Regulatory Consulting’s Insight & Foresight newsletter - June Review 2011

June Review 2011

Dear Readers

June produced some confirmation, at last, of where the Government plans to take our regulatory regime by finally issuing a White Paper and some of the draft legislation to abolish the FSA. The FSA also produced its “approach document” outlining how it proposed to use the new powers in the proposed legislation. To the contrary, the FSA failed yet again to publish its RDR wraps and platforms Policy Statement which is re-scheduled to Q3 2011. In Brussels the Solvency 2 Directive dam began to break with open official consideration of delaying implementation to 2014.

 Its true it’s a rumour

The fictional Jim Hacker was once reduced to tears when his private secretary managed to lead him to believe that his permanent secretary was terminally ill. Hacker failed to spot the obvious sleight of hand in distinguishing between truth and rumour. The parliamentary scrutiny committee of MPs and Peers charged with examining the draft Financial Services Bill could be forgiven for wondering whether they had truth or rumour before them since the draft is incomplete and it will be some time before all the Bill is ready for scrutiny. Whether our parliamentarians are relaxed about that remains to be seen. What is clear is that the Treasury continues to be in an all fired hurry having lost six months to their original timeline already. More slippage is inevitable. It is not clear why there is need for haste. The Treasury Select Committee chairman, Andrew Tyrie MP has counseled taking the time to get it right. Wise words. Presumably Ministers prefer to look competent by prosecuting business promptly and risk getting elements wrong. 

All this is in sharp contrast with the views of a panel of speakers Lansons assembled in June to assess whether “HM Treasury was still the great office of state”. The panel consisted Kitty Ussher, former Treasury Minister in the last administration, Lord Turnbull, former Treasury Permanent Secretary and Cabinet Secretary and Lord Oakeshott, Lib Dem peer and financial services expert. It quickly became clear that none of them believed that breaking up the FSA was the right thing to do. As Lord Turnbull noted you don’t throw a washing machine out every time it breaks; there is such a thing as getting it repaired. The parliamentary scrutiny may not go as smoothly as the Government must hope.

The White Paper itself includes some very subtle proposals for an increase of Treasury influence over the new regulators compared with the FSA. In 1997 Ministers could not get rid of direct responsibility for individual regulatory decisions fast enough, so that they never again would have to stand at the Dispatch Box to defend failure (think Barlow Clowes). But in their haste they went too far creating a significant disconnect between public policy more widely and regulatory policy. Closing up that gap makes good sense. Under the new legislation the Treasury would be able to hold conversations with the Financial Policy Committee (FPC) and the FPC could ask the PRA or the FCA to think about a particular issue. This is rather different from the current situation which sometimes results in the FSA pressing on with initiatives which frustrate the wider public policy agenda. Making it harder for consumers to access financial services would be an example.

I’ll huff and puff and I’ll blow your house down

The FSA’s document outlining the FCA’s proposed approach to regulation when the Financial Services Bill is enacted was really always on a hiding to nothing. Politically, it had to promise more and more rugged action in pursuit of consumers’ interests. The trouble is it does not really see below the surface of the problem to explore the vexed problem of when an outcome is the lesser of two evils: what economists refer to as Pareto optimality. And since the new approach is subject to parliamentary approval the language is reduced to a contingent approach. The risk is obvious that we shall continue to have process regulation (because the FSA exported their ideas about that to Europe long ago and they are enshrined in MiFID) and we shall have product regulation and price controls. No wonder distribution capacity continues to fall. There may not be votes in it but every other sector of the economy is promised deregulatory initiatives. What financial services needs is a re-regulatory initiative which ensures that as fast as the regulators implement new rules, old ones are retired to keep the size of the regime affordable. Perhaps the NAO value for money oversight of the successor bodies to the FSA will shed some light on the size of the FCA Handbook.

Mañana

That the FSA has delayed its policy statement to Q3 2011 on wraps and platforms in the RDR series cannot have surprised many. This is now fully 2½ years late and jeopardises an orderly implementation in time for 2013. In truth, the FSA has always struggled to get to grips with how the industry was changing its approach to processing business. Worse, the concept of increasing entropy applies to regulation acutely. So the more complicated the regulatory proposal, the harder it becomes to make it work in all parts of the market. Put another way, if you embark on a consultation without being fairly certain at the outset what the answer will be you risk ending up in a dead end. It is not clear how the FSA can close out the consequences of banning cash rebates; the issues around so-called legacy commission (an issue of FSA’s own making) and VAT.

It is also unclear how the Treasury Select Committee will stick its oar in. Rumours of Hoban and the Committee compromising on a delay for some parts of the RDR seem well wide of the mark. In the first place Hoban has no political or procedural need to compromise. He nailed his colours to the RDR mast as soon as he came into office (unwisely really) so compromise looks like u-turn. The most likely outcomes are that all will agree that a proper post implementation review should be done or the implementation of the wraps and platforms piece should be delayed. The trouble with the latter is that wraps and platforms are so integral to the market as a whole delay would delay the whole project which is off limits.

Mañana

Delay seems to be catching. There is now a very real prospect of the Solvency II project being delayed by at least a year. This is hardly surprising given its complexity. However, it points to a naïvete and sense that officials and politicians are in denial over the realism of the project. It is said that not only are the industries in ten Member States not ready for implementation; neither are their regulators. It is said that even France is struggling to meet the deadline. There is now a very real risk for the UK that it will suffer the worst of all worlds; a two-track implementation. To save political face, those that are ready on time may implement in 2013 if they wish; others have until 2014. If that happens all the countries with significant insurance industries should be required to move together. Even so, the UK is a loser having played the game and got ready for 2013.

At Lansons’ event on the Treasury Lord Turnbull was pretty scathing about S2 claiming it had been allowed to run on to an advanced state despite being deeply flawed. What can he have meant? One answer is that the flaw was that excessive complication took it beyond the reach of many member states to implement. More likely, however, his concern was that it repeats the weakness of the Basel Accord from Basel 2 onwards relying on black box internal models to calculate solvency capital. Internal models cede advantage to their authors in understanding them. Supervisors seem destined to chasing their tails when it comes to being satisfied that a model does what it says on the tin. Slick regulators will put forward arguments about firms having to prove their models and Boards having to sign off on them. But this is sophistry. Good governance is a pre-requisite but it is not a substitute for proving data quality and the reliability and validity of a unique product.

As with RDR, the march of increasing entropy continues.

Yours sincerely

The Regulatory Consulting Team     

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