Under the current system, the BoE is responsible for setting monetary policy and for financial stability, the Treasury is responsible for the overall institutional structure of financial regulation, while the FSA has responsibility for prudential regulation, conduct of business rules and authorisation (governed by FSMA). (Prudential regulation aims to ensure that firms are financially sound, while conduct of business regulation focuses on firms' relationships with their customers.)

All three institutions share responsibility for the UK's financial stability and this is the government's key reason for reforming the system: namely, because no single institution has responsibility (or the appropriate tools) for overseeing the financial system as a whole, mistakes have been allowed to happen. It also feels that the current "tick-box" compliance approach should be replaced with a system where regulators have powers to supervise proactively and to challenge firms directly.

In parallel, the Independent Commission on Banking is consulting on an interim report on potential reforms to the UK banking sector and has also made recommendations on the regulatory structure reforms (www.practicallaw.com/6-506-1660).

The BoE will have as its aim the protection and enhancement of the stability of the UK's financial system and will be responsible overall for macro-prudential regulation in order to achieve this stability. It will also oversee the operation of the special resolution regime for banks, and will be responsible for the prudential oversight of systemically important infrastructure, including recognised clearing houses, and payment and settlement systems.

Prudential powers and functions will be split out among the three new bodies, with the FCA taking sole responsibility for conduct regulation.

FPC. This will be a committee that sits within the BoE, and will be responsible for managing macro-prudential regulation. The FPC will monitor and respond to systemic risks and will be able to make public announcements and give warnings. (An interim FPC has already been set up to begin monitoring risk and to advise the government on potential macro-prudential tools.)

Although it will not have direct powers over regulated firms, the FPC will be able to make recommendations to, and direct, the PRA and FCA, in their dealings with firms.

PRA. This will be a subsidiary of the BoE (although operationally independent), with responsibility for the management of micro-prudential (that is, firm-specific) regulation of firms that manage significant balance sheet risk as a core part of their business (specifically, banks, complex investment firms, and insurers).

The PRA will be required to provide guidance on how it plans to achieve its aims in relation to the different categories of PRA-authorised persons and activities. Secondary legislation will describe what PRA-regulated activities are. Both the PRA and the FCA (see below) will need to issue guidance on their particular responsibilities.

FCA. Previously referred to as the Consumer Protection and Markets Authority, the FCA will be an independent company limited by guarantee. It will be responsible for the conduct of business regulation across the whole financial services sector, and will have enhanced powers to intervene to ban or restrict offending products and to deal with misleading financial promotions. The FCA's remit will also include the FSA's current role as the UK Listing Authority.

In addition, the FCA will be required to discharge its functions in a way that promotes competition (although this is not one of its primary objectives, despite recommendations that it should be). As part of this duty, it will have the power to require the Office of Fair Trading to consider whether structural barriers or other features of the market are creating competitive inefficiencies in specific markets.

Co-ordination between the different bodies will clearly be key to the regime's success, so the Bill contains a duty for the FCA and PRA to ensure a co-ordinated exercise of functions; they will also need to agree and publish a Memorandum of Understanding (MoU) setting out how they will deliver that duty.

There is also provision in the Bill for an MoU between the BoE, the Treasury, the PRA and the FCA setting out how they intend to co-ordinate their approach with international regulators (including the newly-established European Supervisory Authorities).

The PRA's and FCA's investigatory and disciplinary powers will be broadly similar to those currently used by the FSA (with some extensions). Both bodies will have the same powers to impose penalties on authorised persons. The government is also considering giving the FCA new powers to bring about consumer redress in situations where a specific issue is causing mass detriment to consumers.

In addition, the government is planning to press ahead with a controversial proposal to empower the PRA and FCA to publicise the fact that enforcement action has been launched against a firm. "In practice", says Ian Mason, a partner at Baker & McKenzie LLP, "publication could take place before the firm or individual has had the opportunity to respond substantively to the regulator's case against them. This will alert consumers at an earlier stage when the regulator is taking action, but the earlier adverse publicity could be highly prejudicial for firms and individuals facing enforcement action."

Inevitably, the projected costs of the reforms are increasing. The estimated costs of establishing the new regulators (which will be borne largely by the industry) have risen from £50 million as estimated in June 2010 to "between £115-£175 million". The transitional costs for firms themselves have doubled and are now tentatively estimated at £100 million; ongoing compliance costs for firms are now estimated to be £25-50 million per year (earlier impact assessments had suggested no ongoing costs).

While some elements of the new regime will be familiar, it is the fundamental change in the approach to supervision that firms will need to adapt to. "The ethos of the new regulators will be quite different," says Simon Orton, a partner at Freshfields Bruckhaus Deringer LLP. "The regulators are being encouraged to be more willing to apply their judgment in supervising firms. The idea is that box-ticking should become a thing of the past. The willingness of the FCA in particular to intervene in a firm's business could come as something of a shock. Not only the new regulators but also firms will need to learn how to operate in this environment."

Karen Anderson, a partner at Herbert Smith LLP, comments that the intention is that the FCA will have a lower tolerance than the FSA, and will intervene more proactively, and earlier, when issues first begin to emerge, and firms will see more use of transparency and disclosure as a regulatory tool.

Mason adds that, as a result of the FCA's more interventionist approach towards protecting consumers, firms can expect much greater scrutiny of proposed new products, so will need to build in a longer lead time to their product design processes before launching a new product.

Another key issue is the splitting out of prudential regulation from conduct regulation. It may lead to more accountability, but there is a logistical downside, as Mason points out, because it means that banks, insurers and some other systemically important firms will now have to deal with more than one regulator: "Although operating arrangements will be put in place between the regulators so that they can exchange information and talk to each other," he says, "this will still not be as convenient for firms as being able to deal with a single regulator".

Anderson agrees. "Because dual-regulated firms will experience more intrusive, judgment-led supervision, under a rolling assurance programme," she says, "firms will need to focus more on risk mitigation elements within the risk assessment process; senior managers can expect to be challenged on business models, strategies, governance and controls; and recovery and resolution plans will be subject to ongoing review. If prudential issues begin to emerge, the structured proactive intervention framework will kick in, supervision will become more intense and intrusive, and contingency planning will begin."

Joanna Morris, PLC.