Retrospective action by the regulator - past, present and future
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Speech by Stephen Bland, Director of Small Firms, FSA
PIMS annual conference
8 June 2006
Introduction
Thank you very much for inviting me to speak today; I’m delighted to be speaking here at one of the premier events in the financial advice world.
Those of you that were here last year will recall that my colleague Michael Lord spoke on the subject of phoenix firms. That speech clearly set out our stance on this situation – that is that the FSA would take action where the directors of one firm seek to close that firm and transfer the business to a different entity in order to avoid past liabilities - and that we had already taken action in several cases. It is timely that I am here today because we have recently completed further work in this area and reviewed our own internal systems for dealing with this. We have been pleased to see over the past year firms have been more willing to work with us in ensuring that consumers are protected when there is a change of legal entity, which is good news for us all. Firms are asked to sign an undertaking that they will honour their past commitments or to ring-fence monies to meet those commitments. Our position on this subject remains that we are determined to deal with firms who attempt to phoenix and I can assure you that we have continued to do that. But you will often not be aware of what action we are taking as this won't usually result in a public announcement.
However, phoenixing is not the subject that I want to discuss today. Instead I want to respond to concerns that the FSA applies its regulation retrospectively, and that there is an even greater risk that it may do this as it moves towards a more principles-based regime. There is a line in the Lord of the Rings where Bilbo Baggins confuses his party audience by saying that: "I don't know half of you half as well as I should like; and I like less than half of you half as well as you deserve". Bilbo left his hearers temporarily baffled. My version of that confusing statement today is to pose the question: "Will the FSA in the future be more retrospective than some think we have been in the past and are in the present?!" I will try not to leave you more than temporarily baffled.
We are well aware of existing concerns about alleged retrospective actions by the regulator. There will be those of you who will be concerned or require more clarity that the FSA isn't going to apply standards retrospectively as we focus more on a principles-based approach. To use a topical analogy, would a world cup referee be seen as likely to move the goalposts more often if the FIFA rulebook were less detailed?
The FSA's position on retrospective regulation
It might be helpful to look initially at the suggestion at why retrospective action by the regulator has been raised as an issue in the past. When John Gummer, Association of Independent Financial Adviser's (AIFA) chairman, spoke at their annual dinner back in November, he said that “when complaints are made against firms these need to be judged by the standards, business practices and social and economic climate applicable to the time that the advice was given”. He highlighted the role that AIFA’s “stakes in the ground” initiative could have in terms of documenting the current business environment and practices, as a record to be drawn upon in years to come.
Of course John is not the only one to have expressed these sentiments. The question as to whether the FSA applies its standards retrospectively is something which has been raised by the industry before.
Let me state unequivocally that the sentiments expressed by John are ones that I whole-heartedly agree with and endorse. Firms should indeed be judged by the regulatory requirements applicable when the advice was given and against the assumptions that were reasonably made at the time; there should be no retrospective application of later, more exacting, standards with the wisdom of hindsight. That has always been and will continue to be the FSA’s position.
So, with this as our stance, why is it that we are sometimes considered to have applied today’s rules to yesterday’s business? It is the case that, being a risk-based regulator, we take action when there is a real risk of consumer detriment, rather than seeking to pre-empt every possible risk to consumers. And that can mean that large scale past business reviews take place some time after the initial sales took place. The potential mis-selling of endowment policies, for example, did not emerge as a high risk issue until markets were falling, and regulatory action was not taken for some time after many of the original policies were sold. But that does not mean that we were retrospective in the standards we applied. Indeed we were careful in our guidance to the industry on how to handle complaints to make clear that we recognised that record-keeping standards might be lower than would be the norm now, and that the absence of records should not automatically weigh against the firm (or the consumer).
Our predecessor the Securities and Investments Board (SIB) took the same approach when it initiated industry-wide reviews of past business for personal pension transfers and opt outs (from occupational schemes), as did the Personal Investment Authority (PIA) when it subsequently reviewed Free Standing Additional Voluntary Contributions (FSAVC). In setting up both reviews it was considered that the situation consumers found themselves in as a result of advice given had been foreseeable at the time of the original transactions but had not been properly taken into account and/or that the potential risks had not been adequately explored and explained. Current market conditions were relevant in calculating redress for those to whom it was due, but the standards against which sales were assessed for compliance were those in force when the sale was made.
