Financial services are those products and services being offered by institutions in the finance industry such as banks, investment banks, stock brokerages and etc (see Figure 1). With the goal to facilitate a variety of financial transactions in order to manage money (e.
g. insurance, credit cards, loans and investment opportunities). Other services also include information on the stock markets and related issues such as market analysis of trends (Financial Times Lexicon, 2017 (2)). Figure 1: Types of Financial ServicesWhat is financial regulation?Financial institutions are subject to supervision and regulation known as financial regulation, this comes in the form of guidelines, restrictions which are designed to enhance and maintain the financial system’s integrity. Financial regulation is imposed through both government and non-government organisations. ?2 MAIN BODY 2.1 PRE-FSA ERA: 1982 – 2000 The Bank of Credit and Commerce International (BCCI) was founded in 1972 by a Pakistani financier and operated internationally. Within a decade, BCCI operated in over 78 countries through 400 branches, with assets worth over $20bn.
As a result, it became the 7th biggest private bank globally. In the 1980s, BCCI was investigated by a number of financial regulators because of concerns over poor regulation. Consequently, inquiries found that the bank was involved in a variety of finance crimes including money laundering activities and illegally owning a majority (controlling) interest in an American bank.
On the 5th of July 1991, BCCI was the centrepiece of regulators, 7 different country’s bank regulators and customs officers raided the bank’s branches and seized their files/records. UK and US investigators commented that BCCI was:”set up deliberately to avoid centralized regulatory review, and operated extensively in bank secrecy jurisdictions. Its affairs were extraordinarily complex. Its officers were sophisticated international bankers whose apparent objective was to keep their affairs secret, to commit fraud on a massive scale, and to avoid detection.” Deloitte (liquidators), sued BCCI’s auditors PwC and EY, which in 1998 was eventually settled for $175m.
In 2013, they claimed to have recouped 75% of the overall creditor’s lost money. This example illustrates the amount of money that can be involved where there is poor regulation.Due to a series of financial scandals leading to Baring Bank’s eventual collapse, this created a desire to bring an end to self-regulation within the finance industry and hold accountable those with regulatory responsibilities. Barings Bank was liquidated in 1995, due to poor speculative investments (futures contracts) by one of its employees, Nick Leeson its it Singapore office. The bank made losses off $1.3bn, more than 2 times the bank’s capital, resulting in bankruptcy due to its’ inability to absorb the losses. Furthermore, the bank was further helped by the Bank of England (BoE), who made an exception, allowing Baring’s Bank to lend more than 25% of its’ capital to one person/entity.
As a result, the Securities and Investment Board (SIB) was enacted, revoking The Financial Intermediaries, Managers and Brokers Regulatory Association’s (FIMBRA) recognition as a Self-Regulatory Organisation (SRO). SIB was given its’ statutory regulatory powers under the then Financial Services Act 1986. The Financial Services Act 1986 was passed during the period of Margaret Thatcher’s government, designed for the regulation of the finance services industry. The Financial Services act utilised a mixture of self-regulation and regulation by the government, for example, the Securities and Investment Board was created to overlook SROs.?2.
2 FSA ERA: 2001 – TWIN PEAK During this period, the Financial Services and Markets Act (FSMA) 2000 Act contributed to how regulators regulate, by creating the Financial Services Authority (FSA). The FSA was tasked with regulating the whole UK financial services industry, with a statutory focus on maintaining market confidence, financial stability of the UK financial system, consumer protection and reducing financial crime. The latter objective was clearly not being exercised adequately by the FSA and as a result, during 2008, not only the UK by global economies collapsed. As a result, regulators responded by updating the FSA Act 1986 to the FSA Act 2010.
Key changes made:• A council was created for Financial stability to manage the actions and responsibilities under the tripartite model (consisting of Bank of England, FSA and the Treasury), • In response to the crisis, the FSA Act 2010 delegated responsibilities to the FSA (financial services authority), to ensure financial institutions have in place recovery and resolution plans to tackle financial instability• Established that in the case of mass failure in practice, consumers could get compensation (e.g. PPI where banks have compensated in the billions)Then came the Financial Services Act 2012, abolishing the FSMA and FSA. This act restructured the tripartite model of the UK financial regulation system, as it was seen that no single party had the power, authority or responsibility to oversee the whole system. Moreover, no one was able to identify potential threats and respond to them decisively. As a result, a new structure was introduced, known as the Twin Peaks era.2.2.
1 Basel Accord Basel Accords are sets of banking regulation, providing recommendations to regulators on operational, capital and market risks. The financial crisis highlighted areas of problem that were not being addressed by Basel I (e.g. regulatory arbitrage), which Based II attempted to rectify by enhancing its framework’s effectiveness to tackle issue in the crisis such as off-balance sheet risks or re-securitisation (Caprio, 2013).Although off-balance sheet risks or re-securitisation still exists, they will not be available at such low rates ever again. The challenge is to be proactive and not reactive, for example, Basel II suffers from the fact that its’ scope of ensuring financial stability is limited to only banks and not brokers or hedge funds, which could significantly impact the economy. Another major issue was the capital requirements for banks, whom as a result couldn’t protect themselves from losses, which Basel II addresses by enhancing the minimum capital requirements that banks must hold (Financial Times Lexicon, 2017 (1)). ?2.
