Supervision of small firms
Speech by Lesley Titcomb, FSA Director of Small Firms and Contact
Association of Professional Compliance Consultants, London
5 March 2008
Introduction
Good morning ladies and gentlemen. Thank you very much for the invitation to speak at your London Forum, it’s good to see so many of you here today.
My name is Lesley Titcomb and I have recently been appointed Director of a new division at the FSA which merges the former Small Firms Division and the Contact Centre. And I have also taken over the role of Retail Intermediaries Sector Leader from Stephen Bland. I thought it might be helpful to give you a quick canter through my career – if only to reassure you that small firms and the retail intermediaries sector are in safe hands!
I joined the Securities and Investments Board, in 1994 after qualifying as a Chartered Accountant with Ernst & Young. Since then I have held a wide range of posts covering both regulatory and operational issues at both the SIB and FSA. These have included a period as the Head of Department responsible for the FSA's Contact Centres and a year leading the supervision of small investment firms. During this period, I was involved in encouraging the setting up of this organisation, as the FSA felt that being able to communicate easily with a trade association representing reputable compliance consultants would be an effective lever in raising standards. So it gives me particular pleasure to be here today, and to have the chance to see how you and your organisation have prospered.
More recently, I spent 2006 working with John Tiner and the FSA's Executive Committee in developing our strategy to move to more principles-based regulation and was then promoted Director of Regulatory Transactions Division in January 2006. Hopefully, these roles have prepared me well for the challenges ahead.
Today, I am going to talk to you about how we supervise small firms and update you on the new measures we recently introduced to increase our supervision of – and contact with – these firms. Our aim is to help those firms that are trying to do the right thing, to 'up the pace of compliance' and make faster progress on TCF. We also want to root out, and take a firmer regulatory hand with those firms who are not interested in treating their customers fairly, so that overall standards are raised, and the reputation of this industry is improved. Working more in partnership with firms is very much the way forward – a message which I hope you will help to spread! It therefore goes without saying that we will also need to work, even more, in partnership with you, the very people at the coalface of working with, and advising small regulated firms.
Small firm supervision
As you are well aware, the FSA adopts a risk-based regulatory approach which is tailored to help us deliver our four statutory objectives – maintaining market confidence, promoting public awareness, protecting consumers and reducing financial crime – efficiently and effectively. Our approach for small firms is both proactive and preventative – put in plain English, one which is capable of tackling individual firms who breach our principles and rules and, wherever possible, is able to head off problems in advance.
The pure logistics of supervising such large numbers of small retail firms, approximately 17000, requires us to have an innovative set of systems and business processes which enable us to deliver our responsibilities.
Applying our risk-based philosophy of regulation, this means that we do not routinely visit or inspect all small firms - clearly this would not be a proportionate, risk-based strategy. However, this does not mean that small firms fall under the regulatory radar – quite the opposite! So how do we know what a firm is up to? Firstly, as you know, small intermediary firms have to submit twice yearly regulatory returns to us, which you could say, act as a virtual visit. Last year over 6,000 breaches were found just from firms' electronic returns; 25% of these were categorised as major rule breaches.
Given how important this regulatory information is in identifying risks, it is vital that we receive timely and accurate returns. We have implemented several initiatives aimed at educating and encouraging firms who send in poor returns to improve the quality of their submissions and I want to make it very clear that firms who persistently submit inaccurate regulatory returns will be subject to closer supervision.
We recently finished a piece of work, the findings of which will be published on our website soon, which looked at 200 small firms across all sectors whose regulatory returns generated alerts because the firm had claimed exemption from either the capital resources requirement and/or Professional Indemnity Insurance. Half of the firms reviewed did not provide accurate and up to date financial information, or were unable to verify the information in their regulatory returns. Common problems found were firms using old accounts, using the same set of accounts for more than one reporting period, using rounded figures, estimated values etc. We also found a number of firms who gave us potentially misleading information. When challenged to provide verification of the information submitted, 15 firms voluntarily applied to cancel their permission – you can draw your own conclusions as to why. And a number of firms have also been referred to enforcement.