More recently, the FSA has conducted work on contracting out of the additional state pension via a personal pension with a sample of relevant firms in order to gather information about historical and recent sales practices. This work highlighted that, generally, there was a considerable degree of commonality of approach within the industry. Whilst this work is on-going, we have categorically stated that we will not apply standards retrospectively. Indeed to decide if further regulatory action would be appropriate, we have undertaken extensive work to gather information from the industry about historical and recent sales practices. We have also looked carefully at the legal and regulatory environment in place across the period since 1988. We are convinced that our approach here is not being retrospective.
Helping ensure this
Fine words, you may say. But perhaps you are feeling like the astronomer Galileo. When in front of the pope for having uttered the heresy that the earth moved round the sun, he felt obliged to recant to save his skin. But he muttered under his breath "but yet it moves". So, if you are in that position, how can I reassure you?
Well, there are a number of ways of ensuring that the FSA is properly accountable, and that you can hold us to account if we do not match our fine words.
First, this speech is itself designed to be what the economists would call a pre-commitment mechanism. If we were now to do some retrospective regulation, you would rightly throw this speech back in our faces. So by the very fact of making this speech, we are less likely to do retrospective regulation going forward.
Second, we have been taking steps to make our expectations clear to you in particular circumstances at an early stage. The reason we do that is of course primarily to help you understand what is expected of you; but it also has the side-effect of making it clear at any point in time what those expectations were, and thus were not. For example, the whole of the first year of statutory regulation of the mortgage and general insurance intermediation markets has been full of us issuing our findings in thematic work about various aspects of these markets, so as to make clear our expectations and to help firms to meet them. Our greater emphasis on giving you guidance in itself makes it less likely that we will be able retrospectively to move the goalposts even if we wanted to.
Thirdly, your Trade Associations can help keep us up to the mark. I referred earlier to AIFA’s “stakes in the grounds” initiative, another positive step in terms of developing a wide ranging “map” of current market practices and the factors that may influence those practices at a particular point in time. So, it was good to hear AIFA has just announced that their first “stake”, so to speak, will consider advice on with-profits. I am sure that to have such a written record of the custom and practice of advisers in this and other areas will prove to be useful for all.
Fourthly, if we were to go wrong, there are legal ways of taking action against us. The FSA has ultimately to justify any proposed disciplinary action before the Financial Services and Markets Tribunal. This is an independent Tribunal created by the Financial Services and Markets Act and run by the Department for Constitutional Affairs. It provides a forum for the independent review of certain regulatory decisions.
And fifthly, you as individual firms can help yourselves. Having met our requirements, by establishing suitability and making adequate explanations of risk, you need to ensure that you have properly documented the advice you have given and the reasons why. Keeping adequate records is one area where you can help yourself to demonstrate compliance and reduce the need for regulatory intervention. The FSA made it clear back in 2003 in the context of mortgage endowments how important it is for firms to keep an adequate record of any advice given to consumers and the reasons for it. And we highlighted the need for action by the management of firms to address poor record keeping issues. This is not just a regulatory requirement – it is also good business practice; how can you really know your customer (and thus give them good advice) if you have not established the relevant facts about their position? We consider standards of record keeping as part of our supervision activity, in our risk assessment of firms and indeed in considering referrals to enforcement where appropriate. Of course we will always seek to proceed on the facts rather than on unsupported assertions of either firms or their customers. But appropriate record keeping makes it so much easier for you to justify the stance you took in a particular case.
Financial Ombudsman Service (FOS)
Clear record keeping will also assist firms if complaints are made to the FOS. The FOS is of course a separate entity from the FSA and it is FOS rather than FSA which is responsible for investigating individual complaints. As an organisation independent of the FSA the manner in which it determines individual cases is for it to decide. Where there is a dispute about what happened, the Ombudsman – like the courts – decides what really happened, on the balance of probabilities, in the light of the evidence that is now available. Having done so, the Ombudsman decides whether or not the firm was at fault – basing the decision on the rules and standards applicable at the time of the sale.
