Financial Services Future Regulatory Framework: A bonfire of investor protection?

The House of Commons Treasury Committee (TSC) has published its second report on the future of financial services regulation, considering the priorities for regulatory change.

Its findings strike an unexpectedly cautious note, suggesting that the TSC sees the possibility of change as a costly prospective bonfire of investor protection rather than a much-needed flexing of regulation towards the needs of the UK market and its customers.

Background

The Government is undertaking a review of the UK financial services regulatory framework to address issues that have arisen as a consequence of Brexit. HM Treasury refers to this as the Financial Services Future Regulatory Framework (FRF) Review and consulted in October 2020 and November 2021.

What are the 3 main points made in the report?

• First, not to change too much. While UK regulation can be tailored or simplified, the TSC doesn’t want to see too much change, or for it to happen too quickly.
• Next, no watering down. The TSC believes that HM Treasury wants to weaken regulatory standards to cut costs and attract more business. There’s little evidence for this however, and John Glen MP, Economic Secretary to the Treasury, is crystal clear that there is no interest in a race to a regulatory bottom accompanied by failed firms and ruined investors.
• Lastly, no emphasis on competitiveness. The TSC doesn’t want the regulators to have even a secondary objective of ensuring the UK’s long-term competitiveness, but competitiveness has never implied laxness. A properly risk-attuned rulebook overseen by a slick and efficient regulator would make a major contribution to the UK’s future prosperity. The TSC recognises this by recommending that the regulators review capital requirements, foster innovation and enhance their own efficiency.

The report’s findings in more detail

• There is no need for radical reform of UK regulation. There is no immediate need for a dramatic overhaul of financial services regulation. There are opportunities to tailor and simplify the regulatory framework to better suit the UK market, but regulatory reform should be approached with care.
• HM Treasury must respect regulatory independence. The regulators should not come under any pressure to weaken or water down regulatory standards.
• Cost of change. Regulatory change results in potentially significant costs – even deregulation. The regulators should make every effort to limit costs, although short term costs should not limit the scale of their ambition.
• The importance of mutual recognition. The clear view from the financial services sector is that co-operation between international regulators is better than trade deals for ensuring reciprocal market access. The Government should therefore strive to make progress on mutual recognition as an element in any free trade agreement.
• There should be no new competitiveness secondary objective for the PRA and FCA. HM Treasury has proposed new secondary objectives for the PRA and FCA in relation to economic growth and competitiveness. The TSC expresses unease about the idea of competitiveness being an explicit objective. It fears it may lead regulators to ‘overly loosen regulatory constraints’, and result in a ‘race to the bottom’ on regulatory standards. The TSC therefore recommends there be a secondary objective for the FCA and PRA to promote long-term economic growth only.
• The FCA should have regard for financial inclusion, but this should not be an objective. The FCA has a role to play in financial inclusion and should be mindful of who might be prevented from accessing financial services when making new rules, and report annually to parliament on financial inclusion.
• HM Treasury should commit to a timeframe for moving retained EU legislation across to the regulatory rulebooks. The TSC recommends that HM Treasury and the regulators publish a schedule of approximately when they expect each EU file to be transferred to the regulators’ rulebooks, including timelines for consultations and when the overall project is expected to conclude.
• HM Treasury should proceed cautiously with its proposed accountability mechanisms. HM Treasury has proposed a series of new accountability mechanisms, including a new power for HM Treasury to require the regulators to review their rules and formalise cost-benefit analyses. The TSC urges caution, stressing the need for regulatory independence. The TSC is not positive about HM Treasury’s proposal for a statutory panel to advise regulators on cost-benefit analysis as this will be of only marginal value and could compromise regulatory independence.
• The FCA must work faster. The FCA is acting too slowly in its authorisation work, and a ‘deteriorating picture’ is revealed by the information it provides on its performance against service standards. This will inevitably hold back UK fintech companies and crypto firms, as well as larger firms.
• The FCA should consider how to improve consumer representation. The TSC says the FCA should look at improving its engagement with consumers; this would include improving data about those on the lowest incomes and the issues experienced by vulnerable customers. Engagement at present is skewed towards industry.
• Capital requirements for banks and insurers. The TSC intends to scrutinise the PRA’s ‘Strong and Simple Framework’ proposals for smaller banking firms. When reviewing Solvency II, the PRA and HM Treasury should aim to achieve a robust regime that captures risk and incentivises investment in infrastructure and business and is also appropriately tailored to the UK market.
• Use of internal models. The PRA should consider whether it can do more to reduce the advantages enjoyed by large banks and insurers through modelling their own capital requirements. This would strengthen competition by reducing barriers for smaller/newer firms.
• Controlled experimental innovation. The FCA should investigate how it might enable larger firms to undertake controlled, supervised experiments with innovative products. It might be desirable to allow firms to be more experimental with product design if they set aside additional capital to compensate consumers ‘generously’ if new products turn out not to be as beneficial as anticipated. This is an example of the type of ‘bold approach’ the FCA should be willing to consider.
• Payments innovation. The report notes the range of innovations taking place in payments systems and with alternative means of exchange (including crypto-assets, stablecoins, and central bank digital currencies). The TSC acknowledges the opportunities they represent and the potential for beneficial outcomes, but cautions that there are challenges including consumer protection, preventing crime and financial stability. It intends to conduct further work on how those challenges can be managed.

Analysis:

Those that hoped for an endorsement of bold reforms, prioritising an agile, simplified regulatory regime focused on international competitiveness, may be a little disappointed by the cautious tone of the TSC. However, this report is just one contribution to the debate and it may not persuade HM Treasury to alter its broad reform agenda. HM Treasury may well proceed with its plans, including those for a competitiveness objective, despite these recommendations.

This article was first published in Thomson Reuters on Tuesday 21 June 2022.