Is regulation in the EU and UK doing the right job?
5 November 2004
Speech by Callum McCarthy
- You have asked me to speak on the topic of "Is regulation
in the EU and UK doing the right job?" I am tempted to reply
"Not entirely" or, if that is too short an answer, "Up to
a point, Lord Copper" but I suspect you will find either
of these answers rather incomplete. So I will expand on
what are accurate but not definitive answers.
- Let me start a comment on the question you have set.
A distinction needs to be made between EU and UK regulation.
I simply do not believe it possible to consider them as
a single activity, since they have very different characteristics:
the legislative process is different; the reliance on legislation
is different; there is a statutory obligation to consider
costs and benefits and proportionality in the UK that is
in practice almost entirely lacking in the EU; there are
obvious questions about uniformity or even consistency of
application of regulation between Member States which obviously
have no parallel in terms of uniform application of regulation
within the UK (as far as I am aware, no-one has yet claimed
that FSA regulations are interpreted differently in Yorkshire
and Lancashire or even in Glasgow and Edinburgh). So I
will answer your question separately for first the UK and
then for the EU, as well as drawing some lessons for APCIMS
from each.
UK financial services regulation
- In making a judgment on whether regulation is effective,
we need to first identify what it is trying to achieve.
In the FSA, we have grouped all our activities under three
broad heads:
- promoting markets which are efficient, orderly and clean;
- ensuring the retail customer for financial services gets a fair deal.
- making the FSA a more professional organisation, easier to do business with.
Let me say a little about how I believe we are measuring up against each of these as well as something about the contribution APCIMS members have made and can make in the future.
- The objective of efficient, orderly and clean markets
should be an ambition on which we can all agree. Efficient
markets provide the best results for customers; they are
the best means of ensuring the continuation of London's
position as the most international of the world's capital
markets. Orderly and clean markets avoid discontinuities
which impose costs; they provide the expectation of equal
treatment for all market participants, without unfair preference.
Beneath these advantages is a fundamental assumption: that
the best solution for customers and for competitive providers
of financial services lies in developing efficient markets,
not in regulation. An important principle of the FSA is
that, where we have discretion, we will regulate only when
first there is good reason to believe the market will not
produce an efficient outcome the market failure test
and when second there is a good reason to believe that regulation
will do more good than harm the cost:benefit test. One
of my concerns over the last year has been to ensure that
we apply this principle in practice as well as theory. One
of my continuing concerns is to introduce a comparable test
into EU regulations.
- What has this meant in practice? Our work under the head
of promoting efficient, orderly and clean markets has been
various. It includes the new listing rules,
designed to give confidence in London to both issuers and
investors; the work on softing and unbundling,
where we are encouraging the industry to develop its own
solutions to a conflict of interest which has long existed,
and are making clear we will only intervene through regulation
if this market-based solution fails; the work on more
realistic capital adequacy regimes, both for life
insurance companies (an exclusively UK set of initiatives)
and for banks and also for you as APCIMS members via the
global proposals of Basel 2, which will be reflected in
a new Risk-Based Capital Directive; and of course we have
dealt with the transfer to Britain of various EU
initiatives the Prospectus, the Market Abuse,
the Insurance Mediation Directives, though I'll discuss
those when I come to EU legislation and regulation.
- All these are new, or newish, initiatives. As important
is how we have approached our day-to-day task of supervision
in the wholesale markets. Our approach is again based on
the principle of assessing risks and making a proportionate
response to that assessment. The example I would draw to
your attention was our response to the market timing abuses
identified in the US. Since the problem was conceptually
not confined to the US, and since at least some of the firms
implicated in the US were also active in the UK, it was
clearly something to which we had to pay attention. On the
other hand, we did not want a US problem, if confined to
the US, to taint the UK market. We therefore acted promptly,
by calling a meeting of the main funds in Britain, setting
out to them the problem and the work needed to provide answers,
and a programme of action. The original announcement in
the US was on 3 September 2003; our final announcement
which showed the British problems in terms of market timing
were very small relative to those in the US, and included
compensation of under 5mn paid by six firms was on 18
March 2004. I regard that as an efficient and useful exercise
of our powers, which defused what could have been a cause
of continuing uncertainty about the British markets.