The FSA does of course work together with the FOS where it makes sense for us to do so. The “wider implications” process is one example of this, where both the FSA and the FOS have sought to ensure we are aware of cases that may have wider implications for either firms or customers. Such cases could include those where a widespread issue might result in significant consumer detriment and where regulatory action by the FSA may be appropriate.
Our enhanced procedures under the “wider implications” initiative seek to do a number of things. Firstly, to clarify the different roles and responsibilities of the FSA and the Ombudsman; secondly to enhance co-operation on cases between the two organisations; thirdly to improve the overall transparency of the process; fourthly to set out clearly for both consumers and firms how and when the FSA will deal with such cases through the use of our regulatory powers; and fifthly to publish on joint webpages information about issues that have been resolved through the “wider-implications” process. This "wider implications" process thus enables us to co-ordinate with FOS on issues where a common view is necessary on issues such as the standards expected at a particular point in time.
To give an example, the ombudsman service started to receive a small number of complaints from policyholders in closed funds. Some of those complaints turned on issues that were specific to the individual case – such as the advice the individual investor had received. But other complaints turned on a general allegation that a particular with-profits fund was no longer actively managed as a result of being invested in fixed interest assets. In the light of this, in 2005, the FSA published on its website a description of its process for considering management actions by with-profits insurers. The FSA has also produced information for consumers to help individual policyholders understand the position and the available options. In turn, this will help the ombudsman service explain the background issue to individual complainants.
The FSA will also provide the ombudsman service with relevant information in relation to the FSA’s overview of particular funds so that the ombudsman can consider, in individual cases, whether a fund’s investment decisions can be regarded a legitimate exercise of commercial judgement aimed at the interests of all its policyholders.
More principles-based regulation
And this sort of collaboration does become increasingly important as we move towards a more principles-based approach to regulation.
Under this more principles-based approach, where a previous response to widespread problems of mis-selling might have been to consider more detailed rules, the future response will be more to determine how the existing principles for businesses apply in that particular situation. The key with principles is focusing on the outcomes, and less on the route to achieving them. And this is the way that our focus is moving as we think that is the best way to be able to react swiftly and flexibly in a fast-changing world. And I think it is probably common ground that the world of financial advice is fast-changing. If I may be permitted a quick "plug", next week we are holding the FSA Retail Intermediaries Sector conference in Birmingham looking at the future of the industry and where it is heading. As part of that conference we will consider plausible scenarios for what the world might look like in five years' time – we believe it is really important to consider how the world is changing and how that affects the way that businesses operate going forward. Places are still available via our website.
You may be asking why it is that we are choosing to shift our emphasis more onto the principles-based approach now. We think that a move to a more principles-based approach is important for several key reasons. Firstly because we want to provide firms with the flexibility to better align good regulatory outcomes and good business practice. Secondly we believe that often – although not always - better treatment of consumers can be delivered through firms own initiatives and actions rather than through regulatory details. Thirdly it is a key element of our response to the challenges posed by the better regulation agenda, about which we will be saying more at the end of this month. And finally, though less relevantly for this audience, because we believe it will further consolidate London’s position as the location of choice for mobile capital.
I should say here that principles-based regulation is not new. There are 11 high level principles which have been in place in the current form since 2001 and which are the backbone of the regulatory regime. The key about these principles is they state the outcome we are trying to achieve as opposed to the means of getting there.
Of course we recognise that detailed rules will be required in certain circumstances. This may be for example where we have no choice but to implement EU directives such as the MiFID. Or where we need to achieve consistency of standards, for example by setting prescriptive standards for disclosure documents in order to facilitate comparison and shopping around as well as aid understanding. So prescription is sometimes necessary.
But we mean what we say, and the real proof of the pudding will be seen when we consult on aspects of a radically-simplified conduct of business sourcebook this autumn. This will be a huge step in moving towards more principles-based regulation in the financial advice market. As I hope many of you have noticed, we have put real emphasis in the last year on improving our communications to small firms. This is two-way; we want your views on the consultation papers about the new conduct of business sourcebook – easily done now via the online response form which will be highlighted through our monthly regulation round-up. We need to hear the views of all firms – both small and large.
