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Speech by Dan Waters, Director Retail Policy Division, FSA
Keynote speech at NEWCOB briefings
January/February 2007

Good morning ladies and gentlemen. I am delighted to be with you today to talk about one of the most important developments in the FSA’s move to more principles based regulation (MPBR). That is, the radical revision of the Conduct of Business sourcebook. We consider NEWCOB to be our flagship project for more principles-based regulation. Our revision of NEWCOB of course has included our implementation of the Markets in Financial Instruments Directive (MiFID), which introduced regulation of many aspects of retail investment services in many European member states for the first time. But, in the case of the UK, where we have been occupying MiFID regulatory space for nearly 20 years, we thought it sensible to fold MiFID into our wider CoB reforms.

Producing the NEWCOB CPs has been a major piece of work. We published the draft new Conduct of Business sourcebook (NEWCOB) for consultation towards the end of last year and, apart from core MiFID material, it is still out for consultation. But as important as the CP on NEWCOB and the subsidiary CP on Financial Promotions are, they are just the beginning of a wider programme to implement more principles-based regulation in our day-to-day work, in supervision, policy and enforcement – right across the regulatory board. So today I'm pleased that we are going to cover both the CPs and the wider issues of implementing them.

Before I turn to NEWCOB, I want to take a moment to talk more generally about principles-based regulation and what the FSA is seeking to achieve by moving more strongly in that direction.

More principles-based regulation

I believe that there are three key components at the core of more principles-based regulation.

First: The FSA is being clearer on the outcomes that really matter – hence the focus on principles and high-level rules rather than pages and pages of detailed requirements. In that spirit, you will have seen that our proposals for NEWCOB yield a sourcebook that is about half the length of the old COB.

Second: The move towards more principles-based regulation will give firms more flexibility to innovate as to how they achieve the outcomes we are seeking. We recognise that there is a profusion of different business models in financial services. By having a better understanding of the regulatory outcomes that we are seeking to achieve, firms will be in a position to assess how, in the context of their particular business, those outcomes can be most effectively and efficiently delivered. The primary responsibility for delivery is and remains where it has always belonged - with each firm's senior management.

Third: The FSA will adopt a more interactive and positive approach in giving guidance to firms about acceptable standards, including working with industry trade associations that wish to issue guidance or adopt codes of their own in appropriate circumstances. I stress that this is not about the FSA outsourcing rule-making to trade associations. It is the FSA responding to trade associations that may wish to issue guidance to assist their members in complying with particular areas of our rules and to seek FSA confirmation that their approach is not inconsistent with our requirements.

We recognise that some stakeholders may prefer that the FSA focused solely on detailed rules. We have been asked, "what are the minimum standards with which firms are required to comply?" Surely, the answer is obvious: the requirements in the Handbook. But, in a way, the question risks missing the point of more principles-based regulation, which is to encourage a thoughtful and individual engagement by senior management and firms with the core of what regulation is trying to achieve. More principles-based regulation is about developing understanding of how the Principles and high-level rules apply in practice, in the real world, in the circumstances of particular firms. It is not about a mindset which implies that once I’ve met the minimum, I can forget about regulation. Life changes; firms and their business models change; the implications of the principles and high-level rules in the day-to-day life of firms change too. More principles-based regulation is about carefully considered, challenging engagement, firm-by-firm, with fundamental regulatory questions. There is no rulebook, however long, that could contain the answers to all these questions.

It is worth remembering that principles-based regulation of financial services is not something entirely new to the UK. The FSA's Principles for Businesses have been in place since the birth of the FSA in 2001 and they have their origins further back in the rules of the former regulators. There are also high-level rules in the current COB sourcebook that you will all be familiar with. The requirement that advice on investments must be suitable for a client is a clear example of this. "Suitable" is not precisely defined within the rule. What is required to ensure suitability is something that firms need to judge in each case, in the light of circumstances of the particular client and of the products being advised on.

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So while in fact principles-based regulation is not new, our commitment to a more principles-based approach is. In that regard, radical reform of the COB Sourcebook is, as I have mentioned, just the beginning of an important shift in the way that the FSA regulates. Our implementation of NEWCOB will include an ambitious programme of preparing our staff to supervise, enforce, authorise and make policy in a more principles-based manner. We recognise that this entails important behavioural change and a quite demanding raising of the game for our staff. We will need to be capable of understanding the business models of firms and how the outcomes we seek are achieved in that context. This will involve more challenging discussions with senior management and compliance about delivering real-world outcomes, not just following specified processes or procedures without regard to the end game.

