Converging Regulation

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Westminster & City Conference – 4 July
John Tiner: Keynote Address

Ladies and gentlemen, thank you for inviting me to give the keynote address here today. On looking at the program, I was most encouraged to see the words ‘converging’, ‘regulation’ and ‘opportunities’ appearing in such close succession. There are still some who view regulation of any sort as a threat. But we do believe that as we continue our work to shape our inheritance and get ready for our new responsibilities, we are opening the way for new opportunities. And I see that I will be followed on the platform today by an impressive procession of industry experts who will help you to tease out the opportunities presented by this round of change – so I will leave the detail of the ‘how’ to them.
But I am also very aware that at times it can be hard to keep pace with the regulatory reform program currently in train – much less have a view on the degree of convergence being achieved or the opportunities that might arise.
So I thought that today I would try and help you to fit the pieces of the jigsaw together and highlight some of the issues that converging regulation throws up. I would like to approach this first by taking you through some examples – both prudential and conduct of business - of where we have sought to find the right balance of regulatory convergence. And then to describe the picture we are working towards by setting out our overall aims in reforming regulation of the retail market specifically, and explaining briefly how our key initiatives go towards meeting those aims – a taster of the strategy paper we hope to publish later this year.
But first, by way of context, a quick reminder of where we started from – five years ago - on our journey towards a single integrated regulator, and how our history continues to shape our future.
In January 2000 we set out our proposed approach to regulation in the future in A new regulator for the new millennium. We summarised our goal as being "to maintain efficient, orderly and clean financial markets and help retail consumers achieve a fair deal". This approach is based on a clear statement of the realistic aims and limits of regulation, and recognises both the proper responsibilities of consumers and of firms' own management, and the impossibility and undesirability of removing all risk and failure from the financial system.
As we set about building a single regulator, we identified a number of key building blocks that are fundamental to our overall approach.
The first is our risk-based framework. This framework is used to help us identify, prioritise and address risks to our four statutory objectives. So it aims to help us answer the basic questions: what developments, events or issues pose significant risk to our objectives? And how should we use our resources to focus on the risks that matter most? Our approach is designed to ensure that we apply our limited resources in the most effective way.
The second building block is the ‘Principles for Businesses’. I am sure that I do not need to list them all, and indeed you should not need me to remind you of what they are; but they include principles such as:

A firm must conduct its business with integrity.
A firm must maintain adequate financial resources.
A firm must treat its customers fairly.

