28 OCTOBER 1997
Speech by Howard Davies, Chairman
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Today the Chancellor announced, in his speech, that the organisation I have the privilege to chair will be called the Financial Services Authority.

I have become more and more persuaded over the last five months that the concept of a single financial regulator for the UK's financial markets is an idea whose time has come. And that it will be possible, within such a framework, to achieve significant improvements in operating efficiencies, in consumer responsiveness, and in sensitivity to the market - as long, of course, as we get it right.

The FSA Mission

If we are to get it right, we need to aim high. So we have set ourselves a challenging corporate objective. Our mission statement will be along the following lines. "The Financial Services Authority will aim to be a world-leading financial regulator, respected for its professionalism and integrity both at home and abroad".

Two elements of that statement require highlighting. First, the commitment to professionalism and integrity.

We aim to be an organisation which will attract the best and brightest of those interested in the development of financial markets. We recognise that we are unlikely, as regulators, to be able to pay top dollar in the market. But regulators face that problem everywhere in the world. And they staff themselves most effectively if they are able to strike a balance between a core of long service staff committed to the organisation and its culture, and market participants with recent experience of real operations. So we aim to be an organisation within which ambitious people can built rewarding careers and also one which is open to shorter term staff, whether on secondment, or as FSA employees.

I have been encouraged, so far, by the continued commitment of the excellent regulatory staff we inherit. The market is very buoyant at present, as you will all be aware. But we have seen no unusual exodus of staff and, indeed, many of our people can see the prospects of more varied and worthwhile careers within a single regulatory structure. Of course we will have to pay properly if we are to sustain this loyalty. I am often told by regulated institutions that they think we should pay well, as long as we are efficient, and do not impose unreasonable obligations on the regulated community. That is a balance which we shall seek to strike.

The second aspect of our mission statement to which I would also draw particular attention is its international focus. A number of the unfortunate episodes of recent years with which UK regulators have had to cope have demonstrated that good regulation must have a strong international dimension and that international financial regulation is only as strong as its weakest link. There is an inevitable temptation, when one is preoccupied with institutional restructuring, to pay less attention to international relations. We will not yield to that temptation in the FSA. Because there is a clear and urgent need to enhance international regulatory co-operation, in the face of the growing inter-linkages between financial markets. So I am delighted to be able to say that, yesterday, the Bank of England and the FSA signed an important Memorandum of Understanding with the SEC and the CFTC in the United States governing exchanges of information between the four institutions.

But of course a mission statement is, inevitably, aspirational and conveys little information about the practical objectives of the business, and the way in which those objectives will be pursued.

Statutory Objectives

So we are pleased that we will be given statutory objectives in our legislation. Those objectives will be in four areas.

First, we will work with the Bank of England to sustain confidence in the UK financial sector and markets. The way in which we shall do that is now set out in a Memorandum of Understanding between the Bank, the FSA and the Treasury. I know from my discussions with bankers, in particular, that this aspect of the new regulatory arrangement has been one which concerns them. I am quite confident that the relationship will in practice work extremely well. After all, I have passively smoked with the Governor for some years already. The standing committee structure outlined in the Memorandum of Understanding will be underpinned by working level arrangements. So we now have a robust framework in place, albeit one which we fervently hope will not often be tested in practice.

The second of our objectives will require us to protect consumers by ensuring that firms are competent and financially sound, while recognising that consumers must bear some responsibility of their own for their financial decisions. This is what many would rightly regard as the red meat of our task. Setting the balance between protecting consumers, and requiring a degree of caveat emptor, will not be easy. We hope to ensure, through the architecture of the FSA, that we strike that balance appropriately in different markets.

Many investors in wholesale markets can do a lot to look after themselves, or ought to be able to. We should do more for retail consumers, who face ever more complex products and choices, and who need help and protection. That applies particularly to vulnerable groups - anxious older people for example - and the poor. For them credit is difficult to secure, and often very costly. And the unpredictability of their finances makes some long term savings products unsuitable. We shall keep a particular eye open to the problems of this group, who can often be well served by credit unions and other small local entities.

