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Speech by Stephen Bland, Director, Small Firms Division, FSA
at the Institute of Economic Affairs' 2nd annual conference
4 December 2007

Good afternoon to you all and thank you for that introduction. I should say that I wear three different hats at the FSA: one is as Director of Small Firms, the second is as Sector Leader for Retail Intermediaries, and the third is as the Director responsible for the Retail Distribution Review. Although there is a clear correlation between the three roles, the third of course goes well beyond the small firm or retail intermediary. And it is wearing that third hat that brings me here today.

I suppose it shows how far the Institute of Economic Affairs' way of thinking has become part of the mainstream that a regulator like me, however many hats I wear, can come to an IEA conference to talk about our work without a sense of trepidation.

Many would expect a free-market think tank to view a government-appointed regulator suspiciously. But nowadays regulators like me emphasise working with the market, risk-based approaches and intervention only once market-led solutions have been tried.

So I salute the IEA for its success in propagating its message, and in changing the way the world views markets. And I thank the IEA for inviting me today and gathering such a good audience of influential decision makers from the industry.

The RDR and principles-based regulation

At the FSA we're proud to have been cited as a model for what the Government now calls Better Regulation. That is regulation which is risk-based, which isn't about unecessary red tape and which is focused on the outcomes that matter. We are now pushing through with our aim to be a principles-based regulator where we can. We are one of the few regulators that has actually cut down the size of its rule book, all whilst keeping a close eye on essential consumer protection.

It is an approach which has been sometimes misread as light-touch. As both our Chairman and our Chief Executive have recently stressed, principles-based regulation is not about being light touch but about the right touch – about being outcome-focused and risk-based; it continues to be FSA's preferred way forward. We focus resources on where we think the risks to our objectives and the probability of those risks materialising bring about problems for markets, and for consumers. Our work to help firms meet the principle of treating their customers fairly, by setting our expectations, approaches and a timetable against which achievement can be judged, is a clear example of this principles-based approach in practice and is our first key priority in achieving our aims for the retail market.

Some have asked why the FSA, amid this climate of a more principles-based approach, and when firms are putting so much effort into treating customers fairly, has embarked on an ambitious programme to review retail distribution, a move which some have said looks like market intervention?

Well, I should first categorically state that we are not setting out to introduce swathes of new rules. Rather to work with the market to find ways to make it more efficient, easier to treat customers fairly, and make it more attractive to more consumers.

At the FSA we are clear that well-functioning markets are the best way to deliver good outcomes for consumers so that they have confidence that those markets can fairly meet their financial needs. And we recognise that consumers also have a role to play as a key part of this market. This is why the RDR must also be seen in the context of our second key priority for the retail market: to improve consumers' understanding of the financial system, which we are doing in partnership with others to deliver greater financial capability.

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A more efficient market

But the markets have to function well. This isn't the case with the retail investment market. In our experience, from the findings of our thematic and more routine supervisory work, and also in the opinion of many in the market, the current market is not working as effectively for either consumers or firms. At the core of our review is a desire to stimulate market solutions to deal with these longstanding market problems.

Problems centre around the incentive structures that exist – which emphasise sales in remunerating advice; the ability of firms and consumers to recognise the inherent conflicts that arise and the extent that these are appropriately managed; low professional requirements across the market as a whole particularly when compared to other professions; the apparent inability of many firms in this sector to create or retain value in their business; the indicators that some products and some advice are of poor quality; and the effectiveness of regulation.

This is in a market where consumers – despite the growing need to save more – lack both the capability and the willingness to act as a strong force that would otherwise contribute to an efficient and effective competitive market, especially where products are complex and long-term in nature. So it is an inefficient market that isn't necessarily functioning as well as it could or offering the benefits to all the market participants that it should.

In dealing with these market-wide problems, we are being consistent with our principles-based approach to regulation, which is underpinned by the belief that it is neither possible nor desirable to write a rule to cover every specific situation or need for decision that a regulated firm might encounter.

Instead, we focus on our 11 high-level principles. These set out in general terms the types of behaviour we expect of firms and individuals and cover all aspects of their business and relationships.

We believe a principles-based approach can facilitate the development of market-based and industry-generated solutions to regulatory issues. And this is how we have approached our review of retail distribution. Our third key priority for the retail market.

The Discussion Paper

In June we published the result of our first year's work on the review with a Discussion Paper setting out the potential solutions based on ideas generated by senior market practitioners and consumer representatives.

