The retail environment
Vernon Everitt, Director of Retail Themes and Consumer Sector Leader, FSA
BBA 2nd Annual Retail Banking Conference
15th November 2005
Good morning everyone, and thank you for inviting me to talk to you here today.
I will be setting out the FSA's strategy, priorities and approach in the retail markets area. I will do so in the context of the FSA's overall strategic aims and, more specifically, our four pillar approach designed to bring about a more effective and efficient market in retail financial services.
The FSA's three strategic priorities are: to promote efficient, orderly and fair markets, both retail and wholesale; to help retail consumers achieve a fair deal; and to improve our own business capability and effectiveness.
Under this umbrella, we believe there to be four pillars essential to delivering a more effective and efficient retail market through which a fair deal for consumers can be delivered:
- Capable and confident consumers.
- Clear, simple and understandable information available for, and used by, consumers.
- Soundly managed and well capitalised firms who treat their customers fairly.
- Risk-based regulation.
I'm conscious that there are significant prudential issues around too, but for today I want to focus on the main issues which bear on the retail markets.
Initiatives such as treating customers fairly and financial capability are part of the broader picture designed to deliver these outcomes. And in all of this our emphasis is on outcomes and thus on changing the behaviours of firms and consumers in the real world. So, ultimately, we want to measure the success of this strategy by looking at the difference it makes to your customers, the consumers of financial services and products.
In terms of overall regulatory approach, I should emphasise that our clear preference is to encourage efficient markets as the best means of providing quality goods and services to consumers. Only after market solutions have been exhausted should regulatory initiatives be contemplated. On that basis, the FSA has a prime interest in making the retail market an efficient market.
So how will we know that these outcomes have been achieved? Here are four general propositions.
First, more engaged consumers will be actively thinking about their financial needs and doing something to address them - managing their money well and planning ahead for the longer-term. Consumers will be active in educating themselves about financial products and in seeking out information from a range of sources – including more accessible general information provided by the FSA.
Second, consumers collectively will exert greater competitive pressure in the market by shopping around for the best deal, regularly reviewing their financial position and moving from one firm to another when it makes sense to do so. Consumers will judge firms on the quality of the products and services provided, including how firms behave when things go wrong – the way in which firms deal with complaints, for example.
Third, and following closely from my last point, consumers will feel much more positive about their engagement with the industry; they will take well informed decisions based on clear and understandable information and will be clear about their own responsibilities in taking those decisions.
Fourth, more consumers will be included in the financial services world. This is partly about capability but it is also about access. We recognise absolutely the central importance of financial inclusion as part of this equation.
So what is happening to help deliver this nirvana?
Capable and confident consumers
First, the issue of consumer capability.
There is no controversy about the nature of the problem. Increasing the level of consumer capability is more critical now than it has ever been. We live in an age where responsibility is passing from state to individual. Individuals are being asked to make more and more financial decisions, many of which were previously taken for us in relation to health, or education, or pensions. But against this increasing requirement, the actual capability of those who need to make financial decisions is too often inadequate, in terms of basic literacy and numeracy, as well as in respect of specific financial knowledge.
We can all cite examples of this, so I will limit myself to just one. A study by the Institute of Financial Services showed that eight from ten people did not correctly identify the term APR as describing the interest rate and other costs of a loan. I suspect that our baseline survey of financial capability – more on which in a moment – will provide a decent further supply of such examples.
So the problem of financial capability is immense, in terms of both the basic requirements of literacy and numeracy which underpin financial capability; and in terms of specific financial knowledge.
So how can we respond to this magnitude of challenge?
As you know, FSA has been leading and co-ordinating the National Strategy for Financial Capability. When the work began in 2003, we listened to those who cautioned against trying to address all parts of the problem at once. We and our partners - Government, industry, the media, the voluntary sector, and others - therefore examined seven areas: schools, young adults, the workplace, families, retirement, borrowing and generic advice. Having undertaken a huge amount of pilot work to determine what practical initiatives will put us in a position to achieve the step change in capability that is required, we have started to move on to the next stage towards national delivery.
The Financial Capability Steering Group met last month to take stock of the National Strategy and to consider options for the future. The Steering Group agreed to a set of specific priority projects on which to focus covering:
- schools
- higher education
- the workplace
- maternity/paternity leaver resources
- FSA information campaigns
- development and roll-out of the Debt Test - which is designed to provide guidance to individuals on whether they are at risk of becoming over-indebted
- and further work on whether there is a commercial case for the delivery of generic advice.
