Reshaping the supervisory role in the financial sector The case of the UK Charles Taylor – Chief Operating Officer 25 January 2011 icffr.org

The regulatory cycle Phase 1crisis management and stabilisation Phase 2“grand plan” emerges. G20 international cooperation, the Financial Stability Board. Turner / De Larosiere reports. Economies begin to steady Phase 3detailed legislative proposals tabled, economies start to recover, the tension between international ideals and domestic imperatives become more apparent. Industry pushback becomes more manifest Phase 4detail of legislative proposals is tested. Industry pushback grows, political commitment wanes. G20 falters / reassesses. Long implementation phase begins. Regulatory capture

Thirty years of the Basel process Source: BIS December Full implement’n of Basel III Basel III consultative document issued Revised securitisation & trading book rules Basel II issued Market risk amendment issued Basel I issued Implement’n of Basel III begins Basel III consultative document issued Revised securitisation & trading book rules Basel II issued Market risk amendment issued Basel I issued G20 endorsement of Basel III

Protracted implementation timeline

Existing –vs– new paradigms Existing paradigmNew paradigm Monetary policy focused narrowly on price inflation Monetary policy focused on price inflation, but leaning against financial imbalances Microprudential policy focused on individual banks Microprudential policy married with macroprudential focus on systemic risk Reliance on internal risk management, self-regulation and market discipline Higher bank capital, better governance, and expanded perimeter of regulation Fiscal policy does not incorporate financial stability concerns Countercyclical fiscal policy (fiscal buffers) Domestic focusMore global coordination Source: H Hannoun, BCBS, March 2010

The international regulatory structure Source: CMS Cameron McKenna ESRB European Systemic Risk Board EU Legislators Council of Ministers European Parliament European Commission ESFS European System of Financial Supervision EBA Banking (London) EIOPA Insurance and Occupational Pensions (Frankfurt) ESMA Securities and Markets (Paris) G20 BCBS, IOSCO, IAIS, IASB International standards bodies and regulatory forums FSB Financial Stability Board Working with IMF / OECD Co-ordination Reports on systemic risk Provides data from firm supervision

The new UK regulatory structure Source: CMS Cameron McKenna Government HM Treasury Bank of England PRA: Prudential Regulatory Authority Judgement based prudential and financial supervision CPMA: Consumer Protection & markets Authority FPC: Financial Policy Committee Macroprudential tools MPC: Monetary Policy Committee Banks & building societies Investment banks Insurers & other financial institutions Insurance, mortgage and investment intermediaries Represents UK at EBA, EIOPA and ESRBRepresents UK at ESMA Normal and emergency liquidity provision to banks Prudential and COB supervision COB supervision

The new UK regulatory philosophy Source: ICFR The majority of policy will be formulated at the EU level Regulation now more proactive, outcomes based approach, with focus on forward looking firm based judgement a key element is that orderly business failure with minimum cost should not be seen as a regulatory failure The Prudential Regulation Authority (PRA) will work closely with the Financial Policy Committee (FPC) to assess systemic risks The new Consumer Protection Markets Authority (CPMA) to be the “consumer champion” The CPMA will aim to balance rules vs. principles in the pursuit of “deterrence and redress” Transition to the new structure is planned to occur in the second half of 2012

Role of the PRA PRA will be a focused prudential regulator, equipped with the philosophy, systems and skills to deliver a single statutory objective PRA will promote the stable and prudent operation of the financial system through the regulation of individual financial firms with the aim of minimizing the disruption caused should they fail PRA will use ”judgement” and risk models to determine potential level of impact and hence engagement

Assessing impact to define approach Firms will be analysed and categorised as low, medium or high impact firms in terms of the impact on the economy of their failure Supervision of low-impact firms Centre on resolvability Monitoring of compliance with rules and reacting to any issues that may arise Basically an extension of the FSA’s current regime for smaller insurers and credit unions Supervision of medium-impact firms PRA prepared to tolerate failure PRA will seek to reduce both the probability and the impact of failure through its supervisory strategy Failure of such firms may have a non-negligible impact on the financial system (or be resolved at non-negligible cost)

Assessing impact to define approach Supervision of high-impact firms For high-impact firms the impact of failure is significant PRA will focus senior supervisory resource on delivering intensive, intrusive and judgement-based supervision Focus on issues that significantly effect the safety and soundness of the firm PRA will have a low tolerance for failure PRA wants to distance itself from ’tick box’ regulation

CPMA – objective and scope A more intrusive regulator with earlier intervention Responsibility for the regulation of conduct in wholesale and retail markets to ensure market integrity, stability and efficiency Specific focus on protecting consumers Prudential and conduct of business regulation responsibility for c25,000 firms Responsibility for the conduct regulation of the 2,200 firms regulated by the PRA Regulation delivered using a risk model focusing on early risk identification and prioritisation of interventions

CPMA – consumer protection Using tools for comprehensive risk identification and analysis Earlier intervention and less reliance on firms’ own systems and controls and on disclosure to minimise risks Industry-wide interventions rather than firm-specific inspection (although these will continue at a similar frequency used by FSA) Ability to deploy resources flexibly to tackle issues and risks

CPMA – regulation of conduct in wholesale financial markets Protecting London’s position as a major global financial centre Promoting confidence in the stability, integrity and efficiency of UK financial market UK representation to ESMA

Key considerations Effective cooperation between national and international regulatory institutions Management of systemic risks / data within and cross border Bankers’ remuneration Wind down mechanisms / resolution schemes Competition within the banking sector Competition between financial centres Suitably qualified supervisory staff Economic and financial stability – sovereign and private debt stabilisation – international capital flows Assessing the aggregate cost of new regulation

A closing thought Regulatory effectiveness is determined more by the underlying philosophy of regulation and quality of the judgements made than the specific regulatory structure Will two new focused authorities perform better than the old regime? What does good regulation look like?

Reshaping the supervisory role in the financial sector The case of the UK Charles Taylor – Chief Operating Officer 25 January 2011 icffr.org