Establishment of Financial Services Authority in the UK

Establishment of Financial Services Authority in the UK

The origin and establishment of the Financial Services Authority (FSA) trace from the commitment of the Chancellor of the Exchequer to introduce a more credible function of supervision of the banking sector. Initially, the role of the FSA was assumed by the Securities and Investment Board that gave rise to the FSA upon rebranding in October 1997. As a deliberate attempt to facilitate the regulatory and supervisory functionality of in the industry, the establishment of the FSA sought to avail elusive authority and mechanisms to an independent body other than the Bank of England. Apparently, reforms in the regulatory function of the financial industry were making a dramatic transformation in the sector, with more changes to the existing institutions.

Donating the responsibility of the regulatory functions from the Bank of England in 1998 was aimed at increasing efficiency through specialisation. In 2000, more changes to the sector saw the transfer of the responsibilities of the UK Listing Authority into the FSA’s list of mandates, which were previously held by the London Stock Exchange. To ensure its legal presence in the country, the Financial Services and Markets Act of 2000 (FSMA) came into force in 2001 to effectively transfer the responsibility of several regulatory institutions under the management of the FSA.

Among the effected transfers involved institutions such as Building Societies Commission, Friendly Societies Commission, Investment Management Regulatory Organisation, Personal Investment Authority, Register of Friendly Societies as well as Securities and Futures Authority. Further regulatory authority donated to the FSA includes the mortgage regulation responsibility accorded in 2004 as well as the mandate to enforce Insurance Mediation Directive in 2005 (FSA 2011).

Structure

A body of managers overseeing four units of operation structure conducts the FSA management and operations in a specific structure. Top management consists of the executive chairperson and three senior executives heading three function or business units namely conduct, prudential as well as operations. The conduct business unit deals with identification, assessment and judgment on the implementation of conduct requirements for the financial market stakeholders. In the prudential business unit, the FSA integrates various external requirements into the regulatory approaches adopted for compliance nationally and in the European Union. Direct Reports functionality provides departmental control for various executive administration needs and advices the executive chairperson on the most appropriate strategy to implement FSA obligations. In terms of the needs of the FSA catered for in the operations business unit, effectiveness, internal systems harmonisation and performance improvement form part of the mandate carried out in this unit.

Objectives

According to the interpretations of the FSMA (2000), the main statutory objectives of the FSA are four and include financial industry management approaches to protect the public and investors from harmful practices. Firstly, the FSA has the responsibility of the maintenance and sustenance of market confidence perhaps captures and underscores the role of the regulatory authority needed at all levels of investment spurring economic development. Secondly, the FSA is mandated in assuring the UK of financial stability by providing protector authority against financial system volatility. Additionally, tackling financial crimes falls under the regulatory jurisdiction of the FSA through strict operation environment to weed out criminals in the U financial system. Finally, the FSA is the body whose job it is, to ensure consumer protection from various market forces that pose financial danger if uncontrolled. As witnessed in Brown & ors v Collyer-Bristow & ors (2010) compliance with the financial accountability requirements must be regulated in the country (Chambers UK 2012). Other objectives include providing accountability in political and public institutions in terms of the annual reports submitted. Alternatively, the FSA offers assistance in the provision of legal accountability and interpretation of governance principles in various institutions touching on public interest (FSA 2012).

Legislation Support

A number of legislations provide authority to the FSA since its inception, capturing various regulation needs of the financial markets in the UK. Among the pieces of legislation that directly relate with the FSA and its obligations, include the Enterprise Act 2002, Proceeds of Crime Act and the Banking Act 2009. As mentioned above, the establishing statutes of certain organisations also provide regulatory power to the FSA including Building Societies Act 1986, Friendly Societies Acts 1974 and 1992 as well as the Industrial and Provident Societies Act 1965. Regulatory authority for FSA also emanates from various policy regulations including Unfair Terms in Consumer Contracts Regulations 1999, Financial Services (Distance Marketing) Regulations 2004, Money Laundering Regulations 2007, Regulated Covered Bonds Regulations 2008, Payment Services Regulations 2009 as well as Electronic Money Regulations 2011.

