Reviews, Reports and Responsibilities: We need to talk about regulator accountability (Part 1)

Accountability has become something of a watchword in financial regulation in recent years.??And on one level it’s no wonder - you only have to look back to the causes of the financial crisis to understand why policymakers believed that something had to change.

But the accountability of the regulators themselves is rather more complex. It also gives rise to real questions as to what the regulators are really "for".?

The PRA and the FCA carry out functions which affect the lives of every person living or working in the UK (and in many cases, those outside our borders), pursuing statutory objectives set by Parliament.??The objectives themselves point in different directions??- the PRA looks primarily at questions of safety and soundness, whereas the FCA’s focus is on consumer protection, the integrity of the financial markets and competition.??

If you put the objectives together, the idea is to cover the full range of risks that the financial services industry poses to society.??But the system only works if both regulators are fulfilling those objectives. So, like many complex systems, it depends on all the parts working effectively - both separately and together - to produce results.

Accountability to the industry

An article of faith when the 2013 regulatory reforms were put in place, was that the regulators should?not?be accountable to the industry itself.??

The theory went that the best way to avoid regulatory capture (particularly given that the industry effectively funds the regulators through fees) would be to make clear that the regulators owed their primary duty to society as a whole.

This makes sense viewed from one angle - the risk of regulatory capture (i.e. firms effectively capturing the regulator so that they receive the - presumably lighter - level of scrutiny they would prefer) undermining the system looms large in policymakers' minds.??But in the UK at least, it has not reared its head in any significant way since the Financial Services and Markets Act 2000 came into effect in December 2001, and probably earlier than that.?

(By the way, I’m not fudging?the pre-2001 regime, it just pre-dates my direct experience of financial regulation!)

I’ve touched on this before, but the formal routes for firms to challenge the regulators (tribunal, judicial review) are cumbersome and difficult.??While the regulators - in my experience - can be relied upon act with good faith and for the right reasons, when things obviously go wrong they are nevertheless fairly resistant to challenge.??But, as I noted in a previous article, firms rarely take this step.??This can be for any number of reasons: challenges are expensive, rarely successful, and bring with them the potential for significant adverse impacts on the regulatory relationship.

But the potential for regulatory capture is not a good reason for dissociating the regulators from accountability to the industry.??No system is right 100% of the time.? In a more intrusive regulatory environment, firms need to have an opportunity to be heard when things go wrong, or the judgements made by regulators are incorrect. You'd be forgiven for thinking we don't yet have that balance quite right in the UK.

Looking at the bigger picture, both regulators also maintain statutory panels - made up of firms - whose role it is to hold the regulators to account from an industry perspective.??And they tend to do a pretty good job of questioning the regulators and conveying broad industry sentiment, and specific feedback.??But this is representative accountability often on a policy-by-policy level.??The panels have no role in challenging firm-specific decisions.??Nor do they often deal with the big strategic questions.

Accountability to Parliament

As far back as 2014, Parliament was feted as the solution to a perceived accountability gap in the regulatory system.??The Treasury Select Committee has become the linchpin of that accountability, both through its regular hearings, pre-appointment interviews with prospective senior regulators and specific inquiries.??It does an effective job of scrutinising the regulators’ day-to-day functions and the big picture items that come up from time to time.??

Parliament cannot be a substitute for an industry challenge mechanism, and nor should it be.??MPs rightly have to look more widely to the interests of their constituents, and society as a whole.??And so it has held the regulators to account effectively on a huge variety of issues, from senior appointments to operational resilience; from LIBOR to FX, and everything in between.??The regulators spend a great deal of time preparing for the Parliamentary scrutiny they receive, and take the process exceptionally seriously. They are right to do so: Parliamentary scrutiny has real teeth.

That said, Parliament has - quite understandably - tended to focus on the big issues of the day. It hasn't managed to grapple quite as effectively in establishing the concrete expectations of the regulators in terms of preventing (or mitigating) harm to wider society.

Regulatory failure reporting

Building on a burgeoning list of reports published by the FSA into its supervision of Northern Rock and RBS, the Financial Services Act 2012 contained requirements on the regulators to produce so-called “reports into regulatory failure”, and publish the outcomes via Parliament.??

The idea is to allow for a public explanation of what has gone wrong, and what lessons had been learned for the future.??And it has proved a fertile ground: reviews of the supervision of HBOS and the Co-operative Bank, and the FCA’s actions in relation London Capital & Finance, Interest Rate Hedging Products and Connaught have followed with unerring - and I’m sure the regulators would say, expensive - regularity.?

It’s always useful to have a narrative as to what has gone wrong in a particular incident, what could have been done and what should be done to ensure similar issues don’t arise in the future.??But the nature of the reports are generally backwards looking, and aimed at the correcting the particular failing which gave rise to the duty to report.??

So we shouldn't confuse these reports into regulatory failure with a genuine and broad look at what the regulators are doing, and how they are doing it.

A conversation on the breadth of regulatory responsibility

The Future Regulatory Framework Review carried out by HM Treasury offers an opportunity to look at these issues afresh.

What has perhaps been lacking since the very beginning of the PRA and the FCA is an open and up front conversation about the role of the regulators and the overall cost of regulation.??The FCA and the PRA will cost the industry something in the order of ￡900 million for the financial year 2021/22.??The regulators use those funds to advance their overall objectives, but in doing so they have to pick and choose how and where to spend them. There's always more on the waterfront than the regulators can hope to deal with.

The detailed prioritisation is - for the most part - carried out by the regulators internally.??And while both regulators produce - and consult on - documents setting out their priorities for the coming year, external events (for example COVID, or Russia/Ukraine) often derail the most carefully-laid of regulatory plans. As a result, the regulators often have to pivot, at short notice, to deal with emerging situations. The problem is that, in doing so, other work has to take a back seat. And the regulators could perhaps be better at making that point clearly in public.

But the regularity with which the regulators (and particularly the FCA) are required to report on regulatory failures begs a practical question: what do we really expect of them???We often speak about not having a “zero failure” regime - and that makes sense.??But what does that mean in practice?

Or to put it another way, what level of protection does society have a right to expect, and at what cost?

More on this issue in Part 2.