4 March 2005
Speech by Clive Briault, Managing Director, Retail Markets, Financial Services Authority
APCIMS Investment Day

Thank you for the invitation to address your investment day.  It is a great pleasure to be here.

The macroeconomic overview provides a useful backdrop to the rest of the morning. There has been a gradual improvement in the market over the last year or so, with solid figures for private client assets under management in the UK – £300bn at the end of 2004. And other longer term trends are also relevant to the work of APCIMS, including the shift to consumers taking more personal responsibility for their longer-term financial planning, including pensions and investments.

We understand that regulation – both UK and European – is a significant factor in your business, and can be a cause for concern. Today I will focus largely on our retail agenda (as outlined recently in our Business Plan) including those aspects relevant to APCIMS members. I know that Angela is very keen that we don't represent you as being solely 'retail' but I will be focusing largely on those areas which fall on my patch!

As always there is also a lot going on elsewhere, including cross-cutting issues which affect all aspects of our work – retail, wholesale and markets. We know that these issues have an impact on many APCIMS members. I won't go into these in detail, but they include in no particular order: developments with the LSE, softing and unbundling, forthcoming papers on hedge funds, our internal review of our enforcement procedures, work on costs of regulation, a review of our Handbook requirements and a range of European and other initiatives (Market Abuse, IMD, MiFID, CRD etc).

On the costs and benefits of regulation, this is an area where we know that you and others in the industry continue to have concerns. We are already required by FSMA to be rigorous about the burdens and costs we impose, but we can do more. We announced yesterday further details of our cost of regulation study, which we are conducting in partnership with the Practitioner Panel. The aim is to provide more accurate estimates and better understanding of the costs of our regulation, to analyse the incremental costs of regulation on top of what firms would spend, even in the absence of regulation, and to identify the impact of our regulation on prices, services and competitiveness. There will be a particular focus on the impact of regulatory costs on small firms.

We have also established a project team to lead our Handbook Review. The focus of this work will be to identify priority areas where our requirements can be cut back without damaging or limiting our ability to achieve our regulatory objectives. We will publish a consultation paper later this year setting out areas where we may be able to modify our requirements because they are more restrictive and detailed than is absolutely necessary, are not delivering benefits to justify their costs, or are inconsistent with our focus on senior management responsibility. In this context, the implementation of MiFID will also provide an opportunity to review the wider structure of the COB sourcebook, with a view to streamlining this.

We firmly believe that the Handbook Review and the costs of regulation study are excellent news for the industry, demonstrating that we are listening to your concerns and taking action.

 

Wider retail agenda

Our priority for the retail market is to make retail markets for financial products and services work more efficiently and effectively, and thereby to deliver through these markets a fair deal for consumers.

To achieve this, we are focusing our regulatory activities on four pillars:

  • 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.
  • And risk based regulation.

I will focus today mainly on the last two, but first a few words on financial capability and information.

 

Financial capability

Increasing consumer understanding and awareness to deliver more capable and confident consumers is a key element in improving how the retail market operates.

More confident and capable financial consumers will be better equipped to exercise a stronger influence in these markets; to take greater responsibility for their own actions; and to protect themselves through less mis-buying and being less susceptible to mis-selling.  

We face a huge challenge in this area due to the very low levels of basic financial literacy in the UK. We are doing a range of things to tackle this, including providing information and awareness services to help consumers make informed financial decisions, including our consumer website; our comparative tables; and a range of consumer publications, including guides and fact sheets on a range of topics.

We also lead and coordinate the National Strategy for Financial Capability. This is a long term, ambitious project – involving numerous stakeholders including the industry and the government who also share our interest in this subject – that aims to deliver a step change in financial literacy.

This strategy for financial capability is a huge challenge. To be a success, we will need to reach millions of individuals across the country and persuade each of them to learn more about personal finance, and to be willing to apply these skills and knowledge in their day-to-day financial decisions. Whilst the focus is on basic 'entry level' financial skills, we are also looking to raise levels of understanding more generally among the wider population, including among the private investors and clients of APCIMS firms. This is, and will continue to be, important, not least given the shift to greater personal responsibility for pensions and savings, the decline of defined benefit pensions schemes, and so on.

