Financial crime and market stability
Speech by Philip Robinson, Financial Crime & Intelligence Division Director
26th International Symposium on Economic Crime
3 September 2008
Good morning, and thank you to Professor Barry Rider for inviting me back to Cambridge and the International Symposium. This event continues to be of great value to all those working in the economic crime arena, as a place to share ideas and experiences, reflect on past challenges and successes, and prepare ourselves for what’s to come next.
This year has certainly been a challenging year for everyone involved in the financial markets, whether as providers or consumers of financial goods and services. Market confidence has been seriously undermined by the sub-prime crisis and its consequences. Events have reminded us (if such a reminder were needed) that market stability is a fragile and often transient phenomenon and, once lost, is hard to restore. We’ve seen first hand both the difficulty and importance of maintaining confidence in markets. This is always a fine balancing act, relying on a high degree of market cleanliness, free and open channels of communication between participants, and a detailed understanding of the risks faced by those participants. Indeed, Hector Sants, our CEO, commented at a recent dinner that loss of confidence was due to lack of transparency and understanding of the effects of a correction in risk pricing.
As the regulator of the UK financial services sector, the Financial Services Authority (FSA) has a specific remit for maintaining confidence in the financial system – it is one of our statutory objectives. So much relies on this nebulous notion. The consequences of a loss of confidence can pervade all aspects of society – as the pictures last September of the queues outside the branches of Northern Rock eloquently testified. Do consumers have faith in the security and growth of their investments, savings and pension funds? Are employers able to raise capital and grow their work force? “Does an Englishman still see his home as his castle?”.
And, of course, many of you will have heard me speak before on the value of taking a risk-based approach, and the thorough understanding of the threats to a system that this requires. At the FSA, we’re convinced that this is still the right way to regulate the UK’s financial system. Recent events have shown us how quickly markets can change. Only a risk-based approach offers regulators and firms the flexibility to rapidly adjust their focus to tackle new and emerging risks.
This symposium’s focus is economic crime. As I said a moment ago, market cleanliness is a key part of market confidence, and hence market stability. Tackling market abuse is one of the FSA’s top priorities. We will bring all of our powers – civil, criminal and administrative – to bring to bear in tackling market abuse and insider dealing cases. This is part of a concerted effort to get all market players in the City of London to take this issue more seriously. This year we have brought three criminal prosecutions for insider dealing, and I anticipate that there will be more to come.
Market abuse is one element of economic crime, and it’s easy to see the impact that it has on market stability. But maintaining market confidence is only one of our statutory objectives. We also seek to reduce the extent to which it is possible for a business to be used for a purpose connected with financial crime.
This is a statutory objective – so something we have to achieve by law. We cannot choose to set it aside during periods of market turbulence, nor give it a lower priority.
Nor should we try to do so. I’m sure you’ll all recognise the fact that changing economic climates lead to changes in the profile of economic crime. In our Financial Risk Outlook, published earlier in the year, financial crime remained a priority risk for 2008. We recognised that 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. The motivations and temptations of some market participants may be affected by declining income streams. Some latent crimes, un-noticed during the good times, may come to light during not-so-good times. We recognise that firms are under a multitude of pressures, and (as always) have limited resources to deal with them all.
It’s these considerations which have driven our work on mortgage fraud, even though the housing and mortgage markets have been hardest hit by the deterioration of credit markets.
Mortgage fraud has been perpetrated on a large scale in recent years. Easy credit conditions and streamlined application processes have prompted fraudsters to target the mortgage sector. We know that mortgage fraud causes substantial social harm. It can also be bound up with other forms of criminality such as money laundering and people trafficking. This social harm aspect, the way crime feeds down to our everyday lives, is a fundamental concern for us in the way we approach these issues.
I’ve spoken on several occasions about the value of working together to tackle financial crime. Mortgage fraud is a wonderful example of a market with a true myriad of participants. Essentially, it is consumers that buy and sell houses. Within the FSA’s remit fall the mortgage lenders, who provide the funding, and the mortgage brokers, who pass it to the consumer. In almost every transaction, we also see the vital parts played by solicitors, surveyors, property developers and estate agents. Where there’s evidence of fraud and dishonesty, regulators, professional bodies and law enforcement all have differing combinations of powers to take against offenders. And government agencies and trade bodies all have interests in the housing market being clean and efficient.
But the challenge is that each party has a limited view of the situation. To resolve this we are working broadly across the industry to strengthen the defences against fraud, especially closer investigatory and intelligence relationships with our supervisory and regulatory colleagues. Also, an increased flow of cases to our law enforcement partners will serve as a more robust deterrent for those with criminal intent. The FSA is currently working with over a dozen local police forces and national law enforcement agencies. To ensure the consistent development of multi-agency solutions, we welcome and support the National Fraud Strategic Authority’s current review of the UK’s wider mortgage fraud response.
