Regulatory developments and the challenges ahead
Speech by Clive Briault, Managing Director, Retail Markets, FSA
Compliance Institute Annual State of the Nation Conference
30 January 2008
Thank you for the invitation to address your annual seminar.
The Compliance Institute plays a vital role in establishing and improving standards within the UK compliance profession, as demonstrated by your commendable efforts to raise professional standards in the marketplace with the forthcoming launch of a qualification for compliance officers. You have also supported the FSA in publicising our retail 'placement scheme' to your members. This is where a member of our staff goes out into the industry on a short secondment to one of your firms, providing an invaluable two-way flow of experience and knowledge. Thank you for your support in this.
We published our Financial Risk Outlook yesterday and will publish our Business Plan next week. Both of these publications contain a great deal of material about how we see the coming year and the work that lies ahead. I will leave you to read these documents for details on the areas of particular interest to you, and focus today on a narrower range of topics.
Last year was overshadowed by the liquidity crunch and the subsequent events regarding Northern Rock. We must not, however, forget the many other significant developments last year, including:
- the transition to the new Capital Requirements Directive (CRD) regime. All banks and investment firms are now live on CRD and we have granted 63 approvals for advanced model based approaches. But that does not mean that we have reached the end of the journey; significant challenges remain ahead. The primary objective of the CRD is the delivery of a modern risk-sensitive prudential framework for banks and investment firms, which delivers the right level of capital for the risks being run, so we will be monitoring closely whether the calibration of the framework, firms' models and their risk management are indeed delivering this outcome;
- over the last year we have issued Individual Capital Guidance to some 140 life insurance firms and 160 general insurance firms;
- most of you in this room have probably spent the last year implementing MiFID so I will not prolong the agony by mentioning it further today;
- market abuse continues to be one of the key risks to maintaining efficient, orderly and fair markets. Our strategy in relation to this is a combination of deterrent, enforcement and education tools. We are strengthening our systems to focus on the prevention and detection of market abuse through the development of a more effective market monitoring system;
- we have recently announced a review of the UK listing regime to ensure that there is a balance between competitiveness and investor protection;
- data security is an issue of increasing importance. Data losses by both regulated firms and Government departments have demonstrated very clearly the reputational risks of holding or transferring customer data insecurely and the potential risks to consumers. We have been carrying out a major project looking at data security in financial services firms over the past nine months to establish a benchmark of the data security standards currently in place. We have found that - in general - data security in firms could be improved significantly. Our full report will be published in March;
- we have continued to contribute to a wide variety of EU and international work programmes, including on Solvency 2, liquidity and credit rating agencies; and
- we have taken forward our main retail initiatives on treating customers fairly, the retail distribution review and financial capability. I will cover these areas in more detail in a moment.
Current market conditions
Market developments since August have exposed a number of vulnerabilities. Investors became markedly less willing to invest in or fund mortgage assets, irrespective of their quality, and this spread even to non-mortgage assets. Banks and building societies found it much more difficult to raise wholesale market funding, especially at anything other than very short maturities. And long-established relationships broke down, such as the linkage between three-month LIBOR and official policy rates.
The risks of relying heavily on securitisation or wholesale funding have received the highest profile. But it is also important to observe that some types of retail funding have behaved differently than we have seen in the past, with internet and other rate sensitive accounts, especially those in excess of the compensation limit of £35,000, proving to be much more mobile than had previously been assumed.
As we said in our Financial Risk Outlook for 2008, our central expectation is that economic growth will slow to 1.8% this year, but there is a great deal of uncertainty around that central expectation and the risks are heavily weighted to the downside. Our central scenario identifies five priority risks:
- existing business models of some financial institutions are under strain as a result of adverse market conditions;
- increased financial pressures may lead to financial firms shifting their efforts away from focusing on conduct of business requirements and from maintaining and strengthening business-as-usual processes;
- a significant minority of consumers could experience financial problems because of their high levels of borrowing;
- market participants and consumers may lose confidence in financial institutions and in the authorities' ability to safeguard the financial system; and
- tighter economic conditions could increase the incidence or discovery of some types of financial crime or lead to firms' resources being diverted away from tackling financial crime.