So financial capability will continue to be a key priority for us over many years to come. I encourage you to engage with this.

 

Information

Moving on to the second component of an effective retail market, we want consumers to have access to simple, clear and understandable information and to use it to help them make financial decisions. 

Over the coming year we will continue our work on improving the quality of information on investment products provided to clients at, and after, the point of sale. Our enhanced disclosure proposals include two new disclosure documents – the initial disclosure document or Key Facts and the menu. These Key Facts documents simplify and focus the information about a product, including risk warnings, that we will require firms to provide to consumers.  They are based on the principle that “less is more”.  And they are based on an approach that makes greater use of layers of information – so that consumers who are not willing or able to delve further can at least obtain easily a core set of information.   The first Key Facts documents are now in use for mortgages and general insurance and they will be rolled out for investment products later this year. 

Disclosure of information is also high on the list of priorities for the Treasury Select Committee. In their July 2004 report into long-term savings, the TSC recommended that the FSA should work with the industry to develop a summary box providing information to consumers on key aspects of an investment product, and to develop a simple indicator of risk for investments. 

We share the Committee's view that effective consumer information is a priority, and we believe that our work on these issues is very much in line with the objectives behind the Committee's recommendations.

However we do not believe that a single solution, such as the 'summary box' suggested by the Committee, can work equally well for 'most marketing material', particularly if it is to cover, as the Committee has also suggested, information about guarantees, risks, assets, charges, and early withdrawal penalties.  We expect that what we will deliver will be a package of measures that address consumer information needs in a balanced and proportionate way. 

Our work on the second recommendation -  risk indicators - is still in its early stages.  We have convened a working group of stakeholders that comprises industry and consumer representatives and specialists in the field of risk.  Their initial conclusions are that, despite the clear complexity of the nature of 'risk' in relation to investment products, it should be feasible to improve the way the industry explains risk to its consumers. 

However, this may not be as simple as a 'traffic light' indicator.  The working group noted from the outset of their discussions that it is possible to over-simplify messages about risk.  And we believe strongly that absolute measures are rarely sufficient, as risk must be understood and assessed in context. For example, it is arguable that the most significant risk to get across to a customer from the outset is that most investments carry a risk to capital. 

At one level, a simple, direct, message or symbol that captures that concept alone could be very effective, could have currency across a wide range of marketing material and products to ensure that consumers are in no doubt as to the nature of a product on offer.  But risk to capital can, itself, vary in degree; so we are also exploring indicators that can help the consumer understand the level of that risk and how it may change with the passage of time.  

I know that APCIMS has been doing some positive work on the subject of helping their members and clients understand risk, including the booklet you have produced for use by financial advisers when assessing the risk appetite of the client and the so-called “Checklist for risk”.  We see this is as a constructive contribution to a very difficult subject.

Another key subject in the retail market is the impact of the new depolarisation regime and the new Menu which advisers will be required to give to their clients so they can understand better both the costs of financial advice and the difference between paying for advice on a commission basis and paying a fee.

Our focus may seem to have been largely on the IFA and direct sales markets – and it will be interesting to see how these markets respond. But we do understand that depolarisation will affect many APCIMS members. I would like to reassure you that we are fully aware of, and sympathetic to, your particular interests and concerns on depolarisation. My colleagues have been in dialogue with you and are working to identify practical ideas to mitigate the problems you envisage. Overall we believe that depolarisation will promote lively competition in the retail investment market, and still protect consumer interests – by improving disclosure and transparency, and providing greater consumer choice. 

Of course,  we recognise that APCIMS members, and your clients, vary widely and offer a different range of services from many "pure" IFAs.  But we believe some similar principles apply. You need to make clear the nature of the service you provide and what it costs up front. And in advising clients, you need to be very mindful of their risk appetite and how you have reflected that in your advice and the risks associated with the products and services you recommend.

