INTRODUCTION

  This memorandum sets out the legislative framework governing the UK authorisation and supervision of financial services firms. The framework covers both the prudential supervision of financial services firms and regulation of their conduct of business.

AN OVERVIEW OF THE GOVERNMENT'S POLICY ON FINANCIAL SERVICES REGULATION

  On 20 May 1997, the Government announced major changes to the structure of financial services regulation in the UK. The Financial Services and Markets Act 2000, which creates a new framework for the regulation of financial services, received Royal Assent on 14 June 2000. The Act establishes the Financial Services Authority (FSA) as the single regulator of the financial services industry, operating under a single coherent legislative framework.

  The Act replaces nine different sectoral regulators with a single regulator, the FSA, covering the whole financial services sector. It also introduces a single ombudsman scheme, to resolve consumers' complaints, and a single compensation scheme. The Act gives the FSA clear statutory objectives. The Government believes the statutory objectives will give the FSA a clear set of priorities and a benchmark against which its performance can be measured. The statutory objectives are:

—  market confidence;

—  consumer awareness;

—  protection of consumers; and

—  prevention of financial crime.

  In pursuing its objectives the FSA will also have to have regard to certain important principles, which may be summarised as:

—  using its resources efficiently and effectively;

—  respecting the responsibility of senior managers of regulated firms;

—  ensuring its rules are proportionate, that it is to say the benefits exceed the economic costs;

—  facilitating innovation;

—  respecting the international character of financial services and the competitive position of the UK;

—  facilitating competition.

  The Government believes that the Financial Services and Markets Act 2000 will significantly strengthen the framework for financial regulation in the UK. This new approach, based on one regulator, and one body of law, will provide:

—  clarity—authorisation, regulation and regulatory action by one body on a consistent basis, rather than by several different regulators;

—  fair competition—a level playing field for banks, securities firms and insurance companies operating in the same markets;

—  protection for consumers—a single ombudsman to resolve consumers' complaints, and a single compensation scheme.

  The Government believes these are important aspects of developing a simple efficient, transparent regulatory regime, on a statutory rather than self-regulatory basis, independent of Government.

  In advance of the implementation of the Financial Services and Markets Act 2000, there have been a number of measures designed to pave the way for the single regulator. This memorandum deals with those relevant to the supervision of life insurance companies.

PRUDENTIAL SUPERVISION

  The prudential supervision of insurance companies is currently governed by the Insurance Companies Act 1982. This will be superseded by the relevant provisions of the Financial Services and Markets Act 2000, when it comes into force.

  Prudential supervision relates primarily to the solvency of insurance companies. The scope of the Insurance Companies Act includes the authorisation of companies wishing to undertake insurance business, the regulatory requirements which apply to authorised companies (including capital, financial and management requirements) as well as special rules for changes in the corporate structure of insurance companies.

  Prudential supervision was under the 1982 Act the responsibility of the Department of Trade and Industry until 4 January 1998. The DTI were also the department with responsibility for the relevant legislation and policy. In order to bring together in the Treasury responsibility for the legislative framework and policy in relation to banks, building societies, insurance companies and other financial sector firms, on 5 January 1998 functions which had formerly been carried out by or on behalf of the Secretary of State for Trade and Industry were transferred to the Treasury. The Treasury consequently temporarily also assumed direct responsibility for prudential supervision of insurance companies. Prudential supervisors in the former DTI insurance directorate therefore temporarily joined the Treasury, pending the onward transfer of supervision to the FSA.

  On 1 January 1999, the FSA became the prudential supervisor, following the approval of Parliament to a draft contracting out Order under the Deregulation and Contracting Out Act. This move was an early step towards the integration of financial regulation and the benefits of a single regulatory culture, to the maximum extent possible under existing law prior to Parliament's consideration of the Financial Services and Markets Bill.

  Most of the functions transferred were those carried out under the Insurance Companies Act 1982, although a small number were under other Acts. Powers to make subordinate legislation and certain activities that may affect the liberty of individuals, as well as the power to raise fees, remained with the Treasury. These arrangements will remain in place until the implementation of the Financial Services and Markets Act 2000.

CONDUCT OF BUSINESS REGULATION

  Conduct of business regulation in financial services is currently governed by the Financial Services Act 1986. This too will in due course be superseded by the relevant provisions of the Financial Services and Markets Act.

  The Financial Services Act 1986 applies to insurance firms where they are selling long-term investment-based products. Conduct of business regulation relates primarily to how firms deal with their customers, particularly in the areas of sales and marketing. The scope of the Financial Services Act 1986 includes ensuring that firms authorised to conduct investment business meet appropriate standards of honesty, solvency and competency, and that complaints, compensation and disciplinary arrangements are available.

  The Financial Services Authority is responsible for overseeing the system of self-regulation under the 1986 Act, as was its predecessor, the Securities and Investment Board (SIB), which was established by that Act.

  From 29 April 1988 to 18 July 1994, the immediate regulator of conduct of business for life companies was the Life Assurance and Unit Trust Regulatory Organisation (LAUTRO). Since then this has been the responsibility of its successor body, the Personal Investment Authority (PIA), a Self-Regulatory Organisation (SRO) recognised by the FSA, previously SIB.

  Since 1 June 1998, FSA staff have carried out work on behalf of the PIA Board, under contract, in preparation for the implementation of the Financial Services and Markets Act 2000. From 11 April 2000, the FSA has been a non-voting member of the PIA. Once the Financial Services and Markets Act is fully implemented, the PIA will be wound up.

NEW FRAMEWORK

  The Government believes that bringing all the functions together in the FSA will help the FSA carry out all its responsibilities in a coherent and consistent manner. It will let it draw on the best supervisory practice in what were different organisations with different regulatory approaches. And it will facilitate better communication between supervisors dealing with similar issues or the same regulated firm. The full benefits will follow implementation of the Financial Services and Markets Act. The FSA have set out how they intend to discharge their responsibilities in a series of publications starting with "a new regulator for the new millennium" of 21 January 2000.

EQUITABLE LIFE

  Questions relating to individual firms are primarily a matter for the board and management of the firm concerned. Because of its responsibilities in regard to individual firms, the FSA are also well placed to comment.

  The Government therefore welcomes the decision of the FSA Board, announced on 22 December, that the FSA would prepare a report on the events that led to Equitable Life's decision to close a new business. The report will cover both the FSA's role as prudential regulator and its exercise of its functions under the Financial Services Act 1986, including the Personal Investment Authority's responsibility for conduct of business regulation of long term investment-linked life insurance. The report will also set out the background and events leading up to the point at which responsibility for prudential insurance regulation moved to the FSA.

  The FSA announced that the report is being conducted by a team led by the FSA's director of internal audit, supported by external experts in accountancy and law. The report will be made to the FSA Board, which is made up of 11 non-executive directors and 3 executive directors. The FSA have said that the report is likely to take some months and that it will be published.

  The Government looks forward to seeing the FSA's report.

February 2001