Speech to SOFA Update Conference 27 November 2003
John Tiner

Introduction

1. Good morning ladies and gentlemen. I am delighted to have been asked to speak at your conference today, which I know has earned a reputation for attracting the cream of the industry. I’d like to use this session to give you an overview of some of the items that are currently on our agenda in which we have a mutual interest, and to bring you up to date on where we are. This is not a one way communication exercise, by the way – my formal session should leave enough time at the end for questions and points that you would like to put to me.

The menu and de-polarisation

2. First, let me give you an update on the menu and depolarisation. This is a key piece of the retail reform agenda in which I have taken a personal interest, and has been a subject that has at times elicited emotive responses from various interest groups. Our most recent consultation paper on de-polarisation, CP166, was published at the beginning of the year and the consultation ran up to the end of April. The context for that paper was the FSA Board’s decision, taken after considering responses to CP121, that we should go ahead and remove the polarisation restrictions. So CP166 was about how that should be achieved in practice and laid out the detail of the draft rules for comment.

We had also earlier confirmed that one of the safeguards we had proposed around the concept of ‘independence’ and transparency over the cost of advice, - the defined payment system, - would not be pursued. And that instead we were minded to develop the menu idea as a better and more cost-effective way of meeting similar objectives. And one of the particular attractions of the menu was that, unlike the sector-specific defined payment system, the menu could be a valuable disclosure tool across all market sectors.

CP166 was published before we could fully develop and test a menu, and we have been hard at work on this during the year. But one thing on which the FSA Board has been quite clear, and which we reflected in CP166, was that the polarisation restrictions should not be lifted in advance of having its attendant safeguards in place. And in this the menu is certainly a key safeguard. It bears repeating that the Board was also very clear in its view that there should be a level playing field so that retail customers in all channels receive the same sorts of disclosure enabling them to make valid comparisons of, say, getting advice directly from a product manufacturer or through an intermediary.

3. The menu concept as proposed by AIFA and IFA Promotion in response to CP121 was very much the start rather than the end of the process. So we have spent some time carefully developing the content, the wording, the coverage, the layout and so on, and undertaking consumer research at each stage and iterating the document to improve it. That has involved intensive pre-consultation with key trade associations.

We have now finished the fieldwork for testing the document, and the results of the consumer research have been very encouraging. We think the menu document, on which we are to consult early in the New Year, will be a tool that can really empower consumers to understand much better the fact that advice has both a cost and a value. From what we have seen under test conditions so far, it can prompt consumers to ask some very pertinent questions of their advisers. We think it will sit quite comfortably in the advice and sales process.

Why do we say that? Well we have not just carried out consumer research in a vacuum – we have had the cooperation of some currently practicing advisers to act out a role play of an adviser and prospective client meeting for the first time, and the results of that were very interesting. So we think the menu has advantages not only for consumers but for advisers as well, as a tool for differentiating their service.

4. This consultation paper, which you will be pleased to know, will be the last in the series to depolarise the investment advice market, will cover three points. Firstly, feedback on the responses to CP 166. Secondly, a full set of the draft rules needed to complete the de-polarisation project. Thirdly, detailed proposals for the menu, and of how it would operate. Publication will then be followed by a standard three month consultation period. Once we have considered the responses, we should be in a position to decide on the new rules.

5. When the new rules come into force, and polarisation is abolished, then IFAs can expect to find themselves competing in changed marketplace. And this might happen sooner rather than later. The ground is already shifting in the tied sector, where, following the Barclays deal with L&G, we have now seen HSBC’s decision to go multi-tied with its core proposition.

6. This does not mean, however, that IFAs should see depolarisation as a threat. It will mean that they will face increased competition – and I make no apology for that – but I believe IFAs are well placed to take advantage of this new environment. The IFA sector is important, with around 3,700 directly authorised firms having an estimated annual turnover of around £3.4 billion. There is evidence that quality of business, measured by persistency or by complaints to the Ombudsman, for example, is better in the IFA sector than for company representatives. Most important of all, however, is the fact that, as research done for us by London Economics in 2000 confirmed, consumers value independent advice highly, and there is every reason to believe that this will remain the case.

Mis-selling

7. Let me turn now to an issue on which we have had some public debate with the industry and a useful contribution from SOFA itself: the subject of mis-selling. I make no apologies for the Pensions Review. The fact was and remains that consumers were wrongly advised. It is only fair that you compensated them. The same applies where there is evidence to show that an endowment mortgage was inappropriately sold. But we have not observed systemic mis-selling of endowment mortgages and so have not called for an industry wide review, but we have conducted a targeted review which has already delivered considerable benefits to policyholders who were mis-sold. We continue to believe this is the right and proportionate response.

