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Speech by Dan Waters,
Director of Retail Policy and Asset Management Sector Leader, FSA
Retail Distribution conference
27 June 2007

Good afternoon and thank you to John and to Stephen, Chris, Dick and Angela for your honest and forthright views. We wanted this conference to trigger a wide exchange of different views from across the market, and I think we have got off to a really good start in these last sessions.

The work of the Regulatory Barriers and Enablers Group, which I was privileged to chair, was different from that of the other four industry groups, in that we were asked to assess the proposals being developed by the other groups, and feed in advice and analysis of the regulatory implications of these proposals. This was a challenging but very worthwhile task as proposals emerged during the compressed timeframe of the review. I would like to offer my sincere thanks to the group, who provided valuable commentary and constructive criticism of ideas put forward by the other industry groups. We also commissioned work to be undertaken within the FSA, analysing legal and regulatory issues, as you will see in Chapter 5 of the Discussion Paper. I am pleased to report that the group will be called upon during the next six months to comment and advise on our continuing work. Let me turn now to the approach to the legal and regulatory dimensions of the review, as reflected in the Discussion Paper.

Today I will outline several background considerations, as well as indicating some of the areas where change is likely. Finally, I will briefly mention our plans for the next stages in the process.

When Clive spoke this morning, he said that we would do whatever is necessary within our powers to support industry proposals to bring about better outcomes for consumers. And it is the consumer perspective that is very much at the heart of the proposals. Doing what is necessary means looking for solutions, not hiding behind existing rules. It means that we may have to change our approach, just as our review means that many of you may have to change your practices. It means being principles-based, risk-based and outcome focused. It means recognising that the world is changing, the market is evolving, and that consumer needs and wants are in a constant state of flux.

So we intend to use the six month consultation period on the Discussion Paper not only to gather your thoughts on what needs to be done, but also to undertake consumer and market research so that we better understand the state of the market and what the consumer wants. All of this will help us to compile the cost-benefit analysis that we are required by FSMA to undertake before we put forward any concrete proposals for regulatory change.

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Many of you have observed to us during the course of the review that the time is right for change. I know there won’t be total consensus on this point, and that some of you will read through the Discussion Paper in search of the evidence to prove the need for further change for an industry that has experienced its fair share of regulatory upheaval in the last few years. But by making this a Discussion Paper, we can prompt more radical thinking and ask more open questions than an evidence-based Consultation Paper would permit us. We can now gather the evidence to support change proposals or to prompt their modification. We think this is the right approach. It reduces the risk of being accused in five years’ time of having missed an opportunity to make a real difference to consumers. And this is not necessarily about changes for all. As others have said today, many firms have already moved in the direction described in our paper.

Let us remind ourselves of the important role that regulation plays in this, or indeed in any market. Our statutory objectives require us to put consumer protection and maintaining market confidence at the heart of regulation. We think the market is failing consumers and, if we’re honest, two decades of prescriptive regulation has not yet adequately addressed this. A principal failing is that too few consumers understand the products and services offered by the industry well enough to be an effective force in the market. Consequently, there is a huge reliance on the industry to guide and assist consumers, and on us to maintain a framework which gives consumers confidence to rely on the industry. But is this really working well enough?

In addition to fixing the root causes of current problems, it is vital that regulation keeps pace with wider market developments, allowing innovation and competition to prosper, where these bring about tangible benefits for consumers. So even if there were no past problems to address, there might still be a case for this review.

We have today published another Discussion Paper, alongside this review, on the subject of platforms, looking at the role of wraps and fund supermarkets now and in the future. This is a good example of using Principles-Based Regulation to respond to an area of the market that is continuing to grow and develop. We will use the paper to provoke discussion about how our Principles apply to firms offering or using platforms; the standards they need to achieve; and means by which they can do this.

If this approach is successful, platform use in the industry will support improvements in intermediary professionalism and – fundamentally – improvements for customers in the services they receive. Our analysis thus far leads us to conclude that more detailed regulation should not be needed to ensure that platform adoption and use are parts of the solution, and not part of the problems, discussed today. The challenge for the industry is to prove us right on this. Our Discussion Paper makes clear that we do not believe there is a single 'right' direction for the platform market to develop in, or for intermediaries to incorporate platforms into their business. But it is also clear that there are directions that would lead to less desirable outcomes for consumers and these must be avoided.

