Regulatory challenges in a principles-based environment
Speech by Clive Briault, Managing Director, Retail Markets, FSA
The Westminster Forum
8 November 2007
Good morning and thank you for the kind invitation to speak to you today. I will cover:
- the role of the Financial Services Authority and our statutory objectives;
- principles-based regulation;
- the importance of treating customers fairly; and more specifically
- the sale of Payment Protection Insurance (PPI), as an illustration of some of the challenges for the regulator in a principles-based environment.
Regulation: the role of the FSA
We are the main statutory regulator for the UK financial services industry, regulating some 29,000 firms – ranging from major retail groups and global investment banks to very small businesses.
We have four statutory objectives under the Financial Services and Markets Act, namely maintaining market confidence; promoting public understanding of the financial system; securing the appropriate degree of protection for consumers; and fighting financial crime.
In pursuing these objectives we aim to promote efficient, orderly and fair markets; to help retail consumers achieve a fair deal; and to improve our own business capability and effectiveness.
For the retail markets in financial products and services we are seeking to make these markets work effectively and efficiently to deliver benefits to consumers. There are four main elements to this.
First, capable and confident consumers.
Second, firms and ourselves providing simple and understandable information for, and used by, consumers.
Third, well-managed and adequately capitalised firms that treat their customers fairly.
And fourth, risk-based, principles-based and proportionate regulation that seeks to encourage market-led solutions.
Capable and confident consumers
So our first challenge is that retail financial markets do not always deliver good outcomes for many consumers. Unlike most other retail markets, where consumers are able to make an informed decision to pick and choose products and services, in financial markets consumers tend to lack the capability to choose products and services effectively – and even where they do have the capability they all too often fail to engage properly with providers and advisers. This in turn results in consumers being "sold" rather than "buying" financial products and services.
More capable and confident consumers would exercise greater market power and thus end up with financial products and services that were more suited to their needs. We are responding to this challenge through our leadership of the National Strategy for Financial Capability, which is helping people to acquire the knowledge and skills which will enable them to make capable and confident financial decisions. This is an immense task and it will take many years, and even decades, for its impact to show through.
Principles-based regulation
We want to regulate through a framework based on principles and other high-level requirements. Principles-based regulation is not new. We already have eleven high-level Principles for Businesses that have been in place in their current form since 2001 and have their origins further back in the high level requirements of former regulators. These Principles provide the backbone of our regulatory regime. They cover such things as integrity, skill, care and diligence, management and control, financial prudence, treating customers fairly, and the management of conflicts of interest.
These Principles express in broad terms the outcomes that firms should be trying to achieve. They focus on where we want firms to be rather than on how firms should get there. This leaves flexibility for firms to decide how best to achieve theses outcomes.
There are three main reasons for the move to more principles-based regulation. First, we want a stronger focus on the outcomes that really matter – better outcomes for consumers, for investors and for markets; and therefore better outcomes against our four statutory objectives.
Second, a more principles-based approach should deliver these outcomes more effectively, in particular by emphasising the responsibility of the senior management of firms to engage with the Principles and to ensure that their firms deliver outcomes that meet these high level requirements. We want the senior management of firms 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.
And third, a principles-based approach facilitates the emergence of market-led solutions, where we can work in partnership with the industry, with consumer bodies and with other stakeholders, to generate positive outcomes that focus on what really matters.
Detailed rules clearly have limitations. They have not always delivered the outcomes they were supposed to achieve. Detailed rules cannot cover all circumstances and eventualities - we cannot hope to devise a set of detailed rules to cover all types of business and all types of firm; and we cannot expect detailed rules to be responsive to market innovations and structural changes. Detailed rules tend to address processes, not outcomes - this can encourage a narrow approach to compliance, and can inhibit innovation and competition. And regulators need to avoid tackling problems by writing yet more detailed rules to address yesterday's problems - shutting the stable door after the horse has bolted.
Detailed rules have not been successful in preventing major mis-selling episodes in the UK such as personal pensions, mortgage endowments, split capital investment trusts and ‘precipice bonds’. We have consistently seen examples of firms giving poor quality advice; selling complex, opaque products to consumers without fully identifying or explaining the associated risks; and providing unclear product information.
So our second challenge is to deliver principles-based regulation. And, within this, our third challenge is to ensure that our own staff understand the context in which firms are exercising their discretion; are able to make outcome-focused judgements relating to our Principles; and are able to influence and persuade the senior management of firms to deliver outcomes consistent with the Principles through discussions that focus on these and our other high-level requirements.