The third area is closely linked with the second. We shall have a role in promoting public understanding of the benefits and risks of financial products. In our view, this is very closely linked to the issue of consumer responsibility. Whilst it is intellectually attractive to say that individual consumers must carry some responsibility for their own financial decisions, and that perfect protection against risk would be associated with highly imperfect and sclerotic markets, there is a need for continued efforts to raise the understanding among consumers of the nature of the financial products offered to them. We do not think that a regulator based in the City of London can carry the full burden of educating investors. But we certainly accept a measure of responsibility for providing others with the materials they need to enhance consumer awareness.

And we accept, too, that we should play a role in monitoring, detecting and preventing financial crime. Of course, just as we operate in partnership with the Bank of England on systemic issues, so in relation to financial crime we must also work with other agencies. Our work already with the Financial Fraud Information Network has provided a model of the way in which such co-operation can work to the benefit of all concerned - except the villains, we hope.

Constraints

But of course all these objectives must be pursued in a reasonable way and, without further qualification, they could be said to justify almost any amount of effort by the regulator. So it is right that we should be invited to carry out these objectives in a way which is efficient and economic, with the regulatory burden no heavier than is consistent with the likely benefits. Once again, this will be a difficult balance to strike, and we will need help from the market, and from consumers, in doing so. Our fundamental approach will be to implement risk-based supervision, with the intensity of regulation related to the risks to consumers, and to the capital base of the business.

We should also regulate in a way which does not stifle innovation or competition. The best guarantee of decent treatment of consumers of financial services, as of any other products, is that there are competing offers in the marketplace. Furthermore, financial services have prospered mightily in the United Kingdom on the basis of continued and vigorous innovation. We would score an economic own goal were we to regulate the innovative capacities of the cities of London and Edinburgh out of existence. On the other hand, it is not true to say that the most innovative and competitive financial markets are those which are least well regulated. If that were so, then Europe's leading financial centre might be Tirana.

A regulator cannot have, as one of its prime objectives, the direct promotion of the interests of a particular financial centre. That job goes more properly to the City Corporation and to British Invisibles. But as regulators we should regard the health of the financial markets we oversee as an indication - one among a number - of the appropriateness of our regulation. If we were to observe whole classes of business moving offshore as a result of regulatory restrictions, that should concern us. So we shall monitor success in London's markets, and ask ourselves how we are contributing to that success as we go forward.

We now have a mission statement, therefore, some objectives, and some sensible constraints on the pursuit of those objectives. But we can also now say more about the practical ways in which we aim to put together the new organisation, and about the way in which regulated institutions will be affected in the construction phase of the new institution.

Building The New Regulator

Our approach is described in some detail in the launch document which will be available to you as soon as I sit down. It is not quite a prospectus. Partly, of course, because if I described it as a prospectus I would be accused by some of my eager regulators of presenting misleading information. It is more of an aspirational document than an invitation to invest.

That launch document explains how we will move from where we are, to the completion of an all singing, all dancing single regulator. The best way to explain this process is by looking at a series of milestones.

In the two months after the May announcement we were asked to put together the principles by which we would construct the new single regulator. We did so, under Andrew Large's guidance, by the end of July and produced a report to the Chancellor, which he was kind enough to agree. We then set ourselves the objective of preparing a launch to the marketplace by the end of October, another milestone which we have successfully reached.

We have concluded that the best way forward from there will be to unite the old SIB, the Self-Regulatory Organisations and the supervision side of the Bank of England, in managerial terms, next spring. The precise date will depend on the passage of the Bank of England Bill, which is being introduced to the House of Commons this week. It may well be that we cannot achieve full integration at that point, since the position of the Registry of Friendly Societies and the Insurance Directorate of the Department of Trade and Industry is a little more complex, as we explain. But we have agreed with the Boards of the SROs that they will cede their staff to the Financial Services Authority early next summer, to allow us to put together an integrated organisation. I am most grateful to them for their co-operation in this process, and particularly to their Chairmen, Nick Durlacher of the SFA, Douglas McDougall of IMRO and Joe Palmer of the PIA. Thereafter, those Boards will remain in existence fulfilling their statutory duties, until the implementation of the second major piece of legislation, the financial regulatory reform bill, towards the end of 1999, but services will be provided to them by staff of the FSA. We would expect by far the great majority of the staff of all the SROs to become part of the FSA next spring, leaving only a small company secretary-type function attached to the SRO Boards.

