Future of Financial Services

We agree with the Treasury that the body of EU financial services rules that was on- shored during the process of leaving the EU should be moved into the regulators’ rule books. Keeping rules in statute could require Parliament to amend or pass new legislation every time that the regulators wish to make changes to them. This would be resource-intensive and impractical. The regulators have a key role to play in designing and developing the rules with appropriate Parliamentary oversight. We acknowledge that the process of moving rules out of statute will be time-consuming for the regulators and will be a heavy demand on their resources. It is important that the required resources are provided to ensure this process takes place efficiently.

The Treasury consultation alluded to certain UK-derived rules that are set out in UK statute, and it suggested that regulators might be constrained as a result. But we found that the regulators did not appear to feel constrained by the existence of any domestic rules being set out in statute. We therefore conclude that while periodic review of domestically-derived rules to see whether they would fit better in rule books rather than in statute may be necessary, they do not need to be included in the exercise that moves the EU on-shored rules out of statute and into the regulators’ rule books.

We understand the need for Treasury Ministers to be well informed of the regulators’ policy intentions as a matter of routine. However, we have not been provided with compelling evidence to justify changing the law to allow Ministers the absolute right to see financial services regulators’ policy proposals before they are published for consultation as opposed to the current arrangements whereby significant interaction between Ministers and regulators happens informally as a matter of routine. By doing so, the perception of regulatory independence from government could be damaged. The independence of regulators to be free from political interference is one of the key aspects of UK financial services regulation, and it is, arguably, one of the reasons why the UK is a world-leading financial centre. Regulators must continue to be free to choose what they share with the Treasury in this respect.

The Treasury has in the past been able to delay policies in the interests of the wider negotiations that took place during the UK’s departure from the EU. This suggests that there is already sufficient and appropriate Treasury oversight of the regulators’ policy proposals without needing to put such a power in law.

If the Treasury does wish to give itself the formal power to see policy proposals before they are made public, comments or suggested changes to them using this power should be published alongside the public consultation.

It is not clear to what extent the Treasury wishes to implement activity-specific regulation. While the proposal is a key aspect of the Treasury’s future framework consultation, when we asked the Economic Secretary whether the Treasury The Future Framework for Regulation of Financial Services 27 intended to move more towards regulating by activity, he said it did not. We note, however, that the Financial Services Act 2021 already sets regulatory principles for the FCA to follow at an activity-based level in regulating investment firms, and it gives the Treasury a power under secondary legislation to specify further matters to which the FCA must have regard when regulating in this field. We conclude that the Treasury intends to pursue this policy irrespective of the findings of this consultation.

If done with a deft approach, there may be a role for activity-based principles or “have regards” to allow the Government to instruct the regulators, at a more micro level, how it wishes them to approach specific types of business sector. The Government can already instruct regulators more broadly on how to do this through remit letters. But the Government should be sparing in its approach: the strategic and operational objectives, combined with principles and ‘have regards’ that are set out in their remit letters, are already numerous and expanding, to the point where regulators have to choose which to prioritise on a regular basis when drafting new policy proposals. The creation of too many activity-based principles would add a further layer of issues to which regulators must have regard.

Regulating a company as a whole rather than by activity carried out should provide greater flexibility to regulators to respond to new activities as they develop, rather than needing new activity-specific principles or frameworks each time a new activity emerges.

We will only be able to conclude with more certainty on the merits or risks of activity- based regulation once the Government provides more details on their proposals in its next consultation.

Decisions by the Financial Ombudsman Service set precedents and form a critical part of the consumer conduct-focussed element of the regulatory environment for financial services in the UK. Given that the aim of the Treasury’s consultation is to create a more coherent framework for how financial services are regulated, the Treasury should consider as part of this consultation how the decision-making processes of the Financial Ombudsman Service would interact with the future regulatory framework for the FCA.

