer protection, competition and market integrity and have new powers to take action. This clarity of focus will mean that accountability – to Parliament, the Government, and to the wider public – is clear. We have come a long way in a year; the detail set out in the draft Bill and white paper is testament to this. The Treasury has listened to stakeholders, and sought to respond positively wherever possible. I promised Parliament the opportunity for pre-legislative scrutiny of the Bill, which will lead to further refinements. But there is more to be done. The Bank and the FSA will continue with their programmes of operational preparation for the new framework. The Treasury will continue to lead the process of legislative development. And together, the authorities will continue to play a proactive leadership role in the development of financial regulation at the international level, and particularly in the European Union and G20. I look forward, with the continued help and input of stakeholders, to building a world-leading regulatory system to match the UK’s world-leading financial sector. Rt. Hon. George Osborne MP, Chancellor of the Exchequer 3 4 1 Introduction Financial sector reform 1.1 Since coming into office in May last year, the Government has made financial sector reform one of its top priorities. Financial services is one of the key sectors of the UK economy. As an employer and contributor of tax revenues, as an exporter of UK services to the rest of the world, and as a vital part of the economic infrastructure, a healthy financial sector is an important driver of growth in the UK. 1.2 With this unique role of the financial sector, however, comes the potential for significant risks. As the financial crisis that started in 2007 showed, when things go wrong in the financial sector, the impact on the rest of the economy can be severe. Despite part-nationalising two of the largest banks in the world, and extending tens of billions of pounds of direct and indirect financial assistance to the sector, the Government at the time was unable to prevent shocks in the financial sector from spilling over into the wider economy. This lead to the worst recession in living memory. Weaknesses in the banking system remain a headwind on growth. 1.3 This crisis, and the resultant impact on the economy – globally as well as in the UK – was caused both by failures in the financial sector, and by failures in regulation of the financial sector. Financial institutions did not manage their business prudently and, in particular, did not understand the risks inherent in the business they were conducting. Regulators and supervisors failed to provide the robust scrutiny and challenge that banks and other financial institutions needed to ensure that risks building up on their balance sheets were manageable – not only at the level of individual firms, but across the system as a whole. A number of firms have become so large, interconnected and complex that their failure posed a serious threat to the financial system – and the regulatory system lacked the tools to deal with this ‘too big to fail’ problem. 1.4 The financial crisis exposed the inherent weaknesses in the ‘tripartite’ system of regulation in the UK. Perhaps the most significant failing is that no single institution had responsibility, authority or powers to oversee the financial system as a whole. Before the crisis, the Bank of England had nominal responsibility for financial stability but lacked the tools to put this into effect; the Treasury, meanwhile, had no clear responsibility for dealing with a crisis which put billions of pounds of public funds at risk. All responsibility for financial regulation was in the hands of a single, monolithic regulator, the Financial Services Authority, and there was clearly, in the run-up to the financial crisis, too much reliance on ‘tick-box’ compliance. 1.5 To tackle these issues, the Government has announced, and is delivering, a number of targeted policy responses: • the Government has announced a radical reform of the UK regulatory framework to correct the failings that became apparent through the financial crisis; • an interim Financial Policy Committee has been established to begin monitoring systemic risk and advise the Government on potential macro-prudential tools; • the FSA and Bank of England have begun the process of splitting out prudential from conduct of business regulation, within the FSA, as a precursor to the establishment of the new regulatory structure; 5 • the Government has established an Independent Commission on Banking to consider what steps should be taken to deal with systemically important banks, alongside the question of whether and how competition in the banking sector should be improved; • the Government has introduced a levy to encourage banks to move to less risky funding profiles, and to ensure that banks make a fair contribution in respect of the potential risks they pose to the UK financial system and wider economy; and • agreement has been reached with the largest UK banks on lending and remuneration. 1.6 Good progress continues to be made in all of these areas. The Independent Commission has published its interim report, containing a number of its preliminary conclusions. The Commission’s proposed solution has three main elements: • that the most systemically important banks hold additional capital to the Basel III minimum, to make them better at absorbing losses and less likely to fail; • ‘bail-in’ instead of bail-out – so that private investors, not taxpayers, bear the losses if things do go wrong; and • putting a ring-fence around high street banking to make it safer and to make it easier to allow a bank to fail without disrupting crucial banking services. 1.7 The Independent Commission is still consulting on its proposals. As announced by the Chancellor in the Mansion House speech on 15 June, the Government endorses their approach. The Government will await the Commission’s complete report before taking final decisions. Reforms taken forward will need to meet the following principles: • banks – whether retail banks or investment banks – must be allowed to fail safely without affecting vital banking services; • any bank that fails must be resolvable without imposing costs on the taxpayer. • any reforms must be applicable across our whole banking industry, with all its diversity; and • proposals must be consistent with EU law and the UK’s international treaty obligations. 