It’s not a joke and the date of its demise is coincidental insists the UK Financial Services Authority (FSA), which will be replaced by the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA) on 1 April 2013. The outgoing UK regulatory body has revealed the business plan and risk outlook for the new bodies, including easier entry rules for start-up banks, while also confirming that new Libor rules and regulations, coming in after the manipulation scandal, will also start on Monday 1 April.
The new Libor regime will have benchmark administrators to corroborate submissions and monitor for suspicious activity. Data submitters will be subject to new systems and controls and a conflict of interest policy, while both groups will be subject to an Approved Persons Regime. The new rules start on 1 April and follow the recommendations of the Wheatley Review, which outlined a 10-point reform plan for Libor, and other benchmarks, last September, following the Libor manipulation scandal which came to fruition last summer and adversely impacted corporate treasurers relying on interbank base rates to provide the ‘floor’ for derivatives hedges, right through to consumer repayment loans.
The Euribor index is exempt for the time-being, although this will soon be covered too, as will other commonly used financial benchmarks in compliance with the wishes of the European Securities and Markets Authority (ESMA) and the European Banking Authority (EBA) expressed earlier this year, and the already stated wishes of the FSA (see their policy statement and more details here).
Interestingly, Martin Wheatley, the man who made the UK recommendations to clean up the Libor setting mechanism is also the chief executive officer (CEO) designate of the new FCA regulatory body in the UK, which is the largest of the post-FSA bodies coming into being. It will focus on consumer protection and supervise 26,000 firms across all financial industry sectors from 1 April and the prudential standards of approximately 23,000 firms not regulated by the PRA. The latter body will focus on a small number of larger, systemically important institutions, while the Financial Policy Committee (FPC), which is also controlled by the Bank of England (BoE), will focus on systemic risks to the entire financial system under Britain’s new post-FSA regulatory regime, examining leverage ratios, countercyclical capital buffers, and the like.
The implementation of the Wheatley recommendations is certainly needed, as is an international rulebook, especially with the Freddie Mac lawsuit against the banks responsible for Libor manipulation recently launched by the US Federal Home Loan Mortgage Corporation acting as the latest manifestation of this on-going scandal. For instance, Australia has introduced its own interbank rate setting system.
Commenting on the new regulatory regime being introduced into the UK on Monday, Wheatley said: “Firms need to ensure that they are putting the consumer and the integrity of markets at the heart of their business models and strategies. This includes making cultural changes which promote good conduct; establishing oversight around the design and innovation of products and services; and ensuring they are transparent in their dealings.”
New Banks Encouraged
New rules to make it easier for High Street banks to set up in the UK and provide more competition for the existing big five in the UK of Barclays, RBS, Lloyds, HSBC and Santander, are also to be introduced with the advent of the FCA and the PRA on 1 April. New entrants to the banking sector will have to be approved by the PRA for prudential issues and the FCA for conduct. It will be easier and quicker for start-up lenders to get hold of a banking license under the new regime with a six month turnaround time now promised.
Additionally, the Basel III capital adequacy regime will only begin at the 4.5% minimum Core Tier 1 capital requirement for newcomers, instead of the 7-9.5% requirement that is demanded of existing major banks with higher deposits and risks. There is no automatic new bank liquidity premium anymore, therefore, and the PRA says that “the possibility of bank failure should be accepted as a normal market process provided there are clear mechanisms in place to resolve banks smoothly without threatening financial stability”. This is a clear statement of faith in the new post-crash resolution arrangements and wind-up structures put in place in the UK since 2008 and an encouragement to new banks to challenge the established players.