Of course, lenders are at the heart of the mortgage market. As the ultimate supplier of funds, they are the fraudsters’ main target. Conversely, this position gives them the information to bring an end to the criminals’ lines of credit, wherever they appear in the market. Our ‘information from lenders’ project was introduced, by the FSA and the Council for Mortgage Lenders (CML), to ensure the effective use of the intelligence that lenders hold on the brokers they deal with. It allows us to target our supervisory and enforcement resource on those who bring the industry into disrepute. We have an effective relationship with the lenders which has allowed us to work with them to upgrade the project, and answer some concerns that lenders had about reporting in the past. This work is complemented by the CML’s measure to improve intra-industry intelligence sharing.
To emphasise the importance of cross industry engagement, we have also planned targeted visits to 200 mortgage advisors to examine their systems and controls around mortgage fraud. This follows a series of enforcement actions, including heavy financial penalties and prohibition from the financial markets. These actions have shown how seriously we take this crime. We will also review whether we need to make brokers individually accountable under our Approved Persons regime, as it relates to the mortgage market.
Tighter conditions in credit markets have naturally led to a more cautious pace in mortgage lending over recent months. The measures I have described are not intended to increase the burden on mortgage lenders or brokers at what is, understandably, a difficult time for the mortgage industry. None of these measures imply any significant additional burdens for those firms who are already fulfilling their regulatory obligations. We are just re-emphasising what we already expect market participants to do.
However, we do have an opportunity to remove the stigma, menace and market distortion caused by the dishonest few across the mortgage sector. Working together with industry and law enforcement, I believe that we have already had, and will continue to have, some significant successes. The intention is that, as the market revives, the benefit of a cleaner – and therefore more stable – market will accrue to honest businesses and individuals, not the criminal elements.
I mentioned that the social harm caused by crime is always a concern underpinning our work. We’ve seen lots of examples, during our work on mortgage fraud, which confirm our belief of how important this is.
But it’s a challenge for all of us active in economic crime to turn anecdotes into robust measures. Even when we look for hard and fast evidence of the relative rates of different types of crime, we quickly find obstacles. The nature of crime is that it aims to exist without detection. We don’t, and can’t, know how much crime there truly is in the financial services sector. So how can we then go on to say that mortgage fraud is for example somehow ‘worse’ than insurance claims fraud, or that a better result can be obtained by allocating resources to tackle money laundering rather than terrorist financing or corruption?
At some levels, we can find answers. We talk to you, and other colleagues across the spectrum, to learn from their experiences. We can see the cases which trouble our firms, and the headlines tell us the ones which consumers care about.
And we are clear that at the cornerstone of our risk-based approach is the idea that we should focus our and industry’s resources where they will have most effect. No regulator will end money laundering or fraud overnight, and we don’t pretend to try. But we do believe that effective anti-financial crime systems and controls in firms can make it significantly harder for criminals to access the financial system, so there’s value working with firms to focus their efforts, by sharing our assessment of the threats.
Alongside these intelligence-led and risk-based efforts, we have been running a project to improve our tools available to measure financial crime. The aim of our so-called “Scale and Impact project” is to assess the scale and incidence of different types of financial crime, together with their impact on the UK.
This is where the social harm element returns. We’re not just interested in whether one type of fraud is more common than another, although knowing that would be a good start. We want to know which type of fraud has the greatest impact on society at large – individuals, businesses, or the society’s underlying infrastructure.
We also believe the results will make us better at allocating our own resources, so regulation has a greater effect on tackling financial crime.
We have been working with a team of academics to critically analyse all published work on this topic. This includes methodologies used to measure the scale, impact and harm of financial crime, the issues discovered by their authors and the quality of the results. The central concepts are those of harm, measurability and market failure.
The project has also developed a financial crime typology, identifying what market and other mechanisms the FSA can, given its legal powers, realistically use to bring about a reduction in financial crime. Both this typology and the critical analysis are currently being peer reviewed by another leading academic in the field of financial crime. After the peer review is complete we will look at communicating with the academic community to stimulate analysis and debate.
If successful at this first stage, we expect to continue the project, developing concepts of measurement and their application so we can assess the scale and impact of financial crime using robust techniques.
I have always thought that financial crime policy making should be evidence-based. A key to delivering this is the unique skills and viewpoint of the academic community, which is why we have sought to engage with them on this project. The FSA continues to learn from you, and I hope that the experiences of regulators and the financial sector both give you food for thought in your deliberations. This symposium is an ideal place to share our ideas and ambitions, with a view to making them a reality. And I will be pleased to continue these discussions with many of you throughout the rest of the week.
The key to delivering market stability in the face of increasing financial crime is an understanding of the risks, and transparent communication of these risks. Our work on financial crime measurement is part of this process. The risk-based approach requires continual review, communication and information sharing between and within the public and private sectors. Academic work to improve the means of measurement means better, more targeted action. That, in turn, will lead to cleaner, and more stable, markets.
Thank you