It is also prudent to assume that market conditions will remain very difficult for a sustained period. This economic and financial market fragility means that markets are more sensitive to shocks, so the impact of credit losses or other adverse events on markets and on firms could be greater than would have been the case in previous years.
Our response to this changing environment has been robust.
First, we have increased our surveillance of firms and markets, and have sought to ensure that they have robust risk management, and adequate capital and liquidity, in place. Many firms have made a lot of progress in this area already and we continue to work closely with them. This includes firms:
- assessing their funding and liquidity positions. Firms should be protecting themselves from current vulnerabilities by actively putting in place adequate levels of capital and liquidity;
- assessing their overall capital positions in light of current and anticipated market developments, and considering, where necessary, how they intend to strengthen their capital position and enhance the quality of their capital, to ensure that they remain resilient;
- undertaking robust stress testing. Robust stress testing should form part of the risk management framework of all firms, taking into account both firm-specific and market wide current and prospective conditions, and covering both liquidity and credit risks;
- considering their contingency plans against the worst outcomes, and reviewing and revising these plans in the light of market conditions. For example, we have been drawing the attention of deposit-takers to the need for contingency planning for retail deposit outflows. These plans might include the very practical issue of how to cope with an upsurge in retail deposit withdrawals, from branches, call centres and over the internet; and
- reviewing and assessing their medium and longer term strategies and the options open to them.
Second, we have responded to these market conditions by publishing our discussion paper on liquidity in December, which sets the scene for a constructive dialogue about the shape and content of our future liquidity policy. We need to ensure banks are holding adequate liquidity without imposing liquidity requirements so high that they become an unjustified cost. We are seeking to modernise the liquidity regime not only domestically but also at the EU and international level, and we believe that there are benefits from the application of a more principles-based approach to liquidity. We have committed to publish a consultation paper by the summer which will set out proposals for a new regime.
Third, the tripartite consultation document on banking reform was published this morning. While it will never be possible, nor desirable, to guarantee that a bank cannot fail, it is important to minimise any disruption to the economy and any resulting hardship to individuals. The consultation document contains proposals for:
- strengthening the stability and resilience of the financial system;
- reducing the likelihood of individual banks facing difficulties;
- reducing the impact if, nevertheless, a bank gets into difficulties – including a new "special resolution regime";
- providing effective compensation arrangements in which consumers have confidence; and
- ensuring effective coordinated actions by authorities, both in the UK – including through reforms to the tripartite arrangements – and internationally.
The proposed "special resolution regime" would include a range of tools available to the authorities, such as powers to direct and accelerate transfers of banking business to a third party; to allow the authorities to take control of all or part of a bank (or of its assets and liabilities) through a "bridge bank"; to appoint a suitable person to oversee a bank in the special resolution regime; to provide financial support to a failing bank, through a public sector liability guarantee or public sector capital injection; and, if necessary, to facilitate fast and orderly payment of depositors' claims under the compensation scheme.
Principles-based regulation
As I have mentioned, we remain comitted to principles-based regulation. 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.
We want to emphasise 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 we want to facilitate 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.
What happened with Northern Rock does not mean principles-based regulation is flawed. Indeed, we believe that a full analysis of the events will support our principles-based approach to regulation, and in particular the importance of both us and firms' management focusing on the consequences of their actions rather than rigid adherence to detailed rules. As we have already acknowledged publicly, there were supervisory failings in relation to Northern Rock and we are already addressing these. We will also examine carefully any further lessons that emerge from our internal review of the supervision of Northern Rock. We will be publishing the conclusions of that review in March.
Treating Customers Fairly
Treating Customers Fairly is a leading example of our move towards principles-based regulation – with its focus on consumer outcomes – and of our working closely in partnership with the industry and other stakeholders to deliver better outcomes in retail financial markets. Treating Customers Fairly puts the emphasis on firms' obligations to treat customers fairly throughout the life of the product. Rather than focusing on rules and processes, we have defined six consumer outcomes against which firms should be measuring whether or not they are treating their customers fairly.
