TORIES UNVEIL PROPOSALS FOR MAJOR OVERHAUL OF UK FINANCIAL

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SENSITIVE
SIPDIS

E.O. 12958: N/A
TAGS: ECON EFIN EINV UK
SUBJECT: TORIES UNVEIL PROPOSALS FOR MAJOR OVERHAUL OF UK FINANCIAL
REGULATORY FRAMEWORK

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1. (SBU) Summary: Shadow Chancellor George Osborne on July 20
announced the Conservative party proposals for changes to the UK's
financial regulatory system. A Conservative government would
abolish the UK's tripartite framework and replace it with a
significantly more powerful Bank of England (BOE) and a Consumer
Protection Agency (CPA). The BOE would be given responsibility for
maintaining financial stability, including the micro-prudential
regulation of all significant financial institutions. A new
Financial Policy Committee within the Bank would monitor systemic
risks. The BOE would be given powers to ensure capital and
liquidity requirements account for the riskiness of institutions and
would oversee the creation of "living wills" to assist with any
wind-downs. The Tories would merge the responsibilities for
consumer protection of the Financial Services Authority and the
Office of Fair Trading to form a new Consumer Protection Agency
(CPA). Reaction to the proposals was mixed. Lord Myners, city
minister, said they showed a "lack of knowledge" of the nature of
the BOE, while business groups largely welcomed them but said some
big questions remain unanswered. End summary.

Tory Government to Abolish "Failed Tripartite System"
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2. (U) A Tory government would abolish the UK's tripartite
framework which divides responsibility for financial regulation
between HM Treasury (HMT),the Bank of England (BOE) and the
Financial Services Authority (FSA). (Note: Currently, HMT
determines the structure of UK financial regulation and the
legislation which governs it; the BOE is the lender of last resort,
is responsible for monetary policy, and identifies risks posed to
financial stability; and the FSA supervises individual financial
institutions and the financial markets and protects consumer
interests. End note.) The move would overhaul the UK's financial
regulatory architecture, established by Gordon Brown, then
Chancellor, in 1997 when he moved responsibility for banking
supervision and investment services regulation from the BOE to the
newly created FSA. In its white paper outlining proposals to
overhaul the UK's financial regulatory framework, the Conservative
party said the existing framework is confused and fragmented, with
responsibilities and powers split awkwardly between the three
competing institutions. The tripartite system, it said, is based on
the false premise that it is sensible to separate monetary policy
from the regulation of banks. Flaws in the system were exposed by
the financial crisis, when nobody identified the underlying problems
and nobody had the power or authority to act once the crisis hit,
according to Conservative analysis.


3. (U) If the Conservatives win the next general election (which
has to be called by June 2010),they aim to abolish the FSA and the
tripartite system and replace it with a more powerful BOE and a
Consumer Protection Agency (CPA). The BOE would be given
responsibility for maintaining financial stability, including the
micro-prudential regulation of all significant financial
institutions. Also in charge of macro-prudential regulation, the
Bank would monitor the overall level of credit and debt in the
economy. The Tories would create a Financial Policy Committee within
the Bank to monitor systemic risks, operate new macro-prudential
regulatory tools, and execute the special resolution regime for
failing banks. In charge of micro-prudential regulation of all
banks would be a Financial Regulation Division in the BOE, headed by
a new Deputy Governor for Financial Regulation. This division would
take a "risk-focused" approach to regulation, focusing on the
riskiest activities within individual institutions.

New Regulatory Tools
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4. (U) In addition to changing the UK's regulatory architecture, a
Conservative government would give the BOE new policy instruments to
ensure financial stability. At the micro level, the Tories would
give the BOE powers to ensure that capital and liquidity
requirements take account of the additional risk imposed by an
institution's size, complexity and bonus structure. Banks involved
in high risk activities, such as proprietary trading, would also be
subject to higher capital requirements. A Tory government would
ensure all banks prepared a "living will" to assist with any
wind-down and would introduce a backstop leverage ratio limiting how
much banks can lend for a given amount of capital. The white paper
said it would be neither feasible nor desirable for the UK to impose
Glass-Steagall-type legislation unilaterally.


