Looking ahead: FSA retail programme after MiFID
Speech by Hector Sants, Chief Executive Officer, FSA
APCIMS Conference
Wednesday
17 October
When I took on the role of Chief Executive at the end of July, I envisaged my first month would be a period for listening and learning. That, as I am sure you appreciate, has not been the case. I am thus delighted to be here this afternoon to talk about our long term retail agenda and how APCIMS members can play their part in taking it forward.
More principles-based regulation
However, before turning to the detail of the retail agenda, may I make the most important point of my talk, namely to assure you that the FSA remains committed to implementing more principles based regulation. What's more, I would emphasise that we will not be diverted from our efforts in implementing such a regime by recent market turbulence. I am aware that a number of commentators have asked whether now is an appropriate time to drive forward a regime of fewer and less prescriptive rules.
Well, I would respond that the volatility of recent market developments underline the benefits of the move to more principles based regulation. Principles are, in many ways, a more efficient and real-time means than rule-making, enabling us to meet our statutory objectives and assist firms' management to deal with the challenges they faced in the summer.
More principles based regulation will mean that firms will be under a constant obligation to review the conformity of their business practices, whether in calm or in turbulent markets, with our principles and high-level rules. Considered review by senior management and staff across all businesses on a day-to-day basis of questions such as whether customers are continuing to be treated fairly, whether conflicts of interest are being managed appropriately and, critically, are the business risks being managed, should be the norm in the more principles based world.
We hope that firms' more thoughtful engagement with the outcomes we signal we would like them to achieve, on an ongoing basis, will lead to outcomes that are better for both their consumers and firms themselves.
To be clear, I believe the recent events surrounding Northern Rock reinforce rather than contradict this need to focus on the outcomes and consequences of management actions rather than just on the compliance of the actions with a set of rules. We are not operating a 'no fail regulatory regime'. We recognise that a successful financial market place requires innovation and competition. In turn that means there will be failures. But a principles based regime clearly, in our view, provides the best chance of achieving the requisite balance between the benefits and risks of innovation.
More principles based regulation does not mean of course that we are moving away completely from detailed rules for our regulatory regime. We fully intend to maintain a balance of detailed rules and higher level rules and principles. In some cases detailed rules are, and will continue to be, the best means of delivering a regulatory outcome or mitigating a market failure. For example, consumers may benefit from us prescribing the way in which firms provide key information to them.
However, it seems clear to me that more principles based regulation is fundamentally important to the future success of our regulatory regime, and particularly in the retail market place, where years of rules-based regulation has failed to limit instances of mis-selling – such as of precipice bonds - or improve standards within the market. Though firms have for some time been subject to our principles, focus has all too often been limited to compliance with the letter of our rules – regarded frequently as a definitive set of requirements. Until fairly recently, firms have not, either at our insistence or on their own initiative, looked at the spirit behind our rules and reflected an understanding of that spirit in the whole range of products and services that they offer. Product innovation has frequently seemed to be geared towards strategies accommodated by structures to which a low or negligible level of consumer protection requirements applies.
Obviously, our discretion on minimising the number of rules is, to some extent, prescribed by European Directives. Though this material may limit the scope of our discretion in some areas, we do not think that the implementation of Directives will, as a matter of course, compromise this move to more principles based regulation. As we have stated on previous occasions, Community Law is not in itself incompatible with our more principles-based approach. Indeed Directives are quite often intentionally high-level and outcome-focused to allow transposition by the national authority. For our own part, we intend to implement changes by using 'intelligent copy out' and in doing so intend to maximise the level of flexibility in our regulatory regime, whilst affording consumers and markets the appropriate degree of regulatory oversight as required by our statutory objectives, and our European obligations.
Working with industry
In general, it is clear that the move away from more prescriptive rules towards a combination of rules and principles will afford firms more flexibility in their interpretation of our requirements. In fact, what more principles based regulation does is give firms the opportunity to apply our requirements to their business models and make them relevant to those business models.
The major consequence of granting firms this flexibility is that we at the FSA need to understand the context in which firms are exercising their discretion in interpretation. Just as firms will be able to interpret our principles in line with their business models, so we need to ensure that FSA staff 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.
As a result of this, it is key to the success of more principles based regulation that FSA and firms work together to understand our mutual aims and concerns. In order that we remain confident that firms rightly retain the responsibility to exercise their discretion in a MPBR regime, we need to build lasting and collaborative partnerships with the firms we regulate and the trade associations that represent them.
Understanding APCIMS population
In the context of the wealth management industry, IFSL's December 2006 report on International Private Wealth Management suggested that one of the attractions of the UK as a leading market for international wealth management was the proportionate approach to the implementation of regulation. Compeer data highlighted that private client assets at the end of 2006 equalled more than property, hedge funds and private equity assets added together. Though we do not influence the most important factors that impact the size of the UK wealth management industry – these include the vast amount of specialist expertise in regional investments and a growing international client base resident in London - we hope that our regime will continue to be regarded as an important factor in the success of the UK wealth management industry. Key to this aim will be to reinforce our understanding of your industry and cement our relationship with APCIMS and its members.
