House of Lords - Explanatory Note
Financial Services And Markets Bill - continued          House of Lords

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Paragraph 19: Delegation by and to other schemes

818.     Although the scheme is intended to cover most complaints relating the financial services industry, there is likely to be some continued overlap with other arrangements, for example in the areas of pensions and consumer credit. The scheme would be able to agree with other schemes which body should consider complaints within the voluntary jurisdiction. The arrangements must be approved by the Authority.

FINANCIAL EFFECTS OF THE BILL

819.     The net implications of the Bill on public finances will be very limited. Regulation of most firms in the banking and investment sectors is already on a full cost recovery basis.

820.     Regulation of insurance companies and mutual societies have been respectively the responsibility of the Treasury and the Registry of Friendly Societies, a non-ministerial sub-Department of the Chancellor of the Exchequer. These bodies were vote funded, but have substantially covered their costs in fees. Although the Authority is now carrying out many of the functions of those bodies on a contractual basis, those vote funding arrangements will continue until the Bill comes into force. Thereafter, regulatory costs for these sectors are to be recovered in full by the Authority. There will be a small net reduction in public expenditure. Net expenditure by the relevant bodies in 1998-99 is estimated to be £1.4 million (see table below).

Organisation

Expenditure (£million)

Receipts (£million)

Net expenditure (£million)

Insurance Directorate

10.4

9.8

0.6

Registry of Friendly Societies

7.2

6.4

0.8

TOTAL

17.6

16.2

1.4

EFFECTS OF THE BILL ON PUBLIC SECTOR MANPOWER

821.     The Bill will confer on the Authority responsibility for regulatory functions which have been the responsibility of public sector bodies. Contractual arrangements with the Authority have been entered into in advance of this legislation to bring about the early integration of the constituent bodies of the Authority. As part of those arrangements, the majority of staff of the Treasury's Insurance Directorate, and employees of the Registry of Friendly Societies responsible for the supervision of building societies, friendly societies and credit unions, along with a number of staff from Treasury Solicitor's Department accepted new employment contracts from the Authority and transferred in January 1999. This brought about a reduction in public sector manpower of approximately 150. A further 20 staff continue to be employed by their respective Departments while they are seconded to the FSA. Most of those staff, and up to 50 additional employees of the Registry, are likely to transfer to the Authority in due course.

SUMMARY OF THE REGULATORY APPRAISAL

822.     A regulatory impact assessment giving details of the likely costs of the proposed new regime is set out in the appendix to these explanatory notes. In summary, the creation of a single statutory regulator is expected to lead to a reduction in the recurrent regulatory compliance costs of financial services firms, particularly firms which are currently regulated by more than one regulatory body. There will however be transitional costs in moving to the new arrangements under the Bill. There are also new costs of funding the Tribunal and legal assistance for some cases referred to it under the new arrangements for penalties for market abuse. Overall the discounted expected reductions in compliance costs are expected to be more significant than the transitional and new costs, and the Bill should therefore result in cost savings for businesses and consumers.

EUROPEAN CONVENTION ON HUMAN RIGHTS

823.     Section 19 of the Human Rights Act 1998 requires the Minister in charge of a Bill in either House of Parliament to make a statement, before second reading, about the compatibility of the Bill with the Convention rights (as defined in section 1 of that Act). Lord McIntosh of Haringey has made the following statement:

    In my view the provisions of the Financial Services and Markets Bill are compatible with the Convention rights.

COMMENCEMENT

824.     Certain provisions in Part XXX (Supplemental) of the Bill will commence at Royal Assent. It is anticipated that all other provisions would be brought into force shortly thereafter.

