11.      UK BANKING AND FINANCIAL REGULATION

 

 

UK banking markets have historically been supervised by the Bank of England on an informal non-legal basis for centuries. This was referred to as ‘moral suasion’ and reflected the authority and reputation of the Bank in the markets and the relatively tight and closed nature of the British financial system within which all of the major firms and senior individuals were familiar with each other. Statutory regulation was not introduced in the UK until under the Banking Act 1979, which implemented the requirement to create an authorisation system under article 3(1) of the European First Banking Directive (FBD) in1977. The 1979 Act was replaced by the Banking Act 1987 with a single integrated regulatory system then being set up by the Labour Government under the Financial Services and Markets Act (FSMA) 2000 although this is to be dismantled by a Conservative and Liberal Democrat Coalition in 2012/13.

 

            (1)       Bank of England

 

The Bank of England was originally set up following a proposal by the Scottish merchant William Patterson in 1694to raise funds to cover the cost of continuing European wars. The Bank initially competed with the other private and public banks within the UK and only assumed its larger public and government functions over time. The Bank was not formally nationalised until 1944. The Bank carries out the general functions of a central bank in managing monetary policy, holding the government accounts, managing government borrowing and the national debt as well as foreign reserves, providing financial advice to the government and overseeing the payment systems (Section 3(3) above). The Bank only assumed formal responsibility in providing lender of last resort (LLR) support to the banking system after the first Barings crisis in 1890 having earlier allowed banks to fail.

 

            (2)       UK Bank Supervision and Moral Suasion

 

The Bank historically conducted its oversight of the banking and financial system on an informal basis. The Bank obtained information from the banking sector as part of its conduct of monetary policy and developed close relations with all of the key personnel within the main banks. The traditional method of bank supervision of moral suasion relies on the market authority and reputation of the Bank to ensure that banks comply with its directions. This was nevertheless supported by an implied non-legal threat of withdrawal of daily liquidity and emergency financial support. The system of moral suasion was considered to benefit from its judgement, discretionary and personal style of operation in contrast with the much more fixed and formal approached adopted in such other countries as the US with official bank examiners and mandatory supervisory rules.

            (3)       Banking Acts 1979 and 1987

 

The system of moral suasion began to break down during the early 1970s following the large influx of overseas banks into the UK which prevented the continued operation of the earlier closed or club style supervision previously used. The adoption of a formal licensing or authorisation system was also required under the FBD with the Bank realising that the creation of a formal system may assist deal with the large number of new overseas banks in London. A first Banking Act was enacted in 1979 which created a two tier system of ‘authorised banks’ and ‘licensed deposit-takers’ although this was later abolished under the Banking Act 1987. The 1987 Act was adopted following further crises in the UK including with the £150m rescue of Johnson Matthey which threatened the stability of the London gold market in 1984. Internal supervisory practices were later strengthened again following the closure of BCCI in July 1991 which included dividing the Bank up into separate Monetary Stability and Financial Stability Wings.

 

Responsibility for bank supervision was transferred from the Bank to the Financial Services Authority (FSA) under the Bank of England Act 1998 in summer 1998 (referred to as N1) in anticipation of the creation of a fully integrated single regulatory system within the UK under the Financial Services and Markets Act (FSMA) 2000, which came into effect in December 2001 (N2). Since then, all UK financial markets and services have been overseen by the single FSA subject to the regulatory requirements set out in its integrated Handbook of Rules and Guidance issued under ss138 and 157 FSMA. The new Coalition Government, which came into power in May 2010, has announced that it will re-transfer financial supervision from the FSA to a new subsidiary of the Bank, the Prudential Regulatory Authority (PRA), with the FSA being replaced by a separate Financial Conduct Authority (FCA). A new Financial Policy Committee (FPC) has also been set up within the Bank which will be responsible for overall financial stability and the conduct of macro-prudential oversight within the UK.

 

            (4)       FSA and FSMA

 

The regulatory system set up under the FSMA operates on a delegated rules basis. Detailed requirements are not set out in the statue but in the Handbook of Rules and Guidance issued by the FSA under ss 138 and 157 FSMA. The objective is to create a system which is so far as possible based on common provisions applicable to all financial firms subject to separate special rules, sourcebooks or guides applicable to particular activities.

 

All financial institutions have to comply with the High Level Standards in Block One and the common provisions on Authorisation, Supervision and Enforcement which were dealt with under three separate sourcebooks under the Regulatory Processes Block of the Handbook. These included Authorisation (AUTH), Supervision (SUP) and Enforcement (ENF) with a Decision Procedure and Penalties Manual (DEPP). Enforcement was subsequently moved to a separate Enforcement Guide (EG) in the Regulatory Guides Block of the Handbook with Authorisation being covered by separate guides and fact sheets. Firms also have to comply with the three Redress Block manuals governing Dispute Resolution: Complaints (DISP), Compensation (COMP) and Complaints against the FSA (COAF).

 

Banks are specifically subject to the general provisions set out in the High Level Standards in Block One including the eleven Principles for Businesses (PRIN), Threshold Conditions (COND), Senior Management Arrangements, Systems and Controls (SYSC), Fit and Proper tests for Approved Persons (FIT), Statements of Principle and Code of Practice for Approved Persons (APER) and General Provisions (GEN) as well as new provisions on Financial Stability and Market Confidence (FIN MAR). The main capital, liquidity and prudential requirements are set out in the General Prudential Sourcebook (GENPRU) and Prudential sourcebook for Banks, Building Societies and Investment Firms (BIPRU) with a separate Prudential sourcebook for Insurers (INSPRU) and UCITS firms (UPRU). The earlier provisions contained in the Banking Codes governing relations between banks and their customers have since been moved to the Banking: Conduct of Business Sourcebook (BCOBS). Conduct of business requirements for banks and securities firms carrying on investment services for clients are set out in the COBS sourcebook with separate sourcebooks on Client Assets (CASS) and Market Conduct (MAR including market conduct, stabilisation and multilateral  trading facilities ETFs).

Banks may have to comply with other additional provisions, for example on Electronic Money (ELM) if relevant while firms carrying our securities activities are subject to the Listing Rules (LR), Prospectus Rules (PR) and Disclosure Rules and Transparency Rules (DTR) in the Listing, Prospectus and Disclosure block.

 

(5)       FPA, PRA and FCA

 

The earlier integrated system set up under the FSMA is being  replaced in the 2012 with the new structure based on the Bank of England with its Financial Policy Committee (FPC) and subsidiary Prudential Regulatory Authority (PRA) and a separate Financial Conduct Authority (FCA). Single integrated supervision will still be retained under the new regime insofar as the prudential regulation of all larger systemic firms is dealt with by the PRA but with the supervision of smaller firms being dealt by the FCA. The FCA will also be responsible for market oversight while the Bank will continue to oversee the money payment systems. While this may create some overlap in function and rules, it is hoped that the new system will benefit overall from the improved focus on the financial and systemic stability conducted through the Bank and the FPC.