EUROPEAN POLICY FORUM
DITCHLEY PARK, OXFORDSHIRE
11 OCTOBER 2003
Callum McCarthy
Chairman, Financial Services Authority

1. It is very appropriate that one of the first occasions for me to speak as FSA Chairman should be on European questions. This is due not only to Graham Mather’s persuasiveness – though that should not be ignored – but mainly to the importance of European initiatives to the work of the FSA. As someone who has now been in the job for all of not quite three weeks, a great deal of my time has been spent in stocktaking: in trying to weigh the importance of the many and various tasks with which the FSA is charged, and to reduce the clearly unsustainable number of priorities which the FSA has set itself. In doing this, time after time I have returned to the European dimension of our work in general; and to the Financial Services Action Plan (FSAP for short) in particular. It is with apologies for setting out views which, since they are based on a short period of responsibility for financial services regulation, may appear simplistic that I speak today.

2. I want to address principally questions of application, not of legislation: implementation and enforcement of implementation of directives rather than drafting of new directives. There are several reasons for this. In part, it reflects a strong belief which I hold that it is important to concentrate on the effectiveness of legislation, not the existence of legislation. If I am allowed to stray into utility regulation by way of example, I am much taken by the fact that Commission reports on European energy markets state that both the German and the British markets are 100 per cent open to competition at the retail level. Now, in a legal sense that is true. But in every other sense it is almost totally misleading: the German market is marked by continuing dominance by the traditional incumbents, vertical integration which deters new entrants, practical barriers to competition and an almost complete absence of switching; the British market is in practice open, with substantial new entrants and some 100,000 households switching every week. With experience like that, you will understand why I am concerned with implementation as much as – or even more than – I am with legislation.

3. A second reason is the importance of implementation for the FSAP. The FSAP, as is often pointed out, has achieved the large majority of its 42 targets. And for legislative initiatives, the target is deemed to have been reached once the legislative proposal is adopted by the EU. But this is only half the story. The emphasis now lies on implementing these initiatives. For reasons I will set out, this risks imposing severe strains on those affected. In addressing those, I will not touch on the challenges arising for firms in adapting their business models to the new, more competitive single market reality that the FSAP is designed to facilitate – that is a subject in itself.

4. The financial services industry faces, over the period 2004 2008, the task of implementing more than 14 major EU legislative measures. At least eight of these measures have completed the primary legislative process in the EU. These include, to name but a few, the International Accounting Standards Regulation and directives such as Distance Marketing, Insurance Mediation, Financial Conglomerates and Prospectuses. Each of these will require financial institutions across Europe to make substantial efforts to prepare for implementation over the next 12 months: they will need to install new IT systems; train staff; change managerial processes; and in many instances bring in external consultants – all the normal steps needed to translate a legislative ambition into a practicality. We will, of course, do all we can in the UK to help the firms we regulate, by giving as much certainty as to both the content and the timing of FSA’s implementation work. We are not the masters of the process however. The directives themselves dictate the implementation timetable. Furthermore, some directives require detailed, so called level 2 implementing measures under the Lamfalussy process. These can only be finalised once the primary text has been agreed and therefore eat into the implementation timetable. All the directives will require action by the UK Government, primarily HMT. FSA will then have to make new rules in accordance with the procedures set out in the Financial Services and Markets Act. Given all of this, the commitment that I can make is that FSA will endeavour always to give market participants a minimum of 6 months of absolute certainty as to the regime to be implemented in the UK. Of course, longer would be preferable for those measures that could impose significant costs; this will particularly be the case for new prudential measures.

5. We estimate that these adopted measures will cumulatively place a very heavy burden of implementation on companies across Europe in 2004. The impact of the various directives on firms’ resources will obviously differ: for British institutions, the Distance Marketing Directive, the Insurance Mediation Directive and the Market Abuse Directive will be most resource intensive, the Prospectus Directive the least so, on our analysis. But the cumulative effect will be to place a demand for implementation resources on authorised firms starting in 2004 which will grow very rapidly. Current estimates suggest a substantial respite in 2005.

6. These are the directives whose primary legislative course has been concluded. There are more major initiatives in the pipeline. These include the Transparency Directive, the Investment Services Directive, the Reinsurance Directive, the Unfair Commercial Practices Directive, the Risk Based Capital Directive and Insurance Solvency II. Again, the impact of these on demand for implementation resources is not the same. When we analyse the effect on firms authorised by the FSA, against our present best guess of what each directive will require of them when it emerges from the legislative process, we think some will require substantial resources. It is clear, for example, that the Risk Based Capital Directive will require substantial work, particularly for those institutions wanting to go on the more advanced approaches. Our initial analysis suggests that other directives will be somewhat easier to implement. But even with such an optimistic view, we estimate that 2006 will be another year of severe stress on implementation resources for FSA authorised companies. Our back of the envelope estimate is that the resource demands in 2006 will be as heavy as in 2004, after a relative trough in 2005.