If Parliament itself is to play a role in the setting the regulatory principles of the FCA, it needs to be satisfied that the principles which it has set the FCA are not being undermined by decisions by the Financial Ombudsman Service. (Paragraph 57) Future scrutiny of financial services

We believe that a measure of “ex-ante” scrutiny by Parliament is necessary. But we do not believe that it would be proportionate for Parliament or its committees to carry out, as a necessary part of the rule-making process, the detailed and comprehensive textual scrutiny which the European Parliament’s Economic and Monetary Affairs Committee conducts. The European Parliament’s legislative processes, under which the existing acquis of EU financial services rules was created, were designed for a parliamentary system which is quite different from that of the UK Parliament. (Paragraph 77) 28 The Future Framework for Regulation of Financial Services

We believe that effective scrutiny of regulatory proposals should be carried out through a targeted approach. Each new proposal made by the Financial Conduct Authority or by the Prudential Regulatory Authority under the future financial services regulatory framework would be put out for consultation. Industry stakeholders and civil society groups would have an opportunity to put forward views, as would Parliament, both through the select committee system and through the work of individual Members of either House. If any matter of public interest were to arise that we deemed sufficiently important to scrutinise in more detail, or indeed challenge, we would do so.

We have set out above reasons why we do not believe that Parliament or its committees need necessarily carry out detailed and comprehensive textual scrutiny for every new draft regulation or rule, although it would always be open to a committee of either House to do so. We envisage that scrutiny would be both “ex-ante” and “ex post”. “Ex-ante” scrutiny could be based upon expert analysis of draft texts, together with an exploration of representations made by industry stakeholders, consumer representatives and others, with robust challenge to the regulators when warranted. “Ex post” scrutiny might entail reviews of the impact of regulations and an assessment of the balance struck between protection for the consumer and effective operation for the industry.

We do not see a clear need for the creation of a new committee or a new independent body to carry out this work. It would seem a more efficient use of Parliamentary resources to use the structures that are already available in both Houses. Although the scrutiny task will be substantial, it will be an extended one as new regulations are drafted, rather than a short-term surge of activity. There is already expertise in select committees in the Commons and the Lords, and both have the power to appoint specialist advisers and commission research.

The creation of a new independent body to assess whether regulators were fulfilling their statutory objectives would not remove the responsibility of this Committee to hold the regulators to account, and it would also add a further body to the financial services regulatory regime which we would need to scrutinise.

Our Committee has been consistent in its regular monitoring of the work of the Financial Conduct Authority and of the Prudential Regulatory Authority, the extent to which they meet the objectives set for them by Parliament, and their responsiveness to consumer expectations. There is a strong logic in aligning the scrutiny of draft regulations and policy proposals with that of policy implementation and the day-to- day work of the regulators.

The House could, if it thought it necessary to increase the capacity and broaden the expertise of the Treasury Committee in order to undertake scrutiny of financial services, expand the facility under Standing Order No 137A(1)(e) for non-members of the Committee to take part in certain proceedings. This provision currently enables only members of other committees to participate, but it could be adapted so as to permit the Committee to invite any Member of the House to do so.

The House might also consider increasing the resources available to the Committee if it were, as we anticipate, to expand its existing responsibility for the scrutiny The Future Framework for Regulation of Financial Services 29 of financial services. Although the Committee already has the power to appoint specialist advisers, there may be merit in making provision for the Committee to have the assistance of the Counsel to the Speaker, in a manner similar to that provided to the BEIS Committee in its scrutiny of draft orders under Standing Order No. 141, on scrutiny of regulatory and legislative reform orders.

We will continue to maintain an open mind as to how best to scrutinise the significant flow of financial services proposals that will be made by the regulators, and we look forward to engaging constructively with the Government and with others in Parliament once more detailed proposals emerge from the Government’s consultation response later this year. (Paragraph 93) 30 The Future Framework for Regulation of Financial Services

The EU has reasons to be very prescriptive when setting its financial services rules: it must ensure that all member states are acting together and implementing the same rules consistently across multiple national legal systems. The UK, now that it is outside the EU Single Market, can operate with greater freedom.

Given that the UK has historically exercised significant influence in the framing of EU regulations, the UK’s exit from the European Union should not in itself be the cause of instant or dramatic changes to financial services regulation in the UK. Nevertheless, there will be opportunities to tailor inherited EU regulations to the UK market, and to seek opportunities for simplification, while being mindful of continued compliance with global standards. The new regulatory framework should aim to enable the regulators to respond more quickly and flexibly to new evidence about the effectiveness of regulation, and developments within financial markets.