But I should also stress here that a more principles-based regime is about very much more than just a simplified rule book. We recognise that it will require FSA staff to have the appropriate level of skills and knowledge to make good judgements based on good business understanding and being able to communicate clearly and effectively what it is the FSA is seeking to achieve. Without that, there would be the danger of less consistency in our judgments about individual firms, and thus the risk of retrospective regulation being applied in practice.
However, we recognise our need to address this issue and we have a substantial on-going training and development programme. Within the context of our revised risk assessment framework, we have also launched a dedicated course to inculcating the behaviours we want our staff to display in their dealings with you. Some 300 of our supervisors have received this in depth training with approximately 400 more to follow this year. We also recruit a significant number of staff with recent experience of the financial services industry which we believe really enhances our ability to achieve these goals. And we have a work shadowing scheme in place in which we place staff for short periods within retail intermediary firms really to enable them to get to grips with the issues you all face. We started these industry placements last year and they proved to be a great success for all parties, such that we aim to ramp it up considerably this year. We are always looking for firms to participate in this scheme so if you are interested please talk to one of our staff who are here today or look at our website for more details.
And in helping the move to more principles-based regulation, the trade bodies will really add value. What I mean here is not for the trade associations to become some second-tier regulator but rather to provide real value to their members by providing guidance which helps them to raise their standards in line with good business practice. Again, this will help avoid any danger of retrospective regulation. There have already been some good examples in this area, such as on equity release where the industry has worked well to try to raise standards; our findings on the extent to which standards in the equity release market have progressed will be published shortly.
And there is still more we can and will seek to do in this area. The FSA recognises that it will also need to continue to provide guidance as we move to more principles-based supervision. But we also recognise that there is little value in replacing detailed rules with the equivalent amount of guidance. And the guidance will be just that – the onus will more often be on you to decide how you achieve the outcome.
And you will see evidence of our more principles-based approach as we announce the results of future thematic work. Indeed we are just in the later stages of completing a substantial piece of such work looking at the quality of how advice is given by financial advisers. In this area we unfortunately know some of the current market outcomes for consumers; this project was designed to produce guidance which may help firms' management as they consider how to produce better outcomes. The aim of this project was to measure and improve how consumers of financial products receive advice in the context of treating customers fairly – which as I'm sure you know is one of our principles. It’s a key piece of work, and an example of how we are moving towards a more principles-based approach in the way we operate. The substantive detail coming out of this work will be announced shortly. Suffice to say for the present, that this work confirms to us that a more principles-based approach will also pose challenges for firms.
Generally, the more principles-based approach will require you to understand what we are trying to achieve and align your business to this, and it will require compliance and legal teams to work in a different environment with less prescription. It will involve sometimes working in a different way. But it will also provide you with greater flexibility in how your run your business. And there is no reason why the move to a more principles-based approach poses any additional 'threat' of potential retrospective action. I hope I have been quite clear that firms should be judged against the standards and rules of the time at which they give advice and that remains the case as we move to a more principles-based regime. The industry and its trade associations working together, with constructive and open dialogue with the FSA, will be key to helping to deliver a principles based regime that has soundly capitalised, well-managed firms that treat their customers fairly. Engaging with us in this shift will benefit us all in helping to make it work and limiting the number of instances when the accusations of mis-selling will arise in the future.
I have quoted Bilbo Baggins and Galileo. Who better to quote in closing than the FSA's chief executive John Tiner? When talking recently about Better regulation and the move to a more principles-based approach, he said that "the changes and approach I have outlined will not happen overnight…. But we do believe in these changes and that the effort required will be justified by the benefits they will deliver for firms, consumers and the international competitiveness of UK financial services".
And let me end on a further positive note. The worries about retrospective regulation are in some sense a "nice problem" – there would not be such worries if the industry was not improving its standards over time. A shift to more principles-based regulation creates opportunities for you to run your businesses more flexibly in accordance with good business practice as it evolves, and helps avoids the risk of a one-size-fits-all solution being imposed on you which does not work for your business. That greater flexibility does involve fewer, detailed rules and more onus on you. But this is an opportunity not a threat. A world in which regulatory requirements are more closely aligned with good business practice is an attractive world and I urge you to embrace it wholeheartedly.