 

Treating customers fairly (TCF)

Moving on to the third core strand of our work to achieve more efficient and effective markets in retail financial services and products: treating customers fairly. Or as I should perhaps say to this audience 'treating clients fairly' – an important distinction which APCIMS has been keen to point out.

The responsible treatment of consumers by firms is required by the sixth of our eleven core principles for businesses. We are looking to senior managers to embed the principle of TCF in their corporate strategy and to build it into their firm's culture and day to day operations. 

We want to make progress here without writing ever more detailed rules, and without having to resort to more detailed monitoring or tougher enforcement actions.  Ever more intrusive regulation  would almost certainly create more defensive and costly markets, and thus markets that are smaller and less innovative.  This would not be in the best interests of either firms or their clients.

We would therefore much prefer to rely more on an intelligent, thoughtful and effective implementation by firms of the high level principle that they must treat their clients fairly.  And this will allow us over time to safely reduce the amount of prescription in our rules.   

 

I have heard the view that TCF is about product design and marketing, and therefore not relevant to APCIMS members who neither design nor sell products.  But as Callum emphasised when he spoke at the APCIMS annual conference in November last year, TCF is about the much wider issue of the way authorised firms with retail clients run their business.  So far, our communications have tended to focus on the product life cycle. But many aspects of the product life cycle apply to firms offering services just as much as to those offering products.  And this is particularly relevant where the focus of your business is on developing longer term, more personal relationships with clients.

Clearly, we need to take care to ensure that our communications on this subject are clearly presented and relevant to APCIMS members.

Some of my colleagues met with your Chairman, Mark Powell, only last week to explore the particular areas of the work we have been doing, and to consider their relevance for APCIMS members.  It was a very useful discussion as it gave us an opportunity to gain a better understanding about your business, and to explain why we regard TCF as being relevant to your businesses. 

Let me offer you some examples. We want senior management of firms such as yours to be asking themselves:

  • How do you articulate your fundamental position on TCF, at Board level, and cascade that right through the firm?
  • Do you have procedures and can you show that your Know Your Client records are up to date, so that you can demonstrate a good understanding of a client's attitude to risk and any changes in this attitude? This is of course a key issue for all of those giving investment advice and portfolio management services because the core of your offering is to make sure that your client’s portfolio fits with their appetite for risk, and that they are absolutely clear about what risks they are taking on.  It also needs to be clear to your clients whether the service they are buying is a one off, in the sense that you advise or act only in response to an instruction or inquiry from the clients, or whether it includes a regular review and that you will take the initiative in recommending the action to be taken.  
  • Is your charging structure - whether based on fees or commission - straightforward and transparent? The transparency issue will of course be linked to the question of the service that is provided.  But there may be more to it than that – do you have commission structures that might incentivise your staff to churn a clients’ investments?  If so, what do you do to make sure that cannot not happen?  One of the key messages we try to get over on TCF is that we want firms to review the way they operate so that they are aware of these kinds of risks and then consciously either avoid them or protect against them.
  • There may be other aspects of remuneration that you should look at. We recognise that firms' policies for paying staff are driven by commercial considerations/retention needs/the market you operate in etc. But we believe you should be able to develop your remuneration policies in a way that is also consistent with TCF. For example do you remunerate staff purely on the basis of short term volumes? Or do you operate more sophisticated rewards, for example linked to wider objectives or a balanced scorecard, including persistency and complaints data and longer term client retention and satisfaction? Do you have controls and MI in place to detect and address early any potential inappropriate behavior, for example inappropriate sales, or poor complaint handling?
  • Another big issue for us is complaints handling.  We have heard the arguments that your businesses depend on giving your clients a good service, because if you don’t they will take their business elsewhere.  There may be truth in that, but we don’t live in a perfect world and things go wrong, and people make genuine mistakes.  So do you have effective complaints handling procedures for when things do go wrong? Are the people who investigate the complaints independent of the area against which the complaints is lodged? Are the procedures fair and do you respond promptly?
  • Something that is often overlooked is the useful information that complaints tell you about your business.  No doubt some of you are thinking you don’t have an issue because 99% of the complaints you get are about investment performance.  But doesn’t that tell you something?  Of course some people will try it on, but getting those complaints should make you look at whether, for example, you need to review and improve the way you explain to a client what risks are attached to their investments/portfolio.
  • On the subject of strategic initiatives and change programmes, do you actively consider the impact on your clients of major changes to the way you do business and factor that into your communications with clients? We will shortly be giving some feedback on what we have found in looking at the way firms have approached depolarisation – but this is just one example and the point is equally valid for other kinds of change.
  • On management information - we don't expect that you will need to produce additional MI simply for TCF purposes, but do you have any management information that tells you how well you are doing against these treating clients fairly issues, and whether your approach has been embedded throughout your organisation? And how far up your organisation does that MI go?
  • And finally, occasionally it goes wrong – a fraud, an error or oversight. Is the way you treat your clients when putting that right at the forefront of your approach to resolution?

