Financial Services and Markets Act 2000 (PRA-regulated Activities) Order 2013
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Lord Newby
That the Grand Committee do report to the House that it has considered the Financial Services and Markets Act 2000 (PRA-regulated Activities) Order 2013.
Relevant documents: 18th Report from the Joint Committee on Statutory Instruments, 26th Report from the Secondary Legislation Scrutiny Committee.
Lord Newby
My Lords, I shall speak also to the other three orders made under the Act. As I said in respect of the previous order, the Financial Services Act establishes a system based on clarity of responsibility and focus for the new regulatory bodies, avoiding the confused and ineffective tripartite system that it replaces.
The new system will make the Bank of England clearly responsible for financial stability and will provide for two focused regulators with clear remits. The Prudential Regulation Authority, or PRA, will be responsible for the prudential regulation of firms that manage complex risks on their balance sheets. The Financial Conduct Authority, or FCA, will be a focused conduct of business regulator. This group of statutory instruments relates to the scope of the responsibilities and powers of the PRA and FCA. The Government’s guiding principle in all these orders is that there should be clarity of responsibility and effective co-ordination mechanisms where necessary.
First, I turn to the draft order made under Section 22A of the 2000 Act, which establishes which activities will be prudentially regulated by the PRA. The draft order provides that deposit-taking, effecting and carrying on contracts of insurance, and certain other activities in relation to the Lloyd’s market will all be PRA-regulated activities. All firms that carry them out will be regulated by the PRA. That reflects the complex nature of the risks borne by firms that engage in such activities and the need for specialist prudential regulation. Additionally, the activities of some investment firms are of such scale and complexity or are interconnected with other firms to such an extent that they may pose risks to the entire financial system or to other PRA-authorised firms. The PRA will be able to designate such investment firms to be prudentially regulated by the PRA.
The draft order sets out the criteria which the PRA will apply when considering whether an investment firm should be designated. First, the firm must hold, or be seeking to hold, permission to deal in investments as principal. In other words, it must be an investment firm or be applying to be an investment firm. Secondly, the firm must be of a type and size that is required to have initial capital of €730,000 under the capital adequacy directive. This means that it must be relatively large and complex. Finally, the PRA must conclude that designation is desirable, having regard to its objectives.
When deciding on the designation, the PRA must also give consideration to certain other factors. It must consider the assets of the firm in question. If the firm is part of a financial group, the PRA must also look at the size and complexity of other investment firms in the group, and at whether the activities of the firm in question could affect their safety and soundness. The draft order was first published more than a year ago and it has the overwhelming support of consultation respondents. I hope that it will be equally acceptable to the Committee.
Next, I turn to the threshold conditions order. The threshold conditions are the minimum requirements that firms need to meet to become authorised. They are a key supervisory tool and provide the basis for triggering certain of the regulators’ powers to intervene. On the recommendation of the Joint Committee on the draft Financial Services Bill, which carried out pre-legislative scrutiny on the Bill, the Government reviewed the threshold conditions to ensure that they support judgment-led and forward-looking regulation.
The revised conditions set out in the draft order will provide clarity about which aspects of a firm’s business are of interest to each regulator. They will also deliver clear, relevant and unambiguous standards which firms are required to meet and which will be used by the PRA and FCA in exercising their judgment. Lastly, they are aligned with the priorities of the FCA and the PRA—for example, including a reference to whether firms are “resolvable”, which will be a key consideration for the PRA in understanding the risks posed by individual firms to the financial system as a whole.
I turn next to the Financial Services Compensation Scheme order. The FSCS plays a crucial role in the financial services sector, supporting consumer protection and confidence in financial services while serving to protect and enhance financial stability. The Government are committed to retaining a single Financial Services Compensation Scheme, so that there is a single point of contact on compensation for consumers. However, given the important role that the FSCS plays in the financial system, both regulators will interact with the FSCS, and the Government have legislated that in the new regulatory system the FCA and PRA will have joint oversight responsibility for the FSCS and split rule-making responsibility.
