FSA Final Farewell

Since its creation in 2001, the Financial Services Authority has regulated the mortgage market through the good times and the bad.


It was the watchdog that didn’t bark. When the Financial Services Authority (FSA) was created in its current form by Gordon Brown, it was modelled on the all-powerful US regulators, but it is likely that it will be remembered for only thing: presiding over the near-meltdown of the UK’s banking system.


In its short life, the FSA failed to rein in the banks, and even encouraged the City to explode in the mid-2000s with a “light touch” approach to regulation. It did not notice that Northern Rock was built on such shaky foundations that it could easily run out of money, and failed to prevent the takeover of ABN Amro by RBS just as the credit crunch was biting in late 2007.


By this time next week the FSA, which was set up in 1997, will be entering its final hours. The blue-and-white sign hanging inside its low-rise Canary Wharf headquarters will be taken down and a new white-and-maroon logo bearing the initials FCA (Financial Conduct Authority) put up in its place. At the same time, in the City, just a few metres away from the Bank of England, another new regulator, the Prudential Regulation Authority (PRA), will be preparing to be officially opened by chancellor George Osborne.


Tearing up the FSA – which united the nine regulators that had existed before Labour was swept to power in 1997 – was one of the first key policy announcements by Osborne after the May 2010 election. But it has taken almost three years – much longer than expected – after he first pledged to disband Brown’s regulator to fulfil the vision to create two new ones – the PRA (a subsidiary of the Bank of England to ensure banks have enough capital and liquidity) and the FCA (essentially charged with putting consumers at the heart of the matter when dealing with financial regulation). Both formally begin operating on 2 April, although in practice the separation has already taken place.


When the FSA was created, the Bank of England was reeling from the collapse of Barings two years earlier. Paul Edmondson, a financial services partner at law firm CMS Cameron McKenna, reckons that at the time the FSA was a “sensible idea” to replace the array of organisations with acronyms such as Imro and Fimbra that policed the City in a form of self-regulation.


While the FSA’s legacy seems likely to be the banking crash, Kevin Burrowes, UK head of financial services at PricewaterhouseCoopers, acknowledges that the watchdog was not alone in missing the warning signs. “It’s not apparent that any regulator from around the world can stand up and say they did a great job over this period,” he says.


Even before Osborne announced the breakup of the FSA, changes to the philosophy of regulation were already under way following stinging criticism – including some from damning internal reviews – in the wake of the crisis. Lord Turner, who leaves on Monday, was installed as chairman just as the trouble started in September 2008, while insider Hector Sants had been promoted to chief executive just months before the run on Northern Rock a year earlier.


In the fallout from the crisis, they set about changing what Sants’s predecessor, John Tiner, had described as principles-based approach to regulation. In 2006, reflecting the mood of the time, Tiner said: “Firms’ managements – not their regulators – are responsible for identifying and controlling risks. A more principles-based approach allows them increased scope to choose how they go about this. In short, the use of principles is a more grown-up approach to regulation than one that relies on rules.”


But by 2009, Sants was saying, damningly: “A principles-based approach does not work with individuals who have no principles.” Meanwhile, Turner was outlining to MPs what he saw as a major problem, telling the Treasury select committee: “It was not the function of the regulator to cast questions over overall business strategy of the institutions … You may find that surprising.”


Thankfully, the new regulators are now being encouraged to be more curious and ask more questions. Andrew Bailey – who was brought in to run the PRA after Sants stunned the City by bowing out last year – has already begun to adopt a more intrusive approach to regulation for the 300 major financial institutions he is overseeing.


Meanwhile, Martin Wheatley, the new head of FCA, unveiled his strategy last week and made clear that two “C”s would be important. The “C” in his new logo had a white flash through the maroon to “shine a torch” on consumers, Wheatley said. But the “C” could equally stand for “competition”, the new and untested mandate the former London Stock Exchange executive, who was running the Hong Kong regulator during the financial crisis, has been given.


Wheatley’s FCA will also hand out fines – continuing the investigations into Libor-rigging, for example – and police the markets.


The coalition has also set up a financial policy committee inside the Bank of England – a bit like the monetary policy committee which oversees interest rates – to look for the next bombshell that might hit the financial system. It is the clearest illustration of how the approach to regulation is changing: this week it is scheduled to unveil the results of three-pronged review of bank capital that could reveal a hole of £60bn – although its powers of intervention are yet to be tested.


The FSA is leaving some unfinished business: the report into the near-collapse of HBOS is still to be published. But as the doors shut for the last time, remarks by its first boss Sir Howard Davies remain prescient. When he bowed out in 2003, Davies said: “The biggest disappointment of my time at the FSA has been the failure of firms, and particularly their senior management, to learn the lessons of past mis-selling …”


He was not referring to payment protection insurance, but that latest mis-selling scandal has proved to be the industry’s costliest yet at £12bn. Wheatley’s FCA has power to prevent a repeat of such scandals by banning the sale of unsuitable products.


Other issues may take priority, however. As he outlined his strategy on Thursday, Wheatley made no secret of his concern about potential for contagion in the eurozone – and this weekend it is clear why, as Cyprus scrambles to secure a bailout and reopen its banks. So it may not be too long before the new watchdogs have to show their teeth – and prove they can actually bark.


Barry Naisbitt, chief economist at Santander UK, said the decision was as expected: “After the major change in the approach to monetary policy announced in August, the Monetary Policy Committee (MPC) was not expected to do anything other than hold Bank Rate again this month.


“For the MPC in the months ahead the key will be whether the relatively strong output growth results in a faster reduction in the unemployment rate than it anticipated in August.


“With inflation still above target at 2.7% and steep energy price rises to come, the forthcoming quarterly Inflation Report and any changes that the MPC may make to its outlook for the economy are likely to be the next areas of focus.”


31 Mar 2013

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