5. (U) The Conservatives proposed additions to the BOE's
macro-prudential toolkit that could be used to control systemic
risks at an economy-wide level. They would press for reforms at an
international level to introduce counter-cyclical capital

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requirements. Additionally, a Tory Chancellor would put a Treasury
minister in Brussels, with specific responsibility for European
financial regulation. The minister would ensure HMG was fully
engaged in the EU legislative process and would defend UK interests.
The Tories would oppose the creation of an executive pan-European
supervisor but would support the introduction of pan-European
conduct of business rules in insurance and fund management to
eliminate barriers to entry in European markets.

Consumer Protection Agency to Replace FSA
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6. (U) A Tory government would merge the FSA's responsibilities for
consumer protection and the Office of Fair Trading's responsibility
for consumer credit regulation to form a new Consumer Protection
Agency (CPA). The CPA would be allowed to name and shame firms
which break the rules and would force banks to be more transparent
about retail consumer charges. This new body would provide greater
regulatory consistency for consumers and reduce the burden on firms
by consolidating licensing requirements into one body, according to
the white paper. The Tories would also consult on reducing barriers
to entry for new banks to increase competition and diversity in the
UK banking market.

Reaction: Many Questions Left Unanswered
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7. (U) The Tory proposals demonstrate a "lack of knowledge" of the
nature of the BOE, according to City Minister Lord Myners. He also
claimed BOE Governor Mervyn King did not want the additional
responsibilities proposed by the opposition party. He criticized
the proposals for doing little more than moving most of the FSA to
the BOE and causing huge disruption and uncertainty in the process.
Vince Cable, Treasury spokesman for the Liberal Democrats, said the
banking system had had a "massive heart attack" requiring a more
radical response than that offered by the Conservatives. He said
Osborne's proposals for the tripartite arrangement were disruptive
and said a Lib Dem government would leave the FSA as a unitary
regulator. In contrast to the Tory proposals, Cable said the
Liberal Democrats would break up the UK's biggest banks. Cable said
the Tories are isolated in Europe so would have little influence on
European regulatory legislation, but said the Liberal Democrats
could help steer and amend legislation as part of the powerful
European liberal group.


8. (U) The UK's leading business association, the Confederation of
British Industry (CBI),welcomed the Tories' "radical blueprint" but
said many big questions remain unanswered. Richard Lambert,
Director General of the CBI, questioned how the transition to a new
structure would be managed, who would be responsible for markets and
securities regulation, and whether the BOE would have the capacity
to carry out all its new functions. The British Bankers'
Association (BBA) welcomed the Tory acknowledgement that monetary
policy and regulation are interconnected but said change needs to be
systematically managed. It should be taken internationally and must
be proportionate to ensure stability. The BBA warned against
stifling innovation in the financial sector by effectively taxing
the size of businesses.


9. (SBU) Comment: The Conservative proposal to abolish the
tripartite arrangement established a clear dividing line between
Conservative and Labour financial policy. HMG, in its recent white
paper, strongly favored a beefed-up FSA, compared to Tory proposals
that would significantly strengthen the Central Bank. But despite
being a headline-grabbing proposal, it is not clear that Tory policy
would result in any significant changes to financial services
regulation in the UK, other than moving a large portion of the FSA
to the BOE and its new Financial Regulation Division. Many of the
proposals made by the Conservatives, including making capital and
liquidity requirements reflect the riskiness of an institution,
ruling out the introduction of Glass-Steagall-type legislation, and
introducing a backstop leverage ratio, were all plans announced in
HMG's recent white paper. While Tory plans may not significantly
impact regulation, they could cause significant disruption. The
FSA, for example, which is currently undertaking a large recruitment
drive, may find it difficult to recruit talented staff given its
uncertain future. This could prove particularly problematic
because, even if the Tories win the next general election, it could
take several years to dismantle the current tripartite arrangement.
In the meantime, the FSA will remain the UK's financial regulator.


LEBARON