3 TWIN PEAK ERA: 2013 – PRESENT Figure 2: Reasons for ChangeThe Parliamentary Banking Standards Commission reviewed the collapse of HBOS plc (banking and insurance company), which cost the taxpayer around £20 billion and the loss of thousands of jobs. The key question is whether the new regulatory framework is capable of preventing such an issue. It was concluded that FSA’s regulation of HBOS was painstakingly inadequate. After the merger between HBOS and Lloyds, the FSA identified certain issues but failed to follow through on rectifying them, as they were easily satisfied that they had been resolved (Reuters, 2017). The FSA took too much comfort from reports prepared by 3rd parties with interests not aligned with the FSA’s.In the Twin Peaks era, most of the FSA’s objectives were passed on to the Financial Conduct Authority (FCA) and Prudential Regulatory Authority (PRA). Furthermore, the FSA Act 2012 delegated supervisory tasks over the UK financial system from the FSA to the BoE. For regulators, this meant that the new parties created would overlook the financial services industry through powers delegated.
Figure 3: Twin Peak RegulationFinancial Policy Committee (FPC) – overlooks the directors of BoE who are responsible for macro prudential regulation matters (for the whole UK financial system). This differs from PRA, which performs a micro prudential role of supervising finance corporations. In contract to FCA and PRA, the FPC doesn’t have direct accountability to regulate a specific firm, however, it’s inherent goal is parallel to the BoE’s objective of financial stability. The FPC achieves this by recognising, monitoring and acting upon observations to reduce or remove systemic risks. A “systemic risk” is considered any risk that could destabilise the whole or a substantial part of the UK financial system. For example, in the case of RBS collapsing, it was regarded a systemic risk. In this case the FPC would determine which macro prudential tool to utilise in combating this risk, however, it’s the PRA or FCA whom are responsible for the application of the chosen tool to regulate RBS (FSA, 2011).
Prudential Regulation Authority – PRA is a subsidiary of BoE with responsibility of micro prudential regulation over systemically significant firms (e.g. investment banks, insurers and etc.). These are regarded as PRA authorised firms and dual regulated firms, whereby PRA regulates prudential issues and the FCA acts as their conduct regulators. The PRA’s overall objective is to promote safety and soundness of PRA regulated firms.
Another objective is to protect policy holders (insurers) in the insurance industry by safeguarding them using an appropriate degree of protection. PRA has 3 characteristics (see graph below) focused, judgement-based and forward-looking (Druces LLP, 2017). Figure 4: PRA’s regulation characteristicsWith the financial crisis bringing forth even more the importance of identifying risks, especially with consequences that impact whole economies, the PRA has proposed a new Risk Assessment Framework (graph below) in order to adhere to its’ objective of protecting policy holders. The PRA’s judgment based approach to supervision will shift from rules and focus on forward looking analysis, this includes assessing how firms would be resolved if they fail and the consequential effect on the UK system and in the case of banks, their use of public funds. The goal therefore is to pre-emptively stop the risk before it crystallises. Fundamental to this approach is the new risk assessment framework (see Figure 5). Figure 5: PRA’s New Risk Assessment FrameworkHowever, the argument is: Financial Conduct Authority – the FCA Essentially is responsible for the conduct of business regulation of all firms including PRA authorised firms, currently regulating around 26,000 firms (CII, 2013).
With the exception of systematic risk, the FCA has responsibility for regulating market conduct (FCA objectives on Figure 3). 2.3.1 Current Regulatory Examples Sonali Bank (UK) Limited – £3.
3m:In October 2016, the FCA fined the branch of Sonali Bank Ltd. (Bangladeshi based) for £3.25m. the reason was the FCA deemed the bank to have inadequate anti-money laundering systems during a 4-year period.
The FCA mentioned that even under their investigation, the bank failed to carry out due diligence of customers and failed to report any suspicious activities (Justin, 2016). Aviva Pension Trustees UK Limited and Aviva Wrap UK Limited – £8.2m:In 2016, Aviva became the first company to receive a fine from the FCA for not ensuring appropriate protection of client assets whilst using an outsourcer, they were deemed to have insufficient controls and were fined £8.2m. It was found that Aviva’s adviser department lacked expertise or resources to identify and repair client assets risks (Justin, 2016). 2.3.2 Recent Regulatory Changes New FCA rules to spark ‘intense payments change’Under FCA’s new rules designed to shake up the sector, banks must publish security breach data and complaints they receive.
However, “One of the concerns raised (and ignored) in the FCA’s consultation was that publishing this data would direct hackers to the banks with the weakest security. Perhaps it will, but the FCA’s open approach is commendable. Arxan sees a huge range of attitudes towards mobile app security and we hope that openness will push every bank to be as security-conscious as the best-in-class already are,” The FCA requires providers of personal and business current accounts to publish data helping customers compare the service they could receive from other providers (Scott, 2017).
Under the new rules, customers will be able to find (FCA, 2017):• “how and when services and helplines are available• contact details for help, including for 24 hour helplines• how long it will take to open a current account• how long it will take to have a debit card replaced• how often the firm has had to report major operational and security incidents• the level of complaints made against the firm”UK watchdog says was too slow to probe HBOS auditAn update on HBOS’ case from the financial crisis, shows that the FRC has called to parliament to make it simpler when challenging accountants. As a result, reforms were made allowing the FRC to pursue accountants working for audit firms concerning breaches, by lowering the legal hurdle compared to prior tests showing misconduct. 3 RECOMMENDATIONS Due to consistent issues facing the UK financial system, there are various methods of reforming how regulators regulate this industry. Most importantly, there should be a focus on being proactive instead of reactive. Other improvements include (CBI, 2017):• Collecting evidence on cumulative impact of regulation on whole sector• More formalised collaboration between the FCA and PRA• Regulators should engage with the sector through activities – e.g.
sector secondments and firm open days to give opportunities for regulators to engage with firms