The integration we achieve then will not be perfect. For a few months we shall, in the interests of minimising the costs of transition, operate from our existing premises. But we expect to be able to co-locate all the staff - including, we hope, the Building and Friendly Societies and the insurance regulators - in our new Canary Wharf home beginning in October of next year. From then on we will look, to all intents and purposes, like a single organisation. The launch document contains more details on this process, and explains what it means for different types of regulated business. But the essence of it is that we have signed contractual arrangements with the Boards of the SROs to put the FSA in a position of being able to deliver a consistent and quality-controlled level of service to them during the interim period. We believe that this fast track managerial integration, ahead of legislation, offers the best chance of maintaining a good standard of regulation during the transitional period, and avoiding the problems which would arise from the departure of staff uncertain about their futures in a period of change and uncertainty.

Management Structure

But what kind of structure will be implemented in the new single regulator? Here, again, we have decided the broad outlines of what we want to achieve, and put the initial building blocks in place, though there is much more to do over the next few months. There will be three Managing Directors reporting to me as Executive Chairman, all of whom will be members of the full Board, which will be strengthened in the coming weeks by additional non-executive appointments. Richard Farrant, until last week the Chief Executive of the Securities and Futures Authority, will be the Managing Director and Chief Operating Officer, responsible for putting the whole show on the road. As an enthusiastic cyclist he is used to negotiating dangerous oncoming traffic, and he will need all his skills in that area.

Michael Foot, who currently works at a small unlicensed bank in the City, will be the Head of Financial Supervision of institutions of all kinds. And Phillip Thorpe, currently the Chief Executive of IMRO, will be Head of Authorisation, Enforcement and Consumer Relations.

Let me say a word or two about the logic of this structure. When we began the reconstruction process, we decided that the best way to approach the problem was to begin from the bottom up. In other words, to ask ourselves what the nature of the practical work undertaken in the different regulatory organisations was, and what commonality we could find between the work done in different bodies. That process persuaded us that there was considerable common ground. The process of authorising a financial business is similar in each part of the forest. And there are considerable synergies to be achieved by bringing all of those authorisation processes together. It will not surprise you to learn that undesirables who have been ejected from one part of London's financial markets, tend to try to reappear in another part of them. We obviously do not deny the possibility of rehabilitation, but we believe that the regulator should be as well-informed as the crooks. And bringing together all our authorisation processes in one will help us to achieve that. This will include, as the Government have now made clear, the authorisation of firms currently authorised by the Recognised Professional Bodies.

Once a business, or indeed an individual, is authorised, then it or she needs supervision. For the most part, that supervision proceeds on the reasonable assumption that a business wishes to obey the rules, indeed, wishes to serve clients in such a way as to encourage them to undertake repeat business. Ongoing supervision takes a number of different forms, but the essential activity is similar. Furthermore, financial institutions themselves argue strongly for that supervision to be coordinated. They do not want different regulators to ask them the same questions about their capital base. They believe that one assessment of overall management capability at group level, and the systems and controls environment should inform regulatory judgements across the piece. So we have brought together supervision under one head, and will institute a system of lead regulation within the FSA. In other words, there will be one individual responsible for the consolidated supervision of each financial institution, and for co-ordinating the activities of the different, business line regulators relating to those institutions. So, within the FSA, we will operate a lead regulation system on lines UK regulators have been seeking to commend to their international colleagues for some time.

In some areas, we aim to go further. We believe that some particularly complex groups can be supervised on a consolidated basis, with one team including all the skills necessary to supervise one complex institution. That will be breaking new ground internationally, so we shall proceed with caution, setting up pilots with volunteer institutions, at the outset. That initiative will be led by Oliver Page, who has been appointed the Director of the supervision of complex groups under Michael Foot.

Sadly, from time to time, institutions, or parts of them, break the rules, whether wittingly or unwittingly, and there is a need for some specific regulatory intervention, for enforcement activity, and eventually for discipline. This is, if you like, our equivalent of the CID. And all of that will be brought together, too, under Phillip Thorpe. It makes sense to brigade that activity with authorisation, since much of the intelligence base used is similar. And it makes sense to do it all in one place. A legitimate criticism of the existing regulatory system is that it has been difficult to discern consistency in the disciplinary and, particularly, fining policies of the different regulatory organisations.

