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Speech by Verena Ross, Director, Strategy & Risk, FSA
British Bankers Association- 2nd European Securities Forum
13 September 2007

Ladies and gentlemen, I am delighted to be here this afternoon to speak to you about FSA’s regulatory approach and what it means for regulatory convergence in Europe as well as for mutual recognition globally.

The main subject of my speech today is FSA’s approach to regulation and some of the challenges we and other regulators face in terms of supervisory cooperation and convergence. You will be aware that we published in April 2007, our paper entitled "Principles- Based Regulation- focusing on the outcomes that matter”. This sets out what we mean by principles-based regulation and what we have been doing and propose to do to deliver it. The paper also notes the challenges that firms and the FSA need to get to grips with to adapt to this changing regulatory environment.

Our approach to More Principles-Based Regulation

As a quick reminder, what do we mean by principles based regulation? An approach to regulation which is focused principally on getting the right outcomes, both for firms and for consumers. From firms we want to see a stronger focus on the outcomes that really matter - better outcomes for consumers, investors and markets. There are a number of reasons for moving further towards principles-based regulation but let me briefly mention one that is most relevant.

Financial markets, as the turmoil of this summer has demonstrated, are constantly changing. It is essential that financial regulation keeps pace with this. Continuous innovation and new product developments are important ways in which the financial services industry generates benefits for markets and consumers. At the most basic level it is neither practicable nor desirable for regulation to seek to respond to each market development. More fundamentally, we believe that a regulatory approach that focuses on outcomes rather than prescriptive rules is more likely to encourage and respond to market innovation and development. Thus a more principles-based approach is more durable in the longer-term.

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Constraints in the European context?

I am addressing today an audience well versed in the issues of cross-border market development and regulation, and have heard Mr Holmquist’s perspective on some of this. I would now like to address some of the concerns previously raised by firms that legislative developments in Europe could hinder our intended move to MPBR. We believe that European Community Law is not in itself incompatible with our more principles-based approach. Directives are binding as to the result to be achieved, but typically leave the national authorities the choice of form and methods. In principle, therefore, directives are an exemplum of MPBR since they are, or should be, high level and outcome focussed, and leave the FSA sufficient scope to determine how the objective is to be achieved.

Regulations apply directly in all Member States and therefore do not need to be translated into national law. At first blush, using regulations to provide harmonised technical detail appears inconsistent with a more principles-based approach. However, even a principles-based approach accepts that there are cases where detail will be required. Since regulations apply directly and are copied into our, and others' rules and regulations directly, this approach actually avoids unnecessary copy out in 27 jurisdictions.

This leads me to the conclusion that regardless of the form which Community law takes, what really makes the difference is whether the legislators are able to keep, throughout at times long and difficult negotiations, a clear focus on the outcomes that matter. Following on from my comments earlier, we believe that legislators need to keep this focus on ultimate outcomes and key principles not only because we – as a national regulator - are keen to maintain some flexibility, but because we see a real danger in such detailed Regulations or Directives being quickly overtaken by market events and thus reducing the ability of the European capital markets to be as innovative and competitive as they can be.

Challenges to More Principles-based Regulation

Of course, the difficulty remains that not all Member States share a common view as to what the desired outcome should be. Differing legal regimes (Common law vs Civil Law) and regulatory philosophy can sometimes compound this difficulty. For many of them detailed prescriptive rules are a sine qua non condition to discharging their supervisory duties. But we believe that regulatory convergence – which is one of the stated aims of the Lamfalussy framework can only be meaningfully defined in terms of outcomes. We view convergence as a measured, proportionate and regulator-moderated process, aimed at achieving compatible regulatory outcomes in terms of consumer/investor protection and/or financial stability where it is cost effective to seek these. Others may see convergence of regulatory processes as an essential first step to this – we do not agree. Neither do we think it is always practicable or cost effective.

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More Principles-based Regulation and Lamfalussy

The fact remains many of us, as stated by Commissioner McCreevy, wish to see “fewer rules, that work”, and would welcome any departure from 28+ versions of the truth. We, and HMT, see the Lamfalussy process and work done by CEBS, CESR and CEIOPS as instrumental in facilitating this. Indeed we are working closely with CESR and the other committees to identify means of improving their effectiveness in achieving supervisory convergence.

Our commitment is exemplified by the significant amount of senior management time spent on Committee business. FSA Chairman Sir Callum McCarthy is a member of CESR, our recently appointed Chief Executive Hector Sants succeeds John Tiner as a member of CEIOPS and Thomas Huertas, Acting Managing Director of Wholesale & Institutional Markets and Banking Sector Leader is a member of CEBS and the CEBS Bureau. Furthermore, we estimate that each year around 38 person years are spent by the FSA on EU Directive negotiations.