8. These events have brought into common circulation the concept of "mis-selling". That tag has bedevilled us all, not least the negative impact it has had on consumer confidence in the integrity of firms and the performance of their products. Enterprise and innovation has been put at risk. Consumers may be less attracted to saving than might otherwise have been the case.

9. The FSA has been told by some, that a definition of "mis-selling" is the only way to clear the air. That could be difficult given that is hardly a regulatory concept capable of definition. Moreover, it would be impossible to come up with a definition that would be expected to fit so many different products, so many different consumer needs and so varied means of selling.

10. However, we have published a note in July of this year – "Clarifying Mis-selling – a note by the FSA" clarifying our view of what is and is not "mis-selling". It sets out the key principles around our approach to dealing with claims of mis-selling and how we consider firms need to behave to prevent such claims arising in the first place.

11. Boards and senior management bear a heavy responsibility for carrying on their business in a way that the risks of this happening are minimised. We are unlikely ever to get to a position where no one is mis-sold a financial services product. But firms can make sure that it is the absolute exception.

12. In short, your customers expect to be treated fairly. What does this mean in practice?. First, carry on your business to the highest standards. Second, know your customer and sell only that which is suitable for their needs.

Treating Customers Fairly

13. Intuitively, it appears to be in everyone’s interest for financial services firms to take a strategic approach to treating their customers fairly. On the one hand, firms will develop stronger relationships with their clients, deepen the loyalty of those clients and reduce the cost of client acquisition. On the other hand, firms can expect less intervention from the FSA. And in the extreme, they reduce the risk of enforcement action and they don't play Russian roulette with their reputation. For these reasons, I believe that there is a genuine convergence of interests between the interest of firms, their shareholders, customers and the regulator.

14. We believe that the FSA’s existing Principles, rules and guidance already place responsibility squarely on firms’ senior management to ensure that the fair treatment of customers is built into the firm’s overall strategy. For example, Principle 6 requires firms to pay due regard to the interests of their customers and to treat them fairly. And our Senior Management Arrangements, Systems and Controls Sourcebook requires senior management to put in place a strategy to identify, measure and manage such risks.

15. You will notice that I am pointing you to our principles and overall arrangements for senior management control rather than focusing solely on the detailed rules. This is quite deliberate. It is neither desirable nor practical to legislate for every possible circumstance. In fact, I believe it would be counterproductive because it would only encourage firms to rely on the argument that “we have dotted every ‘i’ and crossed every ‘t’ of the relevant rules so surely that is all we need to do”. And an increase in volumes of rules always risk adversely affecting competition, innovation and the costs of compliance.

16. Financial Promotions is an obvious example. The cornerstone of our approach is that financial promotions must be "fair clear and not misleading". In addition, we set down a number of detailed rules – for example on past performance – but compliance requires not just meeting those detailed rules but also the underlying requirements of fair clear and not misleading. We hear too often firms saying “our compliance department has a check list which makes sure we meet all the detailed requirements in the rules” without addressing the fair, clear and not misleading principle.

17. So our increased focus on treating customers fairly will not be accompanied by hundreds of pages of additional rules – indeed we are committed to reducing the rule book wherever possible. But for a more principles based approach to supervision to work effectively, senior management in some firms will need to change their mindset. Senior management should not think that meeting regulatory responsibilities is a matter for their compliance departments alone.

18. There is not one ‘correct’ method for senior management to incorporate the fair treatment of their customers in their firm’s strategy. But we believe that a well-managed firm will be able to demonstrate that it has given due consideration in developing its strategy to questions such as:

  • Do you adequately monitor the quality of advice given to customers?
  • Does your remuneration strategy incentivise advisers appropriately?
  • And, as senior management, are you (not to mention your Board) receiving sufficient management information at the right time to allow you to assure yourself that you know the answers to these questions?

19. I have heard some in the industry say that a focus on treating customers fairly risks adding yet more cost to the industry by effectively raising standards. I should make clear that we do not see this as seeking to raise customer service levels to a common high standard. There is room in the financial services industry for the equivalent of both the full service airline and the budget airline. However, just as regulatory standards on safety are needed in the airline industry, there need to be standards that take account of the inherent asymmetry of information between financial services firms and their retail customers.

