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Regulatory Accountability for Financial Services

This week the new Bill to revoke retained EU law for Financial Services will be under the spotlight in the House of Lords. But, say Barnabas Reynolds and Richard Samuel,  consumers should have an affordable legal means to challenge breaches of the rules, and the regulators should be held to common law disciplines in making and applying their rules.

The Financial Services and Markets Bill now going through Parliament repatriates the entire EU regulatory rulebook for the industry. It hands to the UK regulators, principally the Financial Conduct Authority (FCA) and Prudential Regulation Authority (PRA), custodianship of and the power to adjust the inherited EU financial regulatory acquis.

During our membership of the EU, financial regulation increased significantly but the methods of accountability in the UK did not. As things stand, the Treasury Select Committee oversees our regulators at the macro level. However, there is almost no role for our judiciary. Regulators’ decisions can be challenged in the Upper Tribunal, but challenges are relatively rare and rarely successful. In addition, there is no cost-effective legal means for consumers to challenge firms for breaches of rules in a way that leads to case law precedent and provides legal certainty for other consumers and the industry. That can, as this piece suggests, now be put right.

In light of discussions with industry and consumer groups, we are proposing certain amendments to be introduced into the Financial Services and Markets Bill at the Committee stage in the House of Lords. These amendments are intended to ensure that the regulators can be challenged when they seek to enforce vague rules in an unpredictable manner, or when they behave inconsistently between firms of a similar type. The proposals also seek to ensure that a body of case law is built up through proper law-based decisions made in the context of disputes between consumers or small companies that can be treated as analogous to consumers, on the one hand, and commercial firms, on the other. This is achieved by ensuring that the Financial Ombudsman Service (FOS) applies the law to a dispute, including regulatory obligations on firms to be fair to customers, by means of adjudication, rather than simply by finding what appears to be a fair and reasonable way to resolve the dispute. It also involves introducing a new First Tier Tribunal (FTT) which resolves disputes between firms and customers according to the law and regulation, including ‘appeals’ from adjudications of the FOS, in a way which creates binding legal precedent. This case law will fill out gaps and uncertainties in the regulatory regime, providing greater predictability over what regulator rules mean and how they apply, and increasing the City’s competitiveness.

The proposals are as follows.

  1. Require common law disciplines to be observed in rule-making. Financial regulators do not have the same long tradition of Rolls-Royce rule-making as Parliament. The proposed amendments require our regulators in drafting their rules to maintain high standards of clarity, predictability and certainty, similar to those achieved by Parliamentary counsel, and to apply common law principles of interpretation to such rules and guidance. Those standards will ensure a market participant knows what the rules mean and how to comply with them.
  2. Ensure independence of regulators’ decision-making bodies. The ultimate enforcement decision-making bodies of the FCA and PRA are at present only semi-autonomous and their procedures are ill-defined. The proposed amendments are intended to ensure the independence of the Regulatory Decisions Committee (RDC) from the FCA and the Enforcement Decision Making Committee (EDMC) from the PRA and require them to apply to their decision-making the same common law methods described at 1 above: reasoned decisions clearly anchored in the facts of the case and in the applicable rules, so that the outcomes are consistent and predictable.
  3. Grant right of appeal to Upper Tribunal on common law disciplines. Decisions of the FCA and of the PRA can be challenged in the Upper Tribunal (UT). This is an existing independent judicial body, but the legislation governing UT proceedings requires enhancement to ensure that the common law disciplines permeate through the entire system. When deciding a case, the UT should have regard to whether a regulator has acted in line with the proposed new predictability and consistency objective. The UT should also, in certain circumstances, make its own determinations in line with that objective.
  4. Introduce proper legal processes for consumer and small business disputes, giving rise to case law precedent, predictability and consistency in the application of the regulators’ rules. Consumer and small business disputes with financial services firms brought before the Financial Ombudsman Service (FOS) are not at present resolved in accordance with the common law principles described above. The proposed amendments adopt the Treasury Select Committee’s proposal of October 2018 to create a new first tier tribunal, the FTT, to resolve such disputes. At present, these disputes fall into a gap between the courts (too slow and expensive) and the FOS (too slow and unpredictable).

The amendments also require the FOS to apply the law properly to disputes which arise before it, by way of “adjudication”, rather than determine cases on the basis of what it deems to be “fair and reasonable”. Adjudication has been used with enormous success in the construction industry to provide a super-quick form of alternative dispute resolution. In the financial services context, adjudication by a renamed Financial Adjudication Service (FAS) should primarily remain an investigatory process (as is currently the case with the FOS). FAS-administered adjudication will relieve pressure on the FTT by providing an expert legal opinion quickly; and experience suggests that 90% of participants will accept this opinion. This will provide for greater legal certainty.

Those consumers and small businesses which are currently entitled to claim up to £375,000 under the FOS procedures will continue to be able to do so, on the basis of the common law and any applicable rules of the regulators. This will include the regulator rules known as “Principles” which cover matters such as “treating customers fairly” and “integrity”, and provide additional protections against mis-selling actions. Both the FOS and the FTT will be able to determine cases on the basis of these Principles. Given that one of the Principles just cited imposes a “fairness” obligation on firms, claimants will not lose any rights of action merely because the FAS applies law and regulation, rather than, as now, being free simply to decide what it regards as a fair and reasonable way to resolve a dispute. The common law courts will continue to hear claims for larger amounts and from larger claimants. Those claims will be decided according to the common law and statute only, consistent with the current arrangements for such claimants.

  1. Allow for binding independent recommendations. At present, the Financial Regulators Complaints Commissioner (FRCC) reviews complaints about conduct by regulators and makes non-binding recommendations. The proposed amendments enhance the FRCC’s powers. They allow it to make binding decisions so long as these do not award compensation; and they extend the scheme to cover complaints where regulators have not exercised their “general functions” (e.g., rule-making powers) in line with the regulators’ statutory objectives. Compensation decisions will still be just recommendations, but the regulators will be prevented from limiting their own financial liability, in so far as it arises, through the use of their own rulemaking powers.

All of the above amendments would refine existing procedures by applying proper common law disciplines. Except in respect of the FTT, the costs of the system would not be increased materially. The additional costs of the FTT would be relatively low: each party would bear its own costs, except where a firm chooses final determination of the complaint by the FTT, in which case they would be obliged to cover the complainant’s costs. The costs of the FTT members could be borne by the taxpayer or by way of an industry-funded levy.

Giving our courts and tribunals a role in financial regulation will bring huge benefits to the industry and its consumers because it will result in greater predictability. It will make the UK more competitive for firms and will reduce costs and increase product offerings for consumers. This is for two reasons: (1) the judiciary and tribunal panel members will ensure that our successful common law disciplines, including those now applied by Parliamentary drafters to statute, are applied to regulatory rule-making and other practices; and (2) our common law doctrine of precedent will mean that case law explains how the regulators’ rules are to be applied in practice.

 

Barnabas Reynolds is a partner and head of financial institutions at Shearman & Sterling and the author of Rules for the Regulators: Regulating Financial Services after Brexit, Politeia, 2022

Richard Samuel, of 3 Hare Court, is a barrister of 25 years’ experience who practised for many years in employment law and now practises in international commercial litigation.

Barnabas Reynolds

Barnabas Reynolds is a partner at Shearman & Sterling LLP and Global Head of the Financial Services Industry Group. He is the author of Restoring UK Law: Freeing the UK’s Global Financial Market, (2021), The Lawyers Advise: UK-EU Trade and Cooperation Agreement – Unfinished Business? (2021), and Politeia’s new publication, Rules for the Regulators: Regulating Financial Services after Brexit.

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