Friday, 8 October 2004
Speech by John Tiner

Good morning. And thanks very much to Sir Peter for the introduction. Sir Peter highlighted some comments I made in my Mansion House speech just over a year ago. I ended that speech by saying that our work on the FSAP had only just begun. A year on, it is clear that there is still a huge amount for us all to do in taking forward the FSAP work and ensuring proper challenge to any new proposals for following up the FSAP – to ensure that any case for new regulation in Europe is properly made out.

In my first year as CEO, and indeed in my time at the FSA, I have to say that the life insurance sector has been a higher priority than the banking sector. And the banking sector continues to look very healthy. In the large banks' interim results, profits before tax were up by more than 18%, the banking sector as a whole remains strongly capitalised, and asset quality is still reported to be improving. The economic outlook for both the world and UK economies remains favourable: world economic growth continues to strengthen, and while the consensus forecast expects UK growth to slow from 3.4% this year to 2.6% next, that remains in line with the long term trend. There are some shadows cast across the landscape, however, notably with the recent signs of some slowdown in the housing market and how this might interact with the high levels of consumer debt. But stress tests show that there would need to be a really quite drastic deterioration affecting the economy as a whole before the large banks' capital was put under significant pressure. At this point of the cycle, my assessment is still that the banking sector is in generally healthy condition.

But perhaps that is just as well given what I want to talk about to you today – which is the array of regulatory challenges that banks now face. So why, you will ask, is there such a large amount of regulatory activity given the position of the banks? There are four reasons, as I see it, why so much change is upon us:

  • First, the Lisbon Conference established clearly the objective of promoting the integration of European markets – so that it will be easier for you to get access to them (MiFID)
  • Second, taking the long view the objective is to improve the stability of the system (the CRD)
  • Third, we need to facilitate greater capital market efficiency (IAS)
  • And fourth, the need to address the structural imbalance between suppliers and consumers of financial services (TCF, Financial Capability work).

So these lead to some immediate challenges for banks: in the prudential regime that applies to them and the conduct of business regime which applies to all their investment business, where the whole rule book will be rewritten in the next 18 months to implement the Markets in Financial Instruments Directive.

As the CEO for the past year of an organisation which is still only just over 6 years old I am all too aware of the challenges which will face Snr Roldan in setting up CEBS and it is a great pleasure to share a conference platform with him today. CEBS is going to play an absolutely key role going forward – and we are very pleased to welcome them to London.

I should also like to welcome Sir Peter Middleton as the new President of the BBA – he too will be fully aware of the challenges we and the industry face.

Today I want to update you on the latest initiatives, grouping them under two of our strategic objectives: promoting efficient, orderly and clean financial markets; and helping retail customers obtain a fair deal. Philip Robinson will talk to you this afternoon about our third strategic objective – of making us easier to do business with.

 

Markets

The FSA's first strategic objective is to promote efficient, orderly and clean financial markets – something which is essential if the UK's position is to be sustained and is to grow. For the UK to remain and to develop as the most international of the world's capital markets we must be efficient; markets must be clean, consumers must be fairly treated and firms must be able to operate effectively and efficiently.

To meet this objective we try to adopt three principles in orienting our regulatory work: first, we seek wherever possible to work with the grain of the market, not against it; second, we place responsibility for standards with the senior management of the firms which are regulated by the FSA; and third, in all that we do, we are concerned to strike a balance between, on the one hand, the benefits of an efficient, orderly and clean market and, on the other, the costs of regulation and the impediment to innovation which can too easily flow from excessive or the wrong kind of regulation.

 

Basel II, the Capital Requirements Directive & domestic implementation: Rising to the challenge

Turning then to Basel II - an issue which I know can either induce an audience into a soporific state or provoke outrage, depending on who the audience is and what time of day it is. I will do my best therefore to ensure that in my comments I avoid both.

In addressing the FSA's annual general meeting on 15th July this year, I briefly highlighted the major task facing both the FSA and BBA members in having to implement the Basel II framework. At the same meeting, Hector Sants, who as you know is responsible for overseeing the FSA's implementation of Basel, made plain our commitment to ensuring we implement the framework in a proportionate and risk-sensitive manner. I will come back to implementation in a moment.