20. As I said earlier, all of this can be derived from our existing Principles and arrangements for senior management oversight. But we acknowledge that we have not set out, in one place, a clear understanding of the obligations we put on firms to treat their customers fairly. Before we do so, we also want to gain a greater understanding of existing good practice, both in individual firms and at an industry wide level. Therefore, we plan to engage senior management on this subject over the coming months. My colleagues and I look forward to a constructive dialogue with you to help us achieve my goal of a regulatory regime that is less focused on detailed, prescriptive rules.

Sandler

21. No doubt you are all eagerly awaiting the next steps in our work on devising a simplified selling process.

22. Why are we considering a simplified selling regime? SOFA, of course, jointly with the LIA and IFP, announced its own views on, among other things, the measures the government should be taking to reduce the savings gap, and simplified products are not high on your list. Now, it is not the role of the regulator to close the savings gap, however understandable such an objective is for government. We do, of course, have a statutory duty to provide an appropriate degree of protection to consumers, but that in exercising our responsibilities we must be proportionate. We have for some time heard the argument that our present conduct of business requirements may be 'over the top' for so called "bread-and-butter products" – whatever this means in this context, and, of course, the devil is well grounded firmly in the detail. Clearly, as a risk-based and proportionate regulator, we should be assessing our regime to satisfy ourselves and our stakeholders that the right balance between our objectives of protecting consumers and the principle of proportionality is being struck taking into account the risks posed by different product ranges.

23. But, even if higher-risk products are shut out and price controls applied, as the government has proposed for its suite of 'stakeholder products', some significant issues remain. Simplicity and value for money do not in themselves deal with the suitability issues. For some consumers even simplified products could be harmful to their financial well-being. As Ron Sandler recognised in his report, simply letting the salesperson rip, with the customer having signed to confirm understanding of a strong 'health' warning, would be a step too far. Our framework must maintain strong standards of investor protection.

24. We have now conducted some consumer testing of a 'filtered question' approach to the sales process, designed to alert consumers to possible immediate needs, such as debt management, 'rainy day' provision, and protection. The process also needs to filter out others for whom even the simplified products are likely to be unsuitable, or who should seek more detailed advice before buying. We are analysing and evaluating the results of this consumer testing and we will publish them before Christmas.

25. Our initial take is that some follow up testing will need to be done before we are able to conclude on whether the less vigorous sales process for stakeholder products will provide an appropriate level of investor protection. We expect to commission this further testing shortly and to have it completed (bearing in mind that the Christmas and New Year break is looming) so that we can conclude it in February. It is worth noting the ensuing steps if we conclude, based on the evidence, that the filtered questions approach, can be made to work for certain products. We will then need to consult formally on our proposals, for the usual period of three months, and then having assessed the responses to issue a feedback statement and consult on the draft rules, again for a period of three months. We will then need to determine an implementation timetable.

Reducing the flow of CPs/ DPs and Handbook accessibility

26. We know that many small and medium firms, who do not have the large compliance and legal departments of larger firms, find the FSA's Handbook increasingly hard to navigate. We are committed to delivering some real wins here.

27. Most immediately, we will facilitate user-friendly Handbook guides for particular sectors, to help firms focus on the rules most relevant to them. Of interest to this audience is that we have already ourselves published, on the FSA website, a Guide to the Handbook for small IFAs, and others are on the drawing board.

28. There are a number of other options, including having a 'rules-only' alternative version of the Handbook, or cutting down sections as has already been done with the Collective Investment Schemes sourcebook. This is a complex task as we need to ensure legal and European requirements, as well as internal consistency, are not compromised. But we will be looking to remove rules where they do not add value to the achievement of our objectives, and will therefore be looking more explicitly to firms to manage their business in accordance with our high-level principles.

29. You will be glad to hear that we are aiming to reduce the number of CPs and DPs we issue. By the end of the current financial year, we will have published about 60 of these in 12 months. We would like to cut this by half for the next financial year. As well as reducing the number, we will also look to reduce their size, whilst maintaining the open consultation process for which we have been praised.

The IFA sector and supervision

30. The FSA’s risk based approach to regulation is now well-documented. We define risk as impact multiplied by probability. It is a fact that many small firms do not have a sufficient impact, on their own, to register high on our risk scale. However, that does not mean we do not supervise small firms any more nor does it mean we intend to abandon consumers who deal with small firms.

