Regulatory change –preparing for the transition

Simon Morris31 October 2012

Looking at …

1. FS Bill – the big picture2. Progress on restructuring3. Tripartite max – the new reality4. Journey to the FCA … and the PRA5. The future

1. FS Bill – the big picture

Lord Sassoon – We asked too much of the FSA

• Process was valued over judgement– Judgement of expert supervisors is put at the heart of the system– PRA strong judgement-led approach

• Engage with business, scrutinise and engage

Preparation points:– Understand the PRA’s policy and the cultural requirement– Understand how this will impact your firm

– We are putting the Bank of England clearly in charge– We will oversee and address systemic risk – FPC

• But we do not want the stability of the graveyard– FCA good news for consumers

• Will seek competition-led solutions for better outcomes

Preparation points:– Understand how the FCA’s consumer agenda will impact your firm– Consider your competitive position

The concerns

The view from the Treasury Select CommitteePolitical points ...– The Bank requires a stronger board with TSC veto over Governor– Chancellor should have power to direct the Bank in a crisis– Need to scrutinise Bank’s development of tools & levers– Majority of FPC should be external– FCA

• Objectives are unfocussed• Weak accountability• Overhang of current FSA culture

– Preparation point – this may sharpen the approach

2. Restructuring is underway

FSA effectively divided– Preparation point – what you are seeing is what you will getChanges in Bill are focused on delivery not substance

• MiFID is pervasive– MiFIR, MAR & AIMFD are on their way

• But the style can change – AUTH, SUP & ENF• And G is important• As is COND, PRIN and APER

– Some PRA/FCA policy statements– Preparation point – the key focus is changes in style

The rulebooks

– Work starting on the rulebooks– A change of tune?– “Making only the changes required to implement the Bill and support

creation of the new regulatory structure” CP12/24• PRA & FCA will designate existing FSA rules – but expect divergence

– As regulators develop them “in line with their objectives and functions”

– In Guidance

• Plus new COND, PRIN & APER• Plus new CASS, FEES & COMP• Substantive changes needed for objectives & functions – GEN & SUP

– Preparation point – study and respond to the consultation

Areas of change in GEN & SUP (to follow Bill)

– Disclosure on stationery – six month transitional period– Skilled persons – some wider powers– VoPs – apply to RA only & separated from requirements– Waivers – test is to be “not affect advancement of objectives”– Controllers – allocation & co-ordination– Passporting – allocation & co-ordination– Notifications – allocation & co-ordination– Some formal reports – allocation & co-ordination

– Preparation point – study and respond to the consultation

A change to APER

– Minimising duplication• Only FCA can specify CF30 for any firm• Only FCA can specify SIFs for single regulated FCA firms• Both FCA & PRA may specify rules for SIFs at a dual firm

– FCA must minimise overlap and co-ordinate with PRA

– Duplication likely for bank/insurer Chief Executives/S&C oversight

– APER extended• Both regulators can police

– At a dual firm either may withdraw SIF approval whoever granted it

– Each can discipline an approved person whoever granted it

• FCA for all approved persons; PRA for SIFs at dual firms

• Extended to cover all regulated activities undertaken for the firm

Apply to the Financial Conduct Authority(‘FCA’)

Single-regulated

Dual-regulated

Table 2only

Are you a single- or dual-regulated firm?

On which table is/are the CF(s) you are applying for?

Table 1 and Table 2

Table 1 only

Are you applying for CF2(PRA) and CF2 (FCA)?

Are you applying for CF2(PRA) and CF2 (FCA)?

Are you applying for either CF3 or CF28?

Are you also applying for either: (a) one of CF1, CF4, CF5, CF6; or (b) both CF8 and CF3 together?

Are you also applying for either: (a) one of CF1, CF4, CF5, CF6; or (b) both CF8 and CF3 together?

No

Yes

Are you making a paper application, or applying by ONA?

Are you making a paper application, or applying by ONA?