APPENDIX

REGULATORY IMPACT ASSESSMENT

PURPOSE AND INTENDED EFFECT

Issue and objective

1.     The Bill gives effect to the proposals to reform the regulation of the financial services industry, announced in broad terms by the Chancellor in his statement to Parliament of 20 May 1997. It creates a single, statutory regulator for the UK financial services industry, with a single set of functions and powers. The Financial Services Authority (FSA) will take over the responsibilities of, and have powers equivalent to those of the nine existing regulators for banks, building societies, friendly societies, insurance companies and investment firms. The FSA will be responsible for the authorisation of those members of the professions carrying on activities regulated under the Bill and will have significant responsibilities in relation to Lloyd's. This Regulatory Impact Assessment (RIA) is an updated version of the RIA published when the Bill was introduced into the House of Commons in November 1999. A draft RIA was published for consultation with a draft of the draft Bill in June 1998. The assumptions as to likely costs and benefits for regulated firms and others made in the draft RIA were not generally challenged in consultation.

2.     The overall framework to be created by the Bill and the FSA's rule book substantially reflects the diverse regulatory arrangements currently applying to relevant firms in different sectors. For the most part, the features are not new, but they represent a significant coordination of the existing arrangements and procedures. Rather than separately identifying the costs arising out of each of the above categories of provision, where the impact may depend on the nature of each sector and the business of relevant firms, this regulatory impact assessment seeks to reflect the overall impact on the total costs to authorised firms.

3.     The general approach in the Bill is to give the FSA a series of enabling powers, so that it can act as it considers appropriate in particular cases, for example by making rules in specified areas. Costs to authorised firms will arise substantially from the FSA rules, rather than directly from the Bill. Before actually making rules, the Bill requires the FSA to consult on the proposed rules and to accompany the draft rules with a cost-benefit analysis. The Bill also requires the FSA to include an explanatory memorandum setting out the purpose of new rules or amendments to old rules, and when, after consultation, a final rule change is published the FSA will have to publish a statement about representations made and its response to them, and about any significant alterations from the original proposal, together with a revised version of the cost-benefit analysis. More generally, the Bill requires the FSA to have regard to a number of regulatory principles, including that any burdens or restrictions should be proportionate to the associated benefit. The FSA must also have regard to both the need to minimise its effect on, and the desirability of facilitating, competition.

Risk assessment

4.     Regulation of the financial services industry helps to protect against market failure. Prudential regulation reduces the chance of losses resulting from incompetent or dishonest management, giving consumers confidence in firms and markets. Regulation of the conduct of a firm's business with its customers is designed not only to protect against dishonesty or negligence, but also (together with prudential regulation) to protect consumers from the consequence of asymmetries of information.

5.     However, the old system of financial services regulation is costly, inefficient and confusing for both regulated firms and their customers. It was based on legislation that created a large number of regulators, each responsible for different parts of the industry, operating under a patchwork of separate powers. In recent years there has been a blurring of the distinctions between different kinds of financial services business. This has added further to the complexity of financial regulation.

BENEFITS

Benefits to businesses and consumers

6.     Combining the existing regulators should produce economies of scale, making regulation more cost-effective and producing savings in compliance costs and regulatory fees. As a significant proportion of firms' incremental compliance costs 4 relate to their reporting to and maintaining relationships with regulators, it is expected that the percentage saving for firms regulated by several regulators will be greater than for other firms. These savings are considered later in the assessment. Increased confidence in the UK financial sector resulting from improvements to the regulatory framework should give the UK's financial services industry a competitive advantage, thereby enhancing its growth prospects. The industry should also benefit from the increased flexibility in relation to collective investment schemes. The proposals for the regulation of exchanges and clearing houses, with their additional flexibilities in terms of increased potential for delegation and for stand alone clearing houses, should also confer significant benefits.

7.     Around 90% of UK households use financial services products. Businesses and consumers will benefit:

  • The FSA will have a greater ability to target supervisory resources where they are most needed. The regulatory framework will be better able to identify and resolve problems which cut across existing regulatory boundaries.

  • There will be single points of access for enquiries, complaints and compensation. The consumer complaints-handling arrangements will, for the first time, be compulsory for all regulated financial services firms and will improve handling of complaints which cut across boundaries.