Working with the Committees

Such commitment to the European agenda would not be effective if I was not able to highlight some of the work recently done by the committees which we strongly support, as it is closely aligned with our regulatory philosophy. CEBS, CESR and CEIOPS have recently carried out a joint consultation on draft Impact Assessment Guidelines to be used by the Level 3 Committees. The guidelines provide the Committees’ Expert Groups with a practical tool for developing Impact Assessment in the course of formulating recommendations. We see the use of these guidelines as helping to deliver better regulation in Europe.

CESR in particular has also taken the lead in establishing a number of important processes and protocols to support regulatory collaboration and convergence. One of these is the articulation of peer review arrangements under which Member States will examine and monitor the implementation of Directives. We believe that Peer Review is a crucial regulatory tool by which to promote and evidence supervisory convergence. We are pleased that CEIOPS and CEBS are also in the process of adopting similar methodologies.

Notwithstanding the development of these protocols and processes, CESR's prime focus has to date been to provide advice at Level 2 on implementing measures of MiFID. We continue to strongly support CESR’s shift in focus from MiFID Level 2 to MiFID Level 3 work so that firms can begin to experience tangible benefits of day to day supervisory convergence. We welcome, for example CESR's work on fostering cooperation between regulators, by removing obstacles to the smooth functioning of the passport under MiFID.

The shift in focus from Level 2 to Level 3 should be allowed to happen before any definitive pronouncement on the effectiveness or future of Lamfalussy. Contrary to some – largely unsupported - assertions circulating at the moment, we believe that the Committees have largely worked well to date. They should be given the opportunity to “come into their own” in their current form and roll out their methodology for Peer Review, with a strong emphasis on a “comply or explain approach” to Level 3 guidance. We daily hear calls for more radical reform. We do not believe that the Lamfalussy process is in any way fundamentally flawed and believe such calls to be premature. It is incumbent on those calling for this reform to explain why it is necessary. Ultimately to our mind, Lamfalussy’s success will depend on the willingness of Member States to offer and accept meaningful challenge.

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Regulatory convergence in the EU/US context

I have spent some time setting out our views of supervisory convergence at the European level, so let me now move on beyond Europe and talk about regulatory convergence in a global world. As I mentioned at the beginning of my speech, legal responsibility for supervision and enforcement of regulation occurs at the national level (even if rules can be framed at the EU level). However many firms and markets operate on a transnational or global basis. This is particularly pertinent for the FSA, as the regulator of the international financial markets in the UK.

The continuing expansion in cross-border business heightens the existing need to continue to clarify the relations of home and host supervisors in respect of multinational firms and markets and make these work as smoothly as possible. This is relevant in a number of contexts, but has been much discussed recently in the context of the EU-US Financial Markets Regulatory Dialogue. The UK, as other EU member states, have to be mindful of the European context of this debate, as much of the relevant regulation derives from EU law.

Commissioner McCreevy’s 6 principles

This is a topic that Charlie McCreevy has addressed on several occasions recently. In New York in March , Commissioner McCreevy set out Six Principles for Building a Transatlantic Market. In shortened form, these were:

• Do no harm: regulators should attempt to stay out of the line of play as much as possible: to observe closely, to step in when needed, but only to do so when absolutely necessary.
• Act in a co-ordinated multilateral manner, rather than try to build the foundations of the new order on a 'thicket of bilateral agreements'.
• Remove regulatory duplication as far as possible. If another regulator offers an equivalent standard of regulation and equivalent enforcement, have the courage to rely on them.
• Equivalence recognition should be based on global understandings and global standards.
• Transatlantic markets should serve as the laboratory of globalisation.
• Underneath these principles, there needs to be consistent implementation, information sharing and enforcement at a technical level between individual jurisdictions.

We fully agree with these principles, and see them as the right basis on which to move forward in the cross-Atlantic discussions.

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Mutual reliance

The FSA enjoys good working relations with the main US regulatory agencies. We for example work closely with the OCC and the Federal Reserve who are responsible for major US banking groups. Not to do so would result either in an incomplete oversight of their activities or, alternatively, major duplication of effort and resources. It would be inconsistent with our wish to see a proportionate and risk-based regime. The Financial Services and Markets Act allows the FSA to rely on others for certain aspects of its supervisory work where the other party is competent to perform such a function.