31. We monitor small firms using a variety of supervision tools ranging from monitoring routine returns, alert driven investigations through to pro-active thematic work looking at issues where firms’ combined impact means that we need to mitigate the risks if we are to meet our statutory objectives.

32. In addition to supervision tools we also use a range of communication tools to leverage messages across the IFA sector, in particular the aim is to help them to help themselves by informing and educating firms about the latest developments that affect them. We are confident that in time these initiatives will help firms comply with the rules and raise standards. To give you a flavour of what we have been doing to improve our communication with IFAs:

  • We are very nearly at the end of our 2003 round of regional roadshows and workshops where we have met approximately 1700 IFAs. The feedback to these events have been overwhelmingly positive and we look forward to meeting many more of you in 2004;
  • We provided all IFA firms with free CD based training on anti-money laundering requirements to help them to understand what we require;
  • And I have already mentioned the guide to the handbook which we issued in October.

33. I can also tell you that we have recently launched a new part of the FSA website dedicated to IFAs. The objective of these pages is to bring together in a one-stop shop relevant information such as consultation papers and other FSA material as well as give access to best practice guides and Frequently Asked Questions.

34. I hope you will agree that we have made a concerted effort to help small IFAs cope with the burdens of regulation and we are committed to continue making it easier for firms to do business with us. This is why we have publicly supported the Money Marketing campaign “Fair Deal for IFAs” and have given them an undertaking that we will do our best to meet their recommendations.

35. I have talked about how we currently supervise 7000 small firms which believe you me is a challenge in itself. Gearing ourselves up to supervise perhaps 25,000 additional firms for the introduction of Mortgage and General Insurance regulation is possibly the biggest regulatory challenge we have faced since merging 10 organisations together, certainly at the logistical level.

36. Apart from authorising the new firms, we also have to make sure that our existing population of regulated firms who are involved in conducting these types of business are prepared and obtain the necessary permissions to carry on doing mortgage and general insurance from next year. We have been drip feeding information to the regulated community for some time now as it is clear the regulatory regime covering these lines of business is about to change radically.

37. The key thing existing firms need to think about now is how they wish to structure their business going forward, as it will greatly affect what they will have to do to obtain authorisation. Dependent on what they decide, firms will either have to vary their existing permissions, which for most will be a fairly straightforward and somewhat quicker process than normal, or apply for a new authorisation if doing this business in a separate entity. Given that we are expecting tens of thousands of new applications, I encourage any of you in the audience today who may be affected by this to give it some thought if you haven’t already. We start accepting new applications in January and you will also be able to apply to vary your existing permissions from January – act now to be sure you obtain authorisation in time. You can find all the details on our website.

38. We are doing some work on the reliance which IFAs place on product provider marketing material, including material we prescribe such as key features documents. Our expectations in this area are relatively straightforward: we think that IFAs should look at marketing material critically and not simply rely on any claims made by the product manufacturer. We also expect them to notice where there are material factual errors or mistakes that you would expect a professional adviser working on behalf of a client to spot. Our project has established that, by and large, IFAs share our understanding of these responsibilities. We are now looking more carefully at what IFAs actually do about this: who looks at what material at which stage of the product recommendation process and what happens as a result. We haven't yet completed this stage of the work but our intention when we have, is to compare what firms actually do against what we expect of them.

39. You would not expect me to address an audience mainly made up of IFAs without mentioning PI. Our latest effort in the continuing fight to ease the problems in the PII market was the publication of CP193, which hit the streets in late summer. We engaged the IFA sector in a round of workshops to make sure we got maximum input into our proposed new policy and rules. This was because we had to be sure that our new policy struck the right balance between, for us, achieving our statutory objectives and, for IFAs, delivering a sensible and workable outcome. I am pleased that from the rounds of workshops we ran on CP 193 and our earlier consultation we got feedback from approximately 750 IFAs, which, I think, is a record for a CP.

40. I won’t attempt here to go through all that is contained in CP 193, and I’m sure that many of you will already be aware that it covers some detailed ground. However, I would like to highlight two important points of principle:

  • PII is here to stay. It has been mandated by Europe. The Insurance Mediation Directive requires all firms involved in insurance mediation - and that includes life insurance or other investment products linked to life insurance - to have PII with cover of at least €1.5 million.
  • The proposals in CP193 aim to allow firms to take a more flexible approach to obtaining PII cover. We propose that the current prescriptive requirements and wordings are done away with. Instead we want firms to negotiate cover with PII brokers and providers that reflects their business model and the risks that their businesses faces.

