A consequence of Brexit is that a substantial amount of power that was previously vested in the EU’s various institutions has been transferred to the UK’s financial regulators, the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA), bodies established by statute, but which operate independently of government. The concentration of extensive rule-making and supervisory powers in these two bodies raises questions about the appropriate limits to their powers and how they should be accountable to government and the public. The Financial Services and Markets Bill, which is nearing completion, attempts to address these questions.

Macfarlanes interviewed participants from across financial services and politicians to assess views on regulatory accountability and the various options to achieve it. We propose a solution that would solve for the two main problems: the ‘political accountability gap’ and the ‘expertise gap’.

A brief history

The UK Parliament has rarely been directly engaged in financial services regulation. The Financial Services and Markets Act 2000 (FSMA) abolished the various regulatory authorities and created the Financial Services Authority (FSA). Following the Global Financial Crisis, the FSA was split into the PRA, with a focus on prudential regulation, and the FCA, with a focus on conduct regulation. A Financial Policy Committee was created at the Bank of England to focus on macro-prudential risk. Parliamentary scrutiny mainly occurred via Treasury Select Committee (TSC) enquiries into topics related to consumer protection.

The EU began to take a greater interest in financial services as part of the creation of the Single Market and, later, to address the causes and consequences of the Global Financial Crisis. Under the EU’s “Lamfalussy process”, the European Parliament has a key role in the creation of ‘Level 1’ financial services legislation, particularly through its ECON committee, and in scrutinising the detailed ‘Level 2’ regulations that are delegated to the European Supervisory Authorities during the Level 1 process.

The European Parliament thus has a far larger role than the UK Parliament in creating and scrutinising financial services regulations. This is enabled by the European Parliament’s greater resources, with staff assisting MEPs at the ECON committee, political offices, parliamentary parties, and often their Member State authorities and national political parties also involved.

Current situation

Brexit removed the EU authorities from the UK’s legislative process, giving the UK’s authorities discretion to create their own rules under a nimbler system. But the UK has also lost a substantial layer of expertise, scrutiny, and checks and balances in the process of creating financial regulation.

UK policymakers have recognised this deficit. In June 2021 and June 2022, the TSC published reports on the Future Framework for the Regulation of Financial Services. The TSC recommended a ‘targeted approach’ in which the TSC would undertake additional scrutiny or challenge of regulations where a matter was deemed to be of sufficient public interest.

A TSC Sub-Committee has been duly established, comprising the current membership of the TSC and supported by two industry experts. The Sub-Committee has conducted several enquiries into regulatory developments such as the FCA’s Sustainability Disclosure Requirements and has written to the regulators with questions.

However, it remains the case that the TSC has a broad set of responsibilities, scrutinising the Government’s fiscal statements, in addition to recent hearings on topics such as Fuel Duty, the cost of living, and growth and productivity. The TSC’s members often have a greater political incentive to consider more pressing matters than the arcana of financial services.

The Government has also recognised the issue. The Financial Services and Markets Bill, and the amendments proposed particularly in the Lords, contain measures in relation to regulatory accountability. Broadly, these proposals seek to strengthen accountability in a piecemeal fashion – for example, giving HM Treasury discretion to request the regulators to consider a particular matter.

A concern raised with us by many in the industry is that the UK’s regulatory regime would not embed a system of political accountability, nor would the mechanisms of accountability have the necessary resourcing and expertise to effectively scrutinise and challenge the regulators’ actions.

Alternative options

An option for the UK is to replicate approaches found in other jurisdictions. The TSC concluded that this would not be appropriate due to the inherent differences between the UK’s institutional framework and, for instance, the EU’s consensus-building model or the US’s stricter separation of powers that results in a more prominent role for Congress.

Another approach would be to create something like the Parliamentary Commission on Banking (a post-crisis innovation with a temporary remit to propose reforms) but established on a permanent basis. One industry player recommended to us a Joint Committee of MPs and Lords, and a group of parliamentarians led by Lord Tyrie and Bim Afolami MP, have made a similar suggestion albeit with a remit that extends beyond financial services.

The dedicated remit of a Joint Committee has merits, but concerns were raised about the need for significant technical expertise to assist parliamentarians. Further reservations were about the risk that public hearings could lead to a superficial debate and that participants could be reserved and risk averse in giving public evidence.

A variant model suggests that a Joint Committee should be supported by an independent expert body, tasked with scrutinising financial regulators. Lord Bridges has proposed, by way of an amendment to the Financial Services and Markets Bill, the creation of an Office for Regulatory Accountability (OFRA).

Membership of OFRA could comprise industry experts, former regulators, academics, economists, and those with experience of internationally competitive environments. It could work alongside parliamentarians to scrutinise not only the regulators’ performance, but also regulatory proposals, take soundings from industry and consumers, conduct public and private hearings, and even issue consultations.

The aim would be not only to improve the day-to-day performance, but also provoke the regulators to consider the strategic direction of policy, the long-term health of financial services, and the UK’s status in relation to other jurisdictions and to international standards.

A modest proposal

There is a widespread concern in the industry that regulators are pursuing an overly cautious approach in many areas, which may be due to too much or too little political direction. Too often there is insufficient differentiation between retail and wholesale financial services, to the detriment of the latter.

Our view is that a combination of a Joint Committee and OFRA would address both the ‘accountability gap’ and the ‘expertise gap’. There are good grounds for political oversight of the independent regulators, but we recognise that there are real concerns about the necessary level of technical expertise and resources, and a need to move beyond today’s headlines. An OFRA would serve and reinforce politically accountability via the Joint Committee, rather than act as a speedbump to the UK’s more agile, post-Brexit regime.

Moreover, we suggest that this new independent body should be focused on wholesale markets, which would pose fewer politically contentious issues, and with an aim to ensure the UK’s global role in these markets.

The Financial Services and Markets Bill will soon receive Royal Assent. However, given the importance of financial services to the UK, we believe that this is a topic that will remain important in years to come.