Potential regulations could allow insurers to provide ‘regulatory investigation cost coverage’, says financial institutions practice leader

New regulations for critical third parties (CTPs) proposed by the Bank of England (BoE), Prudential Regulation Authority (PRA) and FCA could provide insurers with the opportunity to create “insurance that can respond to regulatory investigations” for these firms.

This was according to Neil Beaton, financial institutions practice leader at CFC Underwriting. He explained that “the need to have insurance in this space creates an avenue where [CFC] can see some opportunity going forward”.

CTPs provide certain services and infrastructure to regulated financial services firms - if CTPs were to fail or be disrupted, then that could affect partner firms’ financial stability and cause harm to the financial system in the UK.

Examples of CTPs include cloud computing services or data analytics businesses.

According to a Bank of England discussion paper, which was published in July 2022, financial firms and markets are increasingly reliant on CTPs to provide technological and support functions.

The paper added that the threat of disruption to CTPs was a “systemic risk” to the financial services sector.

This growth in reliance on CTPs in the UK financial market prompted the government to accelerate legislative proposals around the regulation of CTPs in the Financial Services and Markets Bill, which was published in July this year – the drafting of the bill would issue supervisory powers to the BoE, PRA and FCA, allowing them to directly oversee the resilience of services that CTPs provide to the UK financial sector.

The BoE’s discussion paper explained that this oversight could include a framework for identifying CTPs, the implementation of minimum resilience standards and a framework for testing the resilience of the material services that CTPs provide.

Cost of investigation 

The Financial Services and Markets Bill is currently expected to be signed into law in the first half of 2023 – if the proposals around CTPs are to be included, these previously unregulated firms would subsequently become open to the possibility of regulatory investigation.

Many CTPs are small businesses, therefore the majority would find the new demands of regulation challenging, explained Beaton.

He said: “If there’s only 10 or 20 employees [at the CTP], every employee may be involved in responding to a regulatory inquiry and that may prevent them from trading until it’s sorted – there may also be the cost of [additional] third party providers [that CTPs] need to bring in to assist with inquiries.

“There is potential for us to provide cover for interruption to business exposure from regulatory investigation and the response to it.

“It’s peace of mind coverage and our target market is really SMEs and smaller mid-market companies.”

Beaton’s role at CFC includes designing products for the insurer’s financial technology clients – the firm has created a blended product for potential CTP customers that includes “regulatory investigation cost coverage” alongside the standard errors and omissions and directors’ and officers’ cover.

He continued: “The cover provides some comfort and protection that there’s a policy in place to cover some of those costs [of investigation] – some of these costs can be quite material because they involve generating reports to provide to the regulator and trawling through data.”

However, Beaton clarified that CFC’s proposed cover would not respond to a market-wide investigation scenario, where a regulator would ask every CTP to “open their books” at the same time.