The Treasury should respect the principle of regulatory independence, and must not pressure the regulators to weaken or water down regulatory standards, or to accept changes to the regulatory framework which could impede the regulators’ ability to achieve their primary objectives. The regulators have been made operationally independent for a reason. If regulatory standards were to be changed or substantially weakened so as to increase the risks to financial stability, UK consumers and taxpayers could be harmed. Simplifying financial regulation and tailoring it appropriately to the UK market must be approached with care, and without compromising regulatory independence.

We will remain alert for any evidence that regulators are coming under undue pressure from the Treasury to inappropriately weaken regulatory standards.

Deregulation or simplification will in themselves impose costs on industry in the short term. Regulators should make every effort to limit the costs of compliance with the rules, for example by communicating planned changes in advance, grouping sets of changes together, and minimising the frequency of changes to those where a compelling need and a significant cost benefit has been articulated. That said, regulators should not let short-term costs, or the views of market participants who have already adapted to existing arrangements, limit the scale of their ambition when finding opportunities to genuinely simplify the regulatory framework without sacrificing resilience.

The UK’s exit from the European Union has had an impact on the UK’s ability to export financial services to the EU. However, it remains the case that the UK still has many competitive strengths as a global financial services centre. Brexit has served as a catalyst for a renewed focus on the competitiveness of the UK’s exports, including financial services. (Paragraph 45) 54 Future of financial services regulation

There is a clear view from the financial services sector that co-operation between regulators is more significant than trade deals for ensuring reciprocal market access for financial services. While trade deals can open up new markets for financial services, the Government should strive to make progress on mutual recognition as an element in any free trade agreement. (Paragraph 46) Regulatory objectives and priorities

We recommend that there should be a secondary objective for both the Financial Conduct Authority and the Prudential Regulation Authority to promote long-term economic growth. The wording will be crucial: pursuing international competitiveness in the short term is unlikely to lead to economic growth or international competitiveness in the long term if it is achieved by weakening the UK’s strong regulatory standards. Weakening standards could reduce the financial resilience of the UK’s financial system and undermine international confidence in that system and the firms within it.

In designing the new secondary objective, there should also be some consideration for the ways in which financial services serve the ‘real economy’. The financial services industry can help deliver economic growth not simply by growing itself but also by facilitating economic growth by providing capital, credit, insurance and other services to firms in the ‘real economy’.

The Treasury should continue to reject any calls for a growth and/or competitiveness objective to become a primary objective. This would increase any pressure on regulators to trade off competitiveness against resilience, and would undermine the regulators’ ability to deliver on their core functions. There is a danger that as memories of the financial crisis fade, its lessons are forgotten.

The regulations made by the FCA, and the manner in which it supervises and enforces those regulations, could have a significant impact on financial inclusion. However a primary role of the FCA should not be to carry out social policy, or to fill the gaps where it is Government that ought to be stepping in and addressing these issues. Government, community, and individuals all have a role to play in tackling poverty, an issue which is far broader than regulation.

The FCA should make every effort to ensure that it is not designing or implementing regulation in a way which could unreasonably limit the provision of financial services to consumers who might benefit from them. When placing new requirements on firms, the FCA should consider not only the impact on consumers and businesses, but also the impact on those who might be prevented from accessing financial services as a result of those new requirements, or who might find themselves accessing services on inferior terms. We recommend that the Treasury should require the FCA to have regard for financial inclusion in its rule-making, but not to make changes relating to financial inclusion to the FCA’s objectives.

We welcome the clearer acknowledgement that the FCA is working to support financial inclusion, and we would urge the FCA to continue to do so. The FCA should provide an annual report to Parliament on the state of financial inclusion in the UK and the Treasury should consider putting this report on a statutory basis. This Future of financial services regulation 55 report should also include a summary of areas where the FCA’s work has supported financial inclusion or future work which could impact on financial inclusion; and any recommended additional measures lying within its area of competence and which could be taken by Government and other public bodies to promote financial inclusion. (Paragraph 91) The new normal

The Treasury and regulators should publish a forward-looking schedule of approximately when they expect each EU financial regulatory file to move across to the regulatory rulebooks, including timelines for consultation, and when they expect the overall project to conclude. This should give industry a better opportunity to plan for the changes they may need to make, and give the various stakeholders (including industry, consumer groups, academics, and other experts) more time to plan their engagement in the process.

