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Peter Hamilton: The cost of eliminating regulatory ‘underlap’

Last week, the FSA published a consultation paper (CP12/24) on some of the detail involved in the implementation of the Government’s so-called reform of the regulation of financial services. It makes daunting reading.

To put it into context, as we know, the Financial Services Bill is making its way through Parliament at the moment and when passed, it will give the necessary statutory authority to the new regulatory regime in the UK.

The FSA says the bill is likely to become law “over the coming months”.

When that happens, the financial policy committee of the Bank of England will become responsible for the stability of the financial system as a whole. The Prudential Regulatory Authority, which will be a subsidiary of the Bank of England, will be responsible for the prudential regulation of banks and other deposit-takers, insurers and large investment firms. The Financial Conduct Authority will be responsible for regulating the conduct of all firms and will also be the prudential regulator of all firms not falling under the PRA’s jurisdiction.

Whatever else the new system achieves, it will certainly add a new layer of complexity to what is already a complicated situation.

One of the motivations for the Government’s reforms was to prevent a repetition of the situation in which important issues were not addressed by either the Bank of England or the FSA, as happened when financial crisis began in 2008. That was described as an “underlap”. But once the new system comes into force, there will be no lack of overlap – certainly for firms regulated by both the PRA and the FCA.

Since April this year, the FSA has sensibly reorganised itself into two separate divisions, one to replicate the job of the PRA as far as possible under the current law and the other to do the same for the FCA.

That change has created two independent groups of supervisors – one covering the prudential issues of banks, insurers and large investment firms and one covering all conduct issues as well as the prudential issues of all other firms.

In terms of numbers, most firms will fall into the latter category and will therefore only have one regulator – as at present. But the firms to be regulated by the PRA will also be regulated by the FCA and so from April, those firms will have been dealing with two sets of supervisors.

When Hector Sants announced the split into what he called “twin peaks supervision” in a speech in February this year, he warned that “each supervisory group may well ask a seemingly similar question but it needs to be understood that the purpose will be different.

For example, both groups of supervisors will be concerned about a firm’s board and governance processes. The prudential supervisors are concerned as to whether the risks to a firm’s stability are being well-managed and the conduct supervisors are concerned whether a firm’s customers are being fairly treated.”

Thus, from the firm’s point of view, it will have to deal with issues of that sort twice. That must increase the regulatory burden and its cost.

All firms must now think about, and absorb, the changes set out in the consultation paper. The paper describes the proposed changes to the existing handbook which will become necessary due to the introduction of the new regime.

Chief among the changes will be the creation of two new handbooks – one for the PRA and one for the FCA. The FSA is doing the necessary work so that when the new regime takes effect legally (called the “legal cutover”), each of the new regulators will have a rulebook.

The FSA’s approach to the task of creating the two handbooks is to make only those changes required to implement the new regulatory regime. The FSA says in the CP: “A key element of this approach is that when the PRA and FCA acquire their new powers, provisions in the existing FSA handbook will be adopted or ‘designated’, by the PRA, by the FCA or by both regulators, to form new PRA and FCA rulebooks. As a result, the majority of the provisions in the existing FSA Handbook will be carried forward to the new regulators in their respective rulebooks. Readers will be able to see which provisions have been adopted or ‘designated’ by each regulator to form new PRA and FCA rulebooks. From legal cutover, the PRA and FCA will amend those provisions in line with their respective objectives and functions, consulting and co-ordinating with each other as appropriate.”

Any hopes that the process of consultation and co-ordination between the new regulators will be easy and that the new rulebooks will emerge quickly and not require frequent revision are likely to be in vain. Those processes will add to the weight and cost of regulation – and of no obvious benefit to the majority of firms which will be regulated by the FCA alone. Both the new rulebooks will be available online and will be available before the new regulators are fully operational.

In addition to the process of splitting the FSA handbook into two, it will also be necessary to make substantive changes to each of the new rulebooks so that they are consistent with the objectives and functions of the new regulators and their new procedures.

Among the changes, of general significance to all firms are the following parts of the current handbook: the general provisions and common definitions; status disclosure and the use of the regulators’ logos; notifications to the FSA and the reporting requirements.

One of the new terms to appear in the rulebooks will be the “appropriate regulator” which will mean either or both of the PRA or the FCA depending on the context.

As firms will continue to have to disclose which regulator authorises and regulates them, the FSA proposes to prescribe new wording to refer to the FCA or to the PRA, as appropriate. That will require a general reprint of business stationary. For that purpose, the FSA intends to permit a six month transitional period during which to make the necessary changes.

The CP includes a cost benefit analysis. It makes the fair, but unhelpful, point that most of the proposals in the CP are driven by the need to reflect the changes to be made by the bill becoming law and by the creation of the new UK regulatory structure.

Most of the proposals do not address market failures and so the FSA does not expect any economic benefits to arise from the proposals.

As far as direct costs to firms are concerned, the FSA says it does not expect them to be material. Only time will tell whether that statement turns out to be fair or not.

Indirect costs in the form of time spent in absorbing what the changes mean and then giving effect to them, cannot be anything other than high for the regulators and for all firms in the regulated community.

Of course, the firms will have to bear the regulators’ increased costs.

In the end, all those costs will fall on society in general. Many years will pass before we are able to judge whether the Government’s changes will turn out to have been worthwhile and beneficial.

Peter Hamilton is a barrister specialising in financial services at 4 Pump Court and co-founder of


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There is one comment at the moment, we would love to hear your opinion too.

  1. “In the end, all those costs will fall on society in general. Many years will pass before we are able to judge whether the Government’s changes will turn out to have been worthwhile and beneficial.
    No Peter, no need to wait for the years to pass. I think we can safely say what the outcome will be.

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