The Commons Treasury Committee publishes its Report, 'Financial Regulation: a preliminary consideration of the Government's proposals' today.

In July 2010, the Treasury published a consultation document, 'A newapproach to financial regulation: judgement, focus and stability', proposingchanges to financial regulation in the United Kingdom.

The Government proposes to do away with the tripartite system, in which the Treasury, Bank of England, and Financial Services Authority work together, replacing it with a 'twin peaks' structure, separating macro-prudential andconduct of business regulation.

Today's Report is the Committee's response to what has been set out sofar with regard to those proposals.

The Government's timetable

The Government has said that it wishes the legislation to be introducedin 'mid 2011' and to be completed by 2012.

The Committee is concerned about the risks involved in such an ambitioustimetable and the Report underlines the importance of getting reform offinancial regulation right.

The legislation to establish the new regulatory structure should besubject to pre-legislative scrutiny, over a reasonable timescale.

Even with proper pre-legislative scrutiny, once introduced, thetimetable for the Bill should be generous enough to allow proper parliamentaryconsideration, using carry-over if necessary.

The Committee welcomes the establishment of the Independent Commissionon Banking and notes that its work may well have a bearing on the shape ofregulation required. The Report recommends that the Government pay full regardto the ICB before coming to conclusions on financial regulation. This also hasimplications for the timetable set out.

The Committee welcomes the Government's suggestion that FSMA could berevisited in its entirety.

The Report calls on the Government to present a new Bill only after fullconsideration has been given to responses to initial consultation. Drafting thelegislation will then be likely to secure a more coherent final product.

In light of thebanking crisis, the Government is rightly proposing radical changes to the wayin which financial services are regulated. However, having examined the initialproposals, the Committee's overriding concern is about the proposed speed ofimplementation. It is vital to maintain the momentum for reform, but there isno point in flawed change. In any case, these proposals need to be consideredin conjunction with the ICB. Regulatory reform will almost certainly not beenough; the Government will also need firmness of purpose should the ICBrecommend structural reform.

A super regulator - the Bank of England

The Government proposes to give a Financial Policy Committee (FPC),based in the Bank of England, power to monitor the system to ensure financialstability, and to take action when that stability is threatened.

There are sound reasons for insulating economic policy decisions fromshort-term political pressures. However, the Report underlines the importanceof democratic accountability.

Moreover, 'financial stability' is a very broad concept, and may be hardto define in practice. The Report calls on the Government to give much moredetail about what it considers constitutes financial stability.

The macro-prudential tools which the FPC is to use are as yet undefinedand untested, and may have unexpected consequences. The Government must alsodecide which macro-prudential tools it proposes to make available to the FPC.

The Committee welcomes the fact that the Government is going to set outthese macro-prudential tools in secondary legislation and calls for thatlegislation to be published as soon as possible so that Parliament can assessthe nature of the powers to be devolved to the FPC.

The accountability of the Monetary Policy Committee is secured by itsextremely clear remit, and the mechanism for exchanging letters with theChancellor if inflation breaches the target.

In addition, the Bank of England has engaged with the Treasury Committeein an exemplary way to achieve accountability to Parliament. The need forsecrecy, among other things, will mean that the accountability of the FPC willbe different from that of the MPC.

The Committee will consider what is required to secure FPC accountabilityin the light of more detail on the Government's reform proposals.

Given the high profile, yet uncertain nature of its tasks, it will beessential that the FPC has a strong core of credible external members andcontains at least one person with recent experience of risk management at thehighest level.

The Report calls on the Government to reconsider the balance betweenBank personnel and external members and provide a fuller explanation of thereason for including two bank executives as part of the FPC.

Until now, financial stability has been seen as the ultimateresponsibility of the elected Government. These proposals make the Bank ofEngland a 'super-regulator.' If the Financial Policy Committee is to be givenlead responsibility for securing financial stability, the Government needs toprovide clarity about what such stability means.

Such a large transferof power also necessitates robust accountability. There is a clear structure bywhich the MPC is held accountable to Parliament. The structure for the FPC willhave to differ from that for the MPC, but it is of no less importance. In orderto ensure challenge is embedded within the FPC we would also like to see betterbalance of external members. The Committee will return to the issue ofdemocratic accountability.

Prudential Regulation Authority and Consumer Protection and MarketsAuthority

The Government proposes to establish a prudential regulator, thePrudential Regulation Authority, as a subsidiary of the Bank of England.Financial stability does not mean that firms will not fail; it means thatfailures can take place without threatening the system as a whole.

In the absence of further explanation, suggestions that the authoritywould have a "low tolerance" for the failure of systemicallyimportant institutions imply the opposite.

The Consumer Protection and Markets Authority (CPMA) will regulate theconduct of financial institutions. Proper regulation of conduct should initself produce good outcomes for consumers.

However, the Report concludes that branding the CPMA as a 'consumerchampion' would be inappropriate, confusing, and potentially dangerous.

The job of the regulator is to ensure regulation is effective andproportionate. That requires a balance between preventing abusive behaviour andensuring that regulation does not impose excessive costs and restrictions.Financial markets are primarily about the management and pricing of risk, notits removal.

However, the Report recommends that the CPMA should have competition asan objective. This will benefit consumers directly and indirectly. Not onlywill there be a greater choice available for consumers, but the transparencywhich effective competition brings should reduce the need for heavy handedregulation. Greater competition should also help prevent firms becoming too bigto fail.

The Report also draws attention to the importance of markets regulation,and welcomes the Government decision not to separate the UK Listing Authorityfrom other markets regulation. It emphasises the need for a strong marketdivision within the CPMA.

The financial crisis has resulted in a sharp increase in the directcosts of regulation. The indirect costs have doubtless increased further,although they remain difficult to quantify.

The Committee is concerned that the proposals say little about the costof regulation, or about the non-bank sector. The Report warns that regulatorychanges should not be considered without proper evaluation of both their directand indirect costs.

Much more attentionneeds to be paid to the indirect or hidden cost of regulation imposed on firmsbut ultimately always borne by the consumer. That's why the CPMA needs acompetition objective. It is regrettable the Government's consultation paper saidso little about costs. More work is needed to find ways to establish the truecost of regulation and the Committee will be pushing the new regulator toensure this is done.