How can the industry help shape regulation?
Speech by David Kenmir, Managing Director, Regulatory Services
FSA Annual Training & Competence Conference 2005
6 December 2005
Good afternoon. I am delighted to be able to speak to you this afternoon about how the industry can shape regulation. Regulation of all sorts – not just financial services regulation – is very topical at the moment, in the EU and closer to home. The Chancellor mentioned only yesterday in his Pre-Budget Report a 10 Point Plan (‘Reforming the regulation of financial services’) to improve our regulatory approach, one or two of these points I will touch on later in my speech. The timing of this conference is particularly good, as it just a few days since we published a Better Regulation Action Plan setting out how we will continue improving financial services regulation. We do not hear arguments about the basic need for regulation in this sector. It is widely accepted that regulation exists because of the potential economic and social effects of major financial instability, the desirability of maintaining markets which are efficient, orderly and fair and the need to protect consumers in their dealings with the financial services industry. The debate lies in how that regulation is conducted – its form, its methods, its priorities.
The Action Plan sets out a variety of ways in which the industry can contribute to shaping regulation: you should work with each other to develop market solutions to market failures; you should work to maintain standards that we can take account of in our risk-based approach and which facilitate a move to principles-based regulation; and – most importantly – you should talk to us and work with us.
Consultation and cost-benefit analysis at the heart of our approach
The last point, about engaging with us may sound obvious. But I think you would be surprised at both the range of these opportunities the industry has to shape regulation and how little opportunity it sometimes makes of them. The process for developing new regulation is focussed on consultation and discussion. We start by talking to trade associations and firms to help us gather data and facts for proposing and evaluating policy options. Indeed, for some of the most significant regulatory changes we set up dedicated forums with trade associations and firms to discuss our implementation plans. We are currently taking this approach with two major directives: the Capital Requirements Directive (CRD) and the Markets in Financial Instruments Directive (MiFID).
For all but the most insignificant changes to our rules we go on to undertake a formal consultation. This is the clearest and most direct way in which the industry can help shape regulation. Our consultations set out the issues, the policy options and our proposal to deal with it – as you would expect. But, significantly, they also include the cost-benefit analysis on which we have based our thinking. We aim to root our policy decisions in a firm understanding of the costs and benefits: not just the direct compliance costs, but the real impact our proposals will have on, for instance, the structure of a given market or moral hazard amongst market participants. As part of the so-called “N2+2 review” of the FSA we commissioned two independent reports to assess our cost-benefit work. Those reports – which were published in December 2004 – highlighted the substantial positive contribution that our cost-benefit work has made and the international reputation we have earned in this area. But we recognise that we must build on the progress we have made and continue to take on board new insights from external experts. And it’s because we recognise cost-benefit analysis can always be refined – and it’s because that analysis is important to our decisions – that the industry can help shape regulation by engaging with the analysis we publish, challenging the assumptions and offering alternatives backed up by evidence. In passing I should mention the proposal by HM Treasury to use a Regulatory Reform Order to reduce the number of consultations we undertake each year – by up to 20, they estimate. You may have seen this in yesterday’s Pre-Budget Report. This does not represent any downgrading of the importance we attach to consultation – of which there are some significant ones coming up in 2006. Instead it will raise the threshold a little on when we have to consult, to cut out some of those with the smallest impact.
Reviewing the Handbook
But consultation is not just a vehicle for increasing regulation. Consultation is a necessary part of identifying and taking forward opportunities to improve regulation – and even deregulate. You will know that in July we issued a consultation paper on Reviewing the FSA Handbook that set out proposals for changing our requirements on money laundering, approved persons and training and competence. In that CP we described the principles which we will guide us in reviewing the Handbook and asked the general question: what else do you think we should review? The responses we received are gratifying and frustrating in equal measure. They were gratifying because, on the whole, respondents agreed with the approach we proposed and the targets we had selected. Respondents agreed that we should be opportunistic in reviewing the Handbook, so reviewing the Handbook when we are implementing a European directive to avoid causing disruption twice. On a similar note, many newly-regulated mortgage and general insurance firms encouraged us to keep the rules applying to them as they are rather than face further change. Many respondents wanted us to pursue our work on making it easier to access and understand our regulatory requirements. And there was support for a more principles-based approach, though guidance is valued in some areas. This is important feedback, indicating that we are on the right track.
