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U.K. Scraps FSA, Reversing System Set Up by Brown

U.K. Chancellor of the Exchequer George Osborne
U.K. Chancellor of the Exchequer George Osborne speaks at Mansion House in London. Photographer: Chris Ratcliffe/Bloomberg

Chancellor of the Exchequer George Osborne said he will abolish the Financial Services Authority and give most of its power to the Bank of England, undoing the regulatory system set up by Gordon Brown in 1997.

In the most sweeping changes to financial regulation since then, the watchdog will be wound down and replaced by three bodies over the next two years, the chancellor said. A Prudential Regulatory Authority will be created as a subsidiary of the central bank. Osborne will also set up a Financial Policy Committee at the bank and establish a consumer protection and markets agency.

Osborne, whose Conservative Party took power after the May 6 election, is delivering on a promise made almost a year ago to shake up the way the U.K.’s banks and markets are policed. He’s blamed the system established by former Labour Prime Minister Brown for failing to prevent a financial crisis that saddled taxpayers with liabilities of as much as 1.4 trillion pounds ($2.1 trillion) and plunged the economy into the worst recession since World War II.

“At the heart of the crisis was a rapid and unsustainable increase in debt that our macroeconomic and regulatory system utterly failed to identify let alone prevent,” Osborne told bankers at his first Mansion House dinner in London’s financial district last night.

Northern Rock

Brown’s government had to nationalize Northern Rock Plc, the first U.K. casualty of the credit crunch, in February 2008. The lender nearly collapsed in 2007 after it had to seek emergency funding from the central bank and then suffered a run on its deposits. The government also had to take controlling stakes in Royal Bank of Scotland Group Plc and Lloyds Banking Group Plc.

With the economy emerging from recession, Britain now faces the deepest spending cuts since the 1970s to tackle the record budget deficit, overshadowing prospects for recovery.

“Many in the City had felt that giving the Bank of England responsibility for macro-prudential regulation would be a positive step, but there will be disappointment that the government has decided to launch such a radical overhaul of the regulatory system at this particularly difficult time in the economic cycle,” said Nathan Willmott, a lawyer at Berwin Leighton Paisner in London.

Tripartite System

Osborne’s plan scraps Brown’s tripartite system of regulation -- in which the central bank, FSA and Treasury shared responsibilities -- and places most of the onus on Bank of England Governor Mervyn King. Legislation to replace the FSA will be in place by 2012, Osborne said.

Osborne’s predecessor, Alistair Darling, defended the tripartite system and blamed the crisis partly on the “quality, skills and judgment” of individual regulators that failed to examine “the connections between institutions.”

“Can every country, every regulator, hand on heart, say they have sorted out the problems of their individual banks, and are regulators in different countries aware of any residual problems,” Darling said in an interview on Bloomberg Television today. “These problems don’t go away. It’s rather like having a bad smell in the house. There’s no point in ignoring it. You need to get the floorboards up.”

The FSA’s chief executive, Hector Sants, 54, will stay on at the authority while it is wound down and will take up new roles on the bodies that replace it, becoming a deputy governor of the central bank.

‘Macro Issues’

Executive power over financial supervision will go to the Financial Policy Committee at the central bank, which will operate in a similar way to its rate-setting monetary policy panel. The new committee “will have the tools and the responsibility to look across the economy at the macro issues that may threaten economic and financial stability and the tools to take effective action in response,” Osborne said.

The committee will be chaired by King and will include Sants among its members. The panel’s work will be scrutinized by Parliament’s Treasury Committee, the chancellor said.

The Prudential Regulatory Authority “will carry out the prudential regulation of financial firms, including banks, investment banks, building societies and insurance companies,” Osborne said. Sants will be its chief executive and King its chairman. Andrew Bailey, the head of the central bank unit that deals with failed banks, will be Sants’s deputy.

‘Authority, Knowledge’

“Only independent central banks have the broad macroeconomic understanding, the authority and the knowledge required to make the kind of macro-prudential judgments that are required now and in the future,” Osborne said. “They must also be responsible for day-to-day micro-prudential regulation as well.”

Angela Knight, the chief executive of the British Bankers’ Association, a lobby group, said she welcomed steps to make the system “clearer and more effective” and pledged to support the government during the transition.

The third pillar of Osborne’s regulatory overhaul will come with the creation of a Consumer Protection and Markets Authority. Osborne said the agency will regulate financial firms “providing services to consumers” and maintain the “integrity of the U.K.’s financial markets.”

King told the Mansion House dinner that the new framework will assure the stability of the financial system.

‘Credible Regime’

“A credible macro-prudential regime could help forestall both excessive exuberance and unnecessary caution,” King said. “By altering the pressure on the financial brakes according to circumstances, regulation, far from being an inflexible foe, would become a flexible friend.”

FSA Chairman Adair Turner said he welcomed Osborne’s plans.

“The overall future shape of financial regulation is now much clearer and we are in a strong position to create a future regulatory system which builds on the FSA’s achievements over the last few years of major change,” Turner said in an e-mailed statement.

“It is ironic that while in opposition the Tories identified the tripartite system as the root of all regulatory evil, yet here they are as government inventing multiple front-line agencies and creating distracting confusion in the process,” said Ash Saluja, a lawyer at CMS Cameron McKenna in London.

Osborne also said he will bring under one roof the handling of “serious economic crime,” which is currently dealt with by a number of organizations.

The chancellor also gave the names last night of the people who will work alongside former Bank of England Chief Economist John Vickers when he leads a panel on the future of banking.

Martin Wolf of the Financial Times, Bill Winters, the former co-chief executive of JP Morgan’s investment bank, Martin Taylor, formerly of Barclays Plc, and Clare Spottiswoode, the former head of the gas regulator Ofgas, will work with Vickers on the Independent Banking Commission, Osborne said.

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