And the third concerns senior management responsibilities where we look to senior management to satisfy themselves that their firm is operating in a way which meets our requirements. This is not something that can be delegated to a compliance department.
These core building blocks do, we think, represent strong regulatory convergence – they are equally applicable across all markets and are relevant to both firms and their customers. And as we move forward, they will continue to shape our approach.
In bringing together the ten former regulatory bodies, we saw not only some convergence across sectors – banking, insurance, securities, investment advice – but also the bringing together of prudential and conduct of business regulation. Some commentators suggest that there is an inherent conflict between the market confidence aspects of prudential supervision and the consumer protection aspects of conduct of business regulation. My view on this is that it is true there are times when there is a tension between them, although in a market economy it is by no means inherent in the system, and I believe that any such tensions are best resolved within a single regulatory body than between multiple bodies who can only deal with the tension in a way which damages the very objectives the regulatory systems should be working towards.
Moving now to our more detailed business standards. While much of the discussion today will no doubt focus on opportunities arising from changes to our conduct of business regime, I would like first to spend a few minutes on convergence within our prudential regime. The amount of capital you are required to hold will, after all, be an important part of the equation as you consider the business opportunities ahead.
As many of you here will be aware, proposals for a new Basel Accord consist of three mutually reinforcing pillars – minimum capital requirements; supervisory review of a firm’s own internal capital assessment; and market discipline. This framework was developed to be applied to internationally active banks, and some of you may be alarmed at the suggestion that it has a wider role to play in achieving greater convergence of prudential requirements across sectors. But we believe that while the detail of the Accord does not transfer across industry sectors, the underlying philosophy does have a wider application. For example, we have used the three pillar approach to inform our own proposals for the reform of the insurance prudential regime. And it will read across to European directives which affects investment firms too.
We are aware of concerns that this will lead to large increases in capital requirements for investment firms. We hope that this will not be the case – except, of course, where the risks warrant it. That, of course, is not entirely within the gift of the FSA. We recognise that not all firms are alike. Investment firms are not banks, and do not carry the same risks. And within the investment firm community there is a great diversity. We have therefore argued that we need an approach which is based on proportionality – so while some convergence is sensible where the risks are similar, capital requirements will need to be adapted to reflect the differing types of financial institution and the varying degrees of risk that they run.
Similarly, we have worked to find an appropriate degree of convergence within our conduct of business requirements. I would like to share with you some specific examples covering the key elements of the conduct of business regime: appointed representatives; suitability; independence; and disclosure.
Our proposal for extending the appointed representative regime to mortgages and general insurance is a good example of the challenges of finding the appropriate balance. Our proposals in CP159 allowed for firms to have different principals for non-substitutable products. So an appointed representative may have one principal for investment business, two for mortgages and up to ten different principals for its general insurance business. So this was intended to achieve a harmonised approach which did not equate to ‘one size fits all’. However, we have received feedback arguing that this approach would prove too constraining in a number of areas within the general insurance market. So we are looking carefully at the options here and hope to publish our response after the summer break.
Turning to suitability requirements, our proposals again reflect a degree of convergence, whilst retaining some differentiation to reflect the differing risks. Firms providing advice on packaged investment products are already required to recommend the most suitable product (from the range they can offer) to meet the consumer’s needs. They are also required to provide consumers with a suitability letter setting out the reasons for the recommendation. A similar approach is proposed for mortgage advice, though for mortgages we consider a suitability letter would potentially detract from other more important disclosure materials. For insurance products, we have consulted on the basis that an advisor must recommend a product that is adequate to meet the consumer’s needs. And they would (under the IMD) be required to provide consumers with a suitability statement. We think that on balance this variation in the suitability test is proportionate to the risk of consumer detriment – so, for example, based on current proposals, the suitability test applying to the purchase of a personal pension would be higher than that which applies to car insurance.
Similarly we are proposing a differentiated approach to the ‘independence’ concept. By this, I mean the use of rules and guidance to determine whether firms may hold themselves out as being ‘independent’.
In the investment business sector we are proposing that firms should not be allowed to use the term ‘independent’ unless they offer ‘whole of market’ advice and offer the customer the opportunity of paying a fee for the advice. We are making similar proposals for mortgage firms in CP186.
Current practice is generally not to charge fees for advising or arranging general insurance, and the ‘whole of market’ concept does not translate meaningfully into the diverse insurance market. So in the absence of any clear evidence of detriment from the way the term is currently used, we are proposing no restriction on the use of the term ‘independent’ in the general insurance market. Any abuses of the term will be tackled under the clear, fair and not misleading rule.
And finally our proposals on disclosure should also achieve a degree of convergence across the sectors. We have proposed a common initial disclosure template (carrying the new Key Facts branding outlined in CP170). This would be used for all sales in the packaged investment product and mortgage sectors, but would be optional for the general insurance sector (where we think the additional costs may not be outweighed by the benefits). On product disclosure, our proposals for the Key Facts branding will also be carried across the sectors. So while the detail will obviously differ across products and sectors, we should achieve a common presentation of the information.
I hope that these examples show that we intend a reasonable degree of convergence between investment business and mortgages. We have, however, deliberately proposed a lighter touch approach to general insurance. This reflects the usually lower risk of consumer detriment and the implications of that for the cost benefit balance.
Having covered some of the individual pieces of the jigsaw, I will now try and piece them all together.
Starting first with our overall aims. Consumers need to have confidence in the retail market for financial products and services. Confidence in this market may be adversely affected by, for example, instances of mis-selling and high profile cases involving consumer loss. Similarly a failure by consumers to understand fully the inherent risks in particular markets and products may result in unexpected outcomes for some consumers, particularly in volatile market conditions.
So we have developed five high level outcomes that we think go towards supporting an efficient retail market in which consumers have confidence and a more effective regulatory regime for that market. This is a big task and we have varying degrees of influence over these areas.
But it is important to be clear about the FSA’s role in all of this: it is not our role to try and reshape the industry, and this is not our intention. But we do think there is merit in taking a fresh look at how we might improve the interface between consumers and the regulatory regime. So I would like to share with you today these high level outcomes:

Consumer needs are well understood by themselves, firms and the FSA
If consumers needs are not properly understood there is a danger that many consumers will not find what they want and others will buy the wrong thing. If we understand needs well, it could alter the types of products firms design, change the way we talk about them to consumers and shape our education strategy. This will therefore have a significant impact on the extent to which the market operates effectively.
So our activities here are focussed in two key areas:

firstly - undertaking research to improve our understanding of how consumers come to identify financial needs, how they make financial decisions, and therefore what they need to help them do this well; and
secondly - firms’ strategies - where we will be looking to ensure that the needs of retail customers are properly considered. So while I will leave discussion of how to pursue the opportunities to others, I would stress that we will expect firms in pursuing those opportunities to have a proper understanding and take full account of:
1. the risks to retail customers that arise from the firm’s products;
2. the implications of a lack of financial understanding among many retail customers; and
3. the sensitivity of new or existing retail products to major market or economic shifts.