- Let me turn to our second objective: ensuring that the
retail customer for financial services gets a fair deal.
Again, I would make the point that our aim is to make the
retail market, like the wholesale market, work as an efficient
market. It is not to seek ever more intrusive and costly
regulation. But is has to be recognised that there are significant
problems in making the retail market for financial services
operate as an efficient market: the product is complex,
and often described in terms which make the complex incomprehensible;
the customer is too often not equipped to make the decisions
being asked of him or her (recent evidence shows that nearly
80 per cent of adults don't understand APR, and nearly 30
per cent don't understand what a standing order is); and
the providers of financial services have too often neither
helped reduce unnecessary complexity nor discharged their
responsibilities properly.
- The FSA's work under the heading of a fair deal for the
retail customer is again varied. There is the deregulatory
initiative of investigating whether for certain
lower risk products some, but not all, of the suite of
Sandler products a lighter regulatory regime can be introduced.
We believe this is possible, and, if the experience with
the initial set of products succeeds, we will wish to see
how this principle can be expanded. There is much work on
better and clearer information a principle which
lies behind our work on the menu, so customers
know what they are paying for; and which lies behind our
work on key facts, including the provision
for the first time of the essential facts needed to compare
mortgages. There is work we are doing to bring together
the many groups who have an interest improving financial
capability government, the providers of financial
services, employers, those who provide financial advice.
This the task of putting customers into a position where
they both recognise their own responsibility for their financial
decisions and are capable of discharging them has never
been more important. It is a generational task and all
the more important that we make a real start.
- You will have noted that I have not yet dealt with the
responsibilities of those who provide financial services
the work which we group under the heading of treating
customers fairly. Much of that work is looking
either at products to ensure that they are designed to
meet particular needs or at the sales process to ensure
that, if advice is offered, it is based on an understanding
of the customer's needs, vulnerabilities and understanding
of and appetite for risk. These are clearly questions for
those who approach the retail market: the large banks, insurance
companies, their tied sales forces, and IFAs. I well understand
that the position of APCIMS members is different, and that
your business is that of providing professional advice and
expertise in portfolio management to individuals. I well
understand that you have clients not customers, and I recognise
the occasional irritation which is shown on your behalf
when you consider you are being treated either as an undifferentiated
part of the retail market, or as an undifferentiated part
of the wholesale market. But I do not think that you should
assume from that that APCIMS members do not have a part
to play in making real, in your special area, the concept
of treating customers fairly. Let me give four examples,
all of which reflect the special nature of the business
you do. First, I recognise that the business of your firms,
like that of many professional services firms, is based
on continuing client relationships, rather than the one
off selling of products to customers. But do you have "know
your customer" (or "know your client") records which are
up to date, so that you can demonstrate that you understand
clearly and can document if a client's attitude to risk
has changed something which will affect the suitability
of the portfolio you have constructed? Second, is there
clarity of understanding about the service being offered,
and does the documentation you provide help your clients
understand this? Third, in providing a portfolio advisory
service, is your charging structure transparent and comprehensible?
Are any product-based charges identified as well as management
fees? Fourth, if there are problems, how do your complaints
handling procedures work? Are they independent of those
against whom the complaint is lodged, fair and prompt? The
FSA is discussing with APCIMS these and other issues. I
look forward to getting to grips with these and other practical
questions and answers, based on a shared understanding of
the reality of what APCIMS members do. Let me take this
opportunity to deal with one urban myth that appears to
be gaining some credence, at least in the press. I have
read suggestions that the FSA's rules make it impossible
for private client brokers to recommend shares to clients.