Treating Customers Fairly
Our Treating Customers Fairly initiative is a good example of a principles-based approach and of our working closely with the industry and other stakeholders to deliver better outcomes in retail financial markets.
This has included a clear focus on
- high-level outcomes for consumers, as set out in our six consumer outcomes;
- the responsibilities of the senior management of regulated firms to deliver these outcomes;
- our playing back to the industry examples of good and bad practices that we have found through our firm-specific and thematic supervisory work, to help firms to understand the minimum standards implied by the Treating Customers Fairly principle; and
- our setting – and monitoring progress against – deadlines this year for the implementation by firms of Treating Customers Fairly initiatives, and next year for firms being able to measure through their own management information whether they are treating their customers fairly, and whether this is demonstrating the successful embedding of Treating Customers Fairly throughout their businesses.
So our fourth challenge is to ensure that firms deliver against our Treating Customers Fairly principle. We are seeing some encouraging progress here, but in many firms there is still further to go. And our fifth challenge is to be able to identify those firms that are failing to deliver this and to take the supervisory or disciplinary action required to change their behaviour.
Payment Protection Insurance
Our recent work into the sale of payment protection insurance (PPI) is an example of how we are applying our Treating Customers Fairly principle and illustrates some of the regulatory challenges we face.
We have taken a keen interest in the PPI market since we began regulating the conduct of general insurance business in January 2005, because of the large numbers of consumers active in the market, and the perceived substantial risk of consumer detriment. There are around 20 million PPI policies in force, with 6.5 to 7.5 million new policies sold annually. During 2006, consumers paid more than £5 billion in premiums.
We have published our expectations of firms when they sell PPI. They are that firms should ensure that their customers are:
- Being told PPI is optional, where this is the case;
- Given clear information about the product and what it will cost;
- Given the assistance they need to be clear about what they are eligible for under the policy and what the main exclusions are;
- Where advice is given, recommended a policy that meets their needs; and
- Offered a fair refund if they cancel their policy.
The overriding principle here is that firms should treat their customers fairly. We have made it clear to firms that they must comply with this principle, and should consider whether the design, marketing and sale of this product can be judged to be treating customers fairly.
Our latest report into the sale of PPI found that there have been improvements in some areas but, disappointingly, many firms are still failing to treat their customers fairly. Some firms have not improved their sale practices, and consumers are still at risk of being sold something they do not need, do not want, or cannot claim on. This follows the publication of the results of two previous thematic studies; the publication of ten disciplinary actions against firms for the mis-selling of PPI; and our working with trade bodies to improve standards.
We also work in close cooperation with the Office of Fair Trading, who in turn have referred the PPI market to the Competition Commission. The Commission set out its emerging thinking earlier this week, stating that
"At the retail level the initial indications are that consumers buying a distributor's credit product are relatively price insensitive when they consider buying PPI, and that the competitive constraints from alternative products such as income protection are limited. If that is the case then distributors might face little substantive competition when supplying PPI to those people who buy the distributors' own credit product".
Our sixth challenge is therefore to do something to change this situation.
Given our findings on PPI we will continue to work to improve sales processes. We will:
- conduct further mystery shopping on firms to gather additional information on PPI sales; and
- ensure that the refunds firms provide to consumers following poor selling practices are calculated in line with their obligation to treat customers fairly.
We have made clear that we are seeking to introduce stronger incentives for firms to change the way they operate. Incentives take several forms. We have said that good firms will benefit from regulatory dividends, including less intensive supervision. But at the other end of the spectrum we are seeking to increase the level of fines where standards fall below the required level and firms do not treat their customers fairly, in particular where this is warranted by the nature, seriousness and impact of the breach in question, and where this is likely to increase the deterrence impact of a fine.
Firms have been given due warning of their obligations to treat their customers fairly, both generally and on PPI in particular. We hope that by seeking to increase the reputational and financial risk of non-compliance, firms will invest more resources to mitigate the risk of poor selling practices.
Conclusion
Thank you for the opportunity to discuss these issues with you. I hope I have furthered your understanding of principles-based regulation, of our treating customers fairly initiative, and of some of the challenges we face in implementing principles-based regulation. In particular, I have drawn attention to the challenges of:
- the nature of the market for retail financial products and services;
- firms delivering more principles-based regulation;
- our delivery of principles-based regulation;
- firms meeting our Treating Customers Fairly principle;
- identifying those firms that are not meeting our principles; and
- providing the right incentives for firms to meet our principles.