41. Of course these proposals are not without risk, for firms, the consumer or indeed the FSA. But, we have never claimed that we are trying to operate a zero failure regime. Quite the opposite. There will be failures in firms, and some consumers will lose as a consequence. What we are seeking to achieve is a response to PII that is proportionate and appropriate.

42. The impending revisions to the Investment Services Directive (or as we say in the trade, ISD for short) could impact adversely upon the majority of IFAs, by imposing a further requirement for PII. This will be in addition to the need for PII that will be imposed on most IFAs by the Insurance Mediation Directive (or IMD) that comes into force in January 2005. No doubt our friends in Brussels feel you can never have enough protection! The "good news", if you can call it that, is that the ISD requirements are lighter than they might otherwise be for firms that are caught by both directives, and, that we in the UK have secured greater flexibility to use capital instead of PII for the additional amount of protection suggested by the ISD.

43. Furthermore, we have obtained agreement for Europe to review the issue of PII one year after the ISD is adopted. It may still prove possible to take IFAs out of the clutches of the ISD by use of exemptions, but even if we do, there remains the difficulty of most IFAs still being caught by the IMD, as the two directives are not joined-up properly in terms of scope. So, the FSA will be sharing its considerable experience of dealing with PII to help raise awareness with fellow regulators in other member states across the EU as part of the search for a more acceptable solution in the future.

44. I mentioned Europe and the impact of the ISD a moment ago. Before leaving that subject it is worth noting that there has been a major issue in negotiations concerning execution only business. The current text establishes that a full suitability test is carried out where investment advice or portfolio management is provided. In the case of execution-only business a suitability test will not be required where the service is provided at the initiative of the client, relates to essentially “non-complex” instruments (shares, bonds, UCITS) and the client has been warned that the firm is not assessing the suitability of the service provided. We have been working closely with HMG to secure an ISD text that does not impose a restriction on normal marketing of financial services and direct offer promotions.

45. So what does all this mean for the future of IFAs?

46. There are challenges ahead, for example, we are yet to see the strategic position that many product providers take in a changing market place. But change can be the life blood of markets and I would urge you to see it as much more of an opportunity than a threat. Those firms who think strategically about how to position themselves in a changing market, and who can build their reputation for treating customers fairly will be best placed to not only survive but to prosper.

47. We are continuing to see direct sales forces either reduce in size or disappear altogether. And this is at a time when the transfer of investment and longevity risk on pensions to consumers from government and employers continues apace. Consumers need to be educated about both their need for financial services and about the advice in which they can trust. The IFA distribution channel is well positioned to serve this evolving market and it is the well run, consumer focused firms that will be the winners.

FSA’s own reorganisation

48. Finally, I’ll turn the spotlight on ourselves if I may, and tell you something about the FSA reorganisation that we have announced. In the past 5 years, the FSA has – quite rightly- devoted a good deal of effort to preparing for, and then introducing, a new regulatory framework. We now need to shift from policy development to policy implementation. The changes we are making to the FSA are intended to reflect this move. But they are changes that are built on success: our aim, our objectives and our risk-based approach to regulation all remain unchanged.

49. The new management structure will have three Business Units, each headed by a managing director who will be a member of the FSA Board. There will be a Retail Markets unit and a Wholesale and Institutional Markets unit. These units will regulate firms doing business mainly within their respective sector, and deal with any associated policy work. And there will also be a new Regulatory Services unit, which will provide a range of services to consumers, existing firms and firms seeking authorisation, as well as meeting the FSA’s own operational requirements. We are committed to making the FSA easier to business with. So the Regulatory Services unit will hold the authority to take brisk decisions on changes to a firm’s permissions or controllers, for example, without referring routine cases to supervisors for a view. It will also be responsible for receiving and processing data from firms, and for the delivery of this data to supervisors. Finally, the FSA’s Enforcement Division will report directly to me - which is a reflection of the importance I attach to its work.

50. So this is not change for the sake of change, but change to enable more delegation of responsibility, greater speed of action and focus on critical issues, and to sharpen up the execution of our business with firms and consumers. We believe it will achieve these things, and I am glad to say that it has been welcomed by many of our stakeholders. To mention just one, in particular, Paul Smee of AIFA was quoted in Financial Adviser as saying “What I like about it is the focus on delivery. The Regulatory Services unit means that the FSA will have a division looking at consumer-facing and firm-facing issues.”

51. Well this has been something of a tour de force around the regulatory world as it affects IFAs and I thank you for your attention.

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