Twin-peaks regulation: key changes and ... - Better Regulation

financial services 

Twin-peaks 

regulation: 

key changes and 

challenges 

november 2012 

kpmg.co.uk/fs

Twin peaks: 

the new landscape 

On 15 and 16 October 2012, the fsa released publications outlining the approach to be taken by two new bodies, the 

Prudential regulation authority (Pra) and the financial conduct authority (fca), in regulating the UK fnancial services 

industry. The introduction of a ‘twin peaks’ model is a major milestone for the regulatory reform Programme and is the 

frst step in changing the UK regulatory structure in 2013. 

The new model will mean that deposit takers, insurers and major investment frms will have two groups of supervisors, 

one focusing on prudential (the Pra) and one focusing on conduct (the fca). all other frms (i.e. those not ‘dual regulated’) 

will be solely supervised by fca. structurally, the new system looks like this: 

Producing and enhancing the stability of the fnancial 

services system of the United Kingdom, aiming to work 

with other relevant bodies including the Treasury, the 

PRA and the FCA. The Bank’s Special Resolution Unit is 

responsible for resolving failing banks using the Specifc 

resolution regime 

Prudential 

regulation 

Systemic infrastructure 

Central counterparties, settlement 

Systems and payment systems 

Bank of England 

PRA 

Enhancing fnancial stability by promoting 

the safety and soundness of PRA 

authorised persons, including minimising 

the impact of their failure 

Prudential 


Source: HM Treasury, A new approach to fnancial regulation: building a stronger system, 2011 

The fPc will have responsibility for reducing risks to the 

fnancial system as a whole. The Pra is likely to follow direction 

from the fPc based on its view of the macroprudential 

environment and sectoral intelligence when taking frm-specifc 

decisions, deploying prudential regulatory tools or developing 

policy. firms will be able to review the fPc’s periodic financial 

stability report to understand the recommendations that the 

committee is making to the Pra and assess the likely direction 

of future macro-prudential regulation. 

exact numbers have yet to be determined, but around 25,000 

frms will be solely regulated by the fca and around 2,000 

will be dual regulated. To understand what prompted the 

split into the Pra and fca, we need only look at the mission 

FPC 

Contribution to the Bank’s objective to protect and 

enhance fnancial stability, through identifying and 

taking action to remove or reduce systemic risks, 

with a view to protecting and enhancing the 

resilience of the UK fnancial system 

FPC powers of recommendation and direction 

to address systemic risk 

Prudentially signifcant frms, 

Deposit takers, insurance, 

some Investment frms 

FCA 

Enhancing confdence in the UK fnancial system by facilitating 

effciency and choice in services, securing an appropriate 

degree of protection, and protecting and enhancing the 

integrity of the UK fnancial system 

Conduct 


Prudential and 

conduct regulation 

Investment frms and exchanges, 

other fnancial services providers including 

IFAs, investment exchanges, insurance 

brokers and fund managers 

statements of these bodies. The fca’s vision is “to make 

fnancial markets work well so consumers get a fair deal” 

and the Pra’s sole objective is “to promote the safety and 

soundness of Pra authorised frms”. 

The fca’s focus, therefore, is on ensuring that services and 

products are designed to meet customers’ needs and that 

frms put the interests of customers at the heart of how they 

run their business. The creation of the Pra is an attempt to 

focus more closely on ensuring that frms are more resilient 

against failure, and minimising the impact that a frm’s failure 

has on the UK fnancial system, while accepting that a zero 

failure regime is not a feasible proposition. 

© 2012 KPMG llP, a UK limited liability partnership, is a subsidiary of KPMG europe llP and 

a member frm of the KPMG network of independent member frms affliated with KPMG 

2 | Twin-peaks regulation: key changes and challenges international cooperative, a swiss entity. all rights reserved. Printed in the United Kingdom.