You may ask why consumer affairs should be included in this area. But, in practice, we believe that the logical link is strong. Perhaps sadly, much of the practical work in relation to consumers concerns the operation of ombudsmen schemes, on the one hand, and compensation schemes, on the other. Here there is a clear link to authorisation and enforcement. The types of complaints, and the institutions about whom individuals complain, can generate important information for the regulator, particularly for the enforcement area. And of course when cases move into the compensation arena, they move there from enforcement, quite often. So all of these activities have common links, and it makes sense to manage them together.

Furthermore, the Government have today announced that there will in future be a single compensation scheme across the industry. This is a further reason for consolidated management of the FSA's consumer interfaces.

We are now moving towards underpinning these three senior appointments with a set of second tier director jobs, which we will be announcing over the next few weeks. We shall be looking first at our internal resources, but we shall also be advertising to ensure we miss no outstanding external candidates.

After the coffee break you will hear from the three Managing Directors, on some aspects of their own responsibilities. Phillip Thorpe will talk about our first consultation paper on consumer involvement in the Financial Services Authority's affairs. Richard Farrant will explain our approach to cost control and explain how we expect banks to pay for banking supervision in the future. Michael Foot will introduce the third consultation paper on practitioner involvement. These will not be our only consultation exercises; more will follow as the scope of our responsibilities become clearer and, therefore, the nature of the operational issues on which we need advice from the market or from consumers.

The Reasons For Change

But let me conclude with just a few observations on why we are doing all this. What problems are we trying to solve?

It is not easy to describe clearly, or assess numerically, the weaknesses and failings of our existing regulatory system. And indeed my own view is that the systems set up by the Financial Services Act, on the one hand, and the banking supervision arrangements enshrined in the Banking Act, have many strong points on which to build. London has remained Europe's largest financial centre, indeed its dominance has continued to grow. And, while we have had scandals and failures, the cost to the public purse of the failures of financial institutions in this country have been as nothing compared to those experienced in France, Italy, Japan or Sweden, not to mention the enormous costs of the savings and loans debacle in the United States. If I were to add the problems of the Herstatt Bank in Germany, then I can be reasonably sure to have offended the owners of two thirds of the financial institutions represented here today.

But, nonetheless, our system has by no means been perfect. The Bank of England itself has acknowledged weaknesses in its past approach to banking supervision and a work programme to strengthen it was established after the Arthur Andersen review in 1995/96. That is still under way. And in the Financial Services Act area the weaknesses of the two tier system are well understood. They did create duplication and dysfunctional turf wars between regulatory organisations. They created costly overlaps and resulted in a delayed response to problems. The reaction to the pensions mis-selling episode is a case in point.

The net effect of all these problems has been the creation of a vague sense of unease about financial regulation, and about the integrity with which financial institutions carry out their business. It is hard to know whether that sense of unease is wholly justified. But a striking measure of it was provided by a very recent survey of opinion leaders conducted by the Securities Institute. They asked a group of City opinion leaders, on the one hand, and a larger group of opinion leaders drawn more broadly from the City, industry, the media, politics and the Civil Service, for their views on the integrity with which different parts of the economy carried out their business. Respondents were asked to answer on a five point scale, with five being the top mark and one indicating deep mistrust. City opinion leaders were reasonably comfortable about their own business practices and 48 per cent of them gave the City either top marks, or four out of five. Sadly, only 21 per cent of the broader group of opinion leaders shared the same high opinion of the City as did its own denizens.

Perhaps more interestingly, though, the same opinion leaders were asked what measures would enhance the City's reputation for integrity. Here, the Chancellor may draw more comfort. And perhaps representatives of financial institutions may find something to comfort them, too, as they contemplate the introduction of the FSA. Because four suggestions were made of ways in which the City could enhance its reputation. First, recommended by 10 per cent of respondents, City institutions could lower their pay. I cannot imagine that this completely absurd proposition could be supported by anyone in this room. Secondly, a further 10 per cent suggested that the answer lay simply in better PR.