Our implementation of NEWCOB will also include working closely with stakeholders to ensure that they understand what we are seeking to achieve with this change and how they can most usefully engage with it. I welcome the opportunity today to explain our thinking at high level to you, and to further engagement by all of us going forward.

Our move to more principles-based regulation also implies significant changes for firms. All of us, regulator and regulated alike, are quite used to and comfortable with the concepts and practices involved in complying with detailed, prescriptive rules. We are familiar with the focus on process, on carrying out particular procedural steps, checking that they have been done, and moving on. Even in a more principles-based world there will be room for some of this.

But we are challenging firms and ourselves to think much more in terms of the regulatory outcomes that the FSA is seeking to achieve, rather than focusing on a series of preordained processes and procedures. This is a challenging mind-shift, one that is meant to provide firms with a real opportunity to address the underlying culture of compliance in their operations, with a view to understanding much more deeply how the particular business model they operate creates regulatory risks, and how those can best be mitigated. So compliance becomes less about checking that a generic process dictated by the regulator has been followed, and much more about ensuring that the particular activities of the individual business involved are carried out in a way that delivers the expected regulatory outcome.

I know that there is concern in some quarters that the move to more principles-based regulation will disenfranchise or diminish the responsibilities of compliance officers. It is not the FSA’s intention to do that. The FSA focuses its attentions, as you know by now, on senior management and their execution of their responsibilities. But we recognise that compliance staff play a vital role in helping and supporting senior management and business teams to understand the intentions of the FSA and to deliver those in the day to day life of the firm. This is a more demanding role, actually, than simply advising on the minutiae of detailed rules. It is much more about a challenging dialogue within the firm about the real outcomes it is delivering, for example, for consumers, and the extent to which those outcomes have taken into account the regulatory responsibilities that apply to the particular business undertaken.

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The FSA’s view is that a regulated firm which has understood the FSA’s regulatory outcomes in the context of its own business is far more likely to succeed in creating a culture of compliance than a firm that looks for certainty in detailed processes and procedures, without regard to the end result that these deliver. Compliance staff will play an important part in delivering the cultural change in firms that the FSA is seeking through such initiatives as Treating Customers Fairly, and it is essential that the Compliance community engage with, understand and enthusiastically support the move to more principles-based regulation.

In that regard, I encourage you to ask questions of me or other presenters today about any aspects of MPBR that are troubling you or about which you would like clarification. It is in all of our interests that all the key players in the industry understand what we are seeking to achieve and how best to do that.

January Policy Statement

Let me turn now to NEWCOB. My colleagues will cover some of the more technical aspects in their presentations later, but I want to make some broader points here. As you know, the two NEWCOB Consultation Papers published last October involved a split consultation. This was because we needed to transpose MiFID conduct of business requirements by the transposition date of 31 January; but we also wanted to give more time for consulting on our non-MiFID NEWCOB proposals. So we decided to do both! The consultation of the remaining NEWCOB and Financial Promotions material closes, as you know, on 23 February. You will have seen that we recently published the Policy Statement covering the MiFID transposition material, along with the Instruments that transpose MiFID in our Handbook.

Somewhat to our surprise, many respondents to our CPs addressed both the MiFID transposition proposals and the broader NEWCOB and financial promotion proposals. This is helpful in giving us more time to consider the points being made. The feedback in our MiFID transposition Policy Statement focuses obviously on the core MiFID material, but we also took the opportunity to provide informal comments on wider issues arising from the consultation, where we thought this might be helpful. Our intention is to provide a full response to all remaining issues in the NEWCOB Policy Statement in the second quarter of 2007.

In terms of NEWCOB itself, I want to focus, as I said, on just a couple of key issues. The first is our response to Article 4 of MiFID.

MiFID Article 4 notification

As most of you will know, Article 4 of MiFID's 'Level 2' implementing directive limits the scope for Member States to apply additional requirements in the areas covered by the Directive. It sets out the conditions for the creation or retention of national requirements that go beyond MiFID and requires that these be notified to the European Commission. The conditions are essentially that any extra measures are proportionate and address specific risks not adequately addressed by the Directive, and which either:

• are of particular importance in the market structure of the Member State, taking into account firms' and consumers' behaviour in that market; or
• emerge after the Directive takes effect.

I will not rehearse here the rather chaotic course of the negotiation of Level 2, which led to the Member States being surprised very late in the day by the Commission’s position on the maximum harmonising nature of the Directive. Suffice it to say that had Member States been aware of that when giving their advice on Level 2 to the Commission, it would have looked quite different.