The ideas seek to improve the current standards of professionalism; find more cost-effective ways of making advice available to a wider range of consumers; and improve consumer understanding of what they are getting for their money. So the proposals include raising minimum standards of professionalism for people giving advice and clearer, market-standardised, labelling of services. Also, that there should be more economical ways to deliver advice that might encourage more access for more consumers who have the means and a need to save (some of whom aren't accessing the market at the moment). And the paper says there should be greater clarity for consumers on what services they are receiving and for what cost, and more clarity on how they are paying for advice.

When we started the process of identifying these solutions we wanted to stimulate a wider debate based on the ideas coming out of the groups. We wanted to then set these out for wider debate which we did in the June Discussion Paper. And we wanted to give plenty of time to ensure that we got the views of all parts of the market and at the same time undertook our own research to understand more about the impact and practicalities of these industry-generated ideas.

So, we are now nearing the end of that six month discussion period. We have taken part in over fifty events to discuss the RDR; we have been in listening mode and we have been helping to ensure that the debate is focused on the areas and ideas that really matter, being up front that those in the Discussion Paper might not be the only or best answers so generating alternatives. It is absolutely clear to me at this stage in the discussion that even if the ideas in the paper prove not to be the right ideas or were not presented in a way that suited everyone, they have certainly provided the basis for discussion and feedback. That is precisely what we set out to achieve.

Feedback so far

If we have been out talking to as many people in the market as we can, and listening to the helpful feedback, what have we heard so far? Well, we've already received about 300 formal responses to the paper. They are mainly from smaller firms which we are particularly pleased about as it is often these firms that we struggle to engage in important regulatory debates. But we also know that trade and professional bodies and larger firms are still working on their responses and we look forward to reading those as well.

In all we've listened to the views of thousands in the industry through a combination of speaking events, consultation sessions, and written feedback. This has given us a view of what people in the market are thinking. Whilst it is too early and too risky to draw hard conclusions at this stage – especially with many opinions still to come in between now and the end of December – I would like to give you a flavour today of what we have been hearing so far. I should emphasise that we have not yet received, let alone analysed, all the responses to the Discussion Paper, so please don't take this as the way the review will necessarily be taken forward.

Much of the feedback has emphasised a need to keep things simple. Regulators are often accused, perhaps fairly in some cases, of having a tendency to complicate matters so reducing the value of change for either consumers or market participants. This is not the approach we wish to take here.

In the paper we sought to put the market practitioners' ideas into a workable set of proposals. But we have to realise that these seek to make the market significantly better, and so different from today. They are not merely about tweaking things here and there. So although we want to make things easily understandable to consumers – and clarity is one of the key concepts in the Discussion Paper – some of the way forward could appear complicated if mapped against the current world. We need to be more adventurous than that and to think about the world we want to be in which could be quite different from what we have today.

That said, we're being told that more clarity is definitely needed on the proposals for primary advice. We said in the paper that this was a basic concept – the greenest of the proposals – which needed more fleshing out. We have been clear that we will not design a regulatory regime for primary advice unless there is clear interest from the market in us doing so. We have had a number of discussions with firms interested in pursuing the ideas in the paper and we wait with interest to see what these look like when the detail is developed.

Initially public views on primary advice, particularly by the intermediary sector, were pretty sceptical. More recently the concept has increased in popularity with wider interest coming through. For example, the recent NMG survey showed that 44% of independent financial advisers asked thought they were likely to offer primary advice alongside their core services. This is what we thought could happen – primary advice should not just be a province for the banks and product providers but might be something of interest to those firms who are keen to find an economical way to service the needs of all their customers, and to develop more junior staff while they do so.

Feedback has re-emphasised the importance we recognised in the Discussion Paper of ensuring our proposals fit in with the generic financial advice service that the government wants to introduce. There's obviously some common ground between the generic advice work and our aim in the review to allow more people to access the advice market.

Perhaps most interestingly, we have been hearing almost consensual views that there needs to be a clearer distinction not between the types of advice available, but between that which is really advice, and that which is in fact a sales process. Some are talking about 'assisted purchase', others about 'guided sales'. And in these discussions most are talking about some control over both the process and product range, about the need for close links to and from the national generic advice service, and consideration of whether you could group consumers together to service their 'general' needs. So not a million miles away from the ideas in the discussion paper in some respects, but potentially some very big issues for us to consider once we get more formal feedback.

