Briefing note BN022/06
28 June 2006

The FSA has today published four documents dealing with the costs and benefits of financial regulation, and its proposals to extend and take forward its work to strike a better balance between benefits and costs. The four documents are:

  • "Cost of Regulation Report". This analysis, conducted for the FSA and the Practitioner Panel by Deloitte, examines the incremental costs attributable to individual FSA rules by firms in three sectors – corporate finance, institutional fund management and investment and pension advice. Incremental costs are costs which firms would not incur other than to comply with FSA rules. The results are specific to each sector, and no general conclusion about the total cost of regulation can be drawn from them. But it is clear from the diversity of Deloitte's cost estimates, by firm and by sector, that there is no "silver bullet". Working out how best to bear down on the burden of regulation is a complex issue. Therefore our approach, as set out in the Better Regulation Action Plan, is to move forward through a series of detailed steps, mostly about issues that are individually small but that collectively may have an important effect on the incremental costs faced by firms. Deloitte's work will guide the FSA in carrying out these steps by providing a better understanding of the costs imposed by each rule, which we can use in assessing the justification for each rule;
  • "Estimation of FSA Administrative Burdens". This analysis, conducted for the FSA by Real Assurance Risk Management, examines for all financial services regulated by the FSA the costs financial sector firms and individuals incur in reporting to the FSA. Its results, which are indicative rather than statistically representative, suggest that these costs amount to some £600 million, which equates to approximately 0.5% of this industry's total costs. The most significant costs arose in relation to anti-money laundering rules and some general reporting rules. This work was done to respond to the Government's work on estimating the administrative costs of regulation generally;
  • "The Benefits of Regulation – what to measure and how". This study, conducted for the FSA by Oxera Consulting, sets out a framework for identifying and measuring the benefits of regulation. It establishes a best practice methodology for this, building on FSA's existing cost benefit analysis tools. This will enable a better analysis to be made of the benefits of individual rules or clusters of rules and support the comparison of such benefits to compare with the level of incremental cost imposed by such rules; and
  • "Better Regulation Action Plan: Update". This document updates the FSA's own plans for reform of its rules and regulations, first set out in December 2005. It reports on the progress made since then, and relates that work to the two studies on costs of regulation also published today. In particular, it shows that rules which account for over three quarters of the administrative costs are already subject to review by the FSA as part of its Better Regulation Action Plan. The FSA now intends the detailed rule by rule analysis of incremental costs set out in the Cost of Regulation Report as described above to shape its future review of regulatory reform.

John Tiner, the FSA CEO, said:

"We are determined to strike the right balance between discharging our statutory duties and avoiding unjustified costs. We can do this only with a sound understanding of both the benefits and the costs of regulatory action. The three studies published today underpin that understanding and the update on the Better Regulation Action Plan shows the progress made in the last six months.

"The Deloitte report, in particular, breaks new ground by providing a more complete and detailed analysis of costs than any previous study. This has been a major piece of work and I would especially like to thank all the firms who contributed to the study. I recognise it required a substantial time commitment.

"The more significant costs appear to arise from providing point of sale documents to retail customers, monitoring employees' compliance, handling complaints and reporting to the FSA. We have an important programme of work ahead to assess, with an open mind, whether these incremental costs are justified by the benefits and, if not, what changes we need to make."

Cost of Regulation Report

The Deloitte study was designed to establish a methodology for measuring the impact of particular rules on firms, on a sector by sector basis. It identifies the additional costs a firm incurs as a result of FSMA regulation. It was designed to enable the FSA to identify those rules which impose greatest costs, so that they could be reviewed to see whether the benefits justify those costs. It covered detailed case studies of costs in 68 firms (small, medium and large) in three sectors. Like the Real Assurance study of administrative burdens, the results are indicative rather than statistically representative. In particular, considerable interpretation was required of each firm in judging which costs were for them "incremental" – that is, over and above what would have been done by the firm in the normal course of business.

The main conclusions of the study include that:

  • much of what regulation requires is, in fact, regarded by firms as good business practice;
  • the estimated incremental costs of regulation differ markedly both between sectors and between firms within a sector;
  • the incremental costs of regulation in the wholesale sectors covered (corporate finance and institutional fund management) were relatively low: the Financial Services and Markets Act was found to impose no significant costs on the provision of corporate finance advice to institutions, and relatively low costs in institutional fund management;
  • the incremental costs of regulation in the retail sector covered, investment and pension advice, were higher. Given that in response to clear evidence of significant market failures there is a more detailed regulatory regime for the retail market, it is not unexpected that in the retail market incremental costs are markedly higher than in the wholesale sector, where a lighter regime applies;
  • within sectors many individual firms reported outlying incremental costs for specific rules that were much higher than most of their peer group. This dispersion of outliers ranges across a very large number of rules, with no discernable pattern enabling wider conclusions to be drawn. This may be explained by firms taking different views on which costs are required by regulation as distinct from being in the normal course of business, or by outlying firms choosing to interpret rules more strictly than is more widely held to be required by the FSA. Whatever the cause, it makes interpretation of the results more problematic;
  • across all the three sectors, the direct fees collected by the FSA (comprising fees covering the costs of the FSA, the Financial Ombudsman Service and the Financial Services Compensation Scheme) were the highest incremental cost. This was particularly the case in investment and pension advice, where FSA-collected fees accounted for 2.7 per cent of the operating costs of the median firm (higher for many smaller firms, lower for medium and large firms) and where by comparison the second largest individual driver of regulatory cost accounted for 0.4 per cent;
  • across all three sectors, firms recorded cumulatively significant costs of record keeping requirements, spread across a large number of separate rules.