The frustration I referred to stems from the paucity of realistic suggestions for further Handbook review. That does not mean there were no suggestions – but they were limited in number and often in areas subject to European directives which we are obliged to maintain. Other suggestions related to parts of the Handbook that are due to be reviewed as part of implementing the CRD or MiFID, or they fell within the mortgage and general insurance regime which is shortly to be subject to review (we will, of course, feed the M&GI suggestions into the M&GI review team). The disappointing response to this part of the CP is similar to the previous occasions we have solicited suggestions. We would welcome any further ideas you have for review work – they can be emailed to betterregulation@fsa.gov.uk. Whilst we cannot guarantee to take forward all of the suggestions we receive – as we have to balance our legal obligations and statutory objectives – we will give them serious consideration. Therefore this is one of the most direct routes the industry has to potentially shape regulation.
Reviewing effectiveness and the costs we impose
In delivering on our commitment to better regulation we are not just reliant on proposals from others. We have a number of streams of work underway or planned to proactively review opportunities to improve the effectiveness of our regulation. Next year we will commence three reviews of the effectiveness of recently introduced rules. These relate to the mortgage and general insurance regimes, and depolarisation. The reviews will be looking at the effects on firms and consumers of these changes, whilst recognising that we need to allow time for the regimes to settle down. Take the general insurance review, for instance. The general insurance regime was designed to deliver four specific outcomes. The core of the review will have three elements. First, to encourage feedback from firms and other stakeholders on what they think is effective or ineffective in the regime we have introduced. Here – as well as more generally – we are keen for the industry and other stakeholders to come forward with views on the areas which could benefit from re-examination. Second, to undertake consumer research to see whether the intended benefits of our regime are beginning to come through - especially through consumers making good use of the information with which firms are now required to provide them. Third, to continue our thematic and firm-specific work to check that the industry is complying with our regime – since without such compliance the intended consumer benefits have little prospect of being delivered. So a key strand of this work is concerned with industry input and I encourage relevant firms to participate once the reviews begin next year.
As well as undertaking these reviews of specific policy areas, we are also conducting two broader pieces of work looking at financial services regulation. In conjunction with the Financial Services Practitioner Panel we are undertaking a joint study to collect evidence in three specific financial services markets on the costs to firms of our regulation. The results of this survey will be published in the first half of 2006. We are also analysing the administrative burdens that we place on firms. These are another opportunity for the industry – in the shape of the firms selected to take part - to shape regulation by helping us to collect the facts to consider how the costs and benefits of specific areas of regulation stack up. For the firms we approach for data there is a small price to pay – the time it takes to complete a questionnaire or be interviewed by a consultant. But this type of exercise is crucial if we are to pursue the better regulation agenda.
Discussing emerging issues
A central part of our approach involves identifying emerging risks, assessing them and, if necessary, proactively dealing with them. In doing so, we rely on industry and consumer contacts, market data and consumer research, to ensure we have the complete picture. For instance, during 2005 we have discussed with the hedge fund industry the risks funds can pose to our objectives and how we can mitigate those risks in a proportionate way. We also started a dialogue with firms and consumers about the regulatory regime that applies to sophisticated investment products (including, but not limited to, hedge funds) and whether there is scope to allow retail access to a wider range of funds. The feedback to this work will be published in 2006, but the process of early and open dialogue is one we are committed to.
As we recognise in the Action Plan, we are limited in the discretion we can exercise as we are obliged to implement European directives. Influencing and understanding the implications of the European agenda involve a considerable commitment of our resources, including senior management time. We look to our stakeholders for information and input to this important strand of our work. For instance, we published a paper on Trading Transparency in the UK Secondary Bond Market which examines whether there is a need for the provision of greater pre- or post-trade price information in the secondary bond markets. The paper is designed to stimulate debate amongst market participants to enable the FSA to develop an appropriate policy in respect of trading transparency in the secondary bond markets, particularly in advance of the European Commission's consideration of the issue, expected to begin early in 2006. The paper itself was prepared by us with the help of a small industry working group (although the paper itself is our work) and we subsequently held a useful seminar on the issues. Here – with our stakeholders’ involvement – we are proactively working for good regulatory outcomes.