There are big changes in what 

we are doing, and it is an 

exciting time to be putting 

these changes into effect.We 

will get a much clearer focus 

from splitting prudential and 

conduct regulation for banks and 

insurers, from introducing macroprudential 

regulation to help 

to protect the fnancial system 

as a whole, and from focusing 

our regulation on applying 

judgement in a transparent way. 

Andrew Bailey, Deputy CEO designate of 

the PRA (October 2012) 



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Twin-peaks win-peaks regulation: kkey 

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New Powers 

although the Pra will take a more forward-looking, judgement-based approach to prudential supervision, its powers will not 

change signifcantly from those that have been granted to the fsa. 

The new fca, however, has been granted new powers with which to supervise and enforce compliance with regulatory 

requirements. The fca’s new powers will include the following: 

Area of focus New powers 

Product governance 

and intervention 

The FCA are not proposing that they should pre-approve new products, but have signifcantly increased powers in the 

area of product governance – the design, operation and sale of products. They will intervene early in a product’s life 

span and have the power to ban products that they consider pose unacceptable risks. 

Financial promotions The FCA can direct frms to withdraw or amend misleading fnancial promotions with immediate effect and publish the 

fact that a warning notice relating to a disciplinary matter has been issued. 

Super-complaints Certain consumer organisations will be able to make ‘super-complaints’ relating to issues that affect large groups 

of customers. 

Consumer credit The Government will make its fnal decision on whether to transfer responsibility for consumer credit regulation from 

the OFT to the FCA during 2013. Around half of frms with credit licenses are estimated to be at present unregulated 

by the FSA. The other half could face additional regulatory requirements from 2014 if the transfer goes ahead. 

Competition This is another area where the FCA’s approach is embryonic, but there will be a focus on promoting better services, 

choice and value for customers, and the FCA will distinguish between innovation that benefts rather than exploits 

customers. Examples of past competition failures include commission payments that incentivise advisors to favour 

recommending sub-optimal products, or a sales process that encourages customers to take out PPI without 

shopping around. 




[Twin peaks] will embed the forwardlooking, 

judgement-based approach 

and accelerate the move away from 

the old reactive style of regulation.The 

changes will not just be structural but 

involve behavioural shifts from both 

supervisors and frms. 

Hector Sants, FSA Chief Executive (March 2012) 

What challenges do these new powers 

create for your frm? 

• Products will need to be tested before launch to 

ensure that they deliver to customer expectations 

• all products should be regularly monitored using a 

holistic range of MI to ensure they remain suitable 

and consistently deliver good customer outcomes 

• You will need to have robust controls to ensure that 

promotions are compliant yet commercially 

effective and are in line with the expectations of the 

fca and the approach of peer frms. staff responsible 

for approving promotions must have the right 

capabilities and competence to ensure promotions 

are compliant 

• The regulator has given little guidance on new media 

but frms will need to be proactive in ensuring that 

communications made via new media, such as Twitter 

or facebook, are compliant 

• firms should conduct product risk assessments to 

ensure that existing products will not be seen as taking 

advantage of customers, and can be demonstrated to 

provide value and beneft 

• You should be able to show that your end-to-end sales 

process is not only compliant with the letter of the 

rules, but is also designed and operated in a way which 

minimises the risk of customer detriment through 

appropriate controls against inappropriate behaviours 



international cooperative, a swiss entity. all rights reserved. Printed in the United Kingdom. Twin-peaks regulation: key changes and challenges | 5

Changes to the supervisory 

framework: PRA 

The Pra will focus on the ‘big picture’ and on understanding where the main risks to the stability of the fnancial system lie, and 

so the test of materiality for points raised with you will be high. 

The Pra will be forward-looking, seeking to assess whether, on the balance of risks, there are vulnerabilities in frms’ business 

models, capital and liquidity positions, governance, risk management and controls that cast into doubt a frm’s future fnancial 

soundness. risks to the stability of the fnancial system will be assessed via a fve step risk assessment framework: 

PRA - Risk Assessment Framework 

Gross risk Safety and soundness 

Potential impact Risk context 

Potential impact 

Assessment will be directly 

through the impact of frm 

failure on real economic 

activity or the soundness 

of other intermediaries and 

through behavioural effects 

where vulnerabilities within 

one frm affect confdence 

in others. 