Regulatory independence is critical for the competitiveness and effectiveness of UK financial services regulation. The host of new accountability mechanisms proposed by the Treasury must be carefully reviewed in this light, to ensure that regulatory independence is not compromised. These mechanisms largely seem reasonable as individual changes, but there is a risk that the collective impact could be excessive in its impact on regulators’ resourcing, as well as their ability to make decisions quickly where needed.

The Treasury should be sparing in its use of the proposed power to require regulators to review their rules, and should not use it to implicitly require the regulators to consider a general ‘public interest’ requirement for rulemaking. Each use of this power is a potential weakening of the independence of the regulators. Regulators should not be expected to reverse or adjust regulation where such regulation is deemed to remain appropriate to carry out the regulators’ statutory objectives. That being said, the regulators should not impose costs without being able to show benefits.

The Treasury has not set out the expected impact of this new power on regulatory resources. In order to avoid imposing a significant burden on regulatory resources to conduct these reviews, and to safeguard regulatory independence, the Treasury should fund these reviews itself, whether they are conducted by regulators themselves or independent persons. Reviews of regulatory rules which have been imposed by the Treasury should not crowd out the budgets over which regulators have discretion for fulfilling their objectives. The imposition of such costs on the Treasury would also further help it consider whether all such reviews were necessary.

We expect the regulators to prioritise changes where the cost for consumers is lowest in comparison to the benefit. Regulators’ approaches to assessing the marginal impact of new policies is already well-developed. We therefore believe that the creation of a new statutory panel to advise regulators on cost-benefit analysis—in addition to the panels that regulators already maintain for consulting industry and other stakeholders— would add only marginal, if any, value and could pose some risk to regulatory independence. If such a panel is established, however, it should provide comments on rules changes post-publication, to avoid causing delays to the policymaking process. (Paragraph 111) 56 Future of financial services regulation

The information the FCA has made available on how it is performing against its service standards shows a deteriorating picture. The FCA has a reputation for being too slow in its authorisation work, and this will inevitably hold back British fintech companies and crypto firms as well as larger firms. When the FCA publishes its next update on the service standards it should write to us, outlining any areas where it is still not meeting its statutory and voluntary timelines, and setting out its strategy for closing any gaps.

The FCA should consider how to improve its engagement with the poorest consumers, including seeking opportunities to improve the availability of data about people who are on the lowest incomes. The FCA must seek data on the issues vulnerable consumers experience directly. Civil society groups and other researchers can provide a valuable input, but they are more constrained than industry in terms of access to funding. (Paragraph 124) Specific areas of regulation

We will conduct scrutiny of the Prudential Regulation Authority’s ‘Strong and Simple Framework’ proposals. We will examine the impacts of the proposed reforms on the safety and soundness of smaller firms, and whether the reforms would successfully reduce the burden of regulation for these firms.

In their review of Solvency II, the Treasury and Prudential Regulation Authority (PRA) should aim to secure a robust insurance regulatory regime that adequately captures risk and incentivises investment in infrastructure and business, but one that is also appropriately tailored to the UK market.

The Prudential Regulation Authority should consider where there is more that can be done to reduce the advantages from which large banks and insurers benefit through modelling their own capital requirements. The purpose of doing so would be not only to strengthen competition by reducing the barriers faced by smaller or newer firms, but also to assess whether firms modelling their own capital requirements are truly reflecting the levels of risk involved.

The FCA should investigate whether there are more opportunities to enable larger firms to undertake controlled, supervised experiments with innovative products. For example, it may be desirable to allow firms to be more experimental with the designs of new products, by setting aside additional capital in order to compensate consumers generously if new products being tested out by a limited number of consumers turn out not to benefit those consumers as anticipated. This approach would not be without risks, and would have to be carefully designed to avoid disadvantaging smaller firms, but it is an example of the type of bold approach which the FCA should be prepared to consider.

There is a range of innovations taking place in payments systems and with alternative means of exchange, including crypto-assets, stablecoins, and central bank digital currencies. These innovations could provide opportunities to address weaknesses in international payments systems and potentially to serve consumer needs, and in the case of central bank digital currency to safeguard monetary sovereignty. Future of financial services regulation 57 There are challenges associated with innovations in payments, including consumer protection, preventing crime and financial stability. We will be conducting further work on how these challenges are managed. (Paragraph 175) 58 Future of financial services regulation