Keynote address; FSA's conference on more principles-based regulation
Speech by John Tiner, Chief Executive Officer, FSA
FSA's conference on more principles-based regulation
23 April 2007
Good morning, and welcome to today's conference. I'm delighted to see such a packed house to talk about what I believe is a major development in the UK's regulation of financial services. We will today set out our strategy for the future regulation of financial services in the UK; an approach we describe as principles-based regulation which focuses on the outcomes that matter. We will also outline the changes both firms and the FSA need to make to adapt to this new regulatory environment. I am delighted that we have with us Andy Hornby, Mervyn Davies and Peter Vicary-Smith who will discuss, from their particular perspective, the implications, benefits and challenges related to the strategy we are setting out.
Much of what you will hear is set out in the paper we are publishing today and that you have in your packs, which brings together what we have said so far about principles-based regulation, what we are working on currently and what we will do in the future to achieve it. This is not the last word on principles-based regulation; we are a good way from that. But it is also not the first word on it, as I hope will become clear.
But first I want to be clear about what we mean by principles-based regulation. In essence it's about regulating with the emphasis on principles and high level rules, not prescription of processes; it relies on setting out the outcomes we want to see achieved in the financial services market and then directing our supervision to assessing how they are being achieved. This is a direction of travel, not a project to be implemented by a specific date. There is no A Day or N2 for principles-based regulation. It’s a strategic direction that we are convinced is necessary to deliver our statutory responsibilities while at the same time keeping pace with the dynamism of the financial services markets and fostering the innovation and competition that make markets successful.
Why principles-based regulation?
Detailed rules can never be as dynamic as principles. They are usually made post hoc, to stop an event recurring. They will always therefore lag, sometimes significantly, market developments and cannot pre-empt misconduct – I need only mention pensions misselling, mortgage endowments and split capital trusts by way of illustration. High level rules focusing on outcomes, on the other hand, go to the spirit of what the regulator works to achieve; they are more durable as markets develop and harder to avoid.
It is also our experience, not just at the FSA but in its predecessor organisations, that a mass of detailed rules can distract firms from the purpose of regulation and encourage a legalistic and tactical attitude to compliance. And of course it makes it harder for firms’ senior management, and for smaller firms without extensive legal and compliance departments, to get their hands and heads around our requirements. In fact, given the significance of senior management responsibility in our regime, only a principle-led approach provides senior management with the room to take the decisions they need to take for their businesses and customers.
Finally, regulation that is both effective and proportionate is demonstrably a factor in the international competitive position of the UK financial markets. I know Ed Balls will say more about this later; I will only observe that this does not signal that we are entering the game of regulatory arbitrage or a regulatory race to the bottom. That would be irresponsible and run the great danger of attracting the wrong kind of businesses to the UK market.
Benefits and challenges
I have heard many people say that while, intuitively, principles-based regulation is the best approach for the UK’s wholesale markets, the problems of the retail market can only be overcome by the regulator setting out precisely what firms must do. They say this is the only way consumers will feel safe entering the financial services market and the only way firms will feel confident about serving them – because they know exactly what's required and can shelter in that certainty.
But these long-argued approaches have not produced the vibrant, customer-orientated retail market our country badly needs. The shape of the regime we have in mind, described in today's paper, will provide the comfort firms are looking for about whether their processes will meet our regulatory requirements and, we believe, will give them the confidence to stimulate competition and innovation on the supply side. Consumers should receive services better tailored to their circumstances and predicated on being treated fairly. And, over the longer term, the retail market will improve further as consumers’ level of financial capability improves, an essential priority which, together with government, industry and many not-for-profit organisations, we are driving forward.
There are challenges too. Regulating for principles is not easy and can expose both regulator and firms to more risk. Greater manoeuvrability for firms in deciding how to comply will mean key decisions move further up the organisational hierarchy with the Board and senior management having the key role. But because the high level rules will be designed to deliver outcomes which most if not all respectable companies would want to achieve for their businesses, the discussions will be better integrated into everyday business issues. We understand that this more overt responsibility will for some Boards represent a new and difficult challenge as they will need the experience and insight to make sound judgement calls and be willing to accept the responsibility. Indeed, it may be the smaller firms who make up the majority of our regulated population that find it easier to adapt. In those firms, after all, business leaders are often close to their customers and operations on a day to day basis and so have the depth of knowledge and personal experience to make informed decisions about how to meet their regulatory obligations.
