The FSA makes progress towards integrated prudential regulation

The draft new prudential standards do not reflect the current international reviews of standards now in progress but will provide the platform on which the new international standards can be implemented once agreed.

The FSA proposes that requirements on capital and related systems and controls be set as far as possible by risk factor rather than by the sector from which the firm comes. So standards will be organised by market, credit, operational, insurance and group risk - and not according to whether the firm is a bank, an insurance company or an investment firm.

Clive Briault, FSA Director of Prudential Standards, said:

We will adopt a common approach to identifying, describing and mitigating risks and the same systems and controls requirements will apply to all sectors. This will clarify and reduce differences between industry sectors and facilitate competition. And it will be easier for firms to understand prudential requirements linked to the types of risk they take. Our proposals also provide the required platform from which to incorporate the revised Basel Committee Capital Accord and other new international standards, once these are agreed.

Key features

The principal features of the new FSA approach are:

• A requirement on firms to determine for themselves, using stress and scenario testing, the level of resources they need to meet the risks - credit, market, insurance, operational etc - in their business;

• Modernisation of the requirements on insurance companies. There will be more guidance on systems and controls, simplified rules for valuing assets, new and less rigid rules on the use of derivatives and simplified assets and counterparty admissibility limits;

• Simplified requirements for firms whose failure would not normally involve risk of loss to customers, for example those who only offer investment advice, arrange deals for customers or manage their investments;

• A single requirement on outsourcing requiring firms to assess how outsourcing of functions will affect their own risk profile and its potential impact on customers;

• The future capital and other requirements will reflect better the risks that each firm might pose to the FSAs statutory objectives. Standards will normally be set at the minimum laid down in EC Directives and other international standards and will only be higher where there is a significant risk to the FSAs statutory objectives.

Timetable

The FSAs approach is set out in The Integrated Prudential Sourcebook Consultation Paper and draft rules. A period of six months has been set for consultation to allow firms and others sufficient time to consider the issues involved and to respond.

The FSA intends to implement the Integrated Prudential Sourcebook in 2004, if possible at the same time as the new international standards, particularly the revised Basel Committee Capital Accord and related EU capital rules, come into effect. But the sourcebook does not anticipate the new standards and by consulting now, the FSA will be in a position to implement a complete set of prudential standards even if the international discussions are more protracted than expected.

Notes for editors

1. Consultation Paper 97 is available on the FSA Website www.fsa.gov.uk under Publications. Responses should be sent to the FSA by 31 December 2001.

2. The Integrated Prudential Sourcebook will form part of the FSAs Handbook of Rules and Guidance and will set out all the prudential requirements for all authorised firms. Prior to its coming into effect, the FSA''s prudential standards are set out in five separate interim prudential sourcebooks covering banks, building societies, insurers, friendly societies and investment firms. Most of these sourcebooks are available on the FSA''s website. They will be replaced by the integrated Prudential Sourcebook.

3. Prudential regulation by the FSA aims to ensure that the firms it regulates are financially sound. This includes specifying standards covering risk mitigation and other related requirements.

4. Two supplemental Integrated Prudential Sourcebook consultations will be published later covering:
   • Requirements for the Society of Lloyds later this year
   • Prudential rules relating to liquidity and securitisation in early 2002

5. Wide-ranging reviews of international prudential standards are currently being held. The Basel Committee on Banking Supervision is reviewing its Capital Accord, focusing on revisions to the capital adequacy treatment of credit risk and new proposals on operational risk. Parallel work is being conducted in the European Union on standards applicable to banks and investment firms. Consultation exercises have recently been conducted by both the Basel Committee and the European Commission. The EU is also reviewing the solvency margin requirements for insurance companies.

6. The FSA regulates the financial services industry and has four objectives under the Financial Services and Markets Act 2000: maintaining market confidence; promoting public understanding of the financial system; the protection of consumers; and fighting financial crime.

7. The FSA aims to maintain efficient, orderly and clean financial markets and help retail consumers achieve a fair deal.