We know that APCIMS firms have on occasion felt let down by our supervision of their firms and our policy-making. We know this because you have told us. You have highlighted the unsought-for impacts on your community of particular pieces of policy development targeted, you have felt, more squarely at firms that sell products rather than offer services and manage individual portfolios.
I acknowledge these concerns but hope that you recognise our recent endeavours to address these, in particular our initiative to build up the expertise of our staff in your sector. We have an ongoing secondment programme which we are always keen to have new firms join. Over the past 3 years, a number of FSA staff have spent either 6 weeks or 6 months with APCIMS members and we would like to build on this even further. Earlier this year, the representatives of four stockbroker firms, all APCIMS members, presented to over 70 FSA staff on their business model, focusing in particular on the use of complex products.
Our Asset Management Sector Team has an important role as well, in articulating to FSA staff the particular features of industry business models and the risks to our objectives presented by individual business models through the ARROW process. We hope that you continue to talk to them and feed back your thoughts where appropriate.
We also benefit from feedback from individual firms and from APCIMS itself on various matters that affect its members in the course of policy development. In fact, according to APCIMS Annual Report, this trade body responded to 37 separate formal consultations during the reporting period of 2006-7. In addition, APCIMS staff wrote numerous letters, responded to CEO letters and thematic reviews and participated in working groups, industry fora and a number of conferences, and generally did not pull its punches in communicating with FSA on every issue that affected its members.
So having, I hope, given you an overview of our strategic direction and desire to partner with you, let me briefly discuss some of the key elements of our retail agenda and where we are looking to challenge APCIMS members on their delivery against consumer-focused outcomes that we have articulated.
FSA Retail agenda
Our retail agenda is focused on delivering an effective and efficient retail market for financial services and products which give consumers a fair deal.
Historically we have articulated this by stating that our work has four pillars:
- Capable and confident consumers;
- Clear, simple and understandable information available for, and used by, consumers;
- Soundly managed and well capitalised firms who treat their customers fairly; and
- Proportionate, risk-based and more principles-based regulation.
However, we recognise that giving coherency to this proposition also requires a clear framework – a vision of how all the component parts of the industry fit together to deliver these outcomes. As we move to consider the conclusions to the RDR we will seek, in consultation with the industry, to articulate this vision. However, I think I can safely forecast that any such analysis will demonstrate the critical role of advice based participants.
Treating Customers Fairly
Against this framework may I briefly touch on some of the detail of our approach; starting with our "Treating Customers Fairly" agenda.
As regards TCF, we might usefully consider some of the issues arising for the APCIMS firm business model by looking at some of the guidance that we have published around the fair treatment of customers.
Firstly in respect of this topic, I would like to explain the impact of considering the importance of ensuring your advisory approach is geared to an individual customer's unique needs and caution you of the dangers of generic solutions such as standardised portfolios. These are, of course, a sensible starting point, but do not forget TCF is geared to the needs of individual customers, not standardised ones. Do not forget this issue is discussed in our recently issued guidance on providers and distributors.
Secondly, I would like to highlight the importance of a good firm culture in delivering good customer care. We have also recently published material around the cultural issues we believe firms should consider when looking at how best to implement TCF and you may find it interesting to hear more about some of these.
We discuss in our July paper 'Treating Customers Fairly – Culture' that senior management of firms should consider how their reward culture plays its proper part in delivering fair consumer outcomes. We recognise the need for firms to establish targets, where appropriate, which will lead to growth in their business. Firms frequently motivate their staff to deliver this growth through rewarding performance. However, over the course of a number of projects we have identified that some firms fail to recognise the influence of incentive schemes on delivering unfair consumer outcomes. Where firms have reviewed their reward structures, they have often not put sufficient weight on quality issues and do not go far enough in rewarding good behaviour or fair consumer outcomes.
This observation is in fact a reflection of a broader shortcoming – not, I emphasise, specifically with the APCIMS population – in that many firms have yet to consider how their individual performance plans can best reflect objectives around the fair treatment of customers. Senior management of firms should recognise the pertinence to the delivery of fair consumer outcomes of recruiting staff with appropriate values and skills, training staff effectively, and assessing and monitoring their competence.
Guidance material: lessons from TCF for PBR
These examples I have referred to are merely suggestions, and in many cases, will not be contentious for the firms represented here today. However, what firms should not fail to understand is that principles such as TCF apply to all firms and pertain to the relationships between firms and their customers. Where their customers are private or retail or professional clients, firms must use their own judgement to assess the impact of that principle on their relationship and dealings with their client. Firms should not look to the FSA to provide detailed guidance in relation to every nuance for every possible permutation of business model that exists in the market.
