Earlier this month, the FSA and Bank of England (BoE) published approach documents on behalf of the new regulators, the Financial Conduct Authority (FCA) and Prudential Regulation Authority (PRA) (see Legal updates, BoE and FSA publish updated PRA approach documents and FSA publishes paper on journey to the FCA). These documents contain valuable information on the underlying regulatory philosophy of the new regulators, as well as some practical detail, so they certainly merit closer examination. What will it mean to be regulated by the FCA or PRA (or both), and how will they differ from the FSA and from each other?

Just looking at the appearance and presentation of the FCA and PRA documents, there is a marked difference in approach. The FCA document looks more friendly and less forbidding. The front cover includes photographs of a piggy bank and children’s toys, and the document is written in a more informal and readable way. And, of course, we are going on a "journey" to the FCA, which reflects best practice management consultant jargon. It is trendy (at least for a regulator). In contrast, the PRA documents (one for banking and one for insurance) look more staid and traditional. There is only one photograph (of Andrew Bailey, the Managing Director of the FSA’s Prudential Business Unit and possible future BoE Governor), and the text consists largely of numbered paragraphs. One should not, of course, read too much into presentational aspects, but the FCA document conveys a more experimental and modern approach, whereas the PRA documents suggest a return to "traditional values".

The new regulatory approach of the FCA and PRA has already been well trailed in speeches and earlier documents, but the latest documents are helpful in terms of providing some more detail. The FCA document contains some interesting statements on the approach to authorisation. The FCA will apply a new business model threshold condition. Firms will be expected to demonstrate that they have an appropriate, viable and sustainable business model, given the nature and scale of business that they intend to carry out, with a clear focus on the needs of customers. The FCA will recommend refusal at an early stage, where a firm cannot show that it will be able to comply with this threshold condition. In general, the FCA also intends to refuse applications at an earlier stage. The FCA has also reviewed the conduct requirements that apply to new banks to ensure they do not pose excessive barriers to entry. It will publish proposals on this by the end of the year.

The FCA intends to move to more thematic-based supervision, and spend less time supervising individual firms. Firms will be divided into four supervision categories (C1 for the largest firms through to C4 for the smaller firms). Only those firms classed as C1 and C2 will have a nominated supervisor, the vast majority will be supervised by a team of sector specialists. Some firms may only be contacted by a supervisor once every four years, and that contact might be a telephone interview or an online review, rather than a visit.

The FCA will also replace the Arrow supervision model with a new approach, which it calls the Firm Systematic Framework (FSF).This consists of three pillars:

There will be more emphasis on using firms to follow up issues, including by self-certification that issues have been addressed, and with an increased use of section 166 skilled persons reports.

Another difference from the FSA will be an increased focus on "wholesale" markets, where products are sold between professional counterparties, and less willingness to see a clear distinction between "retail" and "wholesale" markets. Rather than relying on the "caveat emptor" principle, the FCA will be more willing to intervene in wholesale markets to prevent poor conduct leading to consumer harm or a risk to the integrity of a market. The failure of the London Interbank Offered Rate (LIBOR) market has certainly been a factor in influencing this more interventionist approach.

The FCA and the PRA documents both refer to a more judgement-based supervisory approach. This appears to indicate a greater focus on a firm’s business model, having a more forward-looking strategy, and being more willing to make subjective judgements, with which the firm may disagree. The FCA and PRA will want to engage more with a firm’s CEO and COO on the business model, rather than the head of compliance on routine compliance matters. The PRA documents emphasise repeatedly that "Firms should not approach their relationship with the PRA as a negotiation", so frankly firms can expect more to be told what to do. However, the good news is that these difficult judgements will not generally be made by youths with clipboards: the PRA will have a larger proportion of more experienced and senior supervisors compared with the past.

It is encouraging that the FCA has decided to retain the Regulatory Decisions Committee (RDC), which is, in effect, the FSA enforcement committee responsible for deciding to impose sanctions, subject to referral of the decision to the Upper Tribunal. The RDC operates independently of enforcement staff, and provides a check on their decisions. It has generally been perceived to be more than a "rubber stamp", and to provide a fair and effective hearing for those wishing to challenge the FSA’s decisions. There was some speculation that the RDC’s role could be abolished in the new structure, so its retention is welcome.

But it would be wrong to think that the FCA will be soft on enforcement. The approach document indicates an intention to bring more enforcement cases, including more cases against individuals and senior managers. The programme of criminal prosecutions for market abuse will continue. There will also be more resources devoted to ensuring that the largest retail and investment banks are complying with their anti-money laundering (AML) obligations through a systematic anti-money laundering programme, a cycle of in-depth reviews of AML and sanctions systems and controls.

The PRA does not provide much detail about enforcement in its approach documents, other than indicating that it intends to intervene earlier to secure remedial action, rather than later after the risk has crystallised. It also emphasises the individual responsibility of directors (and others within the firm) to be proactive and to press for remedial action when there are concerns about a firm, failing which the PRA should be alerted. There will be no more hiding behind board decisions: "The PRA considers the responsibility of board members to be individual, as well as collective."

The new regulators will also have the power to publicise the initial decision to take disciplinary action at the warning notice stage, before the firm or individual has had the opportunity to make representations, and this will continue to be controversial.

The FCA and PRA are expected to be operational by April 2013, which is not far away. Actions for firms could include:

For more information about the FCA, see Practice note, New UK regulatory structure: the Financial Conduct Authority (FCA), and for more information about the PRA, see Practice note, New UK regulatory structure: the Prudential Regulation Authority (PRA).