Transcript: Series 2 Episode 4: The future of regulation: In conversation with HMT

Andrew Strange:

Hi everyone and welcome to our latest Risk & Regulation Rundown podcast. I’m Andrew Strange, your regular host, and as last month, we are recording this remotely, so please note that it might impact on the sound quality.

In today’s episode, I’m delighted to be joined by HM Treasury, as we discuss how the regulatory framework develops in a post-Brexit world. Today’s guests are Lee O’Rourke, Senior Policy Adviser for the Future Regulatory Framework at Treasury, and Conor MacManus, a Director in our Regulatory Insights team, who helps our clients understand regulatory developments.

First of all, there are numerous moving parts to the UK’s future approach to regulation in financial services. We’ve seen publications from Treasury, obviously legislation from the Government, plus the views of the PRA and the FCA need to be considered too.

To start with, Lee, do you want to provide a brief overview of what Treasury is proposing in the Future Regulatory Framework?

Lee O’Rourke:

Hi, thanks Andrew, it’s great to be with you today, it’s great to have the opportunity to discuss our Future Regulatory Framework review. Essentially, what the review is about, is dealing with the issue of what needs to happen to our regulatory framework, now that we’ve left the EU. As everyone will know, our regulatory regime has operated as part of the EU single market for many years. The EU has taken on increasing responsibility for financial services regulation, and our framework has had to accommodate that.

Now that we’ve left the EU, there is a really important job to do of working out how the policy and regulatory functions exercised by the EU will operate in a UK regime, which sits outside of the EU. Importantly, the Government also believes that this is a really good opportunity to review our overall approach to regulation and ensure we have a framework which is right for the UK, which will support a stable, open and globally competitive financial sector for us in future.

Basically, the model that’s proposed by this review, aims to move away from the EU model of regulation, and that’s a model which relies an awful lot on having a lot of prescriptive detailed legislation. That’s something that could be quite problematic, because it leaves you with quite an inflexible regime, one that’s difficult to update, and isn’t very responsive to changing market conditions.

Essentially the review proposes to move back to the regulatory model that was introduced by the Financial Services and Markets Act, which I am sure many of your listeners will be familiar with. That’s a very straightforward model, basically Government and Parliament set the institutional framework, so it establishes the regulators, sets out their remits, powers and objectives. Government and Parliament decide which financial services activity should be regulated. Then the job of designing and implementing regulatory requirements is delegated to independent and expert regulators under that model. Really importantly, the review doesn’t propose just going back to that model, but enhancing it. And it proposes that Government and Parliament have a greater strategic role in setting the policy framework, within which the regulators operate.

The aim is to do that by introducing new policy framework legislation, for key areas of financial services activity. This will allow politicians to have a greater strategic say in what key areas of regulation need to achieve, and crucially the important public policy issues that the regulators should have to think about when they are designing regulatory requirements.

I will just finish by saying that, obviously this model entails quite a high level of responsibility for regulators, so it’s really important that the review examines how regulators are accountable, how their work is scrutinised, and how stakeholders can have their say in the regulators’ policy making process.

Andrew:

Thanks Lee, that’s really interesting, and there is a lot to unpick there, which we will do over the course of this podcast. As you said, quite rightly, FSMA is a really popular read for many of our listeners, but there is also the FS Bill, which is a large enabler of these changes too. Can you tell our listeners a little bit more about the purpose of that as well please?

Lee:

Sure, so while the Future Regulatory Framework (FRF) review aims to deal with how the framework should operate over the long term, the Government is of course still responsible for the UK regulatory regime and has to manage that regime. It’s a top priority for ministers to make sure that the regime remains up to date, that the UK continues to meet its international obligations, and that we make important adaptations for the UK regime to work well, now that we have left the EU. The Bill contains a range of important short-term measures that need to be implemented. Where possible, some of those measures, such as the measures which implement the new Basel III international standards, are implemented in a way which is consistent with the approach that we’ve set out in the FRF review.

To summarise, basically the Bill does what needs to be done to keep our regime up to date and operating effectively in the short term. And the FRF examines how, long term, we will make financial services policy and introduce new regulation.

Andrew:

Thanks Lee, that’s really helpful and quite comprehensive. Conor, if we take some of Lee’s points there and we think about this from a firm’s perspective, how do you feel that the new framework is going to be and feel different for our clients, and what are the messages you have been hearing from our clients?

