Who watches the watchdogs?

In a post-Brexit world, the UK legislature aims to position the country favourably by means of the Financial Services and Markets Bill (FSMB) and is taking a look at the role of the regulators, namely the FCA and the PRA.

Law firm Macfarlanes has commented on the approach taken by the Treasury Select Committee (TSC) and issued a statement to call for the establishment of an independent oversight body for the UK’s financial watchdogs.

“In our extensive conversations with industry bodies and other interested parties, two primary concerns emerged,” elaborates David Gauke, head of public policy at Macfarlanes. “First, there are widespread concerns that the inconsistent performance from the regulators is putting UK financial services businesses at a competitive disadvantage. And second, although there is a need for greater accountability, there is nervousness that greater parliamentary involvement could aggravate matters unless it is carefully constructed.”

“To position the UK favourably as it navigates a post-Brexit world, we propose a new independent body,” adds Gauke. “A function to scrutinise the regulators and provide a long-term, strategic direction to the UK’s financial services market.”

The TSC concluded that “if any matter of public interest were to arise that we deemed sufficiently important to scrutinise in more detail, or indeed challenge, we would do so”, and it did not “see a clear need for the creation of a new committee or a new independent body to carry out this work”.

Subsequently, the TSC formed a new sub-committee, assisted by two industry experts, which so far has applied scrutiny of reforms to Solvency II, sustainability disclosure requirements and investment labels, and broadened access to financial advice.

This current approach has raised additional concerns in relation to the broad set of responsibilities, attracting advisers who may not necessarily be equipped or interested to govern the financial services sector and do not have incentives to take a greater interest. In conjunction with the turnover of the TSC, it makes it challenging to build up this expertise, says Macfarlanes.

While alternative approaches such as the systems in the US or EU were considered, they were ultimately dismissed due to differences in the relevant jurisdictions too grave to allow for a similar establishment in the UK.

Quis custodiet ipsos custodes?
However, there are lessons to be learnt from these other systems, says Michael Sholem, financial services partner at Macfarlanes: “Under the EU legislative system, any regulation undergoes a rigorous process where multiple bodies consult and negotiate on the details of a proposed law, to ensure the final product is fit for purpose.

“Brexit and the FSMB have meant that an enormous amount of policymaking power will be effectively delegated to the UK regulators,” he adds. “This should mean that the UK regulatory regime will be more agile compared to the EU. It is critical, however, that these reforms are made within a system that provides for both rigorous scrutiny of the regulators and enables the provision of expert advice on the UK’s position as a hub for financial services. An independent expert body can help deliver on both those objectives.”

To retain the benefits of the EU’s approach but ensure that the regulator can maintain a swift process, Macfarlanes advocates for the incorporation of a body called the Office for Financial Regulatory Accountability as proposed by Lord Bridges, chair of the Economic Affairs Committee of the House of Lords. The law firm draws comparisons to the structural set up of the House of Commons Public Accounts Committee and the National Audit Office.

Such a body should consist of industry experts, former regulators, academics, economists and individuals with expertise of internationally competitive jurisdictions. The members of this institution would take responsibility for examining regulatory proposals and scrutinising the regulators’ performance against their statutory objectives.

In practice, Macfarlanes proposes this to entail public and private hearings, consultations or reviews, as well as evaluating the UK’s regulatory regime against international standards such as the Basel Committee on Banking Standards.

The law firm advocates that this would support the FCA and PRA in their daily undertakings by providing additional expertise, tackling the first concern highlighted by Gauke, as well as ensuring that the regulators follow a larger, overarching strategy. Thereby addressing the second point of concern.

Finally, Macfarlanes makes a point for independence from the legislature, as Sholem highlights: “The independence of this proposed body is important in the context of international competition. In order to provide a long-term strategy for the UK, it needs to be removed from the legislature so as to avoid it becoming a political tool for the government of the day. Additionally, this would increase the stability provided to the country’s economic ecosystem.”

As the UK continues to position itself in a post-Brexit world, there is a clear need to address the remnants of EU legislation. It should come to no surprise that the regulatory bodies of a single jurisdiction are ill equipped to handle the administration of several institutions governing 27 countries. Any attempt to do so is likely to result in catching up with daily affairs, losing sight of the bigger picture, while the expertise previously provided as part of the European Union is now lacking.

Against this backdrop, the proposal brought forward by Macfarlanes delivers considerable arguments to solve the problem by answering the question “who watches the watchdogs?”