Understanding regulatory requirements
I said earlier that one of the areas commented on by respondents to the Handbook Review CP was that they valued making our regulatory requirements easier to understand. There are many strands to this work, but I want to highlight today a couple of the ways in which we have worked with the industry to develop a shared understanding of our requirements. The retail area is home to one of the most high-profile examples, where we are developing a common understanding with the regulated community of our requirement to treat customers fairly. This has been undertaken with a consultative group drawn from trade associations and consumer bodies. Through statements of good and bad practice plus case studies we have illustrated some of the considerations that firms’ senior management should take into account under this principle. In the wholesale markets we looked at senior management responsibilities in relation to conflicts of interest and non-standard transactions. We hosted roundtable discussions with the senior management of major investment banking operations to identify an industry consensus on best practice in these areas. Our purpose was not to propose new standards but to help firms meet their responsibilities under our rules.
Promoting market solutions
I referred just now to one of our Principles for Business – treating customers fairly. I will come back to the principles more generally in a moment, but before we get to them we need to cover market solutions.
As you know, our approach to considering whether regulatory intervention is justified is to establish whether a market failure exists and then use cost-benefit analysis to identify the most efficient way to correct that failure. One of the ways to solve a market failure is for the market itself – collectively – to act. In the Action Plan we said that we will continue to work with the industry where possible, so that they own solutions to market failure problems. We have successfully promoted market solutions in a number of areas. These include industry solutions that have been delivered for soft commission and bundled brokerage and dealing ahead, as well as work currently underway in the wholesale insurance market looking at the issue of contract certainty. The Handbook Review CP in the summer included two proposals which also take account of the role industry can play. We consulted on a proposal to delete our detailed rules on money laundering and replace them with a high-level requirement focussing on senior management responsibility. This approach reflects the existence of industry guidance developed by the Joint Money Laundering Steering Group. Of greatest relevance to you, is the proposal to delete detailed rules on training and competence for individuals dealing with non-private customers. The changes are, of course, designed to reflect the risks for the different participants in different markets, but they also reflect the potential for the Financial Services Skills Council to work with the wholesale industry to establish standards, with even less involvement from us. We will continue to adopt this general approach, in which the industry helps shape regulation by taking ownership of market failures and delivering a solution.
A more principles-based approach
In his Foreword to the Action Plan, John Tiner commits us to aiming where we can to change the balance of regulation towards a more principles-based approach rather than detailed rules and guidance. Our current approach is a mix of high-level principles and detailed rules and guidance. We are realistic about the extent to which this can be changed in favour of principles: there are significant practical and legal constraints, and we need to ensure we retain rules which add value in our meeting statutory objectives.
How does the industry help shape regulation in a more principles-based approach? We believe that by encouraging a focus on how best to act in a situation rather than following a mechanistic process, there will be better outcomes for firms and consumers. By setting our standards in terms of principles – in terms of the outcomes we want to achieve – we can give firms greater flexibility in how they achieve those standards, in ways that better reflect their circumstances, their business model and the judgments of their senior management (who must ultimately be responsible for a firm’s conduct). In this way a more principles-based approach is a significant step forward for enabling the industry to shape the way in which it complies with regulation.
Making your interactions with us less onerous
I would like to finish by talking about some of the aspects of our work to make us easier to do business with, which is my primary responsibility within the FSA, and will affect how many of you perceive the FSA on a day to day basis.
We have been monitoring the satisfaction of the firms that have completed one of 8 regulatory processes including variation of permission and waivers, through a structured questionnaire administered by an independent market research agency. The detailed results from these satisfaction surveys help us to understand where our improvement activities are best focused and we can ensure we are addressing the issues that matter to the industry. We have already used these findings to help us redesign some of our training procesess for our staff and improve our application packs for firms. We will be publishing the results next year and setting ourselves a target for the future. We are also piloting this technique in our firm contact centre.
We have also been carrying out a review looking to clarify what firms can expect from their relationship managers and are in the process of reviewing the services provided by the Firm Contact Centre that is the main point of contact for those firms who do not have a relationship manager. We will publish statements of what we will do and what we expect firms to do in Q1 2006; and will introduce feedback mechanisms so that you can tell us whether we are meeting our standards and how we can improve.
Conclusion
By working with us you have the opportunity to help shape regulation. I would also encourage you to participate where possible in the various pieces of work the Chancellor has outlined in his report. Our Better Regulation Action Plan covers the many ways in which we have and will continue to work with you to ensure that the overall benefits of financial regulation outweigh the costs, and that we maximise those benefits, and that our routine interactions with you are as smooth as possible. In particular we are keen to receive further suggestions for where we can improve regulation – to remind you, the email address is betterregulation@fsa.gov.uk. But by working with each other, as well as us, to promote market solutions to market failures – and by working to support a more principles-based approach to regulation – you have greater scope to help shape regulation.
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