So what are the next steps for TCF? We will publish a range of material on our website later this month, including reports on our cluster work (on product design, remuneration, management information, complaint handling, producer/distributor interface and strategic change) and an example of a firm-specific case study. This material is not specifically targeted at the APCIMS community – it deals with all the sectors we regulate.  But some of the material will reflect the visits we have made to APCIMS member firms.  I hope you will look at it and think laterally to see how your firms can learn from the feedback.  This will be followed in June by a full report on the last year's work.

 

Risk-based regulation

The fourth pillar of our retail agenda is enhancing the efficiency and effectiveness of our risk-based regulation. This is a broad topic, so I'll mention a couple of the themes under this heading which may be of particular interest to APCIMS firms.

We deal with emerging retail risks in two ways.  First, where supervisors identify risks within the individual firms they supervise, they take steps to mitigate these risks with the firm concerned.  Second, we identify risks arising across different types of firms and market sectors and carry out work to mitigate them (thematic work).

In the context of the first of these, individual firm supervision, we are in the middle of a fundamental review of our Arrow risk assessment framework. Its purpose is to ensure that we identify, assess and mitigate risks to our statutory objectives in a consistent and prioritised way.

We want to strengthen the link between risks and the allocation of our resources; we want to embed the TCF principle more fully into the Arrow framework; we want to continue to improve the capabilities of our staff; we want to introduce closer dialogue with firms throughout the Arrow process; and we want to make further progress in differentiating our approach to firms according to the risks they pose to our statutory objectives.

Within this review of Arrow we are also developing what we are calling our Product Risk Framework. The output will be a set of tools to help us become more effective in spotting emerging product risks and taking timely and proportionate actions.

As well as firm-specific we also undertake thematic supervision to tackle risks that cut across different types of firms and sectors.

We are now operating a streamlined process to identify, assess, prioritise and (where necessary) mitigate emerging retail market and product risks. This process draws on what our supervisors and policy staff are seeing in their day to day work as well as other sources such as the Consumer Panel, the press, MPs, consumer groups and others. As we have finite resource, we prioritise our workload to focus on the biggest risks.  In many cases we decide that further regulatory action is not necessary, but we will often do a small amount of work on an issue to identify whether more action is warranted or more extensive thematic work across a number of firms. We intend to publish on our website examples of the types of risks we have reviewed.

An example where we have taken proportionate action is Venture capital trusts (VCTs).  We carried out some research to better understand the VCT market early last year.  We found that VCTs were mainly sold to relatively wealthy individuals as part of a balanced portfolio, that the VCT adverts being run at that time were clear about the risks, and that they directed potential investors to financial advisers. We decided that immediate action was not warranted at that stage, but that we would continue to monitor the market.  Over recent months we have seen greater activity in the VCT market: there has been an increase in the number of VCTs applying for listing, an increase in the amount of adverts and they have received greater media coverage. Consequently we are currently revisiting this market to see whether the risks have significantly changed and what – if anything – more we should do.