In contrast we undertook another review to look at those firms who continually submit regulatory returns on time and, more importantly, returns that never raise any alerts. I am pleased to say, in this instance, 85% of firms were able to demonstrate and verify the data and information provided on their return. These firms were able to demonstrate they had good systems and controls and effective management information and record keeping in place; enabling them to report timely and accurate returns without any undue burden on their day to day activity. So my message to small firms is if these firms can do it, why can't the rest? Our findings also backed up what we – and you - have been saying for years and that is - compliance is simply good business practice.
Couple the information we get in the regulatory returns with the additional information and intelligence we collect - or are provided with – and you will see how we are able to build risk profiles for individual firms, sometimes with very interesting results.
We receive information such as product sales data from product providers – this covers products they have sold, the intermediary involved, and the method of selling and some customer information. For some time we have been alerted by providers about financial advisers from which they are having difficulty getting clawback amounts; we take that into account when supervising those firms. Last year we worked with the Council of Mortgage Lenders to introduce a whistle blowing scheme for mortgage lenders and brokers which led to a number of referrals to our Enforcement colleagues. Due to this success we introduced a similar scheme in the general insurance market.
Other information comes from the Police, Customs and Excise, the Department of Trade and Industry and other law enforcement agencies. Highly valuable intelligence comes from internal sources such as the firm and consumer contact centres. Individual whistleblowers are also becoming an ever increasing source of useful tip offs. Once all this information is assembled together, we analyse and interrogate it to identify and prioritise the outliers – for example those firms who pose the greatest risk to our statutory objectives , perhaps through not meeting one or more of our threshold conditions for being authorised or where there is risk of consumer detriment.
However, not all risks arise in individual firms but across particular market sectors. These are often best dealt with through a thematic project which co-ordinates a range of regulatory activities designed to investigate, understand and address the risk. The key to success of a risk-based approach, where we don't routinely visit small firms, depends on leveraging and communicating the results of our thematic work so that firms are clear: about how we expect behaviour to change to deliver the outcomes we are looking for; and that we will carry out follow up work, including further sampling and visits to test that firms have acted on our communications. And let's not forget all the information and knowledge we pick up about individual firms as part of this work including the results of mystery shopping all feeds into building the individual risk profiles.
Enhanced strategy
Last year the FSA concluded that we needed to increase the rate of progress small firms are making towards treating their customers fairly. This led us to re-examine our approach towards small firms and we announced last October new measures to intensify our efforts to identify those firms most in need of regulatory attention. Before I get into the detail of what these new measures will mean to small firms I just want to state at the outset that I am in full support of these new measures and have no intention of radically changing or revisiting this enhanced strategy.
Building on our risk-based strategy mentioned earlier, we have introduced an ongoing programme of structured visits and telephone 'assessments' (as we call them) to look into how a firms' management approaches TCF with the first assessments kicking off in Northern Ireland this month.
The assessment will look at the relationship the firm's management has with its staff, how it communicates TCF to its entire staff (not just advisers), and what controls it has in place to demonstrate that it, and its staff, are delivering fair outcomes to its customers. Most importantly, we want to see if, and how, the firms' efforts are being translated into improved outcomes for its customers.
We have set ourselves an ambitious programme and will be assessing approximately 11,300 small intermediary firms as part of a three year regional assessment programme. Whilst it is key that we identify those firms not engaging with us and treating their customers fairly, we are also strongly committed to helping those firms who are trying to do the right thing.
We want to work with as many firms as possible, so even if firms haven’t made sufficient progress, if the management is willing and the culture within the firm is right for change we will work with those firms to raise standards. I also hope that these assessments will help to improve the understanding within firms of our expectations and how to achieve the outcomes we are seeking. This will complement the help and guidance we already provide via numerous channels.
To explain the assessment process and our expectations regarding TCF to firms we have introduced new, interactive roadshows linked to the regional assessment programme. Firms will be able to find out more about how to meet their TCF obligations, work through real TCF issues that may affect their firm, and learn from other firms about how they approach TCF.
