UK: the NAO reports on the FCA and PRA's progress in regulating financial services

The National Audit Office (NAO) has published a report on "The Financial Conduct Authority and the Prudential Regulation Authority: Regulating financial services", examining the progress made to date by the FCA and the PRA in developing and implementing their regulatory approaches.  A number of key facts in the report have grabbed the press headlines - most notably the £127 million forecast increase in the cost of regulation since legal cutover and the £472 million in regulatory fines imposed in 2013 (interestingly, the number of enforcement cases is half that of the FSA's 2010 enforcement cases).  However, the detail of the report, which sets out a number of key findings and recommendations summarised below, provides some useful insights for those working in the regulated sector.

Key findings

• The two new regulators cost more than the FSA: £127 million (24%) higher than the 2012-13 cost of the FSA.
• The regulators have in most areas set out their objectives and strategic approaches clearly: they could do more to build on existing processes by specifically bringing together and sharing their experience of managing potential conflicts between prudential and conduct objectives.
• Some of the changes in strategic approaches are becoming evident at working level: early evidence suggests some slowing of processing in dual-regulated cases, with the average time spent on new firm authorisations increasing by 3 weeks.  It is too early to say whether the FCA has increased enforcement activities, although it is also worth noting that some 40 skilled persons reviews were commissioned by FCA at an estimated total cost to the regulated firms of £140 million in the period Q2-Q4 of 2013, dwarfing the £9 million cost of the 22 PRA-commissioned reviews in the same period.  Working‑level supervisors suggest there have been practical benefits in providing clearer separate focus and greater depth to prudential and conduct work, and earlier and more decisive regulatory intervention.
• Established decision-making structures and risk appetites present some challenges at working level: working-level supervisors are concerned that risk appetites (particularly the FCA’s approach to smaller firms) have not been explained to them clearly enough, and that this impacts how they prioritise work, and also that the more judgement-based approach means more decisions are taken at senior levels, reducing their own individual decision‑making and motivation.
• Challenges in ensuring the right staff capacity and capability: The range and depth of skills the regulators require have increased as remits have expanded.  Both PRA and FCA are currently introducing new frameworks, and working to develop long-term strategies to attract the best talent.  However the departure of skilled and experienced staff has remained consistent, with 31% of all FCA resignations and 26% of all PRA resignations in 2013 classified as ‘high‑performers’ - 34% of FCA staff had less than 2 years’ service with the regulator.  Survey respondents warned that high levels of staff turnover in the regulators, and in particular at the PRA, is limiting the ability of supervisors to understand the firms that they are supervising.
• Determination to improve how regulators collect, use and manage information: it is too early to conclude on the effectiveness as the regulators do not yet have a complete understanding of their inventories of regulatory data collections.  A full evaluation of the changed approaches, and assessments of the proportionality of individual data requests, would require knowledge of the cost to firms of responding to regulatory data requests: the regulators do not currently estimate those costs, and alsoacknowledge that they do not have the technology needed to fully exploit the data and information provided.  Many of the requests are said to be driven by EU requirements.
• Achieving coordination in practice is complex: there is regular working-level communication between the regulators.  There is currently a good working relationship but some concerns that this legacy could deteriorate over time.  The PRA notes some uncertainty around what data can be shared and when.
• How regulators use evaluation to measure the costs and benefits of their activities and to direct resources needs further development: while FCA estimates the level of consumer harm in individual reviews, it has not yet established an overall methodology for estimating consumer harm to direct its regulatory activity.  Neither regulator has yet developed an approach to evaluate different types of regulatory action to help direct resources to where they are most effective.  Management information does not bring together the benefits and costs of different regulatory activities to allow the regulators to demonstrate that the benefits of their activities always justify the costs, and that the right balance is struck when making staffing and other resourcing decisions
• Performance measurement systems could be refined further to improve measurement of the impact they make: the metrics do not bring together information on whether their intended outcomes are being met and the contribution that each regulator’s performance makes in achieving those outcomes.  Unlike the PRA Board, the FCA has not yet reviewed and revised its management information in taking an early view on its strategic focus.
• Whilst the regulators have taken steps towards greater transparency, the PRA could develop further: the PRA intends to publish its business plans when it publishes its Annual Report.  In practice, the wider Bank of England in practice makes or approves resource decisions in relation to the PRA - although the Bank complied with all NAO information requests, the NAO does not have statutory access to the financial information held by the wider Bank.  This presents a risk to reporting on the economy, efficiency and effectiveness of the PRA

Recommendations

• The regulators should develop more structured approaches to evaluation of their respective work over time: this should include developing a better understanding of the relationships between regulatory activities, costs and benefits, which should be used to explain cost changes to stakeholders; and the FCA should develop and keep updated a broader assessment of where harm lies, and direct resources and activity accordingly.
• The regulators should establish a body of evidence from experience of managing potential conflicts between prudential and conduct regulation
• The PRA and FCA should review the effect that staff turnover rates are having in practice, and ensure that the staff offer chosen reflects the target turnover rate.
• The regulators should evaluate the impact of their new approaches to regulatory data requests: they should estimate the cost to firms of responding to proposed new ‘regular’ data requests and monitor the impact increased governance and understanding of data inventory are having in practice.
• The regulators should refine their performance measurement frameworks further and publish their key measures of performance: The PRA should publish operational plans, and both regulators should use their published plans to set out in advance how their performance will be measured over the period covered by the plans.
• Arrangements for assessing the economy, efficiency and effectiveness of the PRA need further clarification: the PRA should consult with the Bank of England and HM Treasury with a view to putting in place a formal mechanism to ensure access to financial information is available from the wider Bank if needed to assess the economy, efficiency and effectiveness of the PRA.