Select Committee on Constitution Minutes of Evidence


APPENDIX

Letters of Understanding between Chancellor and FSA Chairman

Sir Howard Davies

Chairman

Financial Services Authority

Dear Howard

THE NEW FINANCIAL REGULATION FRAMEWORK

  The Government has a responsibility to ensure that the UK's financial sector is effectively regulated and supervised. In response to the failures of the past, and in recognition of the rapidly changing nature of financial markets, we have established a new consolidated regulatory body, operating—for the first time—within a single legislative structure.

  The Financial Services and Markets Act came into force at midnight on 30 November, providing the legal underpinning for the FSA to act as the UK's sole financial regulator and supervisor. The FSA is independent of Government, and separate from the conduct of monetary policy by the Bank of England. There is a comprehensive new framework to ensure that the FSA and its Board is properly accountable to Ministers, Parliament and the wider public, and that it takes into account the interests of all its stakeholders—authorized firms and consumers alike.

  In this letter, I want to set out how I propose to use my powers under the new arrangements to ensure that the accountability process works as effectively as possible. I also want to clarify the circumstances in which sensitive information, perhaps relating to individual cases, might flow between the FSA and Ministers.

The new framework

  Under the new Act, the FSA will regulate compatibly with achieving four statutory objectives:

    —  maintaining market confidence in the financial system;

    —  promoting public understanding of the financial system, including awareness of the benefits and risks of different kinds of investment or other financial dealing;

    —  securing the appropriate degree of protection for consumers, while having regard to the general principle that consumers should take responsibility for their decisions; and

    —  reducing the extent to which it is possible for a business carried on by a regulated person or body to be used for a purpose connected with financial crime, such as money laundering, fraud and insider dealing.

  The Government will remain responsible for:

    —  the legal and institutional framework within which regulation is carried out, including the core corporate governance structure of the FSA;

    —  appointing the executive and non-executive members of the FSA Board, and judging their overall performance in relation to the FSA's statutory responsibilities;

    —  ensuring the boundaries of FSA regulation are correct;

    —  directing the FSA on additional matters to be included in its public Annual Report;

    —  mounting investigations in cases of possible major regulatory failure, and also to assess value for money; and

    —  directing implementation of international obligations.

Accountability

  Under the new legislation, the FSA will set the detailed regulatory rules, and make its regulatory decisions, independently. In recognition of this, there will be a new, strong, framework to hold the FSA Board to account.

  As you will know, the main elements are:

    —  the four statutory objectives;

    —  a requirement also to have regard to principles of good regulation, notably to regulate proportionately;

    —  extensive consultation requirements when the FSA makes new rules, including an examination of proportionality, backed up by statutory consumer and practitioner panels. The Director General of Fair Trading must also keep the regulating provisions and the FSA's practices under review;

    —  in respect of individual cases, accountability is supported by the Complaints Commissioner and (where the Act provides) the Financial Services and Markets Tribunal, together with the possibility of judicial review;

    —  and each year, the FSA must report to the Treasury on "the extent to which, in its opinion, the regulatory objectives have been met". The Treasury can also direct you to cover particular issues in the report. It submits this Annual Report to Parliament; and

    —  the non-executive directors must also report on the discharge of their functions, which include whether the FSA is using its resources in the most efficient and economic way.

  It will be the general responsibility of Ministers to reassure themselves that the FSA is meeting its objectives.

  Without in any way compromising the FSA's statutory independence, I propose to use my powers as follows:

    —  directing the FSA to cover particular issues in its public Annual Report, so that, over time, the Reports will establish an important public information base, through which Parliament and others will hold the FSA and its Board to account. I will encourage Parliament and the Treasury Select Committee to consider the Report carefully. The Treasury Committee may also want to take evidence on it;

    —  the reports will need to cover the FSA's performance against its statutory objectives. I know reports under the interim arrangements have made great progress in this direction. They will also need to set out (subject to any statutory restrictions on disclosure and any market sensitivities) how the FSA has dealt with major regulatory cases, or regulatory issues, which have arisen during the year;

    —  in making any directions, I shall endeavour to take into consideration the views of other stakeholders;

    —  establishing whether the FSA is providing value for money (under Section 12 of the Act) through periodic independent review as necessary;

    —  periodically reviewing the panoply of statutory instruments which sit under the FSMA. Ministers (and Parliament) will also want to consider whether the boundaries of regulation (ie which activities are subject to the FSA's jurisdiction) remain appropriately drawn. In doing that, they will want to take into account your views on whether there are any problems of scope or powers which are hindering achievement of the statutory objectives; and

    —  finally, under Section 14 of the Act, I have the power to launch a statutory inquiry into possible serious regulatory failure, which I discuss further below. Of course, it is important to emphasise that failures of individual firms are not, in themselves, evidence of regulatory failure by the FSA. The Government believes that it is right for the FSA to set the maintenance of confidence in the financial system as its target, rather than the avoidance of failure of firms per se.