So, some more specific proposals are coming forward on primary advice but there is clearly more to do and more for us to hear from the market before we decide how to proceed.

We have been pleased to see that the market generally supports the paper's call for greater professionalism and the importance of improving the reputation of the industry and all players in it. But people want professional standards to be relevant to the roles undertaken and accommodate a range of skills, expertise and experience. In particular, there is a very strong feeling that professional standards must go further than a list of relevant examinations: this was made clear in the Discussion Paper but there is no harm in me acknowledging that again today.

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This is one of the key areas where people have told us there needs to be a smooth and lengthy transition. If this happens, some people are saying they are happy not to have a 'grandfathering' process which would enable everyone in the market to be automatically transferred to a new status. And it is clear from what we are hearing that any transition will have to enable those that are up to standard, because of current qualifications, experience and expertise should be given credit for that particularly if they can demonstrate that this has led to good outcomes for their customers; those that are not up to standard and, importantly, do not deliver good outcomes for their customers, should be weeded out by the process.

The reception for a clearer role for clients in the way advisers are paid has been generally positive. People can see the merit in the principles for Customer Agreed Remuneration – or CAR as it is often termed – but would again like clarity about how it would actually work and its exact definition. Some have asked whether it could apply to everyone who gives advice. Others have suggested we should address commission at the source by tackling the providers. Others have gone so far as to suggest that we should consider again the benefits of restricting the levels of commission that can be paid. It is clear from the feedback we have received so far that the proposals put forward for CAR would reflect the way the market is heading and could accommodate a variety of practices. This is not surprising given that many firms are already operating within these general principles. But, as always, the devil will be in the detail and how our own work progresses.

On the definition of independence for advisers the feedback has been loud and clear. The paper suggested independence meant being free from provider influence over remuneration – so based on customer-agreed remuneration or fees – but the industry has told us it must also mean offering advice over the whole of the market. They do not think an adviser that only offers advice across a limited range of providers can truly give 'independent advice'. We hear you. Some have gone further and also questioned whether product providers having financial interests in distributor firms is consistent with the principles of 'independence'.

There is a feeling among some that we need to do more on our supervision of firms, particularly small advisers. That we should tackle the 'bad eggs' through increased supervision and enforcement action.

Well, this is something we are doing more on already. We recently announced an enhancement to our small firms strategy. We have committed to improving all firms' approach to treating their customers fairly, and next year we have set two deadlines all firms must meet.

Our enhanced strategy will see us devote extra resources to helping smaller firms that want to do the right thing meet those deadlines, whilst identifying and dealing with those that do not want to meet our requirements. We'll have twenty-five percent more supervisors assessing small firms, and we'll have more enforcement resources to take action where it can help raise standards across the market.

So, some very thoughtful responses so far to the paper we issued back in June.

I think we have definitely achieved one of the things we aimed for by publishing the RDR Discussion Paper: that was to set out the ideas that came out of our groups in a way that gave one view of the future of retail distribution and then to test these out on the wider market by seeking feedback from others. Against those ideas we have seen really exciting, energised and much wider debate with some interesting and in some places quite radical alternative ideas. We are also now hearing that many are identifying with the potential opportunities that should come from the RDR - as well as making clear the possible threats. The paper has clearly captured the imagination of many in the market; it was the right paper at the right time. Not all the feedback has been positive. Some has been critical – particularly in the early weeks – and whilst we are happy to receive all constructive feedback whether critical or supportive, we have definitely seen a sea-change in how people view the RDR.

At all stages we have sought to be open and transparent in our approach. We have clearly set out what we thought the problems were after speaking to people in the market. We have facilitated a way for the market to propose solutions to these problems and put the workable proposals in a paper for all to have their say on.

Besides speaking to as many in the market as possible we are also doing research on the proposals in the review paper and how firms and consumers might react to them. We know that we need good data and analysis of the economics of the industry and consumers' and firms' behaviour in order to understand better the proposals and their implications. Indeed, some of this early feedback suggests we might need to explore further still the dynamics and economics.

And we are working together with our colleagues in the FSA who are leading on work that is complementary and highly relevant to the RDR. For example, our Discussion Paper on platforms has had an excellent response so far with some really good quality comments coming back from the industry. The platforms team will be publishing this feedback statement in the first quarter of next year. Similarly, the important paper on prudential requirements for personal investment firms is producing some really interesting questions for us and for those in the market.