We have recently extended our cooperation with US supervisors on prudential issues. With the implementation of the EU's Financial Groups Directive, the SEC developed its Consolidated Supervised Entity regime and assumed the role of the global consolidated supervisor of the largest US broker-dealers. This is a welcome move from our perspective given that these firms have significant operations in the UK and other European markets.

A significant element of our bilateral work might be characterised as looking at the extent to which we may depend – or at least take comfort – from the work of US supervisors – and might therefore be described as centred on 'mutual reliance'. In addition to bilateral work which is part of our day to day supervision, we also work with US colleagues in a variety of 'multilateral' contexts. These include the Basel Committee, the Financial Action Task Force, the Financial Stability Forum and the International Organisation of Securities Commissions. In these fora, the emphasis is principally on agreeing and implementing common minimum standards.

Secondary markets- still some way to go

So, what is the state of play on cross-Atlantic convergence? Much progress has been made in convergence and mutual recognition in the accounting arena, while in others progress has not been as fast as certainly the UK industry has hoped. A prominent example relates to secondary market trading. For our part, we have a regime based on 'unilateral' recognition. Our Recognised Overseas Investment Exchange (ROIE) regime looks for 'equivalent protection'. In this case, US exchanges can establish themselves in the UK (or offer trading services into the UK) based essentially on the regulatory regime in their home country. We need to make sure that the home country regime and the rules of the exchange in question deliver equivalent consumer protection. Once we have done so, the arrangements ensure that there is no duplicative regulatory effort. The FSA relies entirely on the SEC's or CFTC's regulation of the exchange in question, all we require is to be given updates on significant developments that might impact on the UK market and its players. In addition, US intermediaries can become remote members of a UK exchange without requiring FSA authorisation, as long as they do not undertake regulated activities in the UK. Finally, US issuers listed on US exchanges (where the exchange operates as ROIEs) do not need to register in the UK.

While the CFTC in many ways have a fairly similar approach to ours in secondary market trading, the SEC operates on a rather different basis. A UK exchange needs to register with the SEC to do business in the US. Also, while UK intermediaries can be remote members of a US exchange, they must register with the SEC in order to do this. We have been aware for some time that UK exchanges would like to have the ability to place screens in the US without the need for full SEC registration. Against this background, there has been quite a lot of interest in the UK and in other markets in recent statements by senior SEC staff about the potential for widening the scope for 'mutual recognition' going forward.

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New developments

While we still need to see a formal SEC policy proposal, the SEC is showing increased willingness to consider placing added reliance on overseas regulators. In the terminology that has been adopted by the SEC, this means to allow for 'substituted compliance'.

Let me say a few words about this important concept. Mutual recognition or 'substituted compliance' as opposed to full convergence appears to be the most promising route for widening market access. The FSA has worked within the context of mutual recognition for many years, trying to balance the targeted and proportionate regulation of firms with the need for appropriate levels of consumer protection and market confidence. We are keen to engage in any discussion as to whether it is possible to secure benefits for EU (and indeed US) firms without any reduction of essential investor protection. We believe that there is a 'positive sum' game for US and UK markets in doing so. Speaking in February, and responding to various suggestions that London and New York might be engaged in a zero-sum contest, Sir Callum McCarthy, our chairman, said:

Can I simply say that I regard this as fundamentally mistaken: London will flourish all the more if New York succeeds – and vice versa; there is enormous shared interest between these two, the two great international capital market centres of the world; in practice there is great co-operation between the regulatory authorities in the two centres.

In considering the latest ideas from the SEC, we will have to be mindful of the EU dimension and the role of the European Commission. We are keen to play our part in working with the Commission and other Member States in progressing further along the road of mutual reliance between regulators across the Atlantic.

We will need greater specificity from the SEC before we are able to offer a fuller response on 'substituted compliance' and we look forward to this. The SEC held a Roundtable meeting in June to obtain the views of US firms and investors to the concept of mutual recognition, and it is important that market participants continue to be active in specifying what they want to see from this initiative.

Summary

Finally, to summarise the key issues I have touched on today:

• We strongly support the Lamfalussy process and believe that the committees should be allowed to “come into their own”, operating a shift of focus from Level 2 to Level 3 work and be given the opportunity to roll out Peer Review. We believe this will do a lot to achieve supervisory convergence which we see, in accordance with our regulatory approach, as a process aiming to achieve compatible outcomes.
• To our mind, the case has yet to be made for radical reform of the EU regulatory architecture. We believe radical reform would be at best premature at this time and entail potentially more costs than benefits.
• We welcome recent developments in the EU/US regulatory dialogue and look forward to engaging further with the SEC and the Commission on issues of mutual reliance to facilitate business on a cross border basis.

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