But first, as you well know, implementation is not the only challenge we face. In parallel we have to contend with negotiating the Capital Requirements Directive. Those of you familiar with the trials and tribulations of the Financial Services Action Plan over the past five years will know that negotiating even a relatively straightforward directive is at best a challenging affair. Having to negotiate and implement at the same time the longest and most complex piece of financial services legislation to emanate from the European Commission is something altogether different.

Negotiations in Brussels are proceeding at break-neck speed. Member States' experts are currently meeting weekly to discuss the proposal and the Dutch Presidency has expressed a desire to secure agreement on the directive by the end of the year. The European Parliament has also begun its deliberations and will play a key role in determining the final outcome of the Directive.

As the landscape is constantly shifting it is difficult for me to provide an accurate prognosis of where the negotiations will eventually come out. However, what is clear is that central to reaching agreement on the Directive will be the date by which Member States must implement it by. The proposed directive sets out staggered start dates from end-2006 for those institutions wishing to use the basic approaches to end-2007 for those wishing to use the more advanced approaches. HM Treasury, the FSA and BBA and its members have strongly argued for a single end-2007 start date.

Such an approach would allow, among other things:

  • Uniform implementation across EU, thereby reducing potential competitive distortions; and
  • More time for firms to prepare

Some argue that this would penalise those institutions that have already invested heavily in preparation. Given the 95% floor in the first year, it is questionable whether this is as significant an issue as they would like to lead us to believe.

I certainly believe that the effective implementation of legislation that has such profound and wide ranging effects on prudential regulation should not be put at risk for the sake of political expediency.

But we cannot rest on our laurels. The CRD is subject to what is essentially a political process, the outcome of which is extremely unpredictable. It would be unwise to rely on that process delivering our desired outcome. Our implementation plans therefore are continuing apace alongside the EU process.

We have committed to producing two CPs on our implementation of the CRD. The first CP will be published in January. Our assessment is that this should most helpfully focus on:

  • our overall approach;
  • the policy choices we believe we should make in respect of national discretions;
  • the scope of application; and
  • in so far as time permits, a sample of rules where we plan to 'copy out' the CRD text so that firms can see what this means in practice.

The intention is that, while we will be unable to provide comprehensive guidance to firms, there will be sufficient information in this CP to enable firms to continue with their own implementation projects.

The second CP will be published as soon as is practicable after the agreement of the directive text in Brussels and will contain a full set of our implementing rules. Between CPs, we will continue to pursue informal consultation options to keep the flow of information as strong as possible.

In this regard, the FSA has now held several meetings of the Basel Implementation Advisory Group, chaired by Hector Sants to discuss high-level issues with senior industry representatives. We have also provided the industry with a draft implementation pack and draft details of the application process.

In order to ensure we meet the major challenges posed by Basel implementation, we asked the industry to provide us with an additional £1 million. I guess you would like to know how we are spending that very generous contribution. We have been able to re-deploy six firm supervisors to full-time Basel implementation roles, working directly with supervisors and firms alike. In addition we have recruited an additional four members of staff to the Risk Review Team who are working closely with firms' Basel project managers and risk teams to assist in their implementation planning.

As if the challenges of negotiation and implementation were not enough, we must also have an eye on what is round the next corner in Basel. In the short-term, the trading book review being carried out jointly by the Basel Committee and IOSCO will be one of the final, and most significant, pieces in the jigsaw in the revised Capital adequacy Framework. The challenge here will be ensuring that the output of this work is fed into the CRD in good time, otherwise it risks not forming part of the initial EU legislative framework.

The next big step will be recalibration of the Framework during 2006, to be done with end-2005 data from institutions. This exercise will be based on field tests and a further qualitative impact study or QIS 4. I understand from preliminary soundings with UK industry and in particular, from BBA members, that UK institutions are willing to participate in a further impact study.

I hope you have a sense from this that, although there is a huge task ahead for all of us in implementing the CRD, we are absolutely committed to working collaboratively with you the firms and your trade associations in achieving a successful outcome.

 

Lamfalussy and CEBS

We have worked hard to embed the Lamfalussy process into European policy implementation. The Lamfalussy structure is key if we are to enable EU legislation on markets to be flexible enough to keep up with the rapid pace of change we see in financial markets. We also believe it is essential for Lamfalussy to work effectively if the full potential benefits of the FSAP are to be realised. And as the FSAP has unfolded, the need for greater similarity in regulatory authorities' approaches/underlying principles of operation has become increasingly apparent.

