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RUEHZL/EUROPEAN POLITICAL COLLECTIVE

UNCLAS SECTION 01 OF 02 LONDON 001675 
 
SENSITIVE 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: ECON EFIN EINV UK
SUBJECT: TORIES UNVEIL PROPOSALS FOR MAJOR OVERHAUL OF UK FINANCIAL 
REGULATORY FRAMEWORK 
 
LONDON 00001675  001.2 OF 002 
 
 
¶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" 
----------------------- ----------------------------- 
 
¶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 
-------------------- 
 
¶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 
 
LONDON 00001675  002.2 OF 002 
 
 
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 
------------------- --------------------- 
 
¶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 
----------------- ----------------------- 
 
¶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