FCA supervision

25 Jan 2012

Speech by Clive Adamson, Director of Supervision, Conduct Business Unit, FSA at the British Bankers’ Association (BBA) Conference, London.

Good afternoon ladies and gentleman, it’s a pleasure to be here today.

I’d like to give you an insight into how the Financial Conduct Authority’s (FCA’s) supervision of firms will deliver the vision of the new regulator that Martin set out for us just now.

You’ve all heard about the bolder approach to ensuring that you are getting the best outcomes for your customers.  It will fall upon my supervision teams to deliver that in practice through our day-to-day work with your firms.

Conduct strategy

One of the building blocks for this evolution into the FCA is the FSA’s revised conduct strategy, which we launched in 2010. This, in essence, set out the key change in approach that we wanted, which was to move from a primarily reactive to a pre-emptive style of retail conduct supervision. We also wanted to shift our approach from focusing at the firm level on systems and controls to what consumers actually experienced from firms.

The FCA approach builds on this and will emphasise five main elements: 

• Firstly, to be more forward-looking in our assessment of potential problems – so as Martin said, we’re looking at how we can tackle issues before they start to go wrong.  The new powers of intervention will allow the FCA to take this a step further.
• Secondly, it is to intervene earlier when we see problems including earlier intervention in the development or marketing of retail products – and we can see that in the examples on death bonds and the structured products guidance that Martin mentioned. When I say see problems, we will look at these through the eyes of consumers.
• Thirdly, we will want to attack underlying causes of problems that we see, not just the symptoms, as this will be more effective and efficient in the longer term for consumers and firms.
• Fourthly, it’s to secure redress for consumers if failures do occur – and so we’re asking those firms that are moving customers into risky investments, or mis-handling their complaints, to put customers right.  
• And finally to take meaningful action against firms that fail to meet our standards through levels of fines that have a deterrent effect.

Embedded in this supervisory approach are important philosophical changes. These include moving away from a philosophy in retail conduct that relied primarily on transparency at the point of sale and, in the wholesale markets going beyond relying on the caveat emptor principle in ensuring integrity of these markets.

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Supervision model

I would like to turn now to the supervision model we are developing to deliver the greater intensity of conduct supervision envisaged in the FCA approach that I have outlined.

The key components of this are:

• a clearer sector-based approach;
• greater use of forward-looking analysis to understand what is happening in particular sectors and to help in determining risks;
• more focus on intelligence and data;
• greater use of thematic reviews;
• continued, but more focused, programme of firm level assessments; and
• more responsive and flexible use of our resources with fewer firms having a fixed team facing off against them.

We will communicate more on our model over the coming weeks and months but I would like to touch on the firm assessment aspect of our model. As you know this is conducted currently through the ARROW process at the large firm end of the spectrum and what we call the Revised Approach to Small Firm Supervision (or RASFS) at the small end.

We currently intend to keep a firm-assessment framework across the firm population but to replace the ARROW framework with a new  process that is easier to communicate to the senior executives and boards of firms so that they can align good business practice with good regulatory practice.  The intensity of this will depend on the FCA’s categorisation of firms that we are developing.

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The new framework will focus much more clearly on the main drivers of conduct risk at the firm level, but the overall assessment, which will continue to be in the form of a letter to the Board, will be based on all the work that has happened on the firm, including thematic work.

At the most intensive end of the spectrum we will look at a firm’s business model and strategy to see whether these deliver good outcomes for consumers. An important message is that we want the creation of a conduct focused regulator to ensure that a firm doesn’t trade consumer treatment off against financial performance or prudential strength.

We will look at product design to see whether products or services marketed and sold are designed to meet the needs of identified consumer groups and targeted accordingly.

And we will also delve into sales to see whether firms have appropriate systems and controls in place to ensure the delivery and fair outcomes to consumers and that this is reflected in what consumers actually experience.

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Alongside this we will be looking at what happens after the sale, to see whether firms can deliver fair outcomes for consumers after they have bought their product, such as whether complaints are being handled appropriately.

And we will be looking to see whether a firm’s governance arrangements are effective from a conduct perspective. Very important here is the culture of the firm. We see this as a potential root cause of poor outcomes for both retail consumers and wholesale participants. It is clear to us that culture determines a lot about how a firm meets its regulatory obligations.

The FCA will look to firms’ boards and other governing bodies to set, put in place and maintain a culture that will bring about good outcomes for their customers.

In creating that culture, they will need to take into account factors such as their business plan, risk appetite and how they pay and incentivise staff – and this means not just the senior executives, but also their front-line staff who deal with consumers on the ground. 

I have talked about the firm-level framework but want to emphasise our greater use of cross-firm issue and product-based reviews. Our view is that conduct risk can often be more efficiently addressed through thematic work and we intend to execute a higher proportion of our conduct priorities, including at the product level, through this type of work. In undertaking this we will wish to ensure that we are clear to firms about our conclusions and what we expect them to do.

An example of this is at the moment is our work on wealth managers – those firms that manage a portfolio of assets or investments, on either an advisory or a discretionary basis for retail clients.  

