The move to 'twin peaks' regulation of the financial services sector is an opportunity to drive home judgement-based supervision that 'must not be missed', according to the chief executive of the Financial Services Authority, Hector Sants.
Under the change, prudential supervision for banks, insurers and major investment firms will be the responsibility of a subsidiary of the Bank of England, the Prudential Regulation Authority, while the FSA itself will be renamed the Financial Conduct Authority and focus on consumer protection and market regulation.
Speaking at a British Bankers' Association briefing in London on Monday, Mr Sants outlined how the FSA would plan to replicate this model between April 2 and the expected move over to the two separate bodies in early 2013.
'The most important change that will occur at twin peaks, in my judgement, is not the introduction of a new operational framework, but the opportunity to accelerate the process of behavioural change that the FSA embarked on when we began the reform of the supervisory process in the spring of 2008,' he said.
He added: 'The move to twin peaks is therefore an opportunity to drive home and further embed the move to forward-looking, proactive, judgement-based supervision. It is an opportunity that must not be missed. We must crystallise the change from the "old style reactive approach" to the "new style proactive approach".'
Mr Sants explained that the new approach would be based on a willingness to intervene when the regulator judged the outcomes of an activity would be, in the future, at variance to its mandate - even if the firm does not agree.
'Such proactive intervention needs to be proportionate and justified, but if we are to improve outcomes and meet the expectation of Parliament and society, such judgements will have to be made,' he said.
'A pre-requisite of encouraging such judgements is that those making them have clarity of purpose and a clear understanding of the objective against which they will be judged.'
Describing the need for the regulator to have a clear objective as a central element of the regulatory reform agenda, Mr Sants said the old FSA had been unclear about what is objectives were. They were also not well understood by the media or Parliament, he added.
Mr Sants made clear that the prudential and conduct supervisory groups that will be set up in April as a prelude to the formal establishment of the PRA and FCA would have different purposes to each other, even if they asked the same questions of firms.
'Secondly, I would like to emphasise that in a twin peaks world, there will not be a consolidated list of the required actions arising from the two supervisory groups,' he said. 'The two groups of supervisors will not prioritise between prudential and conduct risk.'
According to Mr Sants, the 'biggest challenge' facing the move to a twin peaks model is implementing the required change of behaviour by both supervisors and firms.
For firms, he said there was an onus to show a greater willingness to 'proactively comply' with supervisory judgements and to also recognise there would be time when both firms and the regulator would make judgements which, in hindsight, would turn out to be wrong.
He also acknowledged the increased costs involved in the twin peaks approach to regulation. Firms should 'recognise that this new approach will require greater resources and expertise and thus costs more than the old reactive model'.
In a separate speech delivered at the City Week Conference in London yesterday, Mr Sants also spelt out the importance of engaging with the European regulatory agenda, which he said was 'central' to delivering financial regulation in the UK.
'It needs to be recognised that currently, in respect of prudential regulation, and increasingly over the longer-term in respect of conduct, the rules will be made by Europe and the role of PRA and FCA will primarily be one of supervision and enforcement. Essentially, the UK is moving to become a "supervisory arm" of Europe,' he said.
Mr Sants endorsed the work of the three European Supervisory Authorities made responsible for Europe-wide financial regulation in January 2011 and in particular their important role in maintaining standards.
'However, I continue to believe that supervision needs to be delivered locally and be tailored to a particular set of circumstances,' he said. 'Good supervision needs to be based on forward-looking judgements and a deep understanding of firm-specific circumstances. We need to be careful that the philosophy of harmonisation does not undermine this principle.'
He added: 'It is vital that the supervisor retains the flexibility to customise the capital and liquidity framework for the individual risk profile of the firm. If Europe harmonised to the point of removing judgement, this will increase not decrease risk. It is crucially important that CRD IV and any future regulations are flexible enough to address these concerns.'
Commenting on Mr Sants' speech on the twin peaks approach, Charlotte Hill, head of the financial services and regulation team at law firm Stephenson Harwood, questioned the benefits of the change.
'It is fair to say the twin peaks proposal will to all intents and purposes equate to twice the amount of supervision in the absence of clear, quantifiable commensurate benefits. It is difficult at this stage to see how the proposed approach will deliver better outcomes for firms and ultimately consumers.
Ms Hill also noted that Mr Sants' comments regarding the additional resources and cost involved by moving to a twin peaks model would 'not be welcome' at a time when most financial services firms are feeling the pinch of uncertain markets and falling revenues.