7. We at the FSA have made this forward look for those companies and institutions which we authorise. It is therefore a British-centric view that reflects the outlook for UK implementation. But there is no reason to believe that what we foresee for Britain will not occur across Europe.

8. There are two lines of discussion I would like to pursue from this analysis of the resource implications of the EU legislation in the pipeline. The first asks what should we do if the analysis done by the FSA proves to be correct for other Member States. I think there are a number of steps to be taken. First, we need as a question of urgency to establish whether this analysis is confirmed – by firms and institutions in Britain and across Europe, and by regulators in other countries repeating the analysis for their own country. This analysis should seek to identify particular bottlenecks: it is obvious, for example, that the systems implications of the various proposals in the pipeline will have significant implications for IT resources, but there may be other less easily recognisable constraints. And, since 2004 is more imminent than 2006, this analysis would sensibly concentrate in the first instance on 2004.

9. Second, while regulators are not in control of the process, there are a number of things that they can do individually and collectively to ease the implementation process. Individually, at the FSA, we must ensure that we do not over-engineer implementation and careful consideration will be given before adding further regulatory burdens to the already heavy burdens derived from the EU directives. Collectively, the FSA needs to work with its fellow EU regulators in the regulatory networks such as CESR to ensure that all joint action taken at level 3 facilitates smooth implementation rather than increases the height of the implementation peaks.
10. Third, we need to be sure that the scale of the challenge is recognised by those who will have to respond to it – the management of the firms affected. Firms should now have a clear sense of the nature and scope of the regulatory change they are facing and all parties should not wait until the final “t” is crossed on the last FSA piece of implementing guidance before thinking about their own firm’s needs. In some instances – the major banks’ response to the Risk Based Credit Derivative – this is already happening. But there is a need, particularly for the insurance industry and for those dealing with the consumers of financial services, to do more.

11. Fourth, implementation will require senior management time to counter the natural tendency for ever more detail to creep into the implementing rules as more junior staff and their advisers seek greater legal certainty. This is an area that appears to cause particular difficulty in the UK and is not found in certain other jurisdictions.

12. Finally, we all need to investigate whether there is scope for peak lopping: to rephase the implementation timetable or the intensity of the implementation so as to avoid the present prospect of a peak in 2004, a steep valley in 2005, and a further peak in 2006. Any shifting from 2004 into the next year would clearly be helpful. All this, of course, should be done on a European basis: I am not making a plea for special treatment for Britain or for the FSA. I am seeking to identify sensible measures to match a European problem.

13. There is a second line of enquiry which I think we should also discuss: how is it that we have come so close to the 2004 implementation peak without previously recognising and dealing with it? I think there are at least three reasons for this. The first is because the FSAP was rightly driven by a very demanding and explicit timetable in order to ensure that the benefits which will ensue from the completed programme themselves come through within the foreseeable future. That I applaud.

14. The second is institutional. The directives range widely across financial services, and each tends to be considered by a separate group: the Basel group working on the issues which will form the core of the Risk Based Credit Directive; those concerned with consumer credit working on the Consumer Credit Directive; securities experts on the Investment Services Directive; and so on. An advantage we enjoy in Britain is the ability to take a view across most (albeit not all) financial services and to receive advice on the totality of the initiatives from both practitioners and consumers.

15. But there is a further, and important, process point: the European legislative process in financial services has no binding equivalent to the explicit requirement placed upon the FSA under the Financial Services and Markets Act to ensure that any policy is proportionate. The Treaty obligation in Article 7 on proportionality has yet to be translated into an effective tool in this area. The operational corollary of proportionality is that we should carry out an analysis of costs and benefits. The value of the cost-benefit analysis is not principally in the determination of a monetary estimate of the cost-benefit of any proposal. Rather it is in the focus it throws onto the activities involved in any proposal; it requires the regulator, the proposer of legislation and those affected to identify, with increasing clarity as the proposal advances, what steps will be needed to introduce the proposal; the scale and timing of implementation are first defined and then costed. It is the absence of this process in a European context which has contributed to the late surfacing of the problems of implementation we now face.

16. I am not talking here about rolling back the tide of European-driven legislation. Rather that it be introduced in a phased and measured way, giving firms a realistic timeframe to prepare and plan. We should all be interested in actions, not in legislation.

17. We all – firms and regulators, Commission and Council – need to devote sufficient time and effort to allow for a sensible and proportionate implementation of the FSAP measures. Failure to do so will run the risk of the FSAP creating disproportionate, unnecessary and perhaps damaging costs to the detriment of the competitive benefits of the FSAP to the wider economy, to whose realisation we are all committed.

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