Firms should be clear that this is not just a regulatory requirement. There is a real and growing commercial imperative to treat customers fairly. If applied correctly, Treating Customers Fairly should be integral to a firm's overall management of its business – it should be very much a commercial initiative, not a separate stand-alone project. It should drive decisions about what the firm's retail offering is and who its target market is.
We recognise that senior management in most firms are taking Treating Customers Fairly seriously. And we see signs that some firms are seeking to embed fair treatment of customers within their culture. We have seen an improvement in product design processes and progress on the clarity of information in financial promotions and in mortgage and general insurance disclosure. Nevertheless, overall we are disappointed with the progress that the industry has so far made in delivering fair outcomes for consumers, as evidenced by our thematic and some of our firm-specific work.
We have set firms two important deadlines. First, an interim deadline that by March 2008 firms should have evidence in place - through appropriate management information and measures – to test whether they are treating their customers fairly and meeting the consumer outcomes. And second, that by December 2008 firms must be consistently treating their customers fairly and be able to evidence this.
Meeting these two deadlines will require sustained energy and commitment from senior management in some firms. In many instances it will require cultural change to ensure that the necessary improvements happen and are sustained. We continue to work with firms to improve understanding of the significance of the deadlines and the scale of effort and pace required to meet them. We will use every opportunity to emphasise the priority we attach to Treating Customers Fairly this year; and we will work with industry bodies and other stakeholders to build that understanding.
To help firms assemble the necessary evidence to demonstrate that they are delivering the consumer outcomes, we have published a guide to management information and culture framework and case studies. For small firms, our enhanced strategy will focus as much on help and advice as on more traditional regulatory tools. We intend to undertake a much higher number (between 3,000 and 5,000) of "TCF mini-interviews" each year; and then to use the results of these, together with all our other information sources, to visit in more depth – and to be rigorous in following up any serious breaches of our requirements – those firms we identify as being at the bottom end of the spectrum of compliance. And we will continue to focus our thematic work to help paint a picture of firms' progress.
Where a firm cannot produce its own evidence of progress on Treating Customers Fairly we will undertake more detailed testing, and we will use our culture tool (published in summer 2007) to assess whether there are aspects of the firm's culture which create Treating Customers Fairly risks.
In summary, your focus should be on delivering our consumer outcomes and providing evidence that you are doing so.
Consumers have a keen interest in – and influence on – the success of Treating Customers Fairly. The growth of the information economy means more information is readily available - and information can be exchanged more easily and more rapidly. Our work on improving the financial capability of consumers seeks to improve consumer skills and reduce the information imbalance between firms and their customers. We are beginning to see the impact of better informed consumers on the behaviour of firms. There are a number of examples of consumer action prompted by the media; by campaigns run by organisations ranging from consumer bodies to claims management companies; and by consumers themselves. The most high-profile of these have recently included those relating to mortgage endowments; bank charges; Equitable Life; the and Facebook campaign by students to persuade HSBC not to change overdraft conditions as soon as they graduate.
As President Bush said in his State of the Union address on Monday "In the work ahead, we must be guided by the philosophy that made our nation great. We believe in the power of individuals to determine their destiny and shape the course of history. We believe that the most reliable guide for our country is the collective wisdom of ordinary citizens. And so in all we do, we must trust in the ability of free peoples to make wise decisions, and empower them to improve their lives for their futures".
Our own complaints data, and the data on complaints that are resolved by the Financial Ombudsman Service, reflect this trend of an increasing willingness and ability of consumers to take matters into their own hands. we have seen a sharp – six-fold - increase in complaints about bank charges, and we may be seeing the beginnings of something similar on payment protection insurance. And complaints to firms about poor customer service have increased significantly in the last year.