It should not be thought that by focusing published material, such as case studies, on the more profuse business models, that we are somehow singling out such firms for particular scrutiny. Such guidance is merely an exemplar; to deduce it as being universal and the scope of the principle as limited to the most frequently occurring business model is to misunderstand our expectations for PBR.
Retail Distribution Review
The next issue I thought I would touch on is the Retail Distribution Review. I have made numerous references to our efforts in building our understanding of your business models. One area where this is crucial is in understanding the degree of contiguity between the APCIMS business model and the personal investment firm population.
The Retail Distribution Review, consultation on which is due to close at the end of December, covers all who distribute or advise on retail investment products, including private client investment managers. It proposed, FOR DISCUSSION, amongst many other things, the creation of a top tier of advisers, which for the purposes of the paper were called "professional financial planners". The Discussion Paper suggested that accreditation of the rank of "professional financial planner" should require amongst other things the passing of examinations equivalent to the Chartered Financial Planner, Certified Financial Planner or the Securities Institute Diploma, and transition to a model where product provider influence is removed from remuneration. We really want your input on this issue. We know that wealth managers have competed for some time with a top tier of IFAs, many of whom are independent financial planners. We don't think the business model we're proposing will necessarily challenge existing business for APCIMS members, but we do want to achieve consistent standards of professionalism amongst all those who give investment advice in the retail market, and ensure they have clear labels that help customers understand the services being provided.
In addition, the paper suggested that this set of firms might conceivably benefit from a re-consideration of prudential requirements such that firms could meet these requirements through a balance of PII cover and capital. APCIMS has highlighted that in light of the potential mixing of their firms with personal investment firms in the intermediation sub-classes of the proposed new funding model of the FSCS, it does not support this concession. This is interesting feedback that we will consider closely in formulating our policy response.
Financial Services Compensation Scheme
My final area of focus is the Financial Services Compensation Scheme. As you know we have been reviewing the FSCS funding arrangements and are proposing changes to the funding model to be implemented on 1 April 2008. Northern Rock was brought to its current position by a combination of circumstances which can be broadly grouped into two themes; liquidity issues and a bank run. The first was undoubtedly a catalyst for the set of circumstances that created the second, but I believe that the reason why consumers queued was also partially due to their lack of overall confidence in the authorities and the financial system. This fundamental lesson is arguably the most important to be learned from the Northern Rock incident. Unpacking the lesson of consumer confidence from the FSA's perspective highlights two issues, that of the Financial Services Compensation Scheme, and the overall administration regime for financial institutions. The Tripartite Authorities have already published a discussion document on this, and the main focus for the FSA will be looking at the Financial Services Compensation Scheme.
We have already changed the guaranteed level of deposits on 1 October from 100% for the first £2,000 and 90% of the next £33,000 to a total of £35,000 to 100% of £35,000 and committed to further review the scheme to take into account recent events, utilising the full consultation process. This review will also cover other compensation limits to ensure that we have a fair and logical approach across products. I would urge you to play an active role in this second phase of review.
Consultation documents and their status
My final point is a personal plea and this underpins much of my earlier comments. It seems that firms doubt our willingness to debate an interpretation of principle or our proposals for new policy. Sometimes, it seems that the proposals in discussion and consultation papers are seen as concrete rules before they are even made. In fact, it is in our own best interests to seek your views. Such views can properly give colour and texture to policy proposals, can illuminate policy implications that were not sought, and help us avoid the creation of policy whose cost to the industry in general, or a sector in particular, is disproportionate to the benefit that its implementation would effect.
The status of consultation or discussion documents as merely that – documents containing issues for consultation and discussion – is one that we would re-emphasise now. We generally do not publish these papers simply to give firms notice of policy we intend to implement 6 months down the road, although it's fair to say that at the consultation stage we should have a reasonable idea of the likely impacts of the policy, both on the cost and benefit sides. Good policy-making practice to a large extent rests on a mutual willingness to engage with each other before, during and after the consultation process. APCIMS' enthusiastic participation at all those stages in so many policy initiatives, reflects, I would venture, a belief that such engagement is invariably a worthwhile enterprise.
Telephone taping
We hope that the recent announcement that we have postponed the implementation of rules relating to telephone taping demonstrates our responsiveness to consultation feedback from firms. We have ourselves been particularly interested to hear about the impact on firms across a range of business models and for whom there were a broad distribution of cost and technological issues arising from the proposals. This enabled us to adopt what I hope is a measured and pragmatic stance on the timetable for implementation and possibly, for considering scope of the requirements. This is an issue we will be working closely with APCIMS and its members on in the coming months.
Conclusion
I hope I've made clear today the importance to us all of implementing more principles-based regulation in a manner that is well-thought through and based on firms' clear understanding of our objectives and aims for the retail market and our robust and constructive understanding of firms' business models. This mutual understanding should help not only in facilitating more principles-based regulation, but also in illuminating the context in which we undertake future policy-making and thematic and supervisory work, and in which firms provide products and services to end customers.
We look forward to working with you all in this important endeavour.