Consumers are financially aware, can take responsibility for their financial affairs, and (as a group) are able to influence the market

Consumers need to be able to identify their financial needs and the appropriate products and services to meet those needs. Identifying financial needs has to begin with recognising that you have one at all. Choosing appropriate products encompasses a spectrum from being able to self-select simple products to being aware of when to seek advice before making a product selection. Financially aware consumers should be better able to take responsibility for their financial decisions. They would, for example, recognise the benefits of shopping around and would seek information to answer questions - whether through written information or with advice. This in turn should empower consumers, increasing their ability to influence the market.
So our focus here is to influence consumer behaviour through the provision of consumer education, information and generic advice. (This is distinct from the regulated sales and advice process which I will come to in a moment.) On consumer education and understanding, we will publish later this summer a statement of fundamentals which we and other stakeholders will need to tackle. Securing real improvements will not be easy, even with a change of gear in resources, but it is important that, through partnership with the industry and others, we do grip the key issues.
On information and advice, we have been progressing a number of initiatives that the FSA can deliver directly. For example, as part of taking forward generic advice, we are working with stakeholders, including industry and consumer groups, to develop a ‘financial healthcheck’ to help in providing consumers with basic financial advice. And we are continuing to expand the use of comparative tables as a tool to encourage consumers to shop around. Consumer alerts and fact sheets to raise awareness about specific products and consumer issues also have an important role.

An economically sustainable distribution system that operates to standards that provide appropriate levels of advice and disclosure tailored to the needs of the consumer and complexity of the product
Consumers need access to a level of assistance or competitively-priced advice to help them choose suitable products to meet their needs. This should provide them with the information that they need to understand the products they buy, taking account of the complexity of those products and the consumer’s understanding of, and attitude to, risk. This should be achieved without creating unnecessary burdens for consumers or firms. And it needs to remain economically sustainable.
Our activities here can be categorised into three elements: :
1. the first is initiatives designed to improve the advice regime - where we have proposed to remove the current polarisation rules to free up the supply of advice. The key remaining piece of this particular puzzle is to develop the so-called ‘menu’ approach to commission disclosure. As we indicated in CP166, we will not finally implement depolarisation until we have also consulted on rules for the ‘menu’ to secure effective disclosure of the cost of advice. Modernising the current requirements about the disclosure of commissions, or of commission equivalents in the case of manufacturers’ own sales, is crucial. We have begun the initial round of testing possible templates and expect this work to continue through the summer with a view to publishing detailed proposals towards the end of the year;
2. the second strand is our work to improve the quality of information consumers receive at the various points of the sales process; and
3. the third is the development of our new regimes for mortgages and general insurance sales. Here our proposals are designed to ensure that where a consumer receives advice, it is suitable for their circumstances; and that consumers receive the key pieces of information at each stage of the advice/selling process to help them make informed decisions.
There is a choice of competitively-priced products suitable to meet the financial needs of all types of consumer
Consumers need access to a range of competitively-priced products suitable to meet their financial needs. While the FSA (rightly) does not have a role to play in the provision of products, we do need to ensure that our regulatory regime facilitates the provision of an appropriate degree of product choice. Prudential and conduct of business requirements are relevant here. Our recent review of the CIS rules is an example of where our proposals have the intention of improving consumer choice. This needs to strike an appropriate balance between product and sales regulation. And suitability depends on context. So while a highly complex financial product which carries relatively high charges may be suitable for some consumers, it is unlikely to be suitable for all consumers. And even the most simple low risk product may still be unsuitable for some consumers (a fact that remains at the forefront of minds as we develop our thinking on the sale of Sandler products).
Product choice and product supply are themselves a function of margins in the market. As the treasury considers the future of the 1% cap, I merely observe that - in the Sandler context as elsewhere and as we expressed in our report on the future regulation of insurance in October last year – products need to be priced at a level that enables those firms that operate efficiently to make a return on their capital.

Coherent and proportionate regulatory requirements are aligned to the risk of consumer detriment
Increasingly firms are active in more than one of the three retail sectors (investment business, mortgages and general insurance). Similarly, consumers entering the market for financial products seeking to meet a specific need (such as buying a house for the first time) will not always distinguish between the products and services that the differing sectors provide. We therefore need to develop a coherent regulatory approach across these sectors wherever possible. Keeping sales processes as simple and coherent as possible should benefit both consumers and firms. In doing so, we must ensure that our requirements remain cost effective. So this will not be harmonisation for its own sake, and it does not mean a blanket ‘one size fits all’ approach. There are good reasons why some requirements vary, and some continued differentiation will be appropriate to reflect the differing risk of consumer detriment, established market practice, and the associated costs and benefits. And there are a number of external constraints – such as EU Directives - on the degree of commonality which we can sensibly achieve.
I referred earlier to the strategy paper we plan to publish. This will set out these high level outcomes. No doubt, alarm bells are already ringing amongst those of you wilting under the weight of change, at the suggestion there may be more to come. But I would stress that our aim in publishing a high level strategy is to encourage a full public debate about a longer term vision for the retail market from a regulatory point of view – well beyond the round of (necessarily) piecemeal changes we are currently grappling with. Our aim would be to work with the market to develop evolutionary – not revolutionary – solutions in the longer term.
Well, I know that you will all be eager to get onto the meat of today - how to make the most of this changing environment. I hope that in setting out our high level outcomes and explaining how we are working towards meeting those outcomes, I have provided a helpful foundation from which you can explore new business opportunities. I would just remind you that in pursuing those opportunities you will need to take full account of your responsibilities to your retail customers. Thank you.

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