Conor MacManus:

Just taking the latter part of your question first, the overall feedback that I have had from clients on the proposals has been very positive, both in terms of the substance, but also the level of engagement that the Treasury has done around the topic. There is a general recognition that delegating rule-making powers down to the regulators was the pragmatic option, it’s something that the industry has been advocating for some time, but the idea of them taking into account broader public policy objectives has also landed very well.

In terms of what will feel different for firms, they are very familiar with engaging with the UK regulators and their rulebook, but clearly that’s going to be an even more important relationship. The point that Lee made around this being an opportunity for the UK to really fundamentally reassess its approach to regulation is a really important one. There certainly is scope to use this as an opportunity to make the UK’s regulatory framework more accessible. That’s an important topic for the sector to engage in.

Andrew:

I would certainly agree that there are lots of really positive aspects to this, and it could be a real force for change for good, but the cynic in me always worries about the downsides of these things too. Does the proposed framework have any particular challenges for our clients? You and I have discussed independence at some length, but there must be some concerns filtering through too?

Conor:

That point on independence is obviously a really important one, and one that was discussed at the Treasury Select Committee, with the CEO and Chair of the FCA recently. Clearly, everybody recognises that having independent regulators is a real asset for the UK and one that needs to be preserved.

In terms of other challenges, there is a bandwidth issue for the regulators. They are going to have a lot more policy making to do under the new framework, and they are going to have to resource that. The point that Lee made around understanding the impact of regulation is a really important one. It is something that’s not easy. It will be a challenge both for the regulators, but also the sector, to properly articulate and understand the impact of regulation on those various public policy objectives that they will be looking at.

Andrew:

Thanks Conor. Lee, there are some valid concerns that have been put forward there by Conor, certainly around bandwidth and resources, and impact and the interaction with the public policy agenda. What response do you have to that from Treasury? How do you think you are going to be able to overcome some of those challenges?

Lee:

Thanks Andrew. I hope I can be quite reassuring on those two particular challenges. One of the reasons that ministers think moving back to the FSMA model and enhancing the FSMA model is the right choice for the UK, is that the role of independent regulators is central to the way the FSMA model operates, and ministers are determined to ensure that the independence of the regulators won’t be compromised. What we are proposing with new regulatory principles is not greater political control over what the regulators do, we are just making sure that elected politicians have an appropriate say, in saying what the regulators must consider when they are designing regulatory standards, and crucially that the regulators are fully transparent in explaining how they’ve thought through those issues. At the end of the day, the policy judgments on the standards and the requirements that will be needed will still be a judgment for the regulators to make.

Then on the resources of the regulators, it’s definitely right to acknowledge that, whilst we are not expanding the remit of the regulators under this model, they will of course take on more work and more responsibility in exercising greater policy discretion within those existing remits. But what’s important to remember about that is we already have well established, large internationally active regulators, who are well resourced. And in particular the regulators have had to think carefully in recent years about making sure they’re adequately resourced to deal with the consequences of Brexit. So we think the regulators are well placed to take on the level of responsibility that’s proposed by the review.

Andrew:

Thank you, Lee, and that resource point is interesting. Arguably at the moment, certainly from the FCA in the latter part of this year, we’ve seen a number of delays on particular issues. Things like the duty of care proposals, which have been deferred till 2021. We’ve seen other activities, such as the exit fees for platforms, actually removed altogether from workflow. Clearly, they are reacting to some extent to that resource point. One of the other things that occurred to me was that, with the new objectives being set on an activity-specific initiative basis, so regulators creating a UK version of Solvency II for example, is there a risk that regulators will focus less on initiatives like vulnerable customers, where there isn’t an underlying rulebook?. Do you think we are going to see less of that kind of activity and more of a focus on those specific areas of activity that they are tasked with dealing with?

Lee:

Thanks Andrew, that’s a really important point actually. The new activity-specific regulatory principles are obviously intended to set out important issues that the regulators must think about, that are specifically related to that particular area of activity or regulation, but crucially ministers aren’t proposing to change the overall statutory objectives, which inform everything the regulators do. For instance, the objectives around safety and soundness of firms, market integrity, and consumer protection will stay in place. Ministers think those are the right overall objectives and will continue to give the regulators the right focus for what they need to achieve in a broad sense with their regulatory responsibilities.