Estimation of FSA Administrative Burdens

The study by Real Assurance Risk Management forms part of a government-wide study of the reporting costs of regulation and legislation. It covered 233 FSA rules, and some 340 firms (small, medium and large) across financial services. It was designed to be indicative, rather than statistically representative.

The study estimates the total cost of reporting to the FSA for the financial services sector to be some £600 million a year, approximately 0.5 per cent of industry costs. The highest burdens fall into two general categories: high costs incurred by a few very large firms; and cases of rules which apply to almost all the 25,000 firms regulated by the FSA. In the former category, the most important costs relate to rules on preventing money laundering, which account for around 40 per cent of the total estimated costs. The top 20 administrative burdens cover all rules which individually account for 1 per cent or more of total administrative costs. These 20 rules account for more than 85 per cent of the total administrative costs. Firms report in general low continuing reporting costs, once the investment in reporting systems has been made.

Table 1: Top Twenty Administrative Burdens

Rule

Description

Estimated cost

Percent

ML 7.3.2

Money laundering -records of evidence customer identity etc

99,242,000

16.4%

ML 7.3.3

Money laundering - records of transactions

70,271,000

11.6%

ML 7.3.3

Money laundering staff training

46,272,000

7.7%

TC 2.4.9 G

Training and competence record requirements

38,672,000

6.4%

ML 4.3.2

Money laundering reporting to NCIS

38,537,000

6.4%

ICOB 7.7.1

Claims information to be kept for three years

29,880,000

5.0%

ICOB 5.7.1

Records of policy summaries and policy documents provided to customers

24,910,000

4.1%

IPRU (INS) 9

Life Insurers annual returns

21,310,000

3.5%

SUP 10.12.2

Application for approval of approved persons in controlled functions

17,366,000

2.9%

SUP 16.7.77

RMAR Returns - GI intermediaries

15,996,000

2.7%

AUTH 3.9

Application for authorisation

14,809,000

2.5%

DISP 1.5.1

Making and retaining records of complaints

14,411,000

2.4%

DISP 1.5

Half yearly complaints report

13,850,000

2.3%

IPRU (INS) 9

General Insurers annual returns

13,775,000

2.3%

SUP 16.7.77

RMAR Returns - Financial Advisors

12,735,000

2.1%

CASS 2.6.15

Client asset records

11,785,000

2.0%

SUP 16.7.24

Securities and futures firms regular returns

8,604,000

1.4%

SUP 6.3.15

Application for variation of permission ("VOP")

8,200,000

1.4%

SUP 3.10.4

Client money audit

7,695,000

1.3%

COB 3.7

Records of non-real time financial promotions.

6,852,000

1.1%

The Benefits of regulation – what to measure and how

The Oxera study establishes a methodology for identifying and measuring the benefits associated with rules or combinations of rules, and applies the analytic framework which has been developed from this methodology to three case studies selected to address specific findings in the three sectors covered in the Deloitte report. The case studies clearly establish that for two of the three areas of higher cost examined a direct link can be established between an identified market failure and the mitigating impact of the related rule. The third case study which looked at training and competence requirements, identifies a more pervasive impact of the related rules making more direct linkage to specific market failures more problematic. These examples will inform how the FSA takes forward and uses the methodology in parallel with the work on the costs of regulation to inform future decisions on particular rules.

Better Regulation Action Plan: Update

In December 2005 the FSA published its Better Regulation Action Plan, which set out its proposals for improving the FSA's regulatory regime, so as to meet its statutory objectives effectively. The update published today reviews progress since then. It includes further details on our initiatives to:

  • replace detailed anti money laundering rules with high-level principles;
  • encourage greater senior management responsibility and flexibility in relation to training and competence requirements;
  • lift certain reporting requirements in relation to approved persons;
  • propose greater flexibility for pricing collective investment schemes; and
  • propose liberalised access to hedge funds.

 

Together with other initiatives, these actions cover regulations which account for over three quarters of the administrative costs identified in the Real Assurance Risk Management study. In all cases, the FSA will seek to strike the right balance between the benefit and the costs of regulation.

The update also identifies, using where appropriate the Real Assurance Risk Management and the Deloitte studies, areas for further review. These include:

  • examination of the costs to specific firms with much higher costs than those in their peer group of why a particular rule or group of rules is so costly for them, and in particular whether FSA requirements may be being interpreted too zealously by some firms and not sufficiently by others;
  • a continued focus on the most effective way of implementing a number of EU directives, notably the Markets in Financial Instruments Directive;
  • focusing future review work on the most costly rules identified in the investment and pension advice sector in particular. It has to be recognised, however, that the analysis of the impact of specific rules shows that few have a large impact: only six sets of rules amount individually to more than 0.1 per cent of a typical firm's costs, and together these six amount only to 1 per cent of costs.