Principles-based regulation - moving from theory to practice
Speech by Clive Briault, Managing Director, Retail Markets, FSA
ABI 2007 Conference
10 May 2007
I want to focus this morning on how I see principles-based regulation moving from theory to practice. Indeed, although we published our paper on "Principles-Based Regulation - Focusing on the Outcomes that Matter" only last month, we have been moving in this direction for a while. As John Tiner explained earlier this morning, our reform of insurance regulation over the last few years has been one example of this. Our Treating Customers Fairly initiative is another.
I will cover four areas:
- How a more principles-based approach should help us to achieve our desired outcomes more effectively;
- How we are changing the types of guidance that firms receive on our Principles;
- Investing in our people; and
- Treating Customers Fairly.
Outcomes
From firms we want to see a stronger focus on the outcomes that really matter for consumers. We want senior management to develop a greater understanding of how the Principles and our other high-level requirements should apply in practice; to drive and embed change throughout their firms; and to measure that this is delivering the right outcomes. A more principles-based approach also provides senior management with greater flexibility in how they run their business while meeting our requirements, and greater scope to compete and innovate while doing so; or indeed to compete by exceeding our minimum requirements.
So a more principles-based and outcome-focused approach should encourage senior management to focus more on the Principles and the outcomes we want them to deliver; and should therefore deliver these outcomes more effectively.
We also welcome market-led solutions where we use our influence rather than our formal powers to encourage the industry to change. For example, following our challenge to the industry on contract certainty in December 2004, the market has achieved considerable success in tackling the practice of 'deal now, detail later'. This was achieved without the need for any additional rules and guidance from us. Our Retail Distribution Review is looking for market-led solutions to address issues surrounding the availability of advice, sustainability, professionalism and incentives in the distribution of retail investment products. And at a more detailed level, we have been successful in changing industry behaviour on the advertising of general insurance products by discussing our findings with the marketing directors of firms, not just with compliance directors.
For consumers we are working, in partnership with many others, to improve levels of financial capability. We want consumers to be capable and confident in dealing with the financial services industry. And we are looking for ways to encourage consumers to engage more actively when dealing with financial products and services, since it is in their own best interests to do so.
Principles and guidance
Our move towards more principles-based regulation is not about any lowering of our standards. We are not changing our Principles and other high level requirements. Our Principles are themselves rules. They articulate the outcomes we require firms to deliver. Examples include that firms must conduct their affairs with integrity, that firms must pay due regard to the interests of their customers and treat them fairly, and that firms must maintain adequate financial resources.
In terms of our rules and guidance, there are three ways in which we have shifted the emphasis to a more principles-based approach.
First, we have deleted many of our detailed rules. We have deleted our detailed rules on money laundering, and replaced them with some short high-level requirements. We have consulted on a new Conduct of Business Sourcebook for investment business that is half the length and written much more clearly than the previous version. We are consulting on a more principles-based approach to the permitted links regime. And we have announced our intention to consult on a more principles-based and more differentiated approach to insurance conduct of business requirements, where again we want to halve the length of this section of our Handbook. For commoditised insurance products such as household or motor we believe the markets work reasonably well in the interests of consumers - for these products we are looking at removing requirements that go beyond the relevant EU Directives. In contrast we have found greater risk of consumer detriment for those buying personal protection products and so we are considering a small number of additional measures to improve sales practices around these products.
Second, we see scope for imaginative approaches to how the minimum requirements set by our Principles and other high level rules can be illustrated and interpreted. We have already produced a wide range of supporting materials such as statements of good - and of less good - practice; case studies; short guides to our key requirements; self-assessment tools for small firms; and reports of what we have found from our thematic work into various issues. This includes supporting material relating to insurance specific topics such as our guide to brokers on our client money requirements; statements of good and poor practice on consumer friendly statements on the use of discretion in with-profit funds, on selling general insurance products through call centres, and on advertising general insurance products; and various guides to what constitutes good practice when selling or advising on payment protection insurance.
Third, we have consulted on the possibility of our “confirming” guidance developed by the industry that meets our minimum standards and helps firms in areas – hopefully not too many of them - where they want more detail to provide them with a “sturdy breakwater”. Although we have not yet introduced this confirmation process, we have in effect already adopted this approach. There have been two recent examples in the insurance sector.
Following the introduction of our risk-based capital adequacy regime for insurers at the start of 2005, our regime has led to significant improvements in risk management and to the understanding of risk and capital issues by the senior management of firms. In February this year the Association of British Insurers (ABI) in partnership with others published a Guide to the Individual Capital Assessment Process for Insurers. We worked closely with the ABI and other trade bodies to develop this helpful piece of guidance that provides commentary and examples of how firms may achieve our standards and objectives for Individual Capital Assessments.
Our thematic review of unit linked funds found weaknesses in the existing regime in relation to unit pricing and pricing errors. We worked with industry to come up with an industry-led solution and in June 2006 the ABI produced the 'Guide of Good Practice for Unit Linked Funds'. ABI member firms agreed to do a gap analysis of any issues with regards to pricing by December 2006. Firms then started to put remedial plans in place to deal with any issues they have uncovered. Our supervisors are now starting to work with firms to look at the gap analysis, and see if the remedial actions being taken are appropriate and timely.