Communicating to firms through roadshows is an integral part of these new measures which we are confident will contribute towards smoother assessments and higher levels of compliance. The aim of these events is to deliver messages to firms during a period where they are preparing for and being assessed. We hope this will maximise the opportunity for messages to be acted upon and firms' thinking and behaviours to be challenged and changed, if necessary.
I firmly believe that the vast majority of firms are run by decent, honest people who are genuinely trying to do the right thing and treat their customers fairly, as well as make a living. However, I must also make clear that firms failing to make any effort to engage with us will find themselves facing tough regulatory action including the use of enforcement. We have a range of disciplinary sanctions available to us. Whilst enforcement is an important component, it is not the sole element, of a credible deterrence policy which includes effective supervision and risk mitigation. We need to have sufficient contact to ensure that those who are wilfully trying to evade our regulations believe there is a reasonable chance of being caught and that we are alerted to things that help us catch them.
Treating Customers Fairly
For me, where you as compliance consultants can have the greatest impact is in helping to bring a step change in the way firms approach principles-based regulation and in particular TCF. Too many times we hear from firms that they must be treating their customers fairly otherwise their customers wouldn't come back for repeat business or recommend family and friends. In part, I agree, but these firms could be lulling themselves into a false sense of security by accepting this belief at face value without standing back from their businesses and taking an objective view about how the firm does actually treat its customers and how it is demonstrated. And of course, this belief isn't backed up by the findings of our ongoing thematic work which clearly indicates that many small firms still have some way to go before they treat their customers fairly.
We believe that we are creating incentives for firms to 'do the right thing' by combining a more principles-based approach with our risk-based approach to assessing whether firms are operating in line with our principles. Obviously there is the benefit of knowing that the customer’s best interests are at the heart of everything the firm does, but there will also be a tangible regulatory dividend, because there should be less need for regulatory intervention for firms which behave in this way.
How you can help
We will continue to emphasise the responsibility of management of firms to deliver where necessary a significant change in the way their businesses are run.
Firms of all sizes need to recognise that regulation is changing and the need to work constructively to help develop it. We are not lowering our minimum standards, but we are giving firms more flexibility about how they achieve them. Firms need to make use of the increased freedom provided by principles-based regulation while still delivering proper standards of conduct. And they should focus on delivering real outcomes on the ground, not just going through the motions. It seems to me that at the heart of the shift towards more principles based regulation, there is a deal to be struck between regulator and the regulated. Our part of the bargain is to focus on the outcomes we are seeking to achieve. The firm's obligation is to decide on 'how' to deliver the outcomes.
I believe this change in approach provides compliance professionals with a significant opportunity. I have highlighted today just a few areas where we would expect firms to review the ways in which they run their businesses and I see the management of firms turning more and more to compliance professionals to help them think through how to implement a principles-based approach into their businesses and help them to run their business in a more long-term sustainable manner. This is where you, as compliance professionals, can really add value by working with the management of firms to achieve these outcomes and to ensure they stay ahead of the game.
I must emphasise that we recognise the valuable role that the consultancy industry can play in helping firms to achieve the outcomes we have set, and we are particularly keen to support the work of the APCC, an organisation whose objectives are closely aligned with ours. This is why we are keen to continue to work with this industry, why we support events like this one, and other regional workshops run by the APCC. It is also why we are currently looking into the possibility of providing some bespoke training for compliance consultants, to give you the help you may need to give support to the firms you advise. We hope to be able to say more on this soon.
We would also encourage you all to continue to engage in the debate which Simon is leading on the future of the APCC, and the role it can play in taking the compliance consultancy industry to a new level of professionalism. There will no doubt be some further discussion on this later in the day.
Summary
So in summary with engagement and commitment from us all, firms, colleagues you and us, it is entirely possibly that the retail market can achieve a major break-through in its treatment of consumers. This would have tremendous reputational benefits as, over time, consumers would regain lost confidence, and markets for products and services targeted at customers needs could be expected to grow.
Thank you for the opportunity to speak to you today.