Thematic work may involve firms of different sizes and sectors. It will be particularly relevant for those smaller firms who do not have their own FSA relationship manager or regular Arrow assessments. We are acutely aware that a large proportion of our regulated firms are small. Therefore in our Plan for 2005/06 we outlined a range of ways in which we are trying to make it easier for smaller firms to do business with us. These include guides to the FSA Handbook; improving further the ability of our Firms Contact Centre to deal with queries; the Firms Online system which enables electronic submission of information; sector newsletters, conferences and many more. Within my Retail Markets Business Unit we have a dedicated Small Firms Division – and we have used the arrival of 18,000 new M&GI firms as an opportunity to revise the way we assess and manage risk among all our smaller, primarily retail firms.

 

Relationship with FSA

I would like to take this opportunity to reinforce the importance we attach to building on and maintaining a good relationship with APCIMS and its members. We are taking deliberate steps to increase our contact and dialogue with you. Putting in place the Asset Management Sector lead (Dan Waters and team) was a notable first step. Sam Tymms (Head of Department in our Retail Firms Division) is our APCIMS champion.

Our relationship with you has been tested recently on the subject of our regulatory fees, on which we published proposals in January (CP05/02). We understand that APCIMS is concerned that its members are allocated to fee blocks which include different types of firms, and therefore facing the consequences not only of their own activities, but those of firms doing different business. There are also concerns about the substantial increases in the FSCS levy, where the FSCS is, amongst other things, making provision for compensation claims associated with split-capital investment trusts.

We have held discussions with APCIMS, other trade bodies, and the FSCS on this issue. We are clear that there can be no changes to either the current FSA fee structure or the funding structure of the FOS/FSCS for the year 2005/06. However we do understand that the current structure is a cause of some concern for some of the firms we regulate, and we have indicated that it may be appropriate to consider revisiting some of the decisions taken when the structure was agreed in the early days of the FSA in order to determine whether the rationale for those decisions is still valid.

More generally, I know that APCIMS has a concern that we do not understand or appreciate the private client model which you offer. I have even heard the view that we tend to treat private client advisers and brokers as IFAs. Let me assure you that this is not the case.

We recognise that what you offer in the retail sphere is a service, where relationship management and client retention are your primary measures of success. We recognise that you do not confine yourself to the periodic sale of a packaged product. We also recognise that typically you are at least reasonably well capitalised. We also understand that, while many of you may not all be of the size of say Barclays, you are of sufficient size to have made appropriate investment in systems and controls, and in training and competence, recognising that ultimately it will be these that ensure you treat your clients fairly.

But we do not accept that there are no risks attached to your proposition. These may not be exactly the same risks as in other parts of the financial system, but they are very real. For example we have seen some worrying cases of poor complaints handling by stockbrokers, and instances of clients being advised on investments where the level of liquidity risks associated with these investments were not made clear. We have also seen cases where firms did not make clear to their clients the scope and nature of the service they were being provided with. The key themes I have touched on today – information, disclosure, treating clients fairly – are all relevant here.

Finally, we do agree that your business is an area where we have lost some skills and supervisory knowledge, compared to our predecessor regulators. Part of the thinking behind creating the sector leader roles in the FSA is to increase training and expertise. We are working on a core curriculum which we believe will increase our staff's capability and understanding of the industry. We are also operating short, 6 week secondments from the FSA to the industry to increase our understanding and dialogue. And APCIMS has kindly helped us arrange some industry delivered  training to a number of our staff who supervise this sector. Combined with our continuing graduate programme (which includes a placement in the industry) we hope this will provide a substantial increase in our knowledge of your sector.

 

Conclusions

I hope that I have managed to provide an overview of the key retail priorities from an FSA perspective.

Clearly there are challenges in the relationship between us and the APCIMS constituency. However we value the robust challenge which APCIMS provides. We will continue to engage and work with you to tackle these.

Thank you.

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