In-depth analysis: Regulation: return of the principles
Published 1 September 2016
In the UK, the first half of 2016 saw the announcement of new bosses installed at the main regulators – Andrew Bailey at the Financial Conduct Authority (FCA) and Sam Woods at the Prudential Regulation Authority (PRA). It also saw the passing of the Bank of England and Financial Services Act 2016, which will end the subsidiary status of the PRA within the Bank of England.
These changes mark a further stage in the journey which began with the breakup of the Financial Services Authority in 2013 and the return to the Bank of responsibility for prudential regulation of banks, building societies, insurance companies and some large asset managers.
This left conduct regulation in the hands of a separate regulator and one which its first chief executive, Martin Wheatley, was determined to give a distinct identity. He saw his key relationship being with Parliament as he positioned the FCA as a consumer watchdog first and foremost.
While Wheatley’s approach was inaccurately caricatured as ‘shoot first, ask questions later’, it often gave the impression of valuing eye-catching headlines over regulatory substance, culminating in the botched briefing to the press ahead of the FCA’s announcement in 2014 of a review into life insurers’ legacy policies. There was little surprise when it was announced in 2015 that Wheatley’s contract at the FCA would not be renewed.
An apparently reluctant Andrew Bailey was persuaded to accept the top job at the FCA with a clear brief to change the approach to regulation. This should lead to a return to something more akin to principles-based regulation, says Mathew Rutter, Partner at DAC Beachcroft, who advises on regulatory issues: “Hector Sants [the former chief executive of the Financial Services Authority] famously said he moved away from this style of regulation because a principles-based approach does not work with people who have no principles. But principles can be hugely powerful as a regulatory tool.”
This should be welcomed, believes Rutter: “The principles-based approach was a more effective way of regulating financial services.” However, he cautions against thinking this would mean a less rigorous approach by either the PRA or FCA. “Are we back to lighter touch? No. This is not about a lighter touch. You have to place this alongside other developments which will see greater accountability of individuals and a focus on enforcement and prevention rather than cure.”
The appointment of Sam Woods – a Bank insider already well known to the insurance industry in his role as Executive Director of Insurance – as the new chief executive of the PRA, also serving as the deputy governor with responsibility for prudential regulation, ensures continuity for the insurance industry. He will lead the PRA into a new era of integration within the Bank’s governance structures.
The Bank of England and Financial Services Act, passed in the spring of 2016, will replace the PRA board with a new Prudential Regulation Committee that will have the same status within the Bank as the Monetary Policy Committee and the Financial Policy Committee.
Alongside this, the FCA is developing the use of the more extensive competition powers that it acquired in 2015. This will also shape the new culture of regulation, says Rutter: “The recent trend in regulation has been to make rules and then punish those who breach them and cause consumer detriment, or to identify consumer detriment as a reason for making new rules. A competition-based approach focuses not just on preventing consumer detriment, but on trying to ensure that the market operates more effectively.”
This approach can be seen already with the requirement to publish claims ratios, which will enable consumers to see more readily whether insurance products are likely to represent value for money. This could see the scope of regulation extended into a broader economic sphere, says Rutter: “It is no longer just about the rulebook. The FCA is not yet an economic regulator but it is close to going down that route. It is not hard to imagine it intervening on prices and conditions if claims ratios suggest a product is over-priced.”
The European Union (which the UK will remain part of for at least the next two years) has also signalled that it will be pursuing a much more consumer focused approach (see box). The key driver for this is a desire to complete the single market, says Emma Bate, Partner at DAC Beachcroft: “The real barrier to pan-European retail financial services products is the myriad of additional local law requirements: consumer, financial services and otherwise. For example, local law may require all product literature to be in the local language(s), or local law may automatically apply to the product terms and conditions, plus there may be additional e-commerce and consumer law requirements. Effectively, the cost of taking local legal advice, tailoring product literature and website terms and conditions to that market, and translating them, is a barrier to entry.”
