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Stranger than television: Twin Peaks regulation

MANY PEOPLE still will remember the cult American 1990s television series, Twin Peaks and its not-so-successful prequel film, Twin Peaks: Fire Walk with Me. The latest sensation, however, is the new offering from the Financial Services Authority (FSA): the new Twin Peaks regulatory model, as described by Hector Sants (pictured), chief executive of the FSA, in a pair of speeches given in early February.

This ‘major milestone’ (as Hector Sants describes it) is not a drama about the murder of a teenage girl, double lives and an exploration of small-town respectability, but is the continuation of the drama of the continuing progress of the regulatory reform programme: although most people in the industry seem to be in agreement that there is some underlying seediness, mystery and double-think embedded in there somewhere.

Hector Sants has outlined the plans to operate two separate regulatory models within the FSA from 12 April 2012, in preparation for those models becoming two separate regulatory entities early in 2013, one being for conduct and one being for prudential regulation. So, banks, building societies, insurers and major investment firms will have two separate groups of supervisors, one focussing on prudential matters and one focussing on conduct matters. The aim of the Twin Peaks model is to ensure that the transition to the new regulatory structure – termed the “cutover” in fluent FSA-speak – is “seamless”.

Not only are there two independent groups of supervisors for banks, insurers and major investment firms, however. All other firms (that is, those which are not dual-regulated) will be supervised solely by the conduct supervisors. These separate groups of supervisors each will make their own, separate set of regulatory judgements, which will be made “against different objectives”, as they will be “pursuing different goals”. This somehow will all come together in a process termed “independent but coordinated decision-making”, which appears to mean sometimes working together, but somehow not, but whilst doing so (or not, as the case may be) sharing all data collected from firms.

Separate objectives

It gets worse. The existing ARROW risk mitigation programme is to be split between the Twin Peaks. So, there will be a split between those actions which are relevant to the conduct supervisory group’s objectives and those that relate to the objectives of the prudential group. This is coming upon us with startling speed – from 2 April 2012 onwards, the two separate supervisory units each will run their own risk mitigation programmes and firms will have “two separate sets of mitigating actions to address”. Most firms normally feel that one risk mitigation programme is quite enough, so the spectre of two of them will be difficult to stomach.

The idea is that the two supervisory teams will assess risk separately, against their own separate objectives. Perhaps unsurprisingly, firms do not as yet know what these “objectives” actually are. While each group of supervisors “may well ask apparently similar questions”, it is not at all reassuring to learn that “the purpose will be different”. We are not told what the different “purposes” are – any more than we are told what the objectives are.

Despite the promise – or threat- of two separate mitigating actions to address, Hector Sants went on to explain that following the ARROW visit, the conclusions of the two supervisory teams will be drawn together into a “single pack of documentation” to be presented to the firm’s board. However, this will have two separate sections, one for each supervisory team, to each of which firms are required to give “equal focus”, but there will not be a consolidated list of required actions arising from the ARROW visit.

Summarising all this, it would appear that there will no longer be one ARROW visit but (in effect) two, which will produce one document summarising the conclusions, but this will be divided into two, with two separate set of actions. Given the enormous amount of preparatory work and stress that an ARROW visit engenders under the current regime, not to mention the stress of the increasingly demanding and intrusive interviews, it is hardly welcome news to firms that they are about to be required to double this effort.

Behavioural changes

According to Mr Sants, the new operational framework is not the most important change to be introduced. Far more important is “the opportunity to accelerate the process of behavioural change”. Firms will be required to make “behavioural changes”, so that the new approach works “to the benefit of society” as a whole. Accordingly, firms must comply with regulatory judgements “willingly” and “proactively” – in other words, do not make a fuss. Firms’ goals must be aligned with those of their supervisors and again, “with society as a whole”. So, in addition to all the other challenges facing firms, there are now the “best interests of society” to contend with. No guidance is given as to what that may mean, or how it should be done.

One small and apparently throwaway line delivers the killer punch: firms must “recognise that this new approach will require greater resources and expertise and thus costs more than the old reactive model”. Double the trouble inevitably means double the cost. All this comes at a time when the entire financial services industry is struggling with uncertain economic and political conditions, as well as a tidal wave of new legislation from Europe.

Hector Sants’ speech provides a lengthy and challenging “to do” list of issues still to be addressed in the next twelve months. This includes amendments to the threshold conditions; the designing of a new “operating platform” for the Financial Conduct Authority (“FCA”) and the Prudential Regulation Authority (“PRA”); designing a new supervisory framework to replace ARROW; finalising the new Memorandum of Understanding detailing how the FCA and the PRA will coordinate their activities; splitting the Rulebook between the FCA and the PRA; and training staff. Any one of these would be enough to keep the regulator busy for a good deal longer than twelve months, so it remains to be seen what the final picture will be. Double trouble for firms seems inevitable.

Charlotte Hill, partner and head of the financial services and regulation team, law firm Stephenson Harwood

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