1.8 The Government also supports the Commission’s view of the importance of competition as the best driver of good consumer outcomes; this white paper puts forward the Government’s detailed proposals for increasing the profile of competition issues in the regulatory system. 1.9 The Government is also taking steps to divest assets that had to be acquired during the financial crisis. Following extensive work to consider options for returning Northern Rock to the private sector, and on the advice of UK Financial Investments (the arm’s length body set up to manage the Government’s shareholdings in financial institutions) the Chancellor has announced the launch of a sales process for Northern Rock. The sales process will be open to all interested bidders – including mutual organisations – and will be open and transparent, and compliant with obligations under State aid rules. While this launch does not mean that other options for returning Northern Rock to the private sector have been definitively ruled out, it does reflect the Government’s view at this time that a sales process is likely to generate the best outcome for the taxpayer. 6 [...]... PRA with respect to insurers To further confirm the equal priority to be given to insurance regulation within the PRA, and to set out the different supervisory approaches which the PRA will be taking, the Bank of England and the FSA has published a paper detailing the approach to be taken to banking supervision (which was published on 19 May and is available on the FSA website), the other for insurance... Clause 3 (financial stability strategy and Financial Policy Committee) of the draft Bill inserts new Part 1A (comprising new sections 9A to 9W) into the Bank of England Act 1998 As set out in clause 3, new section 9A (financial stability strategy), Court will set the Bank’s overall financial stability strategy, which the FPC will have to take into account Court will be required to publish the strategy... transferring responsibility for prudential regulation to a focused new regulator, the Prudential Regulation Authority (PRA), established as a subsidiary of the Bank of England; and • creating a focused new conduct of business regulator, the Financial Conduct Authority (FCA), to ensure that business across financial services and markets is conducted in a way that advances the interests of all users and... amend the Financial Services and Markets Act 2000 (FSMA) to give effect to the reform programme, rather than to repeal the Act and redraft and re-enact it 8 in full This approach, which has been widely supported by consultation respondents, will minimise the extent to which regulated firms and other users of FSMA have to deal with legislative change It should also allow more focused Parliamentary and... provides the technical and legal detail in the form of draft legislation and explanatory notes Finally, the annexes summarise the consultation responses from February and the issues being consulted on in this document The annexes also include the latest consultation-stage impact assessment 1.49 Taken together, this material represents another big step forward in the programme of regulatory reform The Government... fund managers able to qualify for a passport into the EU This was a very important outcome for the UK in signalling that the EU remains open to global trade and the free movement of capital 1.12 But a number of challenges remain The ongoing negotiations on the new European capital requirements legislation are particularly important at this time As noted in the recent IMF Article IV report into the UK... first formal meeting on 16 June 2011 Future formal meetings are expected to be held at least quarterly 18 2.27 The FPC will undertake, as far as possible before formal legal powers are created, the permanent body’s macro-prudential role, in addition to vital preparatory work and analysis into potential macro-prudential tools The FPC will: • identify and monitor systemic risks to stability the financial. .. creation of a specialist authority will be a vital part of achieving the objectives of the reform In particular, the FCA will take a more proactive approach to dealing with the conduct of financial firms, and will have a lower risk threshold for potential consumer detriment The FCA will take a cross-cutting, ‘issues-based’ approach to supervision, to make sure that it identifies and deals with potential sources... order to be made by the Treasury under new section 2 2A (designation of activities requiring prudential regulation by the PRA) These will ensure that the regulatory arrangements are adapted to the unique way in which Lloyd’s operates by allowing the PRA to regulate the prudential aspects of the Lloyd’s operations although Lloyd’s names (who actually effect and carry out contracts of insurance) are not authorised... that the Bank can apply to the court for an order for the purposes of preventing a compliance failure (including a failure to comply with a direction given by the Bank) or remedying that failure The draft Bill therefore includes (in clause 63) the following measures: • allowing the Treasury to amend a recognition order for a payment system without issuing a new order; • clarifying that the Bank can . respond are set out in Annex A. 1.18 The Government has chosen to amend the Financial Services and Markets Act 2000 (FSMA) to give effect to the reform programme, rather than to repeal the Act and. has announced a radical reform of the UK regulatory framework to correct the failings that became apparent through the financial crisis; • an interim Financial Policy Committee has been established. crisis, and the resultant impact on the economy – globally as well as in the UK – was caused both by failures in the financial sector, and by failures in regulation of the financial sector. 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