Business Environment and FSA Performance

Since its inception and continued growth in terms of regulatory authority, the FSA found several obstacles in the implementation of its mandate. Conversely, the public eye continually grew intolerant of the performance of the FSA amid turbulent fortunes in the financial markets in the UK and across the globe. As an illustration, the 2007/8 financial crisis that originated from the USA and rapidly spread across Europe and in many parts of the world exposed the UK’s economy to uncertainties that put the integrity of the FSA to test (Akinbami 2012). However impossible it was for a stable regulatory authority in Europe to overcome the crippling effects of the sweeping crisis is a question that arrived at a time when the performance of the FSA was in doubt. Critics argued that the protector obligation of the FSA would have better been realised if the body carried out its mandate appropriately.

The diagnosis of the extent of vulnerability of the financial regulatory regimes at the height of the financial crisis however pointed to certain negligent attributes in the approaches taken by the FSA. Considering the magnitude of protection expectations that the financial sector in the UK placed in the hands of the FSA after all the transformations highlighted above, it would be expected that the body would leave nothing to chance in discharge of its mandate. Following the inability to tackle various financial regulation demands, the FSA faced serious criticism that led to the formation of an independent commission to unearth the weaknesses in the body and provide relevant recommendations for better regulatory protection of the UK financial industry.

Examples of Blatant Failures at FSA

The origin of the 2007/8 financial crisis traced back to negligent approach in handling retail banking and financial activities leading to acceptance of risky trading activities into the financial system. Acceptance of high risk trading in derivative instruments involving questionable properties in the USA for instance brought the mortgage business on its knees only in several months. Spreading the risky retail banking activities in the retail banking industry across the EU exposed the UK economy to untold suffering leading to bailout cries across major banks. As witnessed in the USA, the bailout option was the only stability regaining approaches available, having been exposed to poor regulatory protection from the authority in charge. Avoidance of mistakes of judgment would enable the regulatory authority eliminate litigations such as observed in the matter of Springwell v JP Morgan Chase Bank and ors [2010] EWCA Civ 1221 (Smith 2012).

It is a widely accepted argument that the failure of the FSA in regulatory functions led to the collapse of Northern Rock in the wake of the 2007/8 financial crisis. A close assessment of the roles and responsibilities of the FSA highlights the loopholes in the approach taken to safeguard the UK’s financial sector interests from a collapsing market. According to the BBC News (2008), the struggles of the Northern Rock bank would be absent if the regulatory role of the FSA took the duty care concept seriously. Since the financial industry has a similar operations environment, failure of a single bank may expose the rest of the industry players to risks that would only be tackled by appropriate regulatory measures.

It was therefore arguable that the failure of the FSA in protection of Northern Rock translated to the trouble experienced by the Royal Bank of Scotland. Successive problems in the industry were experienced at the Lloyds Banking Group forcing the UK government to channel taxpayers’ money into their bailout. According to critics, lack of vigilance, appropriate risk assessment and surveillance by the FSA as mandated by the UK public amounts to a blatant negligent conduct. The public across the world would have a claim of negligent conduct from the powerful regulatory bodies that allowed the spreading of the risks and losses. The FSA regulatory authority must have provided the appropriate guidelines to the banking sector to enable protection against the harmful market environment. By the involvement of the banking sector in the risky mortgage business without any directive from the FSA, the financial market was exposed to the associated risks. Cases of regulation getting out and for instance in the legality of financial brokers as observed in HYPERLINK “http://www.bailii.org/ew/cases/EWHC/Comm/2012/584.html” Euroption Strategic Fund Limited v Skandinaviska Enskilda Banker AB [2012] EWHC 584 (Smith 2012). The brokerage service control falling under the FSA would be effectively catered for if the body were in the right state of operations as expected.

Recommendations of the Independent Commission on Banking

The Independent Commission led by Sir John Vickers made several findings among them the observation that more equity and sustenance of debt levels with loss absorption potential as well as the structural separation of the financial activities touching retail business. According to the Vickers’ Commission observations, the regaining of the stability of the financial market in the UK would interact with the regulatory regime in various ways. The proposed recommendations therefore touched on the actual roles of the FSA as the authority with the mandate to ensure stability in the market, to shield the UK economy from volatility emanating from financial markets as observed in the 2007/8 economic crisis. Specific approaches recommended in revamping of the regulatory authority for UK’s financial market include the perspectives discussed below.