ONA

Paper

Apply to the Prudential Regulation Authority(‘PRA’) (Note that the PRA must have the FCA’sconsent to determine an application)

Apply to

both

Applications Flowchart

Table 2: PRA CFs

CF2(PRA): Non-executive directorCF3: Chief executiveCF12: ActuarialCF12A: With-profits actuaryCF12B: Lloyd’s actuaryCF28: Systems and control

Table 1: FCA CFs

CF1: DirectorCF2(FCA): Non-executive directorCF4: PartnerCF5: Director of an unincorporated associationCF6: Small friendly societyCF8: Apportionment and oversightCF10: Compliance oversightCF10a: Client assetsCF11: Money laundering reportCF29: Significant managementCF30: Customer function

Yes

Yes

No

No

3. Tripartite max – the new reality

a) The FPCWe must ...

Understand and guard against the big risksEnsure shareholders’ money is at risk if a bank failsTake away the punchbowl – when this will work

Mervyn Kingb) The PRA

We are seeking to occupy the middle ground between fixed rules and unpredictable discretion

Julian Adams

c) The FCAI am interested in how to intervene to make things better

Martin Wheatley

a) The FPC’s tools & levers – the long list

1. Countercyclical capital

2. Variable risk weighting

3. Max leverage ratio4. Early provisioning5. Distribution limits6. Liquidity buffers7. Max LTV/LTI8. Margin required9. Deal with central

counterparties10. Trading venues

Simple & effective

Sharp & targeted

Cannot evadeCan work in theoryProtects creditIncreases resilienceLimits exposureIncreases resilienceCentralises risk & reduces contagionManages volatility

Crude and capital not predict stressMay displaces risk

May risk upNot effective in SpainMust be targetedUntestedDamps house buildingCan be evadedEmphasises need for infrastructureDiscourages trading

The FPC – the short list

Insulated from political pressure in Bank and looking at sector level only– Recommendations (comply or explain) is main tool– Direction as further action (needed for speed or clout?)– Subject Parliamentary oversight

• On a tool-by-tool basis • Positive resolution required unless urgent

1. Countercyclical capital buffer >T1 if excess credit – part of Basel III2. Sectoral capital requirement – property related – as & when CRD 43. Perhaps leverage ratio 20184. And the FPC to keep the rest under review.

The work of the FPC

– Capital cushion > Basel III transition path• Retain earnings through limited remuneration and dividends

– Enhance balance sheet resilience through prudent valuations• Identify & mitigate € zone risks

– Consistency & comparability of Pillar III disclosuresInterim FPC Policy Recommendations June 2012

– Preparation point – study the form and gauge possible impacts

b) The PRA

Straddling fixedness and flexibility– The rules are the foundation; the focus is on big forward-looking

questions– The actions of the PRA should be broadly predictable but need not

be constant as facts change – making judgements in a framework• Consistency of treatment between insurers and banks• Alert to cross-sectoral risk transfer such as stock lending & asset swaps• Clear focus on financial stability

– Preparation point – get the focus and deduce the application

The PRA’s approach to supervision

1. A new approach to regulation2. At a time of profound change to global regulation3. An approach based on judgement not rules4. Forward looking regulation – current and future risks5. Focus on safety & soundness6. Use of COND – resources, fit & proper, prudent management7. More dialogue with senior management but not be negotiation8. Emphasise ease of resolution for orderly failure

– Preparation point – see the world through the PRA’s eyes

Supervisory categories

1. Most significant firms whose failure => significant disruption or policyholder damage 200 supervisors for 20 firms

2. Significant firms whose failure => some disruption or policyholder damage 200 supervisors for 75 firms

3. Firms whose failure => minor disruption or will damage substantial number of policyholders

4. Firms whose failure => some disruption or damage some policyholders

5. The remainder 3+4+5 = 200 supervisors for 1500 firms

The PRA will focus on ...