From the Commission’s perspective, delivery of a directive that introduces uniformity of regulatory practice should support the goal of a single market. This may indeed be the case in respect of MiFID, although regrettably the market failure and cost benefit analysis to support this assertion was not forthcoming. Article 4 represents a compromise which provides some limited room for Member States to introduce regulations appropriate to their particular markets, within the constraints described above.

In considering the Article 4 notifications that the UK has made it is important to remember that in the case of the UK, MiFID was not writing on "tabula rasa", as was the case in many member states. The UK has been regulating in the territory occupied by MiFID for nearly twenty years. We have learned a great deal in that time about what sort of regulatory interventions do and do not work in the retail and wholesale markets. As you will appreciate, we thought it quite important that Europe should benefit from that knowledge and experience in drafting MiFID, and in many instances this has in fact been achieved.

Having made our case in Brussels, we understood the importance of coming into line with the directive once it was agreed. Our Better Regulation agenda requires us to set a very high hurdle for any superequivalence in our implementation of European legislation. We have done that in the case of MiFID in a very rigorous manner. For my part, I think that given the long history of UK regulation and that the CESR advice to the Commission was based on minimum harmonisation, the fact that only a handful of provisions have been notified by the UK under Article 4, and some of those on a provisional basis, is extraordinary. It demonstrates beyond dispute that we have been very rigorous in seeking to minimise any superequivalence in our implementation.

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So what are the key elements of the UK’s Article 4 case? There are basically only six. They are as follows:

• the requirement to provide a suitability letter – and here we intend to simplify the current requirements substantially;
• the conditions that advisers must meet to call themselves independent;
• the Initial Disclosure Document and Menu – though we are in the process of testing their effectiveness and are likely to recommend changes here too;
• the requirement to provide product information in standardised ‘keyfacts’ documents and simplified prospectuses;
• our recently introduced requirements in respect of disclosure of dealing commission for buying execution and research services; and
• a notification requirement (non-NEWCOB) about the apportionment of senior management responsibility.

We were required to submit Article 4 notifications to the European Commission by 31 January, and we filed some provisional notifications then, pending the outcome of the NEWCOB consultation and other analytical work that we are carrying out. We have also promised to keep stakeholders informed of what we are doing – and we will.

Let me turn from Article 4 to an important practical aspect of the implementation of MiFID, namely, the issuance of guidance.

Guidance

Some respondents to the consultation expressed concerns about whether we had provided sufficient guidance to firms on matters of practical application. We recognise the need to maintain the right balance between the flexibility of a principles-based approach and the need for firms to have certainty over their daily operations. We are considering ways in which we can provide 'working good practice' so that firms will have enough certainty as to how we will approach issues.

We also intend to make continued use of Handbook guidance, where this is appropriate, and of other material, such as case studies. We recognise that the FSA itself is not necessarily the only source of good ideas about how firms can comply with our rules. This is what lies behind our recent discussion paper DP06/5 on FSA Confirmation of Industry Guidance.

As you may know, we are also currently considering guidelines on a number of MiFID-related topics that are being developed by the MiFID Connect group of industry associations, with a view to their being accepted by us under the 'confirmation of industry guidance' framework.

Still to come

Elsewhere there is still much to do before NEWCOB implementation. As I have already said, more principles-based regulation requires significant changes in the approach and behaviour of both us (the FSA) and you (the industry). Our firm-specific and thematic supervision has already moved towards focusing more on management’s responsibility for delivering the right outcomes for consumers. And this year's internal training programme for supervisors is under way. My Supervision and Enforcement colleagues will put you in the picture on further aspects of this later this morning.

What, then, do we need from you now?

The first level of engagement is with the Consultation Papers themselves, and the draft NEWCOB rules. There is a great deal there, some of it new or subtly different, which warrants your attention. Your comments directly, or through your trade body, will be valuable and welcome.

Second, and just as important, is your engagement with the underlying agenda of NEWCOB, namely, the move to more principles-based regulation. As I have said, this is a challenge for each of you; it is a challenge for us as well.

Conclusion

In conclusion, we are looking for an approach to delivery of regulatory outcomes that is dynamic and sensitive to the complexity and variety of financial services businesses in the United Kingdom. In this country, perhaps more than in any other in Europe, there is a plethora of business models, and a profusion of creativity and innovation that we do not want to inhibit through lacklustre regulation.

We firmly believe that, properly and sensibly implemented by firms and by the regulator, a more principles-based approach to regulation will set the trend for future regulatory development globally, just as our work on risk-based regulation did at the beginning of this century. But let us be very clear that delivery of this vision is a joint enterprise between the industry and the regulator; it cannot be achieved in any other way.

Thank you.

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