UK Government Announces Financial Regulatory Changes; ABI, Lloyd’s Comment

The UK’s Conservative government recently announced the long awaited regulatory reform proposals for financial services, covering both banks and insurers.

They are far reaching, and will require changes in the way the UK’s insurance industry is regulated. As a result the insurance community has responded cautiously, but overall positively, to the proposals, which have been in the works since last summer, when the government announced that it planned to abolish the current regulator, the Financial Services Authority (FSA).

In a speech to the insurance community, the FSA’s Chief executive, Hector Sants, outlined first the changes that would be required when the long awaited European Union’s Solvency II regulations come into force at the beginning of 2013.

He then outlined the fundamental changes in UK regulations that have been announced, and will, in all likelihood be enacted. “Specifically, the Government plans to create three new bodies,” Sants stated:

The Prudential Regulation Authority [PRA] –will be a subsidiary of the Bank of England and responsible for stable and prudent operation of the financial system through the regulation of individual financial firms in a way which minimizes the disruption caused when they fail

The Financial Policy Committee [FPC] – will sit alongside the Monetary Policy Committee in the Bank of England and, working with the PRA, will create a comprehensive and clear framework for addressing macro-prudential issues, i.e. looking at the overall risk in the system. It will have the ability to take away the punch bowl from the party. We have yet to determine exactly how it will do this; what its toolkit will be, but as well as using traditional interventions, such as changing capital requirements, we may intervene at the product level, for example by imposing specific limits on retail mortgage loan to-value ratios.

The Consumer Protection and Markets Authority [CPMA] – will be the successor body of the FSA and will have a primary objective of ensuring confidence in financial services and markets, with specific focus on protecting consumers and ensuring market integrity.

Sants also pointed out that the regulatory authorities duly recognize the fundamental differences between insurers and banks. He stated that in contrast to banks insurers don’t normally take on “maturity transformation risks.”

He also recognized that types of insurance differ greatly with a “wide range of insurance products and business models. We have short-term general insurance, where both the liabilities and the assets held against them are relatively short term; and we have long-term contracts – particularly in life term assurance and annuities – where the assets held are longer term but so too are the liabilities. But what we almost never face in traditional insurance business is long term assets held against short-term liabilities, the defining characteristic of banking and shadow banking, and a key source of potential volatility.”

He also indicated that the “failure of insurance firms is not as likely to be systemically significant as that of banks. I am not saying that there are no systemic risks posed by insurance failures, but rather they are different to those posed by banks and certainly less prevalent.”

The response from Peter Vipond, Director of Financial Regulation and Tax at the Association of British Insurers (ABI) was largely neutral. “We welcome the name change and are encouraged that the Government seems to be making clear that the new Financial Conduct Authority will be proportionate, impartial and will seek to promote competition and consumer choice,” he wrote. “Consumers interests will be served by having a regulator that recognizes the value of consumers having a wide choice of products in a competitive market.”

Vipond also indicated that the ABI is generally pleased that the Government is “acknowledging the concerns of insurers about the accountability of the Financial Ombudsman Service, in particular ensuring its role is as an adjudicator not a regulator.”

However, he stated that the ABI remains concerned “that so far none of the bodies will have a statutory objective to maintain London’s competitiveness as a global financial sector – this is too valuable a prize to be thrown away.

“This overhaul of the UK regulatory system is a very significant change. The most important thing is to get these changes right. It will therefore be vital for the Government to remain open minded throughout the pre-legislative process ahead to make sure these changes strengthen the UK’s world leading financial services sector and the customers it serves,” Vipond concluded.

Lloyd’s response from Sean McGovern, its General Counsel (and head of its North American Operations], concentrated on the proposal that the Society of Lloyd’s and Lloyd’s managing agents should be dual-regulated firms.

“The move to twin peaks regulation means it is inevitable that we will be subject to oversight by both the PRA and the FCA,” McGovern wrote. “We welcome the acknowledgement that the unique nature of Lloyd’s will be recognized in the practical implementation of the new regime and that the PRA will be our lead authority. We hope this will minimize the risk of supervisory duplication.”

Sources: Financial Services Authority, Association of British Insurers, Lloyd’s of London