External 

context 

Business 

risks 

The PRA will consider 

whether and how the wider 

external macroeconomic and 

business complexity affect 

the execution of a frm’s 

business model in a variety 

of different scenarios. 

System-wide risks (interest 

rates, excess credit growth) 

and sectoral risks 

(e.g. Credit concentrations) 

will be assessed. 

Operational 

mitigation 

Risk 

management 

and controls 

Management 

and 

governance 

The PRA will evaluate 

the quality of a frm’s 

risk management and 

governance. This will 

include an assessment of 

the adequacy and integrity 

of its risk management, 

systems and controls, 

culture, governance and 

the competence of its 

senior management. 

Financial 

mitigation 

Structural 

mitigation 

Liquidity Capital Potential impact 

The PRA will consider a frm’s 

fnancial strength. This will 

include an assessment of 

the level of capital a frm is 

holding against uncertainties 

about the valuation of assets 

and future risks; as well 

as the quality of its funding 

and liquid assets and 

its approach to liquidity 

management, including 

contingency planning. 

If a frm can be resolved 

in an orderly manner, 

the overall risk that it 

poses to the stability of 

the fnancial system will 

be lessened. Working 

with the Bank’s Special 

Resolution Unit and 

the FSCS, the PRA will 

consider whether, and 

with what impact a frm 

could be resolved. 

• All frms will be subject to baseline supervisory monitoring, comprising an (at least) annual review of a frm’s resolvability, an assessment of the principal risks to 

fnancial stability, an analysis of a frm’s fnancial position, discussions with senior management at the frm and compliance with minimum prudential standards for 

capital, liquidity and large exposures. 

• Those frms that present the greatest risk to the stability of the fnancial system will be subject to more focus from the PRA. 

• The PRA will also establish a Proactive Intervention Framework (PIF) which is intended, as part of the ongoing process of supervision, to identify early risks to a frm’s 

viability and ensure that frms take appropriate remedial action. It will fag actions that the authorities will need to take in advance to prepare for the failure and 

resolution of a frm. 

What challenges does this new approach 

create for your frm? 

• There must be a visible focus from the leadership team on 

risk management which manifests through documented 

risk-based decision-making 

• Stress and scenario testing, including reverse stress 

testing, will be seen as a key tool for management in 

assessing the sustainability of the business model 

• Your frm’s leadership team will need to demonstrate 

a good understanding of the approach that you use to 

assess your frm’s capital and liquidity adequacy 

• You will need to evidence that your frm’s overall 

governance arrangements, including Board effectiveness 

and oversight, are designed appropriately and operated 

effectively. robust governance should extend throughout 

the business to the front-line 

• Your Management Information must be suitably detailed 

and robust to highlight key risk exposures 

• There should be clarity of risk ownership with clear 

delineation of responsibility between the business and the 

risk function 

• Your frm’s risk concentrations and aggregations must 

be visible and it should be readily apparent how these are 

being managed 





framework: FCA 

Perhaps the most signifcant effect that frms will feel is in 

the area of supervision. The new approach to supervision 

demonstrates that the fca’s focus has changed from 

assessing technical compliance to quantifying major 

business risks. To achieve this aim, supervision will be more 

judgement-based, starting at the frm’s business model and 

strategy and leading to early intervention on the basis of 

assessment of conduct risk rather than crystallised issues. 