In addition, the Steering Group left open the possibility of wider rollout of initiatives to Young Adults not in education, employment or training, subject to the findings of ongoing pilots and an examination of the associated business case.
Supported by a team of specialist advisers, we are now preparing business cases which will examine the public policy and potential commercial benefits of taking these specific projects to national roll-out. The business cases will provide the basis for meaningful discussions with public and private sector partners on sustainable funding and the other commitments fundamental to making them happen – this includes, for example, access to both public and private sector workplaces for the provision of financial capability seminars to the workforce.
On timings, we want to be in a position by the end of the first quarter next year to have clear delivery and funding plans in place to move to national roll-out. At the same time, we will also publish another central part of our work on financial capability, the results of our baseline survey. This will describe and measure the state of financial capability in the UK, looking at people's ability to manage money, make financial choices, plan ahead and get help. We will repeat the survey periodically to measure success in raising levels of financial capability and we will, of course, be developing further success measures for the other specific priorities I mentioned.
I would also flag the FSA Innovation Fund. This aims to support new and innovative projects dedicated to financial capability led by voluntary and community organisations. We have made available a minimum of £200K for projects running up until March 2007 with the majority of awards likely to be between £5,000-20,000. We were delighted to receive over 300 applications to the Fund from which a shortlist of applicants has been drawn up. We hope to announce the award winners before the end of year.
We are extremely grateful for the support of BBA members in taking forward work on financial capability, including many contributions to the working groups. We have had particular support from Lloyds-TSB, with Eric Stobart chairing the Workplace Group and Jim Dredge energetically directing the programme of pilots, with full-time support from Alastair Hogg of the Prudential.
So we are now in a critical new phase as we work up the business cases. We are reaching the point when the rubber really hits the road on the funding and other support required to make it all happen. As was ever the case with this initiative, that requires the proactive involvement of government, the industry and the FSA. I look forward to further constructive dialogue with all concerned over the next couple of months.
Clear, simple, understandable information
Alongside the common desire for more capable and confident consumers, we must ensure that those consumers are given the information and advice that is both necessary and relevant when making a financial decision.
Just as you will be familiar with Principle 6 of our Principles for Business – essentially that firms should treat their customers fairly - Principle 7 explicitly states what we expect from firms when it comes to providing information: "Firms must pay due regard to the information needs of their clients and communicate information to them in a way which is clear, fair and not misleading." This ranges from financial promotions in all guises, to product literature and covers all institutions, from small one man advisors to major retail banks.
Good quality financial advice also plays an important role in ensuring that consumers have expert help in making a complex range of important financial decisions. The provision of financial advice is a large industry, and with rising incomes and wealth, and evidence that many individuals are not investing enough for their retirement, there is significant scope for the advice market to expand significantly. The challenge here for providers of advice is to demonstrate to more consumers that there is value to them in paying for these services.
At the simplest level, this means a retail financial advice market that is providing good quality, suitable advice to consumers. And that those consumers should be able to recognise when this is happening, and when it is not, and to respond accordingly.
We are clear that the retail financial services market is not yet operating in a consistently effective and efficient way. On the mortgages side, for example, our early findings report a mixed picture in terms of standards. On the investments side, the market is still changing. Both product providers and distributors face a range of challenges. They need to adapt their business strategies to reflect a depolarised world. Some need to rebuild capital and balance sheets. All this is challenging enough but comes at a time when the industry overall is still coping with sluggish demand for investment products in weak markets and is trying to engage with consumers who still have low levels of confidence in the sector.
As regulator, we do not want to prescribe how the advice market should be structured. Rather, we want to allow firms to choose what advice they provide, and to allow consumers to choose what advice they want to take and how they pay for it. And we want consumers to be able to understand the different types of advice that are available to them.
That is why depolarisation is largely a permissive regime and firms are free to develop their business models in a more tailored way for their customer base, or they can continue trading pretty much as they were before – albeit with improved disclosure and other adjustments such as the requirement for 'independent' firms to offer a fee option.
As you would expect, we are going to conduct a review of how depolarisation is working in practice. The first stage is to check compliance with the new rules. Thereafter, and over longer time periods, we will review the extent to which firm and consumer behaviour has altered.
I should just add a word about the FSA’s own contribution to the provision of general information.