The challenge the EU Commission has set itself shouldn’t be underestimated, says Bate. “Consumer law in the EU and in the UK is already quite advanced. One of the underlying principles is that all consumer terms and conditions must be fair. However, this excludes the subject matter of the contract: that is, the core deal of the financial services product. Further regulation of products would not solve the underlying issue in the retail financial services sector.”
Insurers will be looking beyond the narrow boundaries of specific insurance regulation, says Richard Highley, Partner at DAC Beachcroft – and especially at the new Senior Managers Regimes for banks and insurers. “Both banks and insurers were very concerned to prepare properly for it and have already spent large sums ensuring they will comply with it,” he says. “It is to an extent about the self-reporting of misdemeanours – recognising a problem, owning up, dealing with it and moving on.”
This regime seeks to ensure senior managers are accountable for the conduct of their firms and is due to be extended to all regulated firms from 2018, including claims management companies, which the then Chancellor of the Exchequer George Osborne announced in the 2016 Budget will be regulated by the FCA.
It will mean a significant change in the way legal advice is sought and given when a regulatory breach is suspected: “The days of lawyers simply being asked to advise on what a firm could get away with are long passed. Now they will be asked how best to own up,” observes Highley.
EU consumer agenda develops
The EU’s new approach was announced in the Capital Markets Union Action Plan. During the first quarter of 2016 it consulted on its ‘Green Paper on retail financial services: better products, more choice and greater opportunities for consumers and businesses’. This sought views on improving products, choice and opportunities for firms and consumers across insurance, loans, payments and savings accounts and other retail investments.
It started from the assumption that in the EU there are fragmented markets and insufficient competition, limited cross-border activity, differences in price and choice across member states and minimal consumer switching.
Jonathan Hill, who at the time was the European Commissioner for Financial Stability, Financial Services and Capital Markets Union (but resigned following the referendum result), said at the launch in December 2015: “Financial products like bank accounts, mortgages and insurance are hugely important in the daily lives of millions of Europeans. But people often miss out on the best deals, or pay over the odds because of the barriers that exist in the European market.”
The consultation also considered the impact of digital technology on the market.
The consultation closed at the end of March and the Commission envisages publishing an Action Plan on Retail Financial Services later in 2016, possibly preceded by a conference of interested parties. Given the referendum result, and the resignation of Lord Hill, it is unclear whether the Action Plan will be pursued at a European level, let alone whether it will eventually have an impact on UK firms.
Another set of regulations that will have a significant impact on the sector are the new EU Audit Directive and Regulations, says Highley: “These are likely to result in changes in corporate governance standards as we will see changes in the audit process over the next three or four years.” A key change is the requirement for auditors to report any fall from ethical standards: “With new powers given to the Financial Reporting Council (FRC) to interview staff, and to seek the disclosure of documents from the audited entities, this could be expensive, intrusive and, importantly, potentially damaging to a firm’s reputation. This in turn will over time drive changes in current standards, or so the FRC will hope. Not many people outside the accountancy industry may have heard of the FRC. That will change as FRC investigations demand more headlines.”
Insurers should also take careful note of how new regulations in one field spark the interest of financial regulators, advises Rutter – data protection being an obvious focus at the moment. “The FCA has started to look at big data just as firms are beginning to plan for the new EU General Data Protection Regulation, due to come into force in May 2018,” he says. (See our comments on the impact of Brexit on the GDPR in the Legislation section below.) “The FCA might not have a clear idea of whether there is a problem with insurers’ use of big data but it is trying to send a warning to insurers that they need to think very carefully about handling data professionally and being transparent with customers.”
A principles-based approach will make it easier to deal with new challenges such as big data, social media and connectivity, says Rutter. “If you have a principles-based approach to regulation, that is far more adaptable to new circumstances than a rules-based approach. However, it puts the onus on firms to think carefully about the implications of what they are doing and whether they continue to comply with the principles.”