At this late stage in the discussion period we are clearly still open-minded about how we get to a more efficient market. The proposals in our paper are one way but if there are alternative solutions there is still time to let us know. But I'd also like to use today to encourage you to respond, if you haven't already done so, to both the RDR paper and the prudential requirements paper, It is not too late to respond but, as with Christmas shopping, time is fast running out!

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What does this all mean?

I've given a number of caveats above about the feedback we've had to date: incomplete, too early and risky to draw firm conclusions, and so on. It is clear, however, that the feedback we are receiving adds up to a widespread view that the eventual RDR proposals will need to have greater transparency to consumers and market practitioners (including therefore a reduction in their complexity) if the RDR is to achieve the outcomes for the market and for consumers for which we are striving. Taking the general feedback I've outlined above a step further, three examples illustrate this point.

First, on primary advice, most people have said that any viable form of this will feel to the consumer like a sales process. So call it that, they say, whether or not it is strictly within the definition of regulated advice – and then clarify the consequent FSA and ombudsman treatment.

Secondly, on remuneration of advisers, there is widespread agreement that providers should not be in a position to influence the advice being given to consumers. Many are saying that ways of doing this, such as CAR, should therefore apply to all in the market giving full financial advice. And that in turn raises the question of whether other differences between the proposed types of financial adviser are significant enough still to warrant having two tiers of advisers. Obviously there would then be knock-on effects for minimum standards of professionalism, for how risk-based prudential requirements might apply to firms, and for the nature and length of transitional arrangements.

Thirdly, some have argued that we should go further still, and create clear, blue water between full financial advice and various forms of sales. They argue that no one should hold themselves out as giving financial advice unless they are truly independent in terms both of their whole of market offering and their freedom from conflicts of interest in remuneration arrangements.

Timetable for change

These sorts of ideas for increasing the transparency of the market could clearly represent significant modifications to the ideas in the original discussion paper. And I should stress that we have formed no view on any of them other than that they are worthy of further consideration. And to ensure that ideas for modification of the original proposals do get the full consideration they deserve, by you as well as us, we now plan to publish an interim report in April.

This April document will set out the principal areas of feedback we have received and will outline ideas we want to discuss and analyse further before taking a view on how to proceed. This is us saying yes, we have listened, this is what we have been hearing and this is what we think and what that may mean for the way forward. We want to give the market as much information as we can, as soon as we can, about what we have heard and what we have found both in the interests of transparency and to keep up the momentum. Publishing an interim report in April should achieve this. We also hope to give the results of our own research to date at that stage, together with some of the early findings from our prudential requirements work.

In the New Year, we will need time to consider the results of the feedback and our own research and ensure that we have a clear picture of what we have been told. This means that you might not see much of the RDR team in the first quarter of the year. In other words, no news will mean no news, until April that is!

We will then publish our full Feedback Statement in October. This October document will include our decisions on the future implementation of the RDR. This will detail any regulatory changes required and the detailed plan for formal consultation on changes to rules. We won't be keeping you in the dark until then because we will have said what we have heard in April and indicated how we might take this forward quite a bit earlier than originally planned.

This approach is both a little earlier and a little later than we originally stated. We think this approach will be welcomed. We had said that we would aim to publish the full feedback by the end of June. But the overwhelming message we're getting from all in the market is that if we are to make regulatory changes here, we must get it right. And we are told that if we don't want to be carrying out a further review of this area in a couple of years' time, considering the same problems once again, let's do it properly now and let's get it right.

So, based on this strong message, we think we can achieve better outcomes overall by taking more time during the discussion phase of the RDR to develop the detail and consider the regulatory implications of that detail. At the same time we reduce the risk of getting it wrong or creating further uncertainty by rushing into things. Work will continue on what rule changes might be necessary to implement emerging ideas, and we do not envisage any slowing down of the overall RDR timetable, as by putting more time into this phase of the review we may be accelerating the production of any consultation papers that may be needed.

Finally, of course, in the meantime, there's little to stop firms taking their own action now and doing what many are starting to do and working to achieve the outcomes set out in the paper.

Closing remarks

So, in closing, thank you for listening to me today. I hope that I've shown – not least to the IEA itself – that at the FSA we are willing to listen to the market and work with it to get the right improvements. We are not about unnecessary interference or taking the easy option of new rules. We think our principles-based, collaborative approach can work in the retail market, and that we can all take the opportunity this review offers to ensure a healthy long-term retail investment market with good outcomes for firms and good outcomes for consumers, who will rightly have more confidence to use its products and services.

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