PRA - One part of a stronger regulatory system?

In the months to come, the UK's existing financial regulatory system will undergo sweeping changes, culminating with the end of the current tripartite model made up of the Treasury, Bank of England and the Financial Services Authority (FSA) - and with the FSA being scrapped altogether.

But will the structure's successor - which could potentially be in place by late 2012 - help the coalition government to achieve its goal of a stronger regulatory system that is able to prevent a future global economic crisis on the scale of the one that has occurred in recent years?

In February 2011, the Treasury released details of its planned reforms as part of the publication 'A new approach to financial regulation: building a stronger system'. In it, further information is provided on the new structure, which will consist of the Financial Policy Committee (FPC), the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA).

The FPC will be an independent body within the Bank of England, while the PRA will be run as a subsidiary of the Bank. Meanwhile, the FCA - which was previously known by its provisional title of the Consumer Protection and Markets Authority - is to act as an independent business regulator.

Until this legislation is established, an interim FPC will "prepare the ground", according to the Treasury. This body will be chaired by governor of the Bank Mervyn King, who will be joined by the central bank's deputy governor for financial stability Paul Tucker and deputy governor for monetary policy Charlie Bean, along with the chairman of the FSA Adair Turner and the FSA's chief executive Hector Sants. Mr Sants is also set to take on the positions of deputy governor for prudential regulation of the Bank and chief executive of the PRA when it is established.

Of all the pieces in this new regulatory system, the PRA comes closest to filling in the gap that will be left by the FSA upon its demise, so it may come as no surprise that the watchdog's current chief executive will be heading it. The new body will tie in closely with the FPC. While the FPC will be charged with taking responsibility for the stability and resilience of the UK's financial system as a whole, the PRA will take on the micro-prudential regulation of individual firms that manage significant risk on their balance sheets. These will include banks, building societies, credit unions and insurance providers. Finally, the FCA will monitor conduct issues across the entire financial services sector.

It is hoped that dividing these responsibilities between the three groups will help to avoid some of the problems previously faced by the FSA, with the Treasury claiming that while the watchdog had the regulatory tools to deliver fiscal balance, prior to the banking crisis, it had such a wide mandate it "was not sufficiently focussed" on stability issues. These responsibilities had included monitoring market confidence, tackling financial crime, protecting consumers and boosting public awareness.

Summing up the PRA's role in the new framework, the Treasury paper says: "[The body will promote] the safety and soundness of firms, including - as part of this - seeking to ensure that the failure of the firm would have minimal systemic consequences.

"These objectives embed two vital attributes of the government's proposed regulatory approach - that the regulator has an important role in promoting the soundness of firms that it regulates, but also that firm failure is a necessary and important part of a healthy financial services sector. The PRA will not be judged to have failed if a firm that it regulates fails. Equally, the PRA must take steps to ensure that the impact of this failure on the rest of the system is minimised."

This could have important consequences for the UK's financial services sector as it would appear to suggest that the government is endorsing a move away from the problem of banks being too big to fail - an issue judged by many to be a major cause behind the global economic crisis. This sees the new framework potentially being put in a position where it will not promote a rush to prevent a bank from collapsing, as happened with firms including Lloyds TSB and Royal Bank of Scotland in the lead-up to the recession.

Under the guidelines the PRA will be given is the "responsibilities of senior management" principle, according to the Treasury report. This policy "enshrines in statute" the idea that the leaders of regulated companies will be responsible for ensuring their compliance with the new framework and that the PRA will have the power to hold management accountable for making sure that their business meets these rules and will also be expected to take action if this is not done.

By promoting stability it is hoped that the PRA will increase the UK economy's competitiveness. It will also help to support different types of ownership models within the financial services system, such as mutuals.

As the process of establishing and building the new framework begins, what is the view of the planned reforms?

Damian Reece, head of business at the Daily Telegraph, has written that altering the regulatory structure is one thing, but it is the culture of the financial services sector that needs to change. While he claims that the new model "stands a better chance" of avoiding a repeat economic crisis than its predecessor, Britons still appear to have an "unrealistic view of what regulators can achieve".

"If we expect regulators to second-guess management and to be there to anticipate management's every move, we will end up with expensive, ineffective regulation trying to achieve unrealistic aims. The new system must set basic priorities and protect them, but let the cost of failure be borne by those willing to take risk," he says.

And Mr Reece also warns that more intrusive regulation could serve to dampen competition in the market, along with innovation - issues that benefit consumers and that the government would appear to be attempting to facilitate.

Meanwhile, Margaret Cole, the managing director of enforcement and financial crime at the FSA, writes in the publication that confidence in the market is dependent on how much participants believe others will conduct themselves correctly.

"Financial firms, even large corporates, act only through individuals. Society places a great deal of trust in those we allow to operate our financial industry. Financial professionals are well rewarded for this responsibility. We deserve very high standards of conduct from them - they deserve very firm enforcement action if they let us down," she points out.

But is there really any value in speculating the success of the new framework while it is still at this consultation stage? As many other international markets look to revamp their own financial systems and talk continues of a global regulatory model, perhaps only the prevention of a future fiscal crisis will prove the new system's success, or otherwise.

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