Retail ring fencing as a weighty recommendation by the ICB touches on the treatment of the exposure to risks from ordinary running of business by the banking sector. The committee observed that the financial industry faces the impacts of direct and indirect activities of the banking sector, with a potential entanglement of the economy by incidental activities. In order to facilitate the integrity of the entire industry, isolation of the most important activities for continued specialisation by the banks was proposed, while the incidental activities were recommended for separation. A ring-fenced system would imply that the banking industry obtains the directive of the financial activities in which they should operate to protect the economy from risks exposed by the involvement in activities that are secondary to core business (ICB 2011, p5). As an illustration, the FSA would have had the opportunity to allow only a few banks to deal in derivative securities from the mortgage business, which is not the core function of big banks in the UK. Serving households directly in the mortgage industry as per the interpretation of the ICB implies that the FSA would require dissecting the industry into direct and indirect banking services for better regulation. Ring fencing provides separation of risk exposure of core business and other ancillary activities that are also perceived to be risky in context of the financial crisis.

Loss-absorbency as the next broad recommendation item interacts with the tenacity of the institutions and preventing harmful impact of the environmental forces (ICB 2011, p79). The ability of the banks to overcome possible losses must be guided by regulatory requirement of banks to retain shielding cover through equity, leverage ratio, bail-in, depositor preference and resolution buffer mechanisms. In terms of the requirements to equip banks with internal capacity to handle potential losses, the FSA must accommodate various capacity enhancement mechanisms as outlined. In addition, the issue of the competition among players in the banking sector provides the ICB with a broad area of recommendations allowing business environment tackle unfair activities.

Despite the need for the regulatory authority to ensure that the banking industry offers a fair business and investment environment for all players, it is equally important that the level of competition does not affect the integrity of the economy (ICB 2008, p239). As an illustration of dealing with fairness cases in the banking industry, the matter of Office of Fair Trading v Abbey National plc & Others (2009) UKSC 6 captures the determination by the court. The recommendation of the ICB targets increasing the mandate of the regulatory authority to enable a comprehensive application of regulation in the banking industry to integrate European standards. Similar considerations were discussed in Office of Fair Trading v Foxtons Limited, High Court of Justice, Chancery Division, 10 July 2009 [2009] EWHC 1681 (Ch).

References

Akinbami, F. (2012) Is meta-regulation all it’s cracked up to be? The case of UK financial regulation, Journal of Banking Regulation, 2 May, 2012 Doi 10.1057/jbr.2012.7

BBC News (2008) FSA ‘failed over Northern Rock,’ Available from <http://news.bbc.co.uk/2/hi/business/7209500.stm> [Accessed 1 August 2012].

Chambers UK (2012) Andrew George: Current and recent work, [online] Available from <http://www.blackstonechambers.com/people/barristers/andrew_george.html > [accessed 1 August 2012].

FSA (2010) FSA: Legal framework, [online] Available from <http://www.fsa.gov.uk/pages/about/who/accountability/legal/index.shtml> [Accessed 1 August 2012].

FSA (2011) FSA: History, [Online] Available from <http://www.fsa.gov.uk/about/who/history> [Accessed 31 July, 2012].

FSA (2012) FSA: Statutory objectives, [Online] Available from <http://www.fsa.gov.uk/about/aims/statutory> [Accessed 31 July, 2012]

Gray, J. (2010) High Court considers whether FSA disclosures are exempt from freedom of information requests, Journal of Financial Regulation and Compliance, vol. 18, no.1, pp.70 – 77

ICB (2011) Final report recommendations, [online] available from <http://bankingcommission.s3.amazonaws.com/wp-content/uploads/2010/07/ICB-Final-Report.pdf > [Accessed 1 August 21012].

Smith, H. (2011) Springwell- a source of relief for financial institutions, [online] Available from <http://herbertsmithfsrnotes.com/2011/11/02/springwell-a-source-of-relief-for-financial-institutions/> [accessed 1 August 2012].

Smith, H. (2012) Duties of brokers liquidating positions on behalf of clients in state of default, [online] Available from <http://herbertsmithfsrnotes.com/2012/03/23/duties-of-brokers-liquidating-positions-on-behalf-of-clients-in-state-of-default/> [accessed 1 August 2012].