We also recognise the need to make our supporting materials, and any industry guidance that we confirm, easily accessible to firms.
Investing in our people
Our people, and the way in which they behave, are more important to the success of more principles-based regulation than rewriting our Handbook of rules and guidance. In line with the expectations we are placing on firms, we need to ensure that our people are able to make outcome-focused judgements relating to our Principles, and are able to influence and persuade the senior management of firms through discussions that focus on these high level requirements.
This requires our people to have the right skills, knowledge, capabilities and behaviours. This ranges from our people having a deep and up-to-date understanding of the products, services and markets in which the firms we regulate operate, to our people adopting a genuinely flexible approach to the ways in which firms can demonstrate compliance with the Principles while meeting our desired regulatory outcomes.
We are recruiting and investing in our people accordingly. And I am pleased that we are already seeing some welcome evidence of this in the feedback we have received from both large and small firms, although we recognise that there is further to go here.
Under a more principles-based approach we also need to focus on fewer, higher level and more strategically aligend themes; to join up even more effectively our thematic and firm-specific work so that these are mutually reinforcing; and to communicate clearly to our stakeholders how all of our activities fit together to deliver the outcomes we are seeking.
Treating Customers Fairly
Our Treating Customers Fairly initiative is a specific and long-standing example of our more principles-based approach. This is a key element of our strategy to make retail markets work more effectively and thus to deliver benefits to consumers.
The requirement that firms treat their customers fairly is enshrined in the sixth of our Principles, which states that “A firm must pay due regard to the interests of its customers and treat them fairly.”
Our work in the retail market has consistently found that some firms do not treat their customers fairly. To address this, and given the limitations of detailed rules, we decided four years ago to focus more on the Principle itself; to highlight the areas where customers were vulnerable to unfair treatment; to encourage firms to challenge themselves to ensure that they do treat their customers fairly; and to stress the responsibility of the senior management of firms to deliver this and to demonstrate that they are doing so. This should lead to real and identifiable benefits for consumers.
In July last year we set a deadline for all firms to be at least implementing Treating Customers Fairly initiatives in a substantial part of their business by the end of March 2007 To meet this test, firms needed to show they had allocated appropriate resources and responsibilities, developed plans and processes, and created capability to meet the Treating Customers Fairly principle. The aim was to stimulate action in firms that were slow to appreciate the significance of Treating Customers Fairly; to maintain momentum in those firms that were moving ahead with their Treating Customers Fairly initiatives; and to demonstrate how seriously we take Treating Customers Fairly within our more principles-based approach.
The results that we published earlier this week showed that many firms have made good progress with their Treating Customers Fairly work. The implementation deadline helped to focus firms' efforts on Treating Customers Fairly and generated momentum within the industry as a whole. The proportion of firms that met the deadline varied from 93% of major retail groups and 87% of medium-sized retail firms to 41% of a sample of small firms. Within this, life and general insurance firms were broadly in line with the overall figures.
Only 45% of general insurance intermediaries in our sample of small firms satisfied us that they have reached the implementation stage. This is broadly in line with the overall rate for small firms. More progress clearly needs to be made here, and quickly. Small firms ought to be able make relatively swift progress; we have provided many tools to help them to do so, including our self-assessment tool for Treating Customers Fairly; and we strongly encourage the management of these firms to move ahead on this.
We will increase the focus and intensity of our supervision of firms that missed the end-March deadline. We will take a targeted approach, depending on the reasons a firm failed to meet the deadline, and the scale of the task they face in filling the gap. Our follow-up work is likely to have significant cost implications for these firms.
Beyond implementation, most firms need to go further to reach the embedding phase of Treating Customers Fairly and thereby to deliver fair consumer outcomes consistently. This is, and will continue to be, a significant challenge for most firms, and requires sustained focus from senior management. To reinforce this we have decided to set further deadlines.
By the end of March 2008 firms are expected to have appropriate management information or measures in place to test whether they are treating their customers fairly. And by the end of December 2008 all firms are expected to be able to demonstrate to themselves and to us that they are indeed consistently treating their customers fairly.
So, for the time being, a more principles-based approach does not mean that we will confine ourselves entirely to high-level conversations with the senior management of firms in order to establish that our desired regulatory outcomes are being met. There remains a role for more detailed testing, not least to determine whether the aspirations and intentions of senior management are indeed being translated into putting in place appropriate procedures and into delivering the right outcomes in the customer-facing operations of their firm, especially if firms are not yet testing this. But where firms can demonstrate their own performance (and it is good), there will be less scrutiny by us and therefore a clear regulatory dividend for the firm.
Conclusion
I believe that better outcomes for consumers will be delivered more effectively if the senior management of firms focus on the Principles and our other high level requirements, and if they ensure that these are met throughout their businesses. I look forward to continuing to work with the industry to deliver this.