Risk Outlook and Plans
The out-going FSA has outlined the new business plans and risks for its successor bodies, with the FCA in particular expected to take a much more risk-based approach to supervision in future, recognising the diversity of the firms and markets that it regulates. The new regulator will be much more proactive, acting earlier and more decisively than the failed FSA did, which has been held culpable as one of the contributing factors towards the lax regulatory regime that allowed the UK banking sector to get so bloated before the 2008 financial crisis. It is to be hoped lending, customer services and fair fees to corporate as well as retail banking customers, and those seeking small-scale investment products, will be much improved under the FCA. For larger multinationals and corporate treasurers, which tend to deal with the bigger cross-border global banks, the PRA’s interpretation of its new powers for systemically important institutions will likely be much more interesting. A longer risk overview and focus on market integrity are expected to be watchwords for both new bodies, and for the FPC, which should ensure that credit default swaps (CDS) positions and leveraging do not get so out of control again. The FCA will enforce the rules with inspections and enforcement powers that allow it to take action against anyone who abuses the system.
The business plan sets out how these risks will be managed in the first year and how the FCA will use its human and technological monitoring resources to effectively to meet its objectives, which are:
• To secure an appropriate degree of protection for consumers.
• To protect and enhance the integrity of the UK financial system.
• To promote effective competition.
The FSA undertook the risk outlook to identify the key risks in the financial services industry before its demise. This analysis has shaped the FCA’s priorities for its first year of operation, starting from 1 April onwards, with market integrity set as its guiding primary principle. This is eminently sensible after the reputational battering that banks have got from corporate treasurers and the general public since the Libor scandal, the mis-selling of interest rate hedging products to small businesses’ in the UK, and indeed the onset of the 2008 financial crisis.
The key areas of focus for the FCA during its inaugural year include:
• A renewed focus on consumers: This will help to ensure that firms’ strategies are aligned with producing appropriate outcomes − for example, through work on product governance and incentive structures in firms.
• Market abuse: The FCA will attempt to tackle this by taking strong enforcement action to deter future misconduct, something the FSA was always accused of being slow to do on the financial markets, to the detriment of treasurers and others. Focusing on wholesale conduct will also be critical for the FCA, as will the new approach to the supervision of trading platforms and centrally cleared over-the-counter (OTC) derivatives deals. Misconduct, such as the Libor scam, will also be scrutinised more fully in future it is claimed.
• Ensuring a competitive financial services industry: A significant change for the FCA, this will involve building a new competition department to embed competition analysis across the organisation, and take action where failings are identified.
• Policy and EU harmonisation: The FCA will carry forward major policy initiatives, such as the Retail Distribution Review (RDR) on investments and work closely with European bodies, such as ESMA, on important continent-wide regulations such as the Capital Requirements Directive (CRD) IV which will introduce the Basel III capital adequacy regime into Europe.
The risk outlook underpins the business plan. The main specific risks identified for the coming year are: inadequate product design and opaque distribution channels; payment and product technologies that are too central to the business model and not closely monitored; and a poor understanding of risk and return, which combined with the search for yield or income in a low-interest rate environment – whether from treasurers or consumers – can lead to more risk-taking than is appropriate. So-called innovative, complex or risky funding strategies or structures, which lack oversight and imperil market integrity, are also being targeted.
“Our first year as a new regulator will be an exciting and challenging time but one for which we are well prepared,” said Martin Wheatley, CEO designate of the FCA, ahead of its inauguration on 1 April. “We are introducing new approaches to the way we do much of our work, becoming much more proactive. A risk for all regulators is becoming bound to conventional thinking. That is why the new regulator will be much more transparent, so we can learn from our mistakes. There is no room for the poor behaviour of the past. We will take action early and decisively when we see evidence of poor practices.
“We cannot succeed wholly in isolation. To achieve our aims, we need the cooperation of the firms we regulate and the vigilance of their customers. A strong, successful financial services industry is essential.”
An FS sector that doesn't fall apart and drag down the rest of the economy with it is the ultimate aim of the new UK regulatory regime, of course, but as ever the fear must be that the new rules and structures address the crisis just past, rather than protecting the sector against future as yet unforeseen threats. As Donald Rumsfeld, ex-US Defence Secretary, might have said it's the 'unknown unknowns' – the black swans, call them what you will – that you've got to worry about.