We know that those who use our factsheets, calculators and other web-based material find them to be helpful. But we also know that we need to do more to make that material more accessible and to promote its availability, including in partnership with others such as the BBC. The current ‘mortgageslaidbare’ campaign is a hint of our new approach in this area. We are part-way through the campaign, but we have already seen a very significant increase in traffic to our mortgage resources and we will feedback on the overall success of the campaign in due course. We are planning two further campaigns early in the new year to cover issues around pensions and A-day and to promote the various resources available to help consumers plan their finances effectively. Again, we will ensure that we measure the effectivess of these campaigns in influencing consumer behaviour
Treating customers fairly
As I have set out, the fair treatment of customers by firms is a key part of the broader picture.
As you know, our approach has been not to define precisely what constitutes "treating customers fairly", but rather to challenge the senior management of firms to work this out for themselves, taking into account the particular types of business that they undertake. We recognise that many of you have already done or are in the process of carrying out a "gap analysis", to identify areas of business where more needs to be done.
Treating Customers Fairly needs to be embedded into the culture of a firm at all levels, so that over time it becomes business as usual. This is all very much a responsibility of senior management, not just a compliance issue.
To help, we have produced a number of statements of good practice and case studies to illustrate some of the considerations that senior management should take into account. We have published many of these on our website and further case studies on management information, remuneration, complaint-handling and others were published last month.
These examples reflect real life scenarios and provide material which firms may find useful as background when considering how best to ensure that they treat their customers fairly. In particular, they are intended to illustrate the kinds of questions that firms should consider in particular sets of circumstances. Inevitably, the issues raised are not exhaustive and the practices observed are not prescriptive – treating customers fairly is not something that lends itself to box-ticking.
We have also suggested that a useful starting point is to think of treating customers fairly in terms of the product life cycle. So depending on the precise nature of a firm's business this could mean addressing the fair treatment of customers at any of the following stages: product design and governance; identifying target markets; marketing and promoting the product; sales and advice processes; the remuneration of sales forces and advisers; after sales information; and complaints handling.
As part of the next stage, we will also be looking at quality of advice. The aim will be to consider how we can measure and improve the overall quality of advice, rather than looking at specific products or examples where the advice process goes wrong. We will test current practices, looking at a range of areas including training and competence; the systems and controls that support good advice; and entry standards for advisers and firms.
Risk-based regulation
Which brings me to the final Pillar of our retail strategy - that of FSA being a proportionate, risk-based regulator.
I hark back to my earlier remarks about our preference for market-based solutions over regulatory intervention. Proportionate, risk-based regulation is what brings this to life – helping us determine where our resources are best deployed to address the biggest risks that carry the highest impact were they to crystallise.
For example, we acknowledge that the mortage and general insurance intermediaries market has undergone significant changes and we have been keen to stress that we have taken a graduated approach to supervision in the first year of the regimes. That is, in the main we are telling firms what they need to do to improve compliance levels which we'll come back and check and it is only in the more serious cases that we'll do further investigation. As these changes become more familiar to the market our approach will become firmer.
We deal with emerging retail risks in two ways. First, where supervisors identify risks within the individual firms they supervise, they may take steps to mitigate them with the firm concerned. Second, we seek to identify risks arising across different types of firms and market sectors and carry out work to mitigate them where our risk-based approach justifies doing so – so called thematic work. I’d like to spend a few minutes describing our approach to this.
Identifying thematic risks
Risks in the retail market take many forms; risks to consumers, firms, sectors, or the market as a whole. We identify emerging retail risks in a number of ways, including:
- market data;
- current trends and developments in the markets;
- financial promotions;
- issues identified through our discussions with firms; and
- risks identified by our sector teams, supervisors, contact centres, and other stakeholders.
We look for flags like new or unexpected developments. For example, an unusual surge in retail sales of a product given market conditions might prompt us to make further enquiries about how this produce is being sold. Our monitoring of financial promotions is also an important source of intelligence.
We prioritise our workload to focus on the most significant risks. Where a development could indicate a new risk, we will often do a small amount of work to find out more and help us identify whether action is warranted. In around 60% of the issues we investigate no further action is taken.
If we do decide regulatory action is justified, we consider what tools to use in light of the circumstances of each risk.
Some of the key risks we have identified and on which we decided to do further work include:
- Payment Protection Insurance
- Mortgage Disclosure Documents
- Lifetime mortgages
- Contracting out of the state second pension
- Premium reviews and variable interest rates; and
- Income Withdrawal
How we select firms for thematic work
Thematic work involves looking at a particular issue or set of issues across sample of firms.
When we contact firms they sometimes assume that, because they have been selected, this implies that we have already decided that there is a problem in that firm. This is not the case. The decision takes into account a number of factors, including:
- How many – and what type of – firms are active in the market or product that we are interested in.