For compliance, audit and legal departments there will also be change as they adapt to support their senior management and Directors. There will be less reference to the FSA rule book and more judgement about what processes are fit-for-purpose for their business and their customers. Many will see this as a dilution of the legal certainties they feel they enjoy today. We have given a good deal of thought to how, in a more principles-based world, we can increase flexibility, while not exposing firms to risks they may find unbearable and so withdraw supply. We will be making more guidance material available, not always or even primarily in the form of guidance text in our Handbook but in case studies, Dear CEO letters and industry guidance that we confirm as reliable for compliance. Of course materials such as these do not create obligations on firms; but where firms choose to apply them to a relevant business process, they will be able to rely on them in deciding how to satisfy their regulatory obligations.
I realise that firms will want to be able to find quickly and easily information that's relevant to them, irrespective of whether it's included in our Handbook or in other material we have published, and we are investing heavily in technology to facilitate that. We are also investing in the skills of our people so that we can engage in helpful dialogue with firms about our expectations, not simply directing firms to the relevant rule.
Extending the current direction of travel
Much of this is not new. Our risk- and evidence-based regime already directs our attention to the highest risk issues and firms, to focusing on demonstrable market failures and only intervening where benefits exceed costs. The shift to principles-based regulation is not a break with this model, but an extension of it that will characterise the way we express our expectations of firms.
As I have mentioned already the approach is not new. Its not a revolution. In fact the train of principles-based regulation left the station some time ago. We have, working with the industry, addressed the contract certainty problem in general insurance and the backlog in credit derivatives without recourse to a single rule. We have this year proposed a new, principles-based regime for the conduct of investment business. And the initiative to prioritise and embed the principle of treating customers fairly in the retail market is in many ways the most prominent expression of this emphasis on principles. Clive Briault and his colleagues will be discussing TCF in the Retail break-out group this afternoon.
We met with early industry resistance to our TCF initiative, but this has given way, over time, to a wider acceptance of our approach, of the principle itself, of the priority we are giving it and that it is actually good for a firms business. What TCF shows, by contrast to the experience on contract certainty for example, is that there are instances in which principles-based regulation calls for patience to achieve productive discussions with firms and thereby securing change – albeit not tolerating poor behaviour in the mean time.
I am also conscious that many of you will be wondering whether principles-based regulation will turn out to be no more than the passion of one summer. Will it come to an ignominious halt on 20 July, when I have cleared my desk and the FSA is led by someone new? The answer is, emphatically, no. You are not here today to hear John Tiner’s vision of the FSA’s future but to hear the vision and commitment of the FSA’s Board and executives. Our commitments are costed and public and we will report on them in our annual reports and Business Plans. And the paper we are publishing today also announces our new Outcome Performance Report, a framework that will measure our concrete progress in delivering this agenda and help us direct our operations and priorities accordingly.
Difficult questions
There remain some difficult questions arising from principles-based regulation and I am sure we will hear more about them today. How far, for example, will legislative developments at the European level, and globally, cut across and even obstruct our approach? The recent approach adopted by the Commission to clearing and settlement and the overall direction of Solvency II suggests that the European institutions can be open to market lead and principles-based approaches. And generally, I am confident that our approach will not be derailed by developments elsewhere. But the European Commission has objectives that differ from those of regulators – such as to achieve a single market in financial services. While, I believe we are influential and punch our weight at the EU level, we must be mindful of the risks that EU directives, and especially those which are maximum harmonising, may on occasion, force us into an approach which is counter to the strategy we are outlining today.
We know also that some firms are concerned about the interaction of our regime with the work of the FOS. They fear that they will be held accountable to separate standards by the two organisations and that the FOS's interpretation of firms' obligations will differ from ours. This would risk creating a separate and possibly different 'shadow' rule book, making it hard for firms to operate coherent, and well judged, compliance strategies. I think I have some, but limited, sympathy with these views. The FOS fulfils an essential dispute resolution service and is a vital part of the consumer protection landscape. Of course it would be unhelpful to have a parallel rule book somehow created through the precedent decisions it takes, but it is instructive to observe that only some 5% of FOS cases turn on an interpretation of FSA rules. I am sure Walter Merricks will be happy to discuss these issues this afternoon.
And should more be done to articulate the role of consumers of financial services, given the centrality of the disclosure regime in our regulation of retail markets? We have in the past engaged the Consumer and Practitioner Panels and some of our own non executive Directors to try to reach a common view of consumers' responsibilities, and we could not reach a consensus position. Perhaps we should think about this issue differently. More along the lines of - what actions can consumers take to protect their best interests – and to what extent do these translate into legal responsibilities. As we say in our paper, we plan to revisit this difficult issue.
Conclusion
We want to use today to debate some of these topics. I’m very much looking forward to hearing what our distinguished panellists think about our intentions for principles-based regulation; but before I hand over to Andy, I want to leave you all in no doubt about two things: the FSA is convinced that this approach is the right way for us to maintain a regime that both addresses the current realities of the market and provides the appropriate protections; and we are committed to seeing this change through.
Thank you