Alerting the Government to problems

  The Government has no power to interfere with how the FSA regulates in individual cases. And, ordinarily, I would not expect you to consult Treasury Ministers, or officials, in respect of such cases. However, there will be circumstances in which individual cases bear on wider responsibilities which I, or other Government Ministers have, where you will want to share information, and where it would be appropriate to do so. I appreciate that you will of course need to respect requirements of confidentiality in the Single Market Directives—as will the Treasury and the Government more widely in relation to any information you pass to us.

  Specifically, such circumstances may arise where:

    —  there may be implications for the stability of the financial system as a whole, or for a particular sector. On occasion, there might be a need for a support operation. Normally, all these instances will be discussed by the tri-partite Standing Committee on Financial Stability (which brings together you, me and the Governor of the Bank of England). These meetings usually take place at deputy (ie official) level;

    —  it appears that serious regulatory failures or gaps in the regulatory regime allowed events to occur which posed, or could have posed, significant damage to the market confidence or consumer protection objectives. In such cases, where it is in the public interest to do so, I may want to use my power to launch a statutory inquiry;

    —  we have agreed that you will formally write to Ministers as soon as circumstances or issues arise which you and your Board judge are serious enough to be likely to prompt me to consider launching a statutory inquiry at some point in the future. Your letter will set out the details of the problem, and how you are dealing with it in regulatory terms. It will also be helpful to know at that stage whether you think an inquiry is warranted, or whether some other action (such as a fuller FSA report) is appropriate. I will obviously want to take account of what you say in deciding whether, and how, to respond.

    —  There could also be cases where: diplomatic or foreign relations problems might arise; or where there could be hardship or losses to a significant number of retail customers. More generally, there may be cases which could lead to broader questions to, or debates for, Ministers in Parliament on matters for which we answer.

  I suggest that the most serious of these circumstances—as they arise from time to time—would also be best dealt with through formal correspondence. There may be a case for making these letters public, but I would expect that most of your letters would contain market-sensitive or other confidential information which could not be made public. Of course, Treasury Ministers may also write to you on occasion to raise particular issues, and the separate Standing Committee process might also require you to write from time to time (for example, in relation to a support operation).

  Under such arrangements, I will have a basis on which to take an appropriate view on the wider public policy issues, which I may then wish to discuss with you, and others. However, I stress again, I have no statutory authority to direct your regulatory actions in any case, except where the FSA may be in contravention of European Community law or other international obligations.

  I believe that this framework provides the right incentives for the FSA to succeed, to operate in the interests of all its stakeholders, and to explain and be accountable for its actions.

Yours sincerely

Gordon Brown

Chancellor of The Exchequer

13 December 2001

Rt Hon Gordon Brown

Chancellor of the Exchequer

Dear Gordon

Our Ref: BG/2058

THE NEW FINANCIAL REGULATION FRAMEWORK

  I am writing on behalf of my Board to confirm the basis on which, as you propose, our independence and accountability should be secured under the new framework for financial regulation which has just come into effect. As we take up our new responsibilities, it is helpful to have this framework comprehensively set out in your letter.

  We welcome your commitment to the FSA's independence from Government. This is, we believe, clear in the statutory framework which Parliament has put in place, which gives the FSA its own self standing regulatory objectives. It is also, we believe, vital to the long-term credibility of the Authority, both domestically and internationally.

  We also recognise and welcome the accountability which justifies this independence. In particular, we believe it is right that ministers should seek to reassure themselves that the FSA is meeting its regulatory objectives, as well as to consider how they should exercise their own specific statutory powers under the legislation, and their more general responsibility for the legislative framework within which we operate, both domestically and in Europe.

  Our annual report is a key mechanism for delivering our accountability, and it is sensible as you propose that the Government should provide a framework setting out what it should cover in more detail than is done in the Act itself.

  In addition, I confirm that we will write to you as you request, as soon as circumstances or issues arise which we judge are serious enough to be likely to prompt you to consider launching a statutory enquiry at some point in future, and to deal with the other cases you have specifically identified.

Howard Davies

Chairman

Financial Services Authority

13 December 2001


 
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