This is not to suggest - or even hint at – the notion that a "one size fits all" set of rules is needed. It is not and we shall resist maximum harmonisation of implementing measures. We should aim to coalesce around underlying principles and core standards, so the detail can be tailored to local market conditions.

It is a fact that most of our major policy initiatives are now driven by European legislation. But that is not the only change in the past 5 years. The Directives we face are characterised by more detail than was anticipated in the Lamfalussy vision, and then at level 2, the "technical implementing measures" typically contain a high level of prescription. The combined effect inevitably leaves less room for national legislative discretion, or for the granting of waivers from EU rules once made. So we are increasingly seeing more issues settled at level 2, leaving less flexibility for the national regulator - although this is not a uniform picture.

Consequently, it is even more important that the advice that the CEBS, CEIOPS and CESR groups deliver is informed by both industry and regulatory best practices. We need the banking industry to play as full a part as possible in this process. And here I welcome Jose Maria's approach with CEBS in striving for true co-operation, collaboration and the convergence of supervisory practices. We also support CEBS in focusing on the CRD as its key priority - as I have indicated above the successful implementation of Basel II is critical for the UK banking sector. We would also hope that CEBS would continue to promote broader supervisory convergence – for example through the identification and promulgation of good practice among banks.

The FSA plays an active role in chairing and participating in some of CEBS' working groups looking at the convergence of related supervisory practices, including the review of the national discretions in the CRD, more detailed aspects of Pillar 2, cross-border issues including the relationship between home and host supervisors, and related supervisory practices for the validation of credit risk and operational risk models.

In more general terms, we appreciate the transparency of CEBS work; it has made a very healthy/productive start by already issuing three Consultation Papers, and in its work to set up a Consultative Panel, which will include representation from consumers and industry, and from the UK banking sector.

I would invite you to give Snr Roldan all the support you can in this enterprise.

Sir Peter also commented on the risks of over regulation. It may surprise you to hear that I share this concern.

Since I became CEO, I have required that carrying forward any new policy initiative is conditional on both an insightful market failure analysis and robust cost benefit analysis which demonstrate that regulation is the answer to a market problem and these inform the whole policy development process thereafter. I would urge all European policy makers to follow this discipline.

In our own domestic arrangements, we will do what we can to remove regulation which does not add value....but this will take time. A good example is the steps being taken by the industry through the Joint Money Laundering Steering Group, with the FSA's active support, to take a more common sense and proportionate approach to identity verification. I expect that banks and their customers will see the benefits of this simplification in the not too distant future.

 

Home-host

I would like to comment briefly here on one issue which CEBS will be taking forward, that of home-host responsibilities. Callum recently set out our views in his Gresham House lecture, but I think this is an appropriate forum for me to emphasise that we do not see scope for simplistic polar solutions to the home-host supervisory debate. Those who argue for the complete supremacy of the home supervisor need to recognise the complexities and realities with which any set of supervisory arrangements must cope.

We are sympathetic to the need to simplify and streamline regulatory arrangements for the large cross border banking groups. But the position and implications of a bank with a minor presence in a host country differs from that where the presence is significant, especially where it is material to financial stability or poses systemic risks within the host country.

Going forward, we need to recognise the variety of institutions and situations we face, and devise a flexible approach within which regulators can best co operate across national borders. In some cases it may well be appropriate to place extensive, if not exclusive, reliance on home supervisors. In other cases host supervisors – for example of high impact branches – will need to have the opportunity to engage in more of a dialogue with home supervisors about things that really matter from the point of view of their markets and objectives.

Developing a suitably flexible approach will be a major task for regulators. It will need to be done in a European context, and will therefore require work in all three of the Lamfalussy committees and across the committees where financial conglomerates are concerned.

Let me briefly comment on one other regulatory issues on the prudential side before moving on to conduct issues.

 

IAS

On IAS, we now at last have some clarification on how banks will be expected to account for financial assets and liabilities from 2005, as the long European debate on IAS 39 at last appears to nearing its end.