We are keen to work with firms and trade bodies to improve both the competence of intermediaries using platforms and transparency around platforms themselves. Our new inducements rules, driven by the Markets in Financial Instruments Directive, will prompt platform providers to disclose any rebates they receive from product providers. Greater transparency in this area is surely a good thing. The ease with which intermediaries can assess and compare what different platforms have to offer their clients – and what they cost – will be an important factor in making sure that where platforms are adopted and used, they improve outcomes for consumers.

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I turn now to the EU, which has a significant and increasing influence on retail policy in the UK. Our review is timely because the Commission published its Green Paper on Retail Financial Services in the Single Market at the beginning of May, setting out its longer-term thinking on retail issues. It is also timely because of the entry into force in November of MiFID.
Let’s start with the Green Paper. It builds on the Commission's White Paper on Financial Services 2005-2010 and the results of its sector inquiries into retail banking and business insurance. At the same time, it also suggests that further action is required because European retail financial services markets are too fragmented - as can be shown perhaps by modest cross-border activity, wide price variations and restricted product diversity.

Fortunately, the Green Paper does not seek to propose a raft of new actions, but instead draws together on-going or proposed work and presents it within a strategic framework.

That said, a number of new initiatives have appeared, including:

• A proposed study on price variations in key retail financial services;
  
• A review of why consumers do not generally purchase financial services across borders;
  
• Greater focus on long-term savings, retirement and pensions solutions; and
  
• Greater focus on financial literacy, where the Commission will play the role of a "facilitator" due to limited powers in this area.

We think the Green Paper is a good initiative, to the extent that it provides a useful "stock-take" of the Commission's work. It is not billed as and nor would we welcome the launch of an action plan seeking to create a single retail market through legislative initiatives. In that regard, we are pleased that the Green Paper contains a strong commitment to Better Regulation, which as a concept does not include the creation of markets by regulatory fiat.

We plan to work closely with the Commission as it identifies problems faced by consumers and firms in the market and makes proposals to improve the functioning of retail financial services markets. The aim is for the results of the Green Paper consultation (due to come to an end in mid-July) to be incorporated into the final report of the Commission’s review of the single market, due to be published in the autumn. We will need to consider the impact of the Commission’s work on the solutions emerging from our retail distribution review.

Now to a piece of Community legislation rather more familiar to us. MiFID is likely to have a significant impact on implementing the review’s proposals. The Directive supports our own principles-based approach and gives us plenty of scope to adopt risk-based approaches to regulatory requirements and to our supervision of firms. To the extent that it may limit our ability to implement the proposals as we might wish, we believe that there are alternative measures we can take.

For example, we could look to implement proposals for Primary Advice outside of MiFID scope, as we are proposing to do with the existing Basic Advice regime. This would give us more freedom, should we need it, to define the rules to give the necessary safeguards to consumers and firms to encourage supply and to give confidence to all parties. We know that such an approach may seem inconsistent with principles-based regulation. We have always said, however, that there may be circumstances in which employing detailed rules may be the best or only way of achieving a regulatory outcome. For example, COBS retains many detailed provisions for the Basic Advice regime. In some areas, we think this could be a price worth paying, to give firms the regulatory certainty they might need for there to be a vibrant market in these services. This is a good example of what I described earlier of our willingness to consider doing what is necessary to deliver the right outcome.
Another option is to make notifications under Article 4 of MiFID of super-equivalent requirements. We know from experience that this is a high hurdle to clear. We may consider this approach if, for instance, we thought it necessary to go beyond the Directive’s standards for disclosure in order to give proper effect to some of the proposals. From our discussions with the Commission on our original Article 4 notifications, it is clear that the Commission wishes to see these reserved for exceptional circumstances. It is also clear, however, that the Commission has listened and is prepared to listen to reasoned argument, supported by evidence, that superequivalent rules are addressing problems of particular significance in an individual Member State.

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On the domestic front, there are a number of relevant developments such as proposals for Personal Accounts and Otto’s work on a national service for generic advice. Although it is far too early in the process to be certain of anything, we believe that proposals in our review could complement these wider market developments. So we must ensure that regulation supports all of this appropriately.

