Regulatory turbulence looms on the horizon

Whoever emerges as the victor from the Conservative Party’s seemingly interminable leadership contest later this week will face an in-tray at Downing Street that will be overflowing with urgent government business.

Somewhere amid the huge backlog of issues the new Prime Minister will have to address will be the question of financial services regulation with “Reform” stamped in bold letters on the front of the file, writes David Worsfold, Contributing Editor.

This may pale into relative insignificance alongside the war in Ukraine, the turmoil in the energy markets and the cost of living crisis but it has been an issue both Liz Truss and Rishi Sunak felt was important enough to raise during the leadership campaign.

Both candidates have committed to strengthen the “call in” powers that only appear in a watered down form in the draft Financial Services and Markets Bill (FSMB). These extended powers would give ministers the ability to overrule decisions made by financial regulators. With the Bill already in the Parliamentary system it provides the potential legislative vehicle for the new Prime Minister to overhaul financial services regulation.

This is where the insurance industry could find itself having to take a very depth breath as it could be launched into a period of extreme regulatory turbulence.

There is already a stand-off between the government and the Bank of England over the slow progress of various reforms, with Solvency II at the centre of the row.

The fall-out from the Conservative leadership election could quickly escalate this, however.

Truss, the expected winner, has used her campaign pitches to float the idea of sweeping up Prudential Regulation Authority, the Financial Conduct Authority and the Payment Systems Regulator into a single new mega-regulator. She has done nothing to discourage speculation that this is a serious proposition. It sits alongside her apparent determination to change the overall mandate of the Bank of England and subject it to closer political scrutiny.

If she embarks down this road, it is hard to see how serious work on a highly technical issue such as Solvency II will get much of a look in as the political fireworks go off.

Of course, we have been here before. Not once, but many times as it seems the life span of a financial services regulator nowadays is little more than a decade.

The current arrangement with the PRA and FCA as the two lead regulators was only implemented in 2013 after the global financial crisis and the decision to the break-up the Financial Services Authority – a single regulator. The FSA itself was only born in 1997 when the incoming Labour government decided to reform the system it inherited. Before that there was the Securities & Investments Board, the Personal Investment Authority and a plethora of other regulatory bodies.

Brexit prism
The current debate over another potential major shake-up must be viewed through the prism of Brexit.

When the FSMB was published in the pre-summer Queen’s Speech the government said one of its main aims is to “seize the benefits of Brexit, by establishing a coherent, agile and internationally respected approach to financial services regulation that best suits the interests of the UK”.

This has not gone unnoticed in the European Union. The European Insurance and Occupational Pensions Authority (EIOPA) moved with unusual speed and at the end of July published a consultation paper on the use of governance arrangements in third countries, which is the status the UK now enjoys in relation to the EU.

EIOPA says it is seeking views on “how to enhance the supervision and monitoring of insurance undertakings’ and intermediaries’ compliance with relevant EU legislation concerning governance arrangements in third countries”.

Brexit is top of the list of the reasons why it has launched this consultation, which runs until the end of October:

“These issues were initially identified in the context of the discussion on the risks arising from the UK withdrawal from the EU”, says the consultative paper.

And it does not mince its words when it highlights the potential risks it sees if third countries drift too far out of alignment with EU regulations:

“These governance arrangements may impair risk management and effective decision making, and have the potential to pose financial, operational and reputational risk and ultimately impair policyholder protection. 

“Furthermore, the use of these governance arrangements can affect materially the ability of the supervisory authorities to conduct proper supervision. Supervisory authorities may not have sufficient visibility of the functions performed in a third country if, for example, rights to carry out on-site inspections are impaired.”

What is not clear from the consultative paper is the potential responses EIOPA might adopt if it feels any third country steps too far away from its requirements and whether these might go further than the powers it already has to insist on direct EU authorisation for any cross-border business.

There is potentially a lot at stake if the new Prime Minister decides to press ahead with radical reform of financial services regulation.


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