- The desire to find a sample of firms that is representative of the various sizes or structures in the market.
- The desire to create a representative sample. This will include some firms which we think are likely to set the highest standards in terms of systems and controls and practices more generally in that area.
- Whether any of the firms are – or have recently been – involved in any other areas of our work, so that where possible thematic work is spread across firms. Achieving this spread can be a particular challenge when it comes to the largest groups. Where firms have dedicated supervisors, the supervisor will be involved in decisions about which thematic projects the firm takes part in.
We realise that this "air traffic control" of thematic work and the burden it can impose is of concern to firms and we are committed to holding regular dialogue with the industry to set out an indicative timetable for our future thematic work. Our Business Plan, which will be published in January, provides an ideal peg for such a discussion. We are also examining whether the process for communciating the outcome of thematic work to individual firms and industry trade associations can be improved.
As you will have gathered from my description, thematic work will remain a key supervisory tool, allowing us to respond quickly to emerging risks.
Financial Inclusion
I said at the start that financial inclusion is an important consideration in our work.
The FSA's position on this is very clear. Under the 'public awareness' objective, the FSA has a statutory responsibility for promoting public understanding of the financial system. This objective is intended to be interpreted quite generally.
So while the FSA has no statutory responsibility for financial inclusion, we are absolutely mindful of the impact of our work on all groups.
We see our role in this as twofold.
First, in our regulation of the industry we want to avoid creating barriers to inclusion, including providing assistance to those taking innovative approaches to understand the relevant regulatory issues and possible solutions. When authorising the first purely Islamic bank in Europe we worked constructively with the senior management of the Islamic Bank of Britain on such issues.
We have been very active in working with third sector lenders, for example in delivering a proportionate, lighter touch regulatory regime for credit unions and in working with the Community Development Finance Association to see if a code of practice for Community Development Finance Institutions is the best way forward for these organisations.
And we have, over the last eighteen months, been leading a multi-agency initiative to 'defuse the identification issue’. We welcome the BBA's contribution to the work of the Joint Money Laundering Steering Group, whose new Guidance is published next year. This is expected to include a wider range of options for people to prove their ID so that, by the end of next year, ID should be a significantly reduced barrier to financial inclusion.
Second, in our consumer awareness remit we aim to help consumers become more confident and capable through the National Strategy for Financial Capability and our wider education and information work about which I spoke earlier.
So the FSA is just one partner in the work being done here. The Banking industry, led by its trade association, is of course very active, in particular in addressing the challenge laid down by Government to make significant progress towards halving the number of unbanked households in the UK within 2 years. In partnership with the BBA, we have recently revised our guide to Basic Bank accounts. There are many further examples of industry activity in this area.
We look forward to continuing to work with banks, the BBA and other parties to ensure the difficulties and barriers faced by those who are excluded from financial services can be overcome.
Finally, a very brief word about two other significant challenges in the retail markets area, not least in respect of the impact of European legislation.
MiFID
It is hard to exaggerate the pervasive effect which MiFID will exert over financial markets and financial institutions and it is important to recognise that this is not a wholesale business issue.
We will do all we can to make the timetable pressures more manageable. To help give focus to firms' preparatory efforts, pending publication of the Commission's recommendations and then of our CPs on implementation, we plan to publish in the next week or so a "Planning for MiFID” document designed to help firms get to grips with their planning for implementation despite the continuing debate over Level 2 measures. I urge you to study it.
Strategic challenge of A-Day
Another major challenge facing the industry is A-Day, in other words 6 April 2006, when the new pension tax simplification rules take effect. Last September my colleague Sarah Wilson warned firms to make sure they review the business and strategic impact of A-day.
A-Day is very significant for those of you who deal with the complexities and intricacies of pensions on a regular basis, and who advise consumers on a product which they find particularly complex. It is clear that much work is going on in many firms but, with just over four months to go, both firms and advisers now urgently need to start planning for the changes if they have not already done so.
And a further dimension, of course, is that the government is expected to consult on proposals to introduce a new regulated activity for personal pensions, meaning that the FSA could be regulating the sale of Self Invested Personal Pensions from April 2007.
Conclusion
That completes my tour of some of the main issues as we see them. Although it might seem otherwise, this has not been an exhaustive account – but I hope I have left you with a clear picture of our overall strategic direction based around our four pillar approach.
I suspect that everyone here today recognizes that there remain huge challenges to delivering an effective and efficient market in retail financial services. The FSA will be relentless in playing its part in making that happen in partnership with all of you in the industry.
Thank you again for the opportunity to address your conference.