The frst stage will involve re-categorising frms (a process 

which has yet to be fnalised) according to the risks they pose 

to customers and the market, which will impact the approach 

to supervision as follows: 

Category Criteria Approach to supervision 

C1 Banking and insurance groups with very large numbers of 

retail customers 

Universal/investment banks with very large client assets 

C2 Firms with a substantial number of retail customers and/or 

large wholesale frms 

C3 

Firms with retail customers and/or a signifcant 

wholesale presence 

• Dedicated supervisor 

• Firm-by-frm business model and strategy analysis 

• Dedicated supervisor 

• Firms grouped within sectors to identify common risks of 

business models and strategy 

• Supervised by a team of sector specialists 

• Sampling of frms’ business models and strategies 

C4 Smaller frms, most intermediaries • Supervised by a team of sector specialists 



international cooperative, a swiss entity. all rights reserved. Printed in the United Kingdom. Twin-peaks regulation: key changes and challenges | 7


framework: FCA (continued) 

There are 3 main tools which will be used in supervising frms, with a much greater emphasis on identifying and mitigating 

potential customer detriment before it occurs: 

1. Firm Systematic Framework (FSF) 

The FSF replaces ARROW with an approach that features the following areas of focus, to answer some key questions: 

Area of focus How is this different? Key questions the FCA will ask 

Business model and 

strategy analysis 

(BMSA) 

Four supervisory 

modules: 

i. Governance and culture 

ii. Product design 

iii.Sales or transaction 

processes 

iv. Post-sales/services and 

transaction handling 

This is an assessment of the root cause of conduct risk 

rather than the issues-based approach of ARROW. 

For C1 and C2 frms, these modules will be assessed on 

an going basis, rather than the point-in-time approach 

of ARROW. 

The output of the FSF will be a focussed set of actions, 

rather than the long RMP under ARROW. 

Follow up work will be pushed onto the frm, using s166 

powers where necessary, rather than being completed by 

the regulator. 

• Is the business sustainable from a conduct perspective? 

• What are the future conduct risks? 

• What do the margins on products tell us and where are 

the growth areas? 

• How effectively is the frm identifying, managing and 

mitigating conduct risks? 

• Are products targeted at customer needs? 

• Do the frm’s processes support appropriate 

customer outcomes? 

• Is the fair treatment of customers considered after the 

point of sale? 

• Is Senior Management taking individual responsibility 

for the right areas? 

Note, in the remaining lifetime of the FSA the current ARROW cycle will be retained. So if your frm is due to complete an ARROW assessment before Spring 2013 it will still be subject to a supervisory review, 

however that review will consist of 2 supervisory teams assessing the risks against their new objectives. 

2. Event-driven work 

Using a greater pool of fexible resources, the FCA will continue to react 

to crystallised issues, identifed through, for example, complaints data, 

whistle blowers or more innovative use of intelligence derived from new 

media, for example. 

This intelligence-led approach is aligned with the desire by the FCA to 

take quicker and more decisive action to correct regulatory failures. 

3. Issues and products 

Driven by sector risk assessment (SRA), this work will look at key product 

issues, emerging risks and frm specifc risks. FCA action may take the 

form of policy, enforcement or efforts to promote competition, alongside 

or in place of more traditional supervisory responses. 

The FCA is clear that there will be a focus on wholesale as well as retail 

conduct supervision. While accepting that different customers have 

different experience and expertise, no categories of customers will avoid 

the scope of supervision. As we have seen with Interest Rates Hedging 

Products, which are originated in investment banks but are ultimately 

also sold to retail customers, these products are likely to come under 

greater regulatory scrutiny. 




What challenges do these changes create 

for your frm? 