  • The international role and status of the FSA should lead to improved regulatory cooperation across borders.

  • The wider choice as to the legal form of collective investment schemes will create greater potential flexibility and choice for investors.

  • An improved regulatory framework should increase consumer confidence and understanding in the financial services sector. Some consumers may as a result be willing to exercise their choice to use the services of the sector more extensively. To the extent that better regulation improves the operation of the market, the products consumers select will be more closely matched to their needs.

8.     The Bill sets out explicit regulatory objectives for the FSA, which include raising consumer awareness. This is aimed at reducing the information asymmetries which to a large part underlie the need for regulation. It also responds to the desire of the public to provide better information on education.

Business sectors affected

9.     The UK's financial sector affected by the reforms accounts for about 7% of GDP. Around 34,000 currently regulated businesses will be affected, split broadly as below (there is a certain amount of double counting because some firms are regulated by more than one body).

Banks

600

Building societies

70

Friendly societies

270

Credit unions

650

Insurance companies

850

PIA firms (providers of retail financial services)

4,200

IMRO firms (fund managers etc.)

1,100

SFA firms (securities and derivatives firms)

1,300

Former IBRC firms (insurance brokers) regulated, as an interim measure, directly by FSA

900

Appointed representatives of firms authorised by PIA, IMRO or SFA

10,000

Professional firms

15,000

Lloyd's members' agents and managing agents

80

10.     The 15,000 professional firms (mainly solicitors and accountants) are currently authorised by their professional bodies. Authorisation of such firms will in future be a responsibility of the FSA, where such firms carry on mainstream investment business. However, in most cases, only a small part of professional firms' business is financial services which would be regulated under the Bill. The Bill therefore provides for the exclusion from the scope of regulation for those professional firms which offer investment services to their clients in a manner which is incidental to their main business, and where a series other tests are met, subject to oversight by the FSA. As a result, the number of professional firms which will need to be authorised is thought to be around 2,000. It is expected that the remaining 13,000 firms will either benefit from the proposed exclusion from the scope of the Bill or will benefit from one of the specific exclusions in the Regulated Activities Order (made under clause 20 of the Bill).

11. Additionally, approximately 2,000 UK and overseas collective investment schemes are regulated under the present system and will be affected by the reforms.

12.     The FSA will also take over from the Registry of Friendly Societies registration functions in relation to about 13,000 societies registered under building societies, friendly societies and industrial and provident societies legislation.

Compliance costs for typical firms

Non-recurring

13.     Two main types of non-recurring costs will result from the proposals: one-off transitional costs to the regulator and compliance costs to firms. The FSA estimates its transitional costs, including establishing the single complaints-handling and compensation schemes, to be approximately £15 million (equivalent to slightly less than 10% of the current annual amount of its mainstream regulatory activity costs). These transitional costs will be financed by borrowing and will be repaid over time from regulatory fees paid by authorised persons.

14.     Non-recurring compliance costs will arise because firms will need to adapt to the new regime, training staff and adjusting their systems and compliance manuals to reflect the new handbook. However, the requirements will, in most areas, be broadly consistent with those in existing rules and guidance, which will reduce the extra training necessitated by the Bill. (It is not expected that there should be any material additional transitional costs associated with prudential regulation of firms, although of course the FSA will have powers under the Bill to alter prudential requirements for firms or categories of firms).

15.     To illustrate the possible one-off transitional cost, it is plausible to assume that it would be equivalent to 5% of the existing annual compliance cost for firms and groups currently regulated by one body and by 10% for those regulated by more than one body. Then, for a typical securities firm, assuming an average incremental compliance cost of £110,000 per annum, the transitional costs, depending on the number of supervisors it has currently, could be between £5,500 and £11,000. 5

16.     The Bill will give the FSA responsibility for regulating those professional firms such as solicitors, accountants and actuaries carrying on mainstream regulated activities who are currently supervised by Recognised Professional Bodies. It also gives the FSA significant responsibilities in relation to Lloyd's. The alterations to the existing regulatory framework in these areas may create higher unit transitional costs than for other firms. As noted above, it is likely that only about 2,000 professional firms, that is those carrying on mainstream regulated activities will need to be authorised by the FSA. This could lead to a signification reduction in the overall number of authorised professional firms and the corresponding overall compliance costs. In the case of Lloyd's, the precise costs will depend on the way the FSA chooses to regulate the society and its members. The FSA have consulted on its proposals 6 and issued a feedback statement in June 1999.