Andrew:

I can certainly see a logic that says if it isn’t broken, don’t fix it. But equally, the FCA came into being in 2013, it got concurrent competition powers in 2015. So those overarching objectives haven’t actually changed in a number of years. Certainly, if I think about the market over the last ten years, and think about stuff like AI or crypto, it is quite a different world that we are operating in nowadays. Do you think this is maybe a missed opportunity to have changed some of those objectives?

Lee:

How those objectives operate within the regulatory framework is a really important issue, and this is acknowledged in the consultation document. So although ministers aren’t proposing to change those objectives, they have been examined, and as ministers are responsible for the overall regulatory framework, they will always keep those objectives under review. But ministers concluded that those objectives remained the right overall objectives, but actually we think in practice they will be strengthened by the introduction of specific regulatory principles.

We can deal with emerging issues, for instance, you mentioned the rapid development of business models and new activity in the FinTech and payments spaces. New specific regulatory principles for those areas of activity can ensure that the regulators are thinking about the right issues but are still focused on the overall important objectives of things like financial stability and consumer protection.

Andrew:

Thanks Lee, and as you say, this is a consultation. So, is this a ‘one and done’ consultation? What’s the future timeline of activity for Treasury on this?

Lee:

Thanks, so obviously given the breadth of the subject matter for this review, the overall regulatory framework and the range of stakeholders that will be affected by it, this is intended to be a long-term review. The review actually started almost a couple of years ago now, and the first phase dealt with the more specific issue of coordination between the UK’s regulatory authorities. The second phase, which deals with broader regulatory framework issues, is kicked off by this consultation. This is the first consultation of the second phase, that will conclude early next year.

This first consultation deals with the overall approach but doesn’t intend to solve every specific policy challenge for the future framework. Once ministers have considered the views submitted as part of this first consultation, ministers will then issue a second consultation, which will contain a more detailed package of final proposals, and also set out how the approach is intended to be delivered, how we will transition to the future framework, and that consultation will be issued sometime in 2021.

Andrew:

Thanks Lee, so Conor, that’s the first consultation of the second phase, before we go into the second consultation that looks at the transition, so it’s going to be a quiet year for firms then?

Conor:

Well 2021 is certainly looking like a very busy year from a regulatory perspective and as you alluded to earlier, Andrew, the regulators are starting to react to that. We saw some announcements this week in terms of delays to CRR II and IFR in the UK, which I think is a consequence of the amount of pressure that the sector is under from a regulatory perspective. And actually I think the response from the authorities shows the importance of that first phase of this review that Lee just mentioned, and the regulatory grid which is now being published, was the mechanism by which firms fed back on the amount of change we are going to see next year and resulted in a policy response.

That’s a positive implication of the review that the Treasury is undertaking.

Andrew:

Thank you both, that was a really useful discussion. Given the pressures that are faced by firms at the moment, as we said, in terms of regulatory volume and the Brexit transition ending, and obviously addressing the COVID-19 issue, it is great to see that Treasury and PwC are working to highlight these important changes. As always, with our podcast, is there one key message you would like to leave with firms as a takeaway for what this means for them or why they should engage with the consultation process? Lee, I will start with you.

Lee:

Thanks Andrew, well the first thing I would like to get across is that getting firms to engage with this review is really important. This is a review which will set the overall regulatory approach for a long time to come. So it’s really important that those who are subject to regulation, those who are affected by regulation, get to have their say. Secondly, whilst we’ve set out an overall approach for regulation, which relies on standards being designed and implemented by expert independent regulators, obviously the level of responsibility that gives to those regulators, means that how they are held to account and how they are scrutinised and how stakeholders engage with them, is a really important issue. We do need to ensure that the accountability and scrutiny arrangements that we have in the UK are up to the job. It would be great if those who are subject to regulation think about how the current arrangements work and whether they should be changed or enhanced in any way.

Andrew:

Thanks Lee. Conor, what about you?

Conor:

It is clear that financial services in the UK and across the globe are at a really important juncture. You mentioned Brexit and COVID-19, but there are a range of other challenges and opportunities, such as technology change, change in societal expectations and climate change, a lot of issues that the sector is responding to. And having a regulatory framework in the UK which is fit for purpose, will be integral for the future success of the sector. That really reinforces the importance of this process, of Treasury getting it right, and of the sector engaging in a positive and proactive way.

Andrew:

I agree entirely. Thank you both very much for your time today. I also hope you’ve found this interesting and helpful. Please feel free to share this podcast with colleagues and subscribe to future episodes, and I will be back next month with our next episode.