The Financial Conduct Authority, the newly formed financial watchdog in the U.K., has detailed its approach to investigating and reporting on regulatory failures.

Effective April 1, the FSA and the new Prudential Regulation Authority replaced the phased out Financial Services Authority. The new FCA will supervise the conduct of approximately 26,000 firms across all financial industry sectors.

Responding to inadequacies and missteps in the FSA's handling of LIBOR manipulation, the failure and partial nationalization of Royal Bank of Scotland, and collapse and nationalization of Northern Rock, the Financial Services Act 2012 required the FCA to publish a policy statement describing how it will decide whether to carry out an investigation into possible regulatory failure and the process for reporting findings and recommendations.

“A regulatory system that removed all risk would be prohibitively expensive and could stifle innovation and competition,” said Martin Wheatley, chief executive of the FCA, in a statement. “The instances where we investigate and report to Treasury will be significant events and serious failures, when things have gone badly wrong, and this paper sets out how we will identify and deal with these exceptional cases.”

The framework that establishes what should, and should not be, regarded as a regulatory failure and therefore subject to investigation and reporting. This criteria includes:

A significant failure to secure an appropriate degree of protection for consumers.

A failure that had, or could have had, a significant adverse effect on the integrity of the U.K. financial system, or on effective competition in the interests of consumers.

Events that occurred, or were made worse, because of a serious failure of the regulatory system, or on the part of the FCA.

The Treasury can require the FCA to carry out an investigation when these factors are met. It can also give directions regarding the scope of any investigation, the period during which the investigation is carried out, the conduct of the investigation. Reports must set out: the result of the investigation; lessons the FCA considers that it should learn; and recommendations (if any) the FCA considers appropriate.

The 2012 Act allows the FCA to postpone the start of, or suspend, an investigation if necessary to avoid a material adverse effect on the exercise of any of its other functions.