Recurring

17.     Recurring costs for firms also derive from regulatory fees and compliance costs. Future regulatory costs depend only in part on changes introduced by the Bill, particularly changes in the scope of the FSA's activities. Other factors, such as prevailing salary rates, are important.

18.     The FSA's mainstream regulatory activity costs, at £158.5m, are budgeted to be lower in real terms in 1999/2000 than the sum for the component regulatory bodies in 1997/98. Despite the FSA having a slightly wider scope than that of the nine bodies being brought together, there is also the prospect of further cost savings once the new legislation is in force. These further savings should arise as the FSA becomes increasingly effective in targeting its supervisory resources and as it improves its efficiency by rationalising the diverse systems and procedures inherited from its predecessor bodies.

19.     Compliance costs will depend on the requirements in the FSA's handbook of rules and guidance. In constructing its handbook, the FSA will be able to select the approaches from each of the existing rulebooks that have shown themselves to be most cost-effective and will be able to remove any unnecessary compliance burdens. Its incentives to do so should be sharpened by the obligation under the Bill to ensure that the costs and restrictions on firms are proportionate to the benefits. The FSA will be obliged to consult on its fees and proposals to make rules. Its consultation will include an analysis of the costs and benefits of the proposals, unless it expects there to be no material increase in compliance costs. (Again, it is not expected that there will be any material changes to the costs of prudential regulation of firms).

20.     For those firms and groups currently subject to more than one regulator, the measures in the Bill should create further savings, since they will enable overlap between regulators to be eliminated. Reductions should come especially from having a single handbook of rules and guidance and also from the removal of duplication in compliance related activities (e.g. monitoring visits and regulators' requests for information). The management of these firms should have to spend less of their time in dealing with regulators, problems caused by inconsistencies between the rules will be eliminated, fewer returns will have to be made to regulators, the relationships with the regulators will be more easily manageable and some firms may have less need to create separate subsidiaries.

21.     The FSA estimates that over 800 firms currently have more than one regulator and at least another 1,000 firms are members of groups which are subject to more than one regulator. These firms tend to be the larger firms and so account for a large proportion of total incremental compliance costs. For example, the great majority of life offices have been regulated both by the PIA and by the Treasury's Insurance Directorate. Almost all banks - excepting the smallest - are members of at least one SRO, as well as being supervised for banking activities by the FSA, and some fund managers are regulated by more than one SRO.

22.     To illustrate possible impacts, a plausible initial estimate might be that incremental compliance costs for firms supervised by more than one body could be reduced by between 21/2% and 5%. For an investment management firm currently regulated by more than one supervisor, its annual savings might be between £600 and £1,200, assuming its incremental compliance cost is £25,000 per annum.7 For a securities firm supervised by more than one body, the savings might be between £2,800 and £5,500, based on an average incremental compliance cost of £110,000.8

23.     Given the relatively early stage of the development of the FSA handbook, it is not possible at this stage to make a reliable estimate of total compliance cost savings. It is nevertheless clear that there is scope for substantial savings. For example, the 800 or more firms which currently have more than one financial regulator are maintaining something approaching 1,700 relationships with regulators. This suggests that as many as 900 such relationships will fall away, yielding useful savings in managers' and regulators' time.

