OCEANARIUM, BOURNEMOUTH
TUESDAY 28 SEPTEMBER
Howard Davies
Chairman, Financial Services Authority

There is no doubt in my mind that we are in the middle of an explosion of Internet activity.

One vivid measure of the speed with which the world-wide web is growing is that it took 74 years for the telephone to reach 50 million users. Personal computers hit 50 million in just 16 years. It has taken the web four years to reach the same number.

Until quite recently, much Internet use in the UK was academic or hobbyist. I am ashamed to say that, still, 60% of all the e-mails I have received at home have come from the Manchester City fan club – or more precisely from a particularly active e-emanation of it based in Zurich.

But the Internet is rapidly coming out of the enthusiasts closet, and entering the mainstream. More particularly, we believe it is about to lift off in financial services. The signs are already there. We all know about Egg, the Prudential’s Internet bank. We know about the Motley Fool financial web site. We know about the chat‑rooms tipping shares. We know about the beginnings of Internet based day‑trading.

Overall, this must be a good thing. The Internet will bring cheaper transactions. It also brings good quality information within reach of many millions of investors and savers who previously found it impossible, or too costly to access.

But while I constantly remind myself that this explosion of Internet based financial services is fundamentally beneficial for consumers, I cannot help noticing that it also brings me, and my colleagues, a nagging headache.

Why is that? Why are we not unambiguously celebrating this explosion in access and dramatic reduction in transactions costs?

Because we are already running into problems and encountering hazards for the unwary consumer.

We have seen banks from poorly regulated offshore centres seeking to attract deposits in the UK, purporting to be banks authorised here. We have had to step in, generally with good effect so far. But I would frankly say that our ability to police such activity, if carried on by unscrupulous individuals, is limited. We can alert people to the risks. But if they are prepared to send their money through the ether to a bank in an obscure Caribbean centre in pursuit of what are claimed to be exaggeratedly high returns, there is only so much we can do to help.

We are anxious, too, about investment business transacted over the Internet, again perhaps by people who are not authorised to carry on such business here, and where – therefore – the protections which consumers expect: capital soundness, compensation schemes, Ombudsman schemes, are unavailable.

We are anxious, too, about some of the information that appears in chatrooms, and the purposes for which it is used. Increasingly, both authorised and unauthorised firms have chatrooms or bulletin boards. Some of the information provided may be accurate, some of it is certainly not. The innocent surfer has no way of knowing whether someone who posts a question about the prospects for a company is a party to a share ramping scheme. Similarly, the woman seeking advice on a personal pension or ISA to buy has no way of knowing whether an answer given by Jim@freeserve actually comes from a qualified company salesman.

So what are we doing about these problems, apart from wearing grooves in our mouse‑mats?

The first thing to say is that it is no part of our aim at the FSA to try to stamp out Internet usage by financial services companies. Far from it. Unlike any other financial regulator in the world of which we are aware, the FSA is required to take account of the desirability of innovation in designing its regulatory régime. There are some other regulators, some of them not so far away, whose instinct is to seek to constrain or even ban new entrants. Many of our European colleagues, for example, still argue that only banks should be able to issue electronic money. That would knock on the head some of the more imaginative new approaches to payment methods, approaches which could well bring important benefits to consumers.

That is not our approach. We have to find a way of adapting our regulatory environment to new technology, not adapting the new technology to the old regulatory rules.

But that does not mean abandoning the principles on which financial services regulation has, for good reason, been built. Indeed, I would argue that it would be positively mistaken to abandon those principles in the belief that to do so would encourage the spread of e-commerce, e-money and all the other little “e’s”. Some of the reluctance we see on the part of British consumers to embrace the new technology comes from their anxiety about the risks they run in doing so. Who does ensure that the attractive offers they read about are soundly based? How safe is it to pass one’s credit card number down the line? Is there a cooling off period for Internet investments, as there is through other investment methods? Do the compensation and complaints arrangements still apply? Unless we can give people some reassurance that the normal backstop protections still exist, we will restrain the growth of new technology, rather than encourage it.

So the same principles of consumer protection, transparency and disclosure should apply. But that is, of course, easier said that done. So what approach should we at the FSA be taking, to ensure that our régime, in whose virtues we strongly believe, is not fatally compromised in the new technological environment?

We do not yet have a full answer to that question. But we are beginning to piece together the main elements of a new strategy for e-regulation.

And the first point to make, which many overlook, is that the Internet helps the regulator, just as it helps the investment firm, bank or share promoter. It helps the regulator in two distinct but related ways.