We at the FSA consistently argued that the EU should accept the standards that are set by the IASB as an independent global standard setter. Political expediency has driven the Commission to compromise and carve out some paragraphs of the standard, and we have been working with the members of CESR to minimise the danger of those edits adversely affecting the ability to apply the standard consistently. We can now turn all of our attention to the capital adequacy implications of the standard, and we have every sympathy with the concerns of the banking sector that it is very difficult to prepare to apply a standard that has taken so long to agree. We will publish a consultative paper later this month that will outline a narrow range of issues where we intend to depart from the accounting under IAS 39 for capital adequacy purposes, and that paper will also make it clear that we intend to return to all of the issues in two years' time when the way the standard is applied and affects regulatory capital will be much clearer.

Let me now turn to the FSA's second strategic objective

 

Helping consumers get a fair deal

Here, I'd like to focus on TCF and MiFID.

In our July paper, “Treating Customers Fairly – Progress and Next Steps”, we reviewed the progress firms have made in implementing the FSA principle that requires firms to treat their customers fairly. We also looked at the next steps we and firms must take to build on improvements made and to address shortcomings.

In this initiative, we are focusing on insurance, investments, and mortgages. Our general approach with TCF is not to introduce more detailed and intrusive regulation but to seek to make the market for retail financial services work as an efficient market, something which demands both responsible producers and distributors of services and responsible and capable customers.

We are therefore working with both sides of the demand/supply equation. First with the firms, we are setting up a consultation group to define what it means to treat customers fairly. We will also be doing themed visits to firms on issues such as management information and what it tells firms about their customers, how firms design products, and how staff are remunerated when selling products.

And on the consumer side, we have launched a substantial initiative to improve Financial Capability initiative, where we are working with many public and private sector bodies to improve the skills of consumers over the longer term. Customers taking proper responsibility for their decisions and actions, provided they are treated fairly by the FS firm, is central to effective operation of the market.

 

MiFID

Implementing MiFID is - among other things - going to require a significant rewrite of our conduct of business rules. This will have significant implications for banks, both retail and wholesale. For retail, there are major issues on the new basic advice regime for example, and for wholesale there are some significant issues in client classification and 'know your counterparty'.

CESR is currently consulting on its advice to the Commission on the level 2 "implementing measures" which, as I have indicated, are likely to be fairly detailed. As a consequence, our preferred approach will be to implement by means of "copy-out" of the Directive, adding guidance or rules only where this will be helpful and justifiable, and where this is consistent with the legal effect of the text. Much of what is in MiFID is recognisable from what we have now: eg emphasis on senior management responsibilities, the "fair, clear and not misleading" standards for financial promotions, risk disclosures and so on. But some change is inevitable.

In particular, CESR will be consulting on its draft advice to the Commission on the following 5 MiFID provisions: the definition of investment advice; the nature of the know-your-customer and suitability requirement where a firm provides investment advice or portfolio management; the nature of the "appropriateness" assessment that a firm is required to carry out when providing other types of service (for example, execution or transmission of client orders); the range of "non-complex" products that could be sold execution-only, without requiring either suitability or appropriateness assessments; and the criteria for including corporates in the eligible counterparty regime.

We are hopeful that the draft advice will be flexible enough to be capable of proportionate application to different types of investment service and lines of business. And that it will avoid a prescriptive, "one size fits all" approach - particularly to "know your customer" and suitability obligations. But there are a number of open questions: should generic advice be included in the definition of investment advice?; does the split between execution-only business and the application of suitability and appropriateness tests make commercial sense?; do the proposals strike the right balance between treatment of retail and professional clients?; and will the eligible counterparty proposals be workable for the wholesale markets? On all of these questions it is important that the banking industry makes its voice heard.

 

Concluding remarks

So what message do I want you to take away with you today?

What I have outlined today is clearly a heavy regulatory agenda. There is a lot both for you and for us to do. We understand that this places huge pressures on banks – on senior management time, on systems developments, on your costs, and on the business models which drive your firms. But it's essential that in implementing this programme, we mustn't lose sight of the greater goal – of a far more integrated and efficient European capital/financial services market. And we must clearly work together if we are to achieve sensible and proportionate regulatory outcomes. I can assure you that the FSA will work with you supportively and sympathetically to ensure that the work gets done and that there are real benefits to the UK market and its participants.

 

by John Tiner. CEO, FSA

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