24.     As noted in paragraph 11 above, the FSA have consulted on how they should use their powers to regulate Lloyd's and the approach likely to be adopted suggests total costs of approximately £1.2 million (compared with the current Treasury fee of £200,000 for regulation under the Insurance Companies Act 1982). There may be scope for certain offsetting savings within Lloyd's. These cannot be quantified until the detailed regulatory arrangements are clearer, but the total budget for Lloyd's Regulatory Division in 2000 is £10.7m.

25.     All firms will also face recurring costs from the complaints-handling and compensation schemes. The Financial Services Ombudsman Scheme will be funded from a combination of a levy on all authorised firms and case fees. The Financial Services and Markets Compensation Scheme will be funded from levies imposed on the industry, although there will be separate funds for different industry sectors. These costs will depend on the number of complaints and claims on the compensation scheme funds and the limits on payments to claimants set by the FSA. Most firms already belong (either on a compulsory or voluntary basis) to one or more of the existing schemes and so generally reform will not give rise to an additional cost, except for those few firms who have not so far been members of relevant schemes.

Impact on small businesses

26.     Some types of small businesses will be affected by the Bill, including, for example, Independent Financial Advisers (IFAs) and small stockbrokers. In practice, diseconomies of scale mean that the non-recurring transitional costs might be proportionally higher for a small firm than for a larger company.

27.     It is still too early in the regulatory reform process to determine the impact of the Bill on small businesses (IFAs), since the main effects are likely to flow from the new FSA handbook of rules to be made under the Bill (this handbook is still at an early stage of development) and from improvements obtained by merging regulations (which may have little impact on IFAs just regulated by PAI). However, small businesses should see cost savings from an improved FSA handbook. These savings will be partly offset by a one-off cost. If the one-off cost for such a firm was in line with the assumptions used in paragraph 10, it would be no more than £125. However, if the Bill gave rise to, say, 10 hours of work, assuming average marginal earnings of £31 per hour, the one-off cost would be £310.

28.     Professional firms currently regulated by their professional bodies for investment business would become regulated directly by the FSA. It is thought that around 13,000 of such firms provide investment services which are not mainstream investment business and are derived from and subordinate to the provision of other professional services. Some of these have chosen to be authorised purely for precautionary reasons (that is, where it is not clear whether firms are conducting authorisable business, but firms err on the side of caution). Clarifications to the scope of regulated activities and the proposed exclusion from the scope of regulation for professional firms carrying on non-mainstream regulated activities should limit the number of such firms seeking authorisation. Other professional firms are authorised because they conduct significant financial services business, although this is not the main business of the firm. Many of them are small.

29. Some of the firms currently regulated by the professional bodies are expected to need to be regulated by the FSA (it is anticipated that around 2,000 firms will require full authorisation). The FSA issued a consultation paper on 30 October 1999 on its approach to the regulation of professional firms. Although the proposed level of fees is still under consideration, it appears unlikely that the fees for professional firms would be lower than £1,000 per annum and they could well be higher than this. Even at such levels of fees there could be an impact on the activities carried on by the smaller professional firms. The effect of the increase should, however, be set against the benefit to consumers, in terms of more consistent levels of regulation regardless of where they purchase financial services.


4. Incremental compliance costs are those costs of complying with regulations that would not be incurred by a well run business in the absence of the regulations. Given the Bill's rationalisation of the UK regulatory structure, it is expected that the effect of the Bill on costs is most likely to be felt on the incremental (net) costs of compliance with regulation, rather than the gross costs.    Back

5. Estimates of average incremental compliance costs in paragraphs 15 and 22 are based on mid-points of data presented by Franks, Schaeffer and Staunton, "The direct and compliance costs of financial regulation", Journal of Banking and Finance (1998) 1547-1572 (updated in line with the GDP deflator from the date of the data on which the published figures were based to the end of 1998). (The equivalent figures in the draft RIA published in July 1998 differ only because they were not updated in line with the GDP deflator.)     Back

6. Financial Services Authority Consultation Paper 16, The Future Regulation of Lloyd's, published November 1998.    Back

7. See footnote 2.    Back

8. See footnote 2.    Back

 
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Prepared: 15 February 2000