First, it gives us the ability to know more, in real time, about what is going on in the market place. It is in principle far easier for us to identify an Internet based Ponzi scheme, or simple investor scam, than it is to identify one which passes around town in brown envelopes or on fax machines. It hasn’t been easy to keep up with the latest in implausible offers from Nigeria to people prepared to send their letterheads and bank account details. In principle – I emphasise – Internet based scams are as visible to us as they are to potential victims, as long of course as we are looking for them.

Second, it is also easier for us to communicate directly with investors. We will soon be able to post our own register of authorised firms and individuals on our web site and an individual will be able to find out, almost instantly, whether a firm offering deposit facilities, or thrilling investment opportunities in Belgian Ostriches, is in fact covered by our regulatory régime. Of course people need to be aware that there is such a facility, but that is not an insuperable obstacle. People will not have to go to the trouble of checking a published register, or sitting patiently in a telephone queue to find out the answer. We are about to publish proposals for our new FSA Register.

The Internet will not help us unless we have worked through a strategy to exploit it. But we do, I think, now have the beginnings of such a strategy. It has five components.

1. Surveillance

By which I mean we must be out there, or perhaps up there, looking for trouble. The SEC in Washington has already begun to upgrade its own capacity to identify suspect sites: we must do the same. But others, notably the media and consumer associations, can also do a lot to bring problems to our attention.

2. Education

Our new legislation gives the FSA a statutory duty to promote consumer understanding of the financial system. That is a first for a regulator, either here or anywhere else in the world. In this area we must do two things. It is right for us to alert investors to the upside of Internet investing, and the ability it gives them to compare products and services. But we must also explain the need to carry out basic checks on the firms they want to deal with – emphasising that those basic checks will be cheap and easy in the future, using the FSA’s own web sites. We must get out there and explain the risks of day‑trading without well-policed limits on credit.

3. Co-operation

It is quite clear that the old concept of purely national regulation is not going to be adequate in the future. In a sense, in Europe we are already ahead of the game, with a network of home state/host state responsibilities already in place – at least in theory. So I am responsible for ensuring that any British based firm deals with its customers fairly and properly wherever they are in the EU. And the same is true of European firms in other member states, using their EU “passport” to do business here.

But the mechanisms of co-operation need to be strengthened, and are being strengthened. We have recently set up a Forum of European Securities Commissions (FESCO) – and an enforcement arm, wittily called FESCOPOL, to beef up cross-border co-operation between regulators.

We need to extend that into the wider world. We already have the links we need with US regulators. But there are problems with some offshore centres which require global action to resolve. The new Financial Stability Forum, set up on Gordon Brown’s initiative this year, is working on that issue at the moment and made some preliminary proposals two weeks ago.

4. Security

Our overall aim must be to ensure that saving and investing through the web is as secure as other investment routes. That does not mean complete security – no regulator can guarantee that. But it means that people feel confident that the protections in place in the rest of the regulatory régime also apply to the e-régime. That they can expect a decent standard of transparency and disclosure of meaningful information. That the capital standards we require of firms and intermediaries are maintained, and that there is proper backing in the form of Ombudsman and compensation schemes in place.

5. Enforcement

– is always the least popular part of our activities. But it is essential that we have the ability to make our régime stick, and that we are not afraid to use the odd stick, as well as the carrot. We have already set out some principles on how we will look at web sites, and decide whether or not they are contravening our regulations. It will be vital for us to keep that régime up to date. But I believe the new legislation, when it is through next year, will give us the statutory backing we need to do so.

This five-pronged strategy – SECSE – does not have as memorable an acronym as it might. But, with a hard C, it is not too bad phonetically.

Let me conclude by re-emphasising that the FSA does not see the explosive growth of Internet‑based financial services as a tiresome problem. There is a good chance that it can reinforce, and indeed strengthen the competitiveness of the UK as a global centre for financial services. It is estimated that around 80% of web sites are in English, which gives us a kick-start. And we and the Americans are certainly at the leading edge of finding an appropriate régime which will allow the business to grow fast, but safely.

Exponential growth without the safety and soundness protections I have described would only lead to a crisis of confidence later. So regulation must go hand in hand with the development of the market. And the introduction of the FSA, as a single financial regulator, with its ability to look across the whole financial services sector, will be another major competitive advantage, as soon as Parliament has done the necessary on our Bill. Other countries are wrestling with dealing with this problem with a multiplicity of regulators, on old sectoral lines, which makes no sense at all in an Internet world.

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