Furthermore, any changes we encourage or otherwise require by our rules, must remain within the boundaries of the relevant general law. Competition law may also be relevant, although this will bite harder if restrictive practices emerge by agreement rather than if we require it. We have therefore maintained a dialogue with the Office of Fair Trading throughout this review. It is too early of course for the OFT to make concrete judgements, as much will depend on the nature of eventual changes and the manner of implementation.

In taking this review further, we will join up with other related FSA work. In particular, as part of the post-implementation review of Basic Advice, we have been conducting an examination of the extent of the target market and whether that might help to explain the current take-up of the Basic Advice regime. A second important work stream is the Depolarisation Review, which is examining possible changes to disclosure requirements in a depolarised market. We are reviewing the scope and timescales for these reviews to bring them into line with the Retail Distribution Review.

I won’t go into detail again on the proposals for change, but it is clear that there are many regulatory implications. We expect that we will need to review our requirements in all of the areas you can see on this slide. For instance:
- We will work with the Financial Services Skills Council on minimum qualifications for advisers.
- We will look to require Professional Financial Planners to be remunerated on terms agreed with their customers, and we will want to offer regulatory incentives for other advisers to move to this basis.
- For Primary Advice, we may need some form of approved advisory process, with products limited in scope according to certain criteria which remove the risk of material consumer detriment.

There are two other areas of particular interest to financial adviser firms that I would like to cover: prudential requirements and the concept of adviser independence.

We have already spent part of today discussing the role of capital. The RDR Discussion Paper seeks feedback on a risk-based prudential regime, which provides material incentives for firms to adopt practices that reduce the risks of consumer detriment. This is an approach already implemented for Banks under the Capital Adequacy Directive and for insurers under the Individual Capital Adequacy Standards (or ICAS) regime. In parallel with the RDR, we are reviewing the Prudential Requirements for Personal Investment Firms. We will publish a separate Discussion Paper on this Review in early July, to debate in more detail the extent to which prudential requirements for personal investment firms, which include professional indemnity insurance, could reduce consumer detriment. For example, it will consider whether firms that leave the market should leave behind resources to fund compensation claims arising at a later date. Capital resources requirements for Personal Investment Firms have not been subjected to a thorough review for nearly 20 years, so the time is right to review them. In taking forward the Review we will have to consider the interplay between the Capital Adequacy Directive and any proposals for changes to requirements for Personal Investment Firms.

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The other matter I wanted to raise is the “independence” label. This has an important brand value for many firms, although it is less clear that the concept is well understood by consumers. There are proposals in our retail distribution discussion paper to modify the definition and we are interested in views on this. For instance, it is suggested in the Discussion Paper that, for full advice, only professional financial planners might be allowed to call themselves independent. As we have proposed that professional financial planners would only be able to receive remuneration on a basis agreed with the customer, we think independence can then really mean freedom from the conflicts of interest that could lead to provider bias. We would also be interested, however, in views on the suggestion to allow certain Primary Advice firms to be designated as “independent”.

Labelling advisory firms as tied, multi-tied, or independent, on the other hand, may not be the most important factor for a consumer when choosing an adviser. Our research points to the issue of trust, rather than the business model of the adviser, as a key factor. So alongside these proposals, we also ask whether a services-led industry needs these labels at all.

So finally, where do we go from here? We intend, as I said earlier, to gather views from you on the implications of these proposals. In addition, as I have already mentioned, we intend to conduct our own consumer and market research, which will focus on the changes that are needed to achieve the outcomes we are seeking. So, for instance, we will be looking at the market for simpler products sold in a more streamlined way, building on the research we originally planned for Basic Advice, to understand better what consumers want and need in this segment of the market. We will also be asking firms about their activity in this market, to identify the conditions under which they would be more active participants in supplying these types of product and service. Meanwhile, our Depolarisation research will continue to examine ways of providing information to customers in order to deliver the information they need to make an informed choice.

We have allowed six months for consultation and we expect to publish a feedback statement in the second quarter of 2008. This feedback statement will set out the route map for the consultation paper or papers that will follow. It is likely that these CPs will incorporate, as needed, outcomes from the Basic Advice and Depolarisation reviews. We are mindful of the need to progress at a sensible pace to limit the detrimental impact on consumers, but also to be fast enough to capitalise on the momentum already built up.

I have covered a lot of ground today, but then this reflects the very broad scope of the review. Thank you for listening, and I look forward to a healthy debate over the next six months.

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