This is said to be because the FSA requires brokers to make
recommendations solely on the basis of the client's attitude
to risk, without considering any other influencing factors
such as tax or the client's ethical preferences. Therefore
any two clients with the same attitude to risk so it is
claimed - should be invested in identical portfolios, regardless
of any other factors. Can I say to you all that this is
nonsense? We do expect you to establish a client's circumstances
and objectives, and make suitable investment recommendations
based on that analysis. But we do not expect identical performance
or investment for the same attitude to risk. You do not
need me to tell you that higher risk stocks can reasonably
form part of an overall lower risk portfolio depending on
the rest of the portfolio. Indeed, it is for that expertise
and guidance that your clients come to you. The FSA will
not challenge advice which can be demonstrated to be suitable
at the time it was given.
- I turn now to my third grouping of FSA objectives, namely
making the FSA more professional, and easier to do business
with. You know what we have undertaken to do: both to reduce
the length of our consultation papers and to halve them
in number an undertaking on which we are delivering. This
year I expect the FSA to produce 22 consultation papers
against the previous year's 55, and we have significantly
reduced their length. We are making the FSA's rulebook more
user-friendly. We will soon be launching a series of sector-specific
handbooks, containing only the requirements relevant to
each sector. These will be similar to the "tailored" handbooks
for mortgage and general insurance intermediaries which
we launched in August. These are less than 10% of the size
of the full handbook. We are also simplifying and shortening
the rules themselves: the new listing rules published for
consultation are 40 per cent shorter than the rules they
replace; we have cut 200 pages from our rules for unit trusts
and other collective investment schemes.
- We have also reorganised our own internal structure to
make it easier for us to communicate effectively with those
we regulate. I should make clear what I mean by "communicate
effectively". It means both speaking frankly to particular
sectors; and as important it means listening carefully
to particular sectors. To do this, it is important the we
have a proper understanding of those sectors an objective
which lies behind the creation of sector teams within the
FSA, each headed by a FSA director. For asset management,
Dan Waters is the sector leader, and within the asset management
sector we are keen to identify and understand the special
position of APCIMS members. You have some advantages here.
First, there is the size and importance of what you do.
APCIMS members undertook nearly 13 million trades in UK
equities on the London Stock Exchange last year. They have
240 billion under management for the private investor.
The UK is estimated to be second only to Switzerland in
terms of managing non-domestic private client investment
mandates. Second there is the clarity and force with which
your able and formidable chief executive expresses your
views no lack of effective communication there. We are
keen to extend this effective communication. We have appointed,
within the asset management sector team, a head of department,
Sam Tymms, with special responsibility for APCIMS. We are
hosting a half day event arranged by APCIMS with four speakers
from member firms, who will be explaining their varied business
models. Nearly a hundred FSA staff have booked to attend
and our Edinburgh office has asked for a video of the event
to be sent to them so as not to be left out. In the new
year, we have six staff who are keen to be seconded to APCIMS
firms for six week periods each. We intend to build this
into a permanent substantial programme of secondments which
we see meeting both your and our own objectives. I hope
it is clear to you that I would not be here today unless
the FSA took APCIMS and the work of your members very seriously.
EU financial services regulation
- Let me turn to EU financial services legislation. Again,
let me start by identifying what EU regulation, as set out
in the Financial Services Action Plan, was designed to do.
It had three specific objectives:
i. to create a single EU wholesale market;
ii. to achieve open and secure retail markets; and
iii. to revisit prudential rules and structures of supervision.
You will be relieved to know that I do not intend to detail and discuss the 42 separate legislative initiatives which flowed from the agreement on a Financial Services Action Plan at the Lisbon Summit in the year 2000. What I think is more useful is to consider what are the lessons from that legislative programme, and how we regulators and practitioners, the FSA and APCIMS should apply those lessons going forward.
- I would draw three particular lessons from the experience
of the FSAP to date. The first is that we need to be more
selective in what we choose to do by way of regulatory intervention.