Business Model and Strategy Analysis 

• You will need to have conducted BMsa, which analyses 

your frm’s market position through the lens of conduct 

risk. This should establish your conduct risk appetite and 

ensure it is aligned to your strategy, critically analyse your 

current and future strategy (including competitor analysis 

and considering the effect on consumers), identify the 

key drivers of conduct risk, highlight priority areas and 

incorporate an action plan to mitigate conduct risk 

Governance and culture 

• Your governance structures should be operating effectively, 

aligned to a customer-focussed culture 

• Your risk and compliance functions must be effective in 

meeting new regulatory challenges. This means a move 

away from monitoring technical compliance and adopting a 

forward-looking, judgement-based approach based on 

an assessment of risk. adopting a conduct risk approach 

will help defne the role and priorities of risk and compliance 

• senior Management must understand the new supervisory 

approach and you should be ready for your frst FCA visit 

– there will be more personal, individual accountability for 

key elements of regulatory focus 

Product design 

• Product design drivers should be based on clear customer 

need evidenced through data or research. Design should 

follow from customer insight and focus on meeting customer 

expectations as well as achieving commercial targets 




• Products should go through a clear ‘gateway’ approval 

and sign off process which includes compliance, legal 

and consumer champion stakeholders which tests the 

customer value in new products. clear parameters need 

to be set where more ‘light touch’ sign offs can be applied 

(e.g. little change in product features) 

Sales or transaction processes 

• sales are fair and clearly describe the product, ancillary 

options and pricing structures in order that customers are 

able to make an informed choice as to the benefts and 

suitability of the product 

• Where advice is given, it must be demonstrably suitable 

and take into consideration the hierarchy of customer needs 

Post-sales/services and transaction handling 

• customers’ expectations are met and customers 

consistently obtain appropriate and fair outcomes 

after the point of sale (including complaints, customer 

communications and ongoing charges) 

• Outcome testing should be conducted on a regular basis. 

Where customers are not obtaining consistently fair 

outcomes or where products fail to meet their reasonable 

expectations, the design of the product needs to be 

re-reviewed and amended appropriately – in addition to 

any relevant remediation required. 

Twin-peaks regulation: key changes and challenges | 9

Changes to enforcement 

FCA Enforcement changes 

In terms of Enforcement, the FCA is committed to progressing the 

direction in which we have already seen the FSA moving. This means 

that we can expect to see: 

• More enforcement cases, including the use of s166 powers 

• More severe penalties, including higher fnes 

• An increased focus on action against individuals, especially 

senior management 

• More criminal prosecutions for offences such as insider trading 

• A focus on pursuing compensation for customers. 

In addition, the FCA will have the power to publicise the fact that it is 

taking enforcement action against a frm or individual. 

10 | Twin-peaks win-peaks regulation: kkey 

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hallenges 

What challenges do these changes create 

for your frm? 

• When problems occur you need to identify them quickly, 

remediate them effectively and learn from them 

• You will need to demonstrate that key aspects of your 

business model or culture, such as remuneration and 

incentivisation, product development and training and 

recruitment are designed and operated in a way which 

takes into account the needs of customers 

• The compliance function needs to have a prominent and 

defned role in key aspects of the business, including 

product development and overseeing customer interaction 

to ensure that good customer outcomes are achieved 

• You must be able to evidence the “tone from the top” 

needed to demonstrate a customer-focussed culture 

• Your frm’s systems and controls must mitigate the risk 

of fnancial crime (fraud, money laundering and bribery 

and corruption) 

The FCA’s core 

purpose is to make 

sure markets work 

well so consumers get 

a fair deal – to do that 

we will have not only 

new powers, but a new 

supervisory approach and 

a new culture. Key to the 

success of this approach is 

ensuring that good consumer 

outcomes are built into the 

business models of the frms 

we regulate. 

Martin Wheatley, CEO designate of the 

FCA (July 2012) 



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Summary of key changes 

We set out below the new Pra and fra regulatory frameworks. as you will see, these combine new elements and existing 

tools in a way that represents a new model and approach to regulation. 