As the scope of prudential regulation by the PRA is set out in secondary legislation, it is also necessary to specify the claims that each regulator may or may not make compensation rules for by statutory instrument. Broadly reflecting the division in regulatory responsibilities between the PRA and the FCA, the order makes the PRA responsible for making compensation rules in relation to claims for deposits and claims under a contract of insurance.
The order also provides that the PRA may make compensation rules relating to the activities of managing the underwriting capacity of a managing agent at Lloyd’s, or arranging contracts of insurance written at Lloyd’s. The inclusion of these activities in the order reflects the PRA’s regulatory responsibility in these areas but does not mean that the PRA will be expected to make compensation rules for them. To be clear, the FSA does not currently make compensation rules for these activities and it is not expected that the PRA will do so. Conversely, the FCA will be responsible for making rules to deal with claims for all other matters. This will include claims for mis-selling.
Finally, I turn to the mutuals order. The FSA’s most important regulatory functions and powers were established in the Financial Services and Markets Act 2000. However, the FSA also has a range of functions under the legislation that governs the establishment and operation of mutuals. This order does two things. First, it replaces references to the FSA in the various pieces of mutuals legislation with references to the FCA, the PRA or, in some cases, both. Secondly, it inserts mechanisms similar to those in the Financial Services Act requiring the two regulators to consult each other and co-ordinate their actions in certain cases.
The division of the responsibilities under mutuals legislation follows the general division of responsibilities between the PRA and the FCA under FiSMA. The PRA is given all of the FSA’s mutuals functions that are relevant to the safety and soundness of PRA-authorised mutuals. The FCA will take over the other functions of the FSA, including those related to registration, the register and the public file, the enforcement of offences and the majority of the functions related to administering mutuals in general.
I draw to the Committee’s attention that the order applies the PRA’s objectives to its functions under mutuals legislation but not the FCA’s. Applying the PRA’s objectives means that when carrying out a function under mutuals legislation, such as directing the merger of two building societies, the PRA will be held to account for whether its actions promote its objectives. However, the FCA’s tasks under mutuals legislation are mostly administrative in nature. It will have little discretion as to how it goes about them, so it would not really be possible to hold the FCA to account for whether it was approaching its tasks in a way that advanced its objectives. In the legal sense, there is little to which the FCA objectives could apply. The FCA’s objectives of course apply to all its regulatory activity in relation to mutuals that is carried out under FiSMA, such as making rules and imposing requirements.
With that explanation, I commend these orders to the Committee and I beg to move.
Lord Eatwell
My Lords, I am grateful to the noble Lord for introducing these orders. Like him, I will deal with them altogether. Before doing so, I declare an interest as a non-executive director of a financial services firm as set out in the Register of Lords’ Interests. Turning first to the PRA-regulated activities order, I still am somewhat puzzled as regards the whole definition of the large investment firm. Are we simply relying on the CRD definition expressed as €730,000-odd or is there some broader definition of what is meant by a “large investment firm” which the PRA has in mind?
Also with respect to that, under Article 6.5, what is the procedure if the FCA disagrees with the PRA’s decision to withdraw a designation? The consultation process should form a check on the PRA and not just act as a rubber-stamping on behalf of other bodies. There should be some scrutiny of important decisions that the PRA wishes to undertake, although of course without undermining its powers. What will be the dynamic when there is some form of disagreement and how are those disagreements to be mediated?
The threshold conditions are entirely appropriate but I want to focus on Article 2A about suitability. I found the discussion of suitability as a threshold condition—a very important threshold condition in any regulatory system—to be rather more vague than I would have expected. For example, under Article 2E(e) those who manage the affairs in investment firms have to have “adequate skills and experience”. Who defines adequate? What is meant by adequate? Does adequacy refer to a particular examination standard or standards of experience which might be expected?
In addition, the PRA might be expected to act with probity. Do we need a more precise definition of probity or will we simply regard it as having not yet been caught? How will we determine the conditions of suitability? Should they not be more precise, as individuals who wish to work in the financial services industry surely should have precise conditions and not be turned down on the basis of those rather general statements?
I have rather more questions on the Financial Services Compensation Scheme. Again, I will start with the problem of consultation between the PRA and the FCA. It seems to me that the PRA and the FCA are required to develop rules for access to the FSCS. How will they disclose that? What is the rule-making procedure referred to in this instrument? What will the procedure look like? Will they review the FSCS’s current rules? Presumably, they will. When we have had that review, will there be a transparent report to Parliament of the substance of that review?