This leaves the other two options, increased transparency and, supported by a remarkable 37 per cent of respondents, an independent regulatory authority.

I would see the two as being closely linked, since we will have a strong commitment to openness in our own dealings, and furthermore a strong commitment to enhancing the transparency with which business is done both in markets and exchanges, and with individual retail consumers.

From all this I hope you would conclude that the work we are undertaking to develop the FSA is in the market's, as well as the consumer's, interests. But you may nonetheless harbour some doubts in your mind. And you will have seen, in the public prints, some criticisms of what we are up to. Five charges have been laid against us which I would like to try to rebut before I close.

Criticisms - And Responses

First, it is argued that the new structure will be costly and, in particular, that the transition costs will be high.

I hope not. Of course there will be some transitional costs. But there are significant opportunities for improvements in operating efficiencies in the new system, and opportunities to spread our overheads across a much larger business. I would like to be able to say that the overall costs of regulation will not rise under the new arrangements. And I believe that that will be true in the sense of the total costs of regulation - yours and mine. But of course the costs of the FSA itself will depend on the size of the financial sector, and on the evolution of salary costs in financial services, which is after all where we recruit most of our people.

What we can assure you is that we will manage your resources effectively. I believe our decision on accommodation is a sign that we are acutely sensitive to cost issues. And the right disciplines are created when a regulator is paid by the regulated. I ran an organisation on these lines at the Audit Commission for five years, which worked well. Richard Farrant will talk a little later about the way in which we seek to develop our accountability to those who finance us, and to expose our financial decisions to you as we proceed.

The second charge is that the delayed introduction of the Regulatory Reform Bill will create a kind of planning blight over the system and result in regulatory degradation.

I have already set out the main lines of our answer to that. We aim to achieve, on a contractual basis, the full integration of staff in the early part of next year, to avoid, or at least to minimise the risk of the loss of important individuals as a result of uncertainty. We believe that the risk of moving forward quickly is lower than the risk of leaving the existing system in place for a lengthy period. Furthermore, to have sought to introduce a major reform bill to Parliament in this session would have been an even more risky endeavour. Indeed, I am persuaded that the timetable we now have is an entirely rational way to proceed.

Thirdly, it is argued that putting together the prudential and conduct of business regulation of financial institutions across the piece creates conflicts within one organisation. I do not follow this argument, myself, though I have heard it many times. It seems to me that such conflicts exist in any regulatory system. They exist either across institutions or within them. Where there are tensions - and the occasions on which those tensions appear are relatively limited in my view - they have to be resolved in one way or another, and can be just as well resolved within one institution than across a number, indeed usually rather better.

Fourthly, it is argued that a different character of regulation is required in wholesale markets. That is a proposition which I can enthusiastically support. And I also believe that it is one which can be recognised within one institution, just as well across a number. We will do so.

Lastly, some claim that a single financial regulator, with perhaps 2,000 staff, will be bureaucratic, unresponsive and unwieldy. Well, it will of course be a large organisation. But there is no necessary correlation between size and unresponsiveness. We can all think of small local shops whose standard of service is well below that of Sainsburys (to name one bank at random), or of local mini cab firms whose understanding of consumer service is significantly inferior to that of British Airways. I cannot prove to you that we will be similarly responsive, but nor can anyone prove to me that size means unresponsiveness. The proof of the pudding is in the eating. And we are content to be judged on our record.

Conclusion

In conclusion, I would like briefly to thank those who have helped us to get this far. Firstly, the Chancellor and the Treasury who have themselves worked hard on the legislative framework. Secondly, the Governor and the Bank of England, with whom our co-operation has been extremely close. Thirdly, I am grateful to my own Board and to the Boards of the Self-Regulatory Organisations, who have been most cooperative in agreeing to the contractual arrangements I have described. Fourthly, to all the staff involved. In spite of the fact that many of them face continued uncertainty about their own positions in the new structure, I cannot speak too highly of the co-operation that I have received from people in all of the organisations which will form part of the Financial Services Authority. The enthusiasm, not to mention the sheer hours put in to get us where we are now have been remarkable. And, lastly, we have had very full hearted co-operation from those in financial institutions themselves whom we have consulted.

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