This includes many types of firms, from major international banks to smaller UK-focused firms.  What brings them together is an obligation to consider the suitability of the service they are offering to the client.

In a review last year we found that for every five files we looked at, four had a high risk of unsuitability, or suitability could not be determined.  This is obviously not where customers or we want firms to be, and this gulf between regulatory expectations and what customers sometimes experience is an example of what the FCA will need to narrow.

So, what we have tried to do in that work is to set out our conclusions and expectations for firms as clearly as possible and I am pleased to say that many firms have put in place major rectification programmes to deal with the issues we identified.

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Turning now to how our new approach will feel to firms as this, I expect, will be of more interest. I would like to highlight several aspects here:

• First, and perhaps you have already sensed this from what I have said, it will be more intensive.
• There will also be more concentration on whether your business models deliver acceptable outcomes for consumers.
• There will be greater appetite for pre-emptive intervention.
• There will be more purposeful engagement through firm assessment and thematic delivered by a range of sector-skilled supervisors.
• There will be more focus on causes of problems that we see.
• We will have a greater expectation of a strategic approach to the conduct agenda and senior management and board engagement in it.
• There will be a greater expectation that firms will demonstrate that they have resolved issues promptly rather than the FCA devoting resources to monitoring this.
• There will be more engagement of FCA senior management particularly for the larger firms.
• Last, for those firms subject to dual regulation by the Prudential Regulation Authority (PRA) and FCA they will receive independent, but coordinated supervision from FCA/PRA.

But while there will be a new emphasis and new ways of working, there will be familiar features in the FCA’s approach to supervision.   We know that we need to keep the things that currently work well, and one of our tasks is to weave current good regulatory practice in with the FCA’s new approach. 

So, for example, we intend to continue to publish the Retail Conduct Risk Outlook as a way of setting out for firms and the wider community our view of the key conduct risks that we see both currently and emerging. This is consistent with our greater emphasis on forward-looking risks and will be an important part of our move to more transparency and engagement with the wider community.

Being more forward looking will mean that we will undertake more research and analysis in order to look at the risks that may be on the horizon, and this will be will be complemented by additional intelligence gathering.

We know we must speak to you and bodies like the BBA as we look at understanding market developments. You can help us make the clearest sense of the variety of information that we get and help us as we seek to get early insights into potential conduct problems.

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Wholesale conduct

So far I have talked about retail conduct but I would also like to cover wholesale conduct as well. In our FCA Approach Document we also said we would put greater emphasis on wholesale conduct and the risks attached to activities in the wholesale markets.

Wholesale conduct covers how firms conduct their business in wholesale markets and, as such is not new — the FSA has been doing this but perhaps has not badged it as wholesale conduct. As an integrated conduct regulator, the FCA will look across the whole financial services sector, not only in investment and capital markets but also in banking and wholesale insurance markets.

Our focus here will be to ensure the integrity and resilience of these markets rather than to seek to introduce concepts of detriment and redress that we use in retail markets to wholesale markets. This has been the approach in the FSA and we intend to carry this forward into the FCA.

However, we will want to place more emphasis in particular on three areas. Firstly, where wholesale products filter down or are distributed to retail consumers.  Secondly, where certain behaviours in wholesale markets can cause damage to market integrity and thirdly, where market structures can result in participants being disadvantaged or the market being inefficient.

We intend to flesh out our thinking on these areas over the coming months but, apart from the FCA intending to be more systematic and focused on wholesale conduct issues, I do want to flag that there is a degree of philosophical change in these areas from what I have said. Namely, that whereas in the FSA we may have relied on the ‘caveat emptor’ principle and focused our efforts on market abuse and transparency and disclosure, we in the FCA are likely to go beyond relying on caveat emptor where we see potential damage to market integrity and intervene ourselves.

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Transition to the FCA

Before I finish, I just want to touch briefly on where we are now in terms of the transition from the FSA to the new regulators, and our intentions for the months ahead.

We are expecting final approval from Parliament sometime in early 2013, after which the PRA and the FCA will officially begin their separate lives.

To get to that point we are undertaking a large amount of preparatory work including incorporating into our design work helpful feedback from a wide variety of stakeholders.

As you may recall, a key milestone for us was the move we made in April last year to the creation of the Conduct (CBU) and Prudential business units within the FSA. At that time we moved all firms that will be solo regulated in the future into the Supervision Division within the CBU. The next milestone is the splitting of conduct and prudential supervision of firms that will be dual regulated in the future and the move of these into CBU Supervision for conduct purposes. 

I hope though you’ll have seen from what I’ve said and from Martin earlier that we are intent in achieving a step change in conduct supervision as the FCA comes into existence in order to achieve better outcomes for retail consumers and ensure market integrity for wholesale market participants.

In doing this we will embed a pre-emptive approach that will be based on making forward-looking judgements and intervening early to tackle potential risks to consumers and market integrity.

There are still many unanswered questions that we need to work through as we move to the FCA. We very much welcome engagement with you as we do this and we will certainly keep you informed of our progress during the transition.

Thank you for listening, I look forward to hearing your questions

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