These actions show that a firm's reputation could be damaged very quickly. And we are likely to see further such action with improvements in the access to information and financial capability. Increasingly, consumers will judge for themselves whether they are being treated fairly.
Retail Distribution Review
I turn next to our Retail Distribution Review. The Review seeks to identify – and provide market-led solutions to – significant and persistent problems in the distribution of products in the retail investment market. It has the long term aim of delivering a more efficient retail investment market – which brings benefits for consumers, providers and distributors.
We want to move to a market for retail investment products where more consumers have their needs and wants met, with higher levels of saving and investment benefiting individuals, firms and society as a whole; greater clarity for consumers on the products and services they are buying; standards of professionalism that inspire consumer confidence and trust; the removal of the harmful effects of conflicts of interest from remuneration arrangements; viable firms which can deliver on their longer-term commitments; and regulation that supports these aims, not stifling innovation or competition where these forces would work for the benefit of consumers.
I do not apologise for these ambitious aims: it seems that many share our enthusiasm for delivering real change and seizing the opportunities the Review brings. You will know that we have just closed our very thorough first discussion period for the Review. During the last half of 2007, our collective engagement and open approach to feedback generated nearly 900 responses to the initial ideas put forward in the Discussion Paper. The time we spent out in the market - speaking at or running over 50 events – enabled us to hear the views of a wide range of interested parties.
So far, we have heard some clear messages. You have told us to keep things simple: that the real distinction should be between advice and sales, not different tiers of advisers. You have said that you want professionalism to reflect not only qualifications but the wide range of skills, ethics and experience that determine whether someone is competent. You have told us not to tinker around the edges, to take the time to get it right, that you do not want further reviews of this market in a couple of years' time, but neither do you want change to cause mass disruption so the transition is vital. And you are clear that whatever is achieved by the Review must be meaningful to consumers and fit neatly with the Thoresen generic advice model.
We have heard generally positive, although sometimes confused, comments on Customer Agreed Remuneration, so I want to clarify our aims here. We set out clearly in the July Discussion Paper last year our desire for remuneration practices that remove any conflicts of interest that might otherwise inhibit firms from acting in the consumer's best interests. We want to shift the focus of remuneration away from the provider and towards the customer, thus removing the potential for provider-led remuneration to result in bias. We want providers to meet their responsibilities to design target and market their products in ways that treat their customers fairly – and this includes the ways in which they remunerate both their in-house staff and third-party distributors. We want advisers to act solely in the best interests of their clients, not on behalf of providers who are paying them commission. And we want simple charging structures that are capable of being understood by consumers.
We remain genuinely keen for you to deliver changes. I am delighted to see real examples already of movements in the market, whether towards the aims of higher standards of professionalism where the CII has seen the highest increase in membership for over 70 years, or in efforts to adopt a more customer-focused approach to the provision of and payment for advice. Any changes that we introduce will be consistent with our principles-based approach and our preference is of course to be consistent with existing requirements from Europe (such as MiFID) as far as appropriate. We have to acknowledge the findings from many of our reviews of the retail market which call into question how far traditional regulatory tools, such as disclosure, can really help consumers make sensible, informed decisions. So we are equally open to radical change if that is the right response. We promise to continue to be transparent in our thinking and to take your views along the way.
Our new timetable – an Interim Report in April with full feedback in October – will give us the time you say we must take to find solutions that are not only fit for the market today, but fit for the market of the future.
Our April paper will concentrate on areas which look promising for market-led changes, but on which we need further evidence, to undertake more analysis, or to have further dialogue with you. This might includes areas such as what we initially called Primary Advice but has now evolved into "guided sales" or "assisted purchase"; the development of guiding principles for remuneration; and how best to deliver in practice the general agreement on the need for higher standards of professionalism. As we develop our thinking further, it is vital that we deepen our understanding of the economic context and drivers for the retail markets so that any change can be considered in that context. Indeed, this further work may well lead to us dropping or changing one or more of the ideas that have emerged to date from the review, perhaps because firms find that an idea is not economically viable for them; or because we cannot satisfy ourselves about the right balance between economic viability and consumer protection; or because the ideas are too complex or unappealing to consumers. So the April document will be very much a continuation of the discussion process rather than a policy statement. That will come later.
