To:
Financial Regulation Strategy
HM Treasury
1 Horse Guards Road
London
SW1A 2HQ
15 October 2010
AFM Response to consultation on a new approach to regulation
1. I am writing in response to this consultation paper, on behalf of the Association of Financial Mutuals. The objectives we seek from our response are to:
· Comment on the proposals to deliver a new approach to regulation;
· Highlight the vital need for the new regulatory system to better cater for a range of business models, in order to secure meaningful benefits within a new regulatory regime.
2. The Association of Financial Mutuals (AFM) was established on 1 January 2010, as a result of a merger between the Association of Mutual Insurers and the Association of Friendly Societies. Financial Mutuals are member-owned organisations, and the nature of their ownership, and the consequently lower prices, higher returns or better service that typically result, make mutuals accessible and attractive to consumers.
3. AFM currently has 57 members and represents mutual insurers and friendly societies in the UK. Between them, these organisations manage the savings, protection and healthcare needs of 20 million people, and have total funds under management of over £80 billion.
4. We accept the general premise for the consultation and the policy objective for reform, as:
“The tripartite system of financial regulation failed to ensure financial stability - in particular by failing to identify the risk posed by the rapid and unsustainable increase in debt in the economy. This resulted in considerable economic costs in lost output and in a substantial deterioration in public finances…The policy objective is to reform the regulatory system for financial services to avoid a repeat of the financial crisis.”
5. We broadly agree with this overview and with the analysis that supports it. Much has been written about the causes of the financial crisis and how it was allowed to have such a devastating effect. Ineffective regulation and the bonus culture were cited as primary reasons, to which we would add the increasing lack of diversity in the financial market. As The Economist wrote earlier this year, “Just as an ecosystem benefits from diversity, so the world is better off with a multitude of corporate forms.”
6. Recently AFM, along with the Building Societies Association sponsored work by the Kellogg College, University of Oxford to consider how the coalition might effectively deliver on its commitment to support mutuality within financial services. Amongst the conclusions reached by Professor Michie were that financial regulation was currently biased toward the proprietary business model, and that the development of legislation to create new regulators provided the opportunity to incorporate a statutory commitment to recognise the value of diversity.
7. The report also made a series of recommendations on the way the various agencies proposed in this consultation might demonstrate a commitment to a diversified financial services market, and these are summarised in an Annex to this paper. We conclude that a vital element in reform of financial regulation is that diversity must be facilitated by the legislation; as Professor Michie states, there is an: “urgent need to translate positive words into substantive actions”.
8. We agreed that a vital element of regulatory reform is better regulation in general, and better regulatory recognition of the mutual model in particular.
9. Our responses to the specific questions raised in the consultation are attached.
10. We would be pleased to discuss further any of the items raised by our response.
Yours sincerely,
Martin Shaw
Chief Executive
Association of Financial Mutuals
Annex: Extract from report: “Promoting Corporate Diversity in the financial services sector”[1]
Within the new regulatory framework, there needs to be a clear responsibility in the regulator’s charter to promote diversity of ownership. In the past, the objection to taking this step is that it would require legislation. But now there is going to be legislation in any case, and there is going to be a new regulator, so this is the moment to ensure that the regulator is given proper responsibility towards fostering diversity and promoting mutuals. So, firstly, the regulator must have a responsibility and a requirement to demonstrate that they are taking diversity into account.
Secondly, the regulator needs to have somebody within the organisation who is at a senior level defined as a head of mutuals policy. (There is not anyone who has that particular remit currently and, therefore, there is no particular incentive for anyone in the organisation to think beyond the standard plc model.)
Thirdly, regulation needs to be proportionate. Regulation and the demands it makes represents a powerful competitive advantage for large incumbent players because they can absorb that cost. The resource costs and the monetary costs impact more heavily on smaller players, constituting a barrier to entry – you have to comply with regulation before you have done your first deal – and it stops the smaller people thriving in a way that would provide meaningful competition to the big incumbents. On the whole that disadvantages mutuals, and it is certainly a barrier to greater diversity. Ironically, it actually favours the ‘Too Important to Fail’ banks that are part of the problem. There is a precedent with the rules relating to credit unions which much more effectively enable new organisations to be developed, and we recommend that this approach is translated to other forms of mutual, to remove the barriers to entry and early survival.
Fourthly, on the Prudential Regulatory Authority (PRA) and Consumer Protection and Markets Authority (CPMA):
i. the White Paper makes it clear that the new consumer protection markets authority is responsible for the ‘promoting mutuals and fostering diversity’ agenda: this needs to be written into new Prudential Regulatory Authority objectives as well;
ii. there should be a commitment in the PRA and the CPMA to take due account of diverse business structures; and
iii. there needs to be a mutuals’ policy function in both the CPMA and the PRA: these bodies need somebody on the inside who understands the difference at the grass roots of producing policy in diverse sectors – people who don’t automatically assume that the plc model is the only model; a counterweight is needed to that general assumption that this is how banking and insurance is organised.
Fifthly, on the Bank of England:
i. given the immense extra powers that the Bank of England now has, it is urgent that its accountability improves concomitantly;
ii. it is also vital that the Bank be required to explain decisions in relation to mutuals on each regulatory rule: what the impact on mutuals is, in the context of the commitment to promote mutuals; and
iii. the Bank should also be required to report on diversity in the sector, producing an annual review of diversity and how its actions have maintained it; this would utilise the measurement of diversity referred to in Section 7.1 above, which should be the responsibility of the PRA rather than the Treasury.