– Peer analysis– Structure– Governance– Risk management & controls– Capital & liquidity

And will use the Proactive Intervention Framework– Increasingly intensive supervision– Triggering recovery plan

PRA supervision for insurers (and banks)

A single supervisory strategy based around 30 questions:• Is the firm financially sound?

• Is the business model robust?

• What are the vulnerabilities and how are they mitigated?

• What do the stress tests tell us and how are the results actioned?

• What harm will failure do and how can this be mitigated?

In four stages1. Assess business model vulnerability

2. What is a reasonable resolution approach? Scheme, runoff or what?

3. What is the financial strength as determined under Solvency II?

4. Are risk management and governance adequate?

– Preparation point – identify & manage the risks as PRA sees them

c) The FCA

The new philosophy– Looking at consumer behaviour and what drives decisions– People make easy mistakes

• How can they assess risk?• How can they compare complicated products?

– Transparency is not enough ... does your business model deliver• Product and approval processes that produce the right product?• Point of sale processes that produce suitable outcomes?

Martin Wheatley May 2012

– Preparation point – look through your customers’ eyes & think TCF

The Journey to the FCA ...

1. This is a unique opportunity to shape financial services regulation

• Our opportunity to reset conduct standards

2. We will tolerate lower levels of risk –

• FSA’s £250m in 5 years => 10,000 customers ach lose £300

3. We will not stifle growth but allow innovation & appropriate market access

4. Our leaders will make decisions and reach judgements faster

5. The six retail TCF outcomes remain core

6. We will conduct rigorous research ... Including behavioural insights

7. We will scrutinise product governance & intervene earlier

8. Firms must observe high standards in operational risk management

9. Greater focus on wholesale – protection & value chain

10. The Daily Mail test

• Preparation point – anticipate the challenge

Some new powers

– Ban misleading financial promotions to help us raise standards

• Not always the worst cases nor always measure harm

– Publicising enforcement action earlier

• Helping consumer better understand our action

– Consumer bodies can raise super-complaints

• Over consumer and competition issues

– Ensuring fair treatment of consumers through CCA regulation

– Taking a more pro-competition approach to regulation

• Still thinking but will take bold and wide reaching action

• Will challenge providers on value for money of products

• Barriers to entry/expansion; market dominance; weak consumer engagement –bundled/inertia

FCA conduct supervision

– In-depth supervision for firms with potential to cause greatest risk

– Underpinned by supervisory judgements on model, culture & TCF

• C1(large retail bank/insurer) continuous individual analysis 2 year cycle

• C2 (large retail/wholesale) continual group analysis 2 year cycle

• C3 (retail/large wholesale) analysed by sample for outliers – 4 year cycle

• C4 (small intermediary) touch point every 4 years

– Firm Systematic Framework – customer interests and market integrity at heart of the firm => spotting issues before they happen

• Governance

• Product design

• Transaction process

• Post-transaction handling

The FCA is considering eight success measures

1. Successfully intervening earlier2. Dealing quickly and effectively with crystallised risks3. Putting consumers at the heart of what it does4. Addressing competition issues to benefit consumers5. Influencing international policy

• Negotiation position based on consumers’ interest and ensuring no dilution of consumer protection

6. Delivering judgement based early intervention7. Delivering BAU8. Encouraging positive firm cultural change

FCA agenda by sector – a measure of continuity

Retail banking

– Responsible lending

– Bundled accounts

– Uprisking

– BCOBS

Asset managers

– SYSC

– CASS

– Platform transparency

IFAs

– Suitability – CIP, DIF &c

– Pressure of RDR

Wholesale

– Market integrity

– Systems and controls

– Place in the product chain

Generally

– Cost cutting

– Remuneration

– Cross selling

– Outsourcing controls

– Complexity in product design

Preparation point: grasp the agenda

FCA agenda – draft product intervention policy

– To address potential or actual consumer detriment– Looking at breadth, depth and context

• How many? How much? How vulnerable?

– Outside FCA’s view of proper market• Obnoxious features• Market cannot address – barriers to entry or exit

– For example• Single premium PPI• SCARPs

– Preparation point – review and build into your design process

The FCA agenda – competition plans

– Promoting effective competition in the interests of consumers– Product intervention to tackle competition problems such as products

and services with the following characteristics• One-off high value transactions• Long term investments where problems only appear many years on• Asymmetries of information• Inherent complexities• Linked-in sales practices such as tying and bundling• Barriers to switching• Barriers to entry.

– Preparation points• Review your products through a competition filter• Consider also comparative prices, value for money and clarity of pricing.

Continuity & change in Enforcement

Credible deterrence has been at the centre of our enforcement strategy for a number of years. Simply put, credible deterrence is about taking tough, targeted, effective, public action against firms’ and individuals’ mis-conduct as a way of changing behaviours ...

Martin Wheatley July 2012

... enforcement needs to get further up the chain of command – to look increasingly at those in senior management who fail to recognise and manage the risks their firm is running

… we need to have a low tolerance for firms that constantly bump along the bottom.

Tracey McDermott July 2012

PRA + FCA = ?????

– You will be dealing with two regulators– Two sets of people will ask you questions – conduct & prudential– You must prioritise them equally– We will try not to duplicate– There will be a culture of cooperation

Martin Wheatley May 2012Coordination & an MoUCommon standardsSupervisory committees– Preparation point – staff up and be resilient

4. But there is still a future yet to happen ...

a) The future crisisb) Restructuring UK banksc) The future EU (coming our way soon) agendad) The future global agenda

a) Handling the future crisis

– FPC should spot and pull the levers– PRA/FCA should respond and address the issue– And if failure occurs

• Bank: compare NT v B&B• Special Administration Regime: FSA can require prioritisation of return of

client money, engagement with market infrastructure & business transfer– MF Global => SAR 31.10.11

– Client money return commenced 8.12.11

– 90% client money recovered by 1.5.12

– Pritchard Stockbrokers: FSA facilitated transfer to another firm

b) Volcker, Vickers & Liikanen – restructuring banks

HMT has accepted Vickers (July 2012) …– Retail banking ring-fenced within separate stand-alone subsidiary– Domestic retail banking inside; wholesale/investment banking outside. The ring-fence– Must – deposits & overdrafts to individuals and SMEs; – Not - wholesale & investment banking, prop trading, securities & derivatives.– May - domestic & large corporate loans; payment & transaction servicesBut –– Not follow US/Volcker – Not match the EU regime and Liikanen proposals?– How affect Channel Island retail deposits (Ex EEA)

c) EU timetable: Single market, banking crisis reforms and now the Euro-crisis

– Banking– CRD IV: 2013-2019– RRD: 2014 – 2015 – Banking Union in

Eurozone: 2013-2014– Liikanen Review– DGS

– Funds– AIFMD: 2013– UCITS IV: 2011– UCITS V: 2014

– Insurance– Solvency II: 2014– IMD II: 2015– IGS

–Key

–No Proposal

–Trialogue in process

–Adopted but implementation still to come

–In force

EU timetable (2)

– Securities, Derivatives, and Investments

– MiFID: 2015– Short Selling: 2012– MAD II: 2015– REMIT: 2013– EMIR: 2012/13– PRIPs: 2014– CRA– CSD

– Listing and Prospectus– Amending Prospectus

Directive and delegated Regulations: 2012

– Transparency Requirements

d) G20 – the global agenda

Elements of a new global financial regulatory framework– Minimum standards for bank liquidity & capital – Basel III– Ending “too big to fail” through R&R planning – Regulation of OTC derivative markets– Reform remuneration– Work still required on

• Cross border cooperation• Strengthening supervisory mandates• Oversight and regulation of shadow banking• Common accounting and financial standards

– Preparation point – keep watching out for change