There is a relationship between the discussion of mutuals and the FSCS. As the noble Lord will be aware, there has been considerable disquiet, to put it mildly, among mutuals with respect to the contributions that they make to the FSCS relative to those made by banks. I may have missed it, and if I have I apologise, but has there been any development on the levies made on mutuals in their contributions to the FSCS?
Turning specifically to the order before us, are there any substantial changes to the functions of the regulator in relation to mutuals contained in this order, or is it purely a transfer activity? Let us take one example which attracted my attention as I read through the order and raised this question. Paragraph 5 of Schedule 1 states that the FCA has an obligation to,
“maintain arrangements … to determine whether persons are complying with requirements”.
That is pretty vague. What sort of arrangements do we mean? Could there be some clarity as to what is to be implemented here?
Given the Government’s determination to make five regulators where there was once just one, what will happen with respect to consultation between the PRA and the FCA when action is required rapidly; for example, in criminal proceedings? How can we ensure that the consultation procedure will be prompt?
Overall, we are broadly content with the orders. We are concerned specifically about a lack of clarity at various points, to which I have referred, and about the introduction of additional complexity because of the requirement for consultation at various stages between the PRA and the FCA. I would like some reassurance on those points.
Lord Newby
My Lords, if there is a leitmotif running through the noble Lord’s questions, it has to be about how the two bodies work together. This theme ran also through previous debates in your Lordships’ House and gets to the core of arguments about whether the Government were right to split the FSA at all. The view that we took is that we needed to give greater focus to the two elements of regulation. It was very important, having done that, we then set in place ways in which the two regulators would work together. As the noble Lord knows, there are a number of points in the Act where the two bodies are required to establish memoranda of understanding explaining exactly how they are going to work together. The success of the new structure will depend to a very large extent on that working. I know that the bodies as they are establishing themselves are absolutely aware of that and are putting co-ordination and consultation procedures in place.
Perhaps I may deal with some of the specific points that the noble Lord raised. He asked whether the designation of a larger firm was simply the €730,000 capital requirement. The order takes a number of criteria into account, not all of them from the CRD. I read some of them out. The PRA, for example, has to conclude that designation is desirable, having regard to its objectives—this is part of the regulator exercising judgment. That is an additional criterion beyond the €730,000; it is not automatic.
The noble Lord asked what would happen if the FCA disagreed with the PRA’s decision to withdraw designation. This is a decision for the PRA. We expect it to give considerable weight to the views of the FCA, but it is ultimately a matter for the PRA.
The noble Lord asked whether the definitions should be more precise, in particular the definition of “probity”. The Government do not consider that the concept of probity is significantly more subjective than other criteria against which the regulator must make regulatory judgments. Recent conduct and mis-selling scandals have shown more than ever how important it is that firms conduct themselves with probity, and it is right that the regulators can make an assessment on whether this is the case and take action where it is needed. A general question for legislation is how far it attempts to define terms which are in common parlance and have a common understanding. Our view is that in this respect the legislation goes as far as it should do.
The noble Lord asked about mutuals and whether there had been a change in class. This has been a long-standing beef of the mutuals; they feel that they have to bear the burden of the incompetence, folly and recklessness of others. That is a question for the authorities to decide, but for the time being they remain in the same levy class that they have already stayed in.
I shall try to deal with one or two other points. The noble Lord asked about the procedure for FSCS rules. The same procedure applies as for other rules; there is a duty to consult but no duty to carry out a cost-benefit analysis. There are no plans to change the rules as part of the transition. Once the transition has taken place, it will obviously be for the new regulators to decide whether they are happy with them, but we are not planning to do that at the same time.
On the question of consultation between the FCA and the PRA on mutuals functions, the order makes express provision for consultation where it is needed. The general provisions relating to the FCA/PRA MoU, which I referred to earlier and which are set out in Section 6 of the Act, will apply in this area as they will in many others.
I hope that I have answered the majority, if not all, of the questions posed by the noble Lord, and I commend the regulations to the Committee.