Thus, good, strong and transparent regulation is required that takes account of the particular structures within the mutual sector. To achieve this would require a mutuals policies function within the PRA and CMPA, with them reporting on the success of their efforts to promote diversity, and also commenting on the impact on diversity and on mutuals of each individual significant regulatory proposal.
Responses to specific consultation questions
The Bank of England and Financial Policy Committee (FPC)
We believe the FPC should maintain a single, clear, unconstrained objective. To introduce an extensive series of secondary factors would be to run the risk of duplication and misaligned priorities between different agencies, and to dilute the primary and vital role of the FPC.
We agree that the FPC should itself be made up of a combination of Bank of England executives, supplemented by external members. However we think there is a risk in presuming the former will form the main part. Specifically this is because it risks creating lack of proper accountability in the FPC.
We would be keen to ensure that there is at least one representative from the mutual sector present on the FPC, to enable the Committee to effectively take account of business model diversity. This would enable to FPC to undertake one of the recommendations in Professor Michie’s paper on diversity in the financial services sector, that within the regular reports of the Committee is a report on diversity in financial services (see Annex above).
We envisage this should be one of the secondary factors for the FPC, and that these should be formalised in legislation, and also taken into account the monitoring, reporting and actions summarised in paragraphs 2.31 to 2.33.
Prudential regulation authority (PRA)
We agree with the contention in the report that a major failing of the current regulatory system has been a lack of attention to understanding firms’ business models and strategies. Whilst the context within the consultation was in relation to the financial crisis, this failure is just as acute in the unbridled bias towards the proprietary business model within the Financial Services Authority. This has resulted in severe problems for the mutual sector- for example in capital problems and FS Compensation Scheme costs for building societies, and in the treatment of with profits in mutual insurers. This approach risks terminal harm to the mutual sector, and stems from a disregard and misunderstanding of the mutual business model.
Similarly there has been a focus within the FSA on “one size fits all” regulation. Since the financial crisis, much attention has been given within FSA to creating new corporate governance and remuneration rules for large banks. Much of this is being transferred into non-banks and to much smaller organisations in an unsympathetic manner, creating disproportionately higher costs for small firms.
We therefore strongly recommend that the proposal that “in future supervisors should focus more on understanding institutions’ business models and strategies” (paragraph 3.3) is formalised into the PRA’s supporting objectives (referred to in paragraph 3.7 as “secondary factors”), and that as part of these formal secondary objectives it is also made clear that this includes to “foster diversity” as this echoes the government’s own commitment. This appears to sit within either the second or third category listed in paragraph 3.7. Such an approach would mirror that envisaged for CPMA, as provided in paragraph 4.12.
We also suggest that as well as including such a requirement in the legislation, that the consultation process demonstrates that diversity was taken into account, and that this can be best facilitated by appointing a Head of Mutuals Policy.
We agree with the nature of the objectives posed in Question 4 therefore. Specifically we do not consider that there is an unmanageable tension between the PRA primary objective and the responsibility to have regard to potential adverse impacts on innovation and competitiveness. Other UK regulators appear to manage this balance adequately, and given the importance to the UK economy of the financial services sector it would risk public harm for the PRA not to have regard to the impact of its policies on the sector.
In respect of Question 5, there is a risk that giving two authorities’ responsibility for authorisations and permissions could cause problems. For example, paragraph 3.16 suggests both PRA and CPMA will be responsible for approving persons to undertake significant influence functions. This creates the risk that one authority will approve whilst the other rejects. Dual responsibility is also likely to extend the approval process, and already within FSA the time taken to approve individuals is often unacceptably long. We conclude that this responsibility should sit with one regulator only- that with primary responsibility for supervising a firm.
With regard to questions 6 to 8, we believe another key function should be to explicitly expect that PRA seeks to understand individual organisations’ business model and form, and strategies.
We are concerned that the paper appears to suggest that the current FSMA requirements for FSA to issue a consultation with a detailed cost-benefit analysis might be removed for PRA. The consultation process is a vital strength of regulation in this country. As a trade body, we find it necessary to respond to a significant number of consultations, to highlight the often unintended consequences of proposals. Effective consultation should give confidence amongst consumers and firms that regulation is working properly. Indeed we would encourage government to strengthen the consultation and CBA requirements on regulators- to avoid the growing tendency of FSA to issue “Dear CEO letters” that circumvent proper consultation, and to ensure the benefits of new proposals are better understood and truly weighed up against the costs, and to require pre-implementation review that encourages assessment of whether new rules have had the intended effect.
We agree with the governance issues covered in the paragraphs leading up to Question 9. However, whilst accepting that PRA and CPMA should have separate powers to raise a levy from firms according to its duties and who is lead regulator, we consider that the total cost of the new regulatory bodies should not, on a business as usual basis, exceed that of the FSA- which itself has seen enormous increases in levies over the last ten years.
Consumer protection and markets authority (CPMA)
Before the advent of the Financial Services Authority, members of AFM were accustomed to meeting the regulatory demands of two or more authorities- for example, friendly societies were regulated by both the Friendly Societies Commission and the Securities and Investments Board.
Having a second regulator with a clear but different set of objectives is not therefore in itself a new concept. Indeed in many parts of the world it is the norm to have prudential and consumer regulation separate. For example ASIC in Australia and FCAC in Canada have for many years provided a distinctive brand of consumer protection working alongside prudential regulators (alongside which the CFPA in the US is modeled). This appears to work well in terms of removing the ambiguity of roles, though there are potential risks, including: