Sent by email to [email protected] and mail to Financial Regulation Strategy, HM Treasury, 1 Horse Guards Road, London, SW1A 2HQ HM TREASURY: A NEW APPROACH TO FINANCIAL REGULATION – building a stronger system Dear Sir/Madam, I am writing on behalf of Deloitte LLP in response to your request for comments on this paper. We welcome the chance to contribute again to the continuing debate on these important questions. As you will see, we have summarised what we believe are the key issues in an introductory section to our response. Russell Collins Deloitte LLP Hill House, 1 Little New Street, London EC4A 3TR, UK Main+44 (0) 20 7936 3000 [email protected] www.deloitte.co.uk HM TREASURY: A NEW APPROACH TO FINANCIAL REGULATION – building a stronger system We welcome the chance to comment again on the Government’s proposals to restructure the framework for UK financial regulation, and appreciate the considerable detail provided in this document. Before turning to the specific questions set out in the paper, we have summarised our principal points in an introductory section. General comments Transition As we said in response to the first consultation, there are considerable risks in the transition process, especially since it is occurring at a time when there is also a pressing need to agree and implement a wide range of changes to regulatory policy, carry out high-quality operational supervision, operate effectively in international fora, and in particular avoid imposing unnecessary costs on business. We know those involved recognise this, in particular the significant personnel and systems issues involved in splitting the FSA1 into two units and in integrating the arrangements of the PRA2 with those of the Bank of England: it is also important to consider how best to “grandfather” existing authorisations and permissions. As such we think it might be helpful to set out in more detail the plans that already exist to mitigate these risks, to satisfy stakeholders that the process is being managed in a way consistent with best practice for a major “change” project. Timetable As you are well aware, the legislative timetable is challenging. While understanding the wish to minimise the period of uncertainty, we agree with those who have said that it is even more important to take the time to ensure that the end-product is well- designed and robust. An essential aspect of this, as recognised by HMG, is wide and proactive consultation, which we hope will continue in the months ahead. Governance There remain some questions over the proposed governance of the PRA and FCA3. The PRA will be a subsidiary of the Bank of England, with a board chaired by the Governor, and will implement the macro-prudential decisions of the FPC4. In other respects the paper states the PRA will have operational independence for the day-to-day regulation and supervision of firms, with a majority of non-executives on its board and with the Bank having no formal power of direction over it. However, there is more emphasis in the latest paper on the PRA being part of the “Bank of England group” (eg in discussion of its location, and the “close and constant” working relationship that the two bodies will have). If so this could result in the risk of a bottleneck, given the huge responsibility and workload placed on the individual who is Governor of the Bank and 1 Financial Services Authority 2 Prudential Regulation Authority 3 Financial Conduct Authority 4 Financial Policy Committee will also chair the PRA and FPC, unless there are robust arrangements for delegation and other forms of support for these tasks (see Q8). Within the FCA, the Government proposes a strong specialist markets division to lead on all market conduct regulation: indeed, it sees it as a centre of excellence that will enhance London’s reputation globally. We very much welcome this, believing there is a need to distinguish between retail and markets regulation in order to ensure that the regime applied to wholesale business is proportionate and effective by being appropriately differentiated. While the division will need to be integrated into the rest of the FCA, this should not be at the expense of differentiation in some areas: in that context we welcome the proposal to establish a panel for markets practitioners and hope that the distinct identity of the markets area will also be supported by other governance features, such as a strong representation among the non-executive directors of the FCA. Finally, we think it important that a standing practitioner group is established by the PRA to supplement its other arrangements for consultation with the industry. Ideally this would be supported by requirements in primary legislation, even though substance is more important than form here. Its purpose would not be to act as a lobbying group or as a form of accountability, but instead to be a sounding board that could advise - for instance - on how particular regulatory objectives could be delivered in the most proportionate fashion, and on how well supervisory coordination was working both within the UK and more widely. Having a permanent cross-sectoral body of this type would allow for more effective interaction with the industry, since it could more easily cover the regulatory picture as a whole (and its cumulative impact over time) than might ad hoc arrangements with less knowledge of supervisory objectives and practice. PRA/FCA coordination It will be important for the FCA and PRA to work together so that firms do not face unnecessary inconsistencies or duplication in terms of data requirements, meeting requests, supervisory demands and so on. In other words, effective relationship management with the industry will be important to the success of the new structure. The new paper contains more information on how this might work, and we are very pleased that much more detail will be published by the FSA and the Bank of England later in the spring. We believe it would help allay concerns if those concerned also took soundings from the market as to which areas of overlap and duplication might be especially burdensome. While accepting that the PRA and FCA will not be able to delegate their own responsibilities to each other, there is a particular need to spell out how arrangements on governance and controls, as well as “approved persons”, authorisations and permissions, will in practice work, in a way that balances accountability with the need for pragmatism. This might be supplemented by an additional regulatory principle that both bodies should cooperate with one another, to complement the statutory duty to coordinate, unless to do so raises important legal issues. At a more micro-level there is a need for government to clarify, relatively soon, the boundaries between the PRA and FCA on the supervision of “prudentially significant” investment firms. Proportionality This is an important principle, which lies behind concepts such as cost/benefit analysis, considerations of UK competitiveness and the need to ensure that “one size does not fit all”. We are very pleased that this now seems to be embedded much more fully in the new arrangements. Consultation questions Bank of England and Financial Policy Committee (FPC) 1 What are your views on the likely effectiveness and impact of these instruments as macro- prudential tools? Establishing and operating a robust framework for macroprudential supervision is both immensely important and immensely difficult. Since so many of the tools are untested their potential impact is uncertain, and we therefore support the requirement that the FPC set out its proposals for the use of a tool in advance, and review the tool’s effectiveness regularly. In thinking about macroprudential tools we agree work is needed both on the structural and the cyclical issues: the debate on the latter – ie on how to manage the credit cycle – must not lead to neglect of the former. In particular “single points of failure” such as central counterparties must be subject to robust controls and risk management arrangements, and the interconnections within the system should be well understood by policymakers, and by firms themselves. Such steps will address some of the issues on information problems, contagion and market infrastructure set out in paragraph 2.6. We therefore have some concerns that most of the tools described in paragraphs 2.46 to 2.70 are designed to tackle cyclical excess rather than infrastructural problems, though we accept the latter can sometimes best be resolved at source rather than via a “macro” tool. Issues around using these tools (“taking away the punchbowl”) are well known. But there are also problems about ceasing to use them: for instance market pressures may not allow firms to run down capital in a downturn. If so the problem might be addressed by instead reducing the risk-weightings lying behind the capital requirement, such that headline ratios do not appear to fall. Such an approach would not influence the leverage ratio, however, and would therefore represent only a partial solution. We agree further work could usefully be done, over time, both on liquidity and on repo margining requirements: both can exhibit “frothiness” over the cycle and in both cases changes in requirements might take effect relatively quickly. In addition both are intimately connected to the traditional central bank role of providing liquidity. However this work needs to take full account of the wider implications of such a step, on the economy and the availability of credit. 2 Are there any other potential macro-prudential tools which you believe the interim FPC and the Government should consider? Achieving financial stability depends on a wide range of factors - a system which protects financial stability in the event of a Long Term Capital situation would exhibit different characteristics from one resilient to a fall in house prices.