I have explained that the FSA has a twin test which must
be passed before a regulatory intervention is followed:
first, there must be a market failure, and second regulatory
intervention must be judged beneficial on a cost:benefit
basis. In practice, neither test exists for EU regulation
and as a consequence it is too easy for special interests
both consumer protection interests and producer protection
interests to use the political process of drafting and
introducing Directives and Regulations into law to incorporate
initiatives which do not bring benefit, or are disproportionate.
We need to prevent this happening by subjecting proposals
to much more rigorous analysis than has been the norm.
- The second and linked lesson is that we need to avoid
any assumption that when problems exist they can best be
solved or solved at all by legislation. In the retail
market for financial services there are many factors which
prevent the establishment of a single market within the
EU. Tax is the most obvious, where the tax treatment of
investments and pensions varies greatly between Member States,
and is a substantial barrier to the creation of financial
products of appeal in all or even several Member States.
But other issues arise: the legal system, for example, differs
greatly between Member States, which affects, again for
example, the ease and speed of taking possession of charged
assets, with all that this implies for the risk profile
of secured lending, including mortgages, in different countries.
And there are clearly cultural questions as well: it is
not a surprise that national institutions long established
in a particular country should have a special hold on the
inhabitants of that country. None of these factors tax,
law or culture is susceptible to legal action aimed at
financial products, or at the way in which financial products
are supplied. It is important that we recognise this when
contemplating further EU regulatory action by way of legislation.
- The third lesson is the importance of being realistic
about both the timing and the consistency of implementation
of implementing new financial services regulation across
the EU. There is a need for significant improvement on both
counts. The present position is particularly unsatisfactory
in terms of the timing of implementing EU initiatives. There
is a peaking of implementation at the end of this year and
the start of 2005 which will place unreasonable strain on
all concerned. And it is clear that the present timetable
for certain parts of the Financial Services Action Plan
is simply unfeasible. The evidence from practitioners, particularly
the detailed and well-documented evidence put forward by
LIBA, shows the need for the timetable for MiFID to be re-examined.
What is at present proposed is not realistic. I am glad
that the Commission appears to have taken this on board,
and await their response with keen interest. Timing is the
first dimension of implementation which needs examining
a matter as I have said now for the Commission. The second
and arguably even more important dimension is consistency
of implementation, a task where I think you can reasonably
ask more of regulators across the EU, and more of the Lamfalussy
Committees, particularly CESR. Until now, CESR has been
preoccupied by the essentially technocratic task of advising
the Commission on how the very many Directives which affect
securities should be interpreted an important and necessary
task for CESR, but not obviously the most important task.
As the legislative burden becomes lighter, I expect CESR
to spend more time on the questions of consistency of implementation
in practice of those things which have been agreed in principle.
It is important that we do so.
- Let me dwell for a moment on MiFID the ISD as was.
It is important that the scope of the Directive is fully
recognised, as it will have widespread influence over conduct
in both wholesale and retail markets, and will affect all
APCIMS members. Issues around the way the market operates,
issues of best execution, client agreements, suitability,
compliance and outsourcing are all issues which affect you
directly. I therefore strongly encourage you to make your
voice heard clearly in the consultation process which CESR
is engaged in. Angela Knight has been typically and splendidly
forthright in her contributions to the securities expert
group. I have every confidence that APCIMS' voice will continue
to be heard.
- You will see that my response to the question whether
EU regulation is doing the right job is more qualified than
my answer to the question about UK regulation. I hope that
in deciding on what is to succeed the FSAP the new Commission
will recognise that there are difficult questions to be
answered, and that the answers which were advanced in devising
the FSAP are both capable of being improved and also need
rethinking.
Conclusion
- I have attempted to answer the admirably direct question which you have posed me. Like many examination candidates, I started by redefining the question into the different position, approach and even philosophy of UK and of EU regulation. I have described how in the UK we at the FSA are approaching our task under three broad groupings of our priorities and indicated how this will affect APCIMS members. In a EU context, I have suggested three substantial changes in approach which are needed if EU regulation is to become more effective, and have encouraged APCIMS to continue its effective communication. I hope that this has been more informative albeit longer than my initial two word summary answer to your question.