The PRA’s new framework 

Risk and impact 

identifcation 

• Forward looking, judgment based 

and commensurate with the level 

of risk 

• Risk assessment based on the 

extent to which the business 

model is sustainable 

• Risk alerts: 

- Annual review of resolution plans 

- Assessment of compliance 

with capital, liquidity and large 

exposure standards 

- Regular contact with senior 

management 

• Challenging but constructive 

relationships 

• Focus on impact that frm failure 

would have on fnancial stability 

without relying solely on the 

resolution regime 

The FCA’s new framework 

Risk and impact 

identifcation 

PRA intervention 

• Policies and rules on frms’ 

resilience (covering such areas 

as capital, liquidity and leverage) 

• Supervisory assessments and 

interventions 

• Mechanisms to support resolution 

• Early and proactive supervisory 

interventions designed to reduce 

risks to the stability of the system 

FCA intervention 

Risk mitigation/ 

remediation 

• S166 reports 

• Pillar II Capital add-ons 

• Use of statutory powers to compel 

frms to take actions 

• Restrictions on permissions 

• Fine frms/individuals 

• Prosecution through the courts 

• Disclosure and market discipline 

Risk mitigation/ 

remediation 

Review 

• Self reporting by frms 

• Third party reviews 

• Follow up supervision visits 

Review 

• Conduct risk and market analysis • Whole market/sector wide review • Competition referral • Self reporting by frms 

• Business model analysis • Firm/peer group review • Market-wide policy interventions • Increased use of third party reviews 

• Risk alerts: • Product/thematic interventions • Individual frm risk mitigation plans • Follow up supervision visits but 

- Product sales data • Governance/risk • S166 Reports these are no longer the primary tool 

- Regulatory returns/ framework effectiveness • Product level prohibition 

complaints data • Consumer redress programmes 

- Market intelligence • Tougher enforcement action 

• Conduct supervision activity 

• Referral by consumer groups 

(‘super complaints’) 

Where are the opportunities? 

The changes outlined here represent an opportunity to take 

control of and manage regulatory risk, by reacting quickly 

and effectively to the changing approach to supervision, to 

seize a competitive advantage. Consider the following... 

• supervisors are more empowered to make judgements, 

based in part on the information you provide them. so take 

the opportunity to get it right - ensure your Mi allows them 

to make what you feel are the right judgements 

• More pro-active regulation, looking to prevent issues rather 

than focus on remediation of crystallised issues, means 




that there is value in showing that you understand the root 

cause of conduct issues...’not just deal with symptoms at 

the point where the failure occurs across the value chain’. 

consider PPi as an example 

• The Pra will focus on the ‘big picture’ and on understanding 

where the main risks to the stability of the fnancial system 

lie, so getting it right will reduce the supervisory burden on 

the frm 

• The fca will focus on the product lifecycle, including the 

power to ban products, so investing in robust approval 

processes and monitoring over the lifecycle will signifcantly 

reduce regulatory risk 

Twin-peaks regulation: key changes and challenges | 11

Contact us 

Fiona Fry 

Partner 


frM regulatory 

T: +44 (0) 20 7694 2364 

E: fona.fry@kpmg.co.uk 

Giles Williams 

Partner 

regulatory centre of excellence 

eMa region 

T: +44 (0) 20 7311 5354 

E: giles.williams@kpmg.co.uk 

Nicholas Henderson 

Partner 



T: +44 (0) 20 7694 2172 

E: nicholas.henderson@kpmg.co.uk 

Giles Adams 

Partner 



T: +44 (0) 20 7694 2143 

E: giles.adams@kpmg.co.uk 

Tim Howarth 

Partner 



T: +44 (0) 20 7311 6640 

E: tim.howarth@kpmg.co.uk 

www.kpmg.co.uk 

The information contained herein is of a general nature and is not intended to address the circumstances of any particular 

individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such 

information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such 

information without appropriate professional advice after a thorough examination of the particular situation. 

© 2012 KPMG LLP, a UK limited liability partnership, is a subsidiary of KPMG Europe LLP and a member frm of the KPMG network 

of independent member frms affliated with KPMG International Cooperative, a Swiss entity. All rights reserved. 

Printed in the United Kingdom. 

The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. 

RR Donnelley I RRD-275743 I November 2012 I Printed on recycled material.

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