Financial Capability and the Thoresen Review
Our financial capability and disclosure initiatives, on the demand-side of the retail market, aim to move consumers to a stronger position to influence the way that products and services are demanded by them and delivered to them, and to enable consumers to make better informed decisions when buying financial products and services.
More than ever before, people are being asked to take responsibility for managing their personal finances. Many, however, are ill-equipped to navigate the financial highway, especially when faced with increasing complexity and choice, and a lack of access to basic advice on money management.
Through our leadership of the National Strategy for Financial Capability we are seeking to help people acquire the knowledge and skills which will enable them to make capable and confident financial decisions. We have set ourselves the ambitious target of reaching at least 10 million people by 2010/11 and, in order to do so, we are scaling up our activities significantly and investing £60mn in this work over the next three years.
We have seen some significant successes in our financial capability strategy so far. We are half-way through our 'Delivering Change' plan, a five-year strategy to improve the financial capability of UK consumers, with a particular emphasis on schools, young adults and the workplace. To date we have reached 2.6 million people.
The National Strategy for Financial Capability brings together a range of partners from the financial services industry, consumer bodies, voluntary organisations, government and media, with the FSA providing leadership and co-ordination, working in partnership with a range of trusted intermediaries to support the expansion of entry level generic financial advice. But we are also a direct provider of generic advice to the public through, for example, our Moneymadeclear website, our consumer helpline and our Make the Most of Your Money seminars and resources that have reached employees working in around 400 firms.
This expansion of entry level generic financial advice will, in turn, stimulate demand for a more in-depth advice service. But we can only go so far. That is why we fully support the work of Otto Thoresen’s independent review for the Government to research and design a national generic financial advice service. The Review is not yet complete but Otto’s interim report has provided a clear indication of his thinking about some of the key challenges that need to be addressed.
I would like to offer two brief observations on Otto's Review:
First, the new generic advice service should aim to complement, and be integrated with, the National Strategy for Financial Capability. There is a real opportunity for the organisation appointed to run the service, whether that is the FSA or another body, to build on the momentum that has been generated through the National Strategy and to make further progress on strengthening the demand side of the retail market – that is, achieving more capable and confident consumers who are able to exercise greater market power and take up financial products and services more suited to their needs. And as well as strengthening the demand side of the market, I can see a significant opportunity for the service to complement supply side initiatives, including our Retail Distribution Review and Treating Customers Fairly initiative, which aim to create a more dynamic and efficient retail marketplace.
Second, partnership working will need to be at the heart of the service. Working effectively with other organisations will be essential if the service is to deliver generic advice successfully to a wide range of people. A key element of our approach is to work through trusted intermediary organisations that target certain groups. These organisations already have a trusted brand – and those working for them have established trusted relationships with their clients. This puts them in a good position to engage clients - for example, young adults who are not in education, employment or training - on the subject of money in order to improve their well-being. That is why we have developed 'Young People and Money' - a free one day training course with supporting materials which we are delivering nationally from January. By 2010 we aim to train 20,000 people working with young adults to equip them with the basics about income and budgeting, banking and saving, credit and debt, and also the skills to engage young adults in financial matters.
We very much look forward to the outcome of Otto Thoresen's Review and the Government’s response, and to seeing the convergence of improved financial capability with a proper functioning national generic advice service so that consumers are better equipped to participate in the retail market.
Conclusion
To conclude, it is clear that we all face many challenges. Some of these arise from long-standing initiatives, such as our work on market abuse and on treating customers fairly. Others arise from the deterioration in market conditions and in the economic outlook. And some arise from learning lessons and from implementing changes as a result.
In tackling all of these challenges we will continue to work in partnership with our stakeholders; to be principles-based, risk-based and proportionate in our approach; and to facilitate market-led solutions where these are consistent with our regulatory objectives.