'Regulation & Entrepreneurs' - What is the role of regulation in facilitating the development of innovation & entrepreneurs
Speech by Hector Sants, Chief Executive, FSA
Edinburgh Chamber of Commerce/ Scottish Financial Enterprise Joint Event
15 October 2008
Entrepreneurs are vital to the continued advancement and economic health of the UK. They create wealth and jobs, and can improve our quality of life through the ideas, products and services they develop and provide.
I want to talk today about how the FSA and its guiding beliefs and objectives contribute to making the UK an environment in which entrepreneurship is rewarded, and in which entrepreneurs in the financial services sector, in particular, can succeed.
Before I do, I would like to make some remarks about the recent market events. The measures announced this week and last to support the banking system are a significant and comprehensive package, which we welcome. They represent decisive action taken by the FSA, Treasury and Bank of England to maintain financial stability. All the measures are important; together they address liquidity provision, capital, and future funding needs. As the banking supervisor we are at the forefront of ensuring banks and building societies maintain strong capital and liquidity positions.
And – speaking on a platform in Scotland – you would expect me, I am sure, to comment specifically on the impact of recent events on two major Scottish banks. I am well aware of the great anxiety and concern - in the financial services industry, among the general public and in the Scottish Assembly – occasioned by recent events. The unprecedented market developments have required the authorities to take tough decisions. I am convinced that the steps which the Tripartite Authorities have taken over the last few weeks have been necessary to maintain financial stability and to restore market confidence in the UK as a whole.
The package is an important step in dealing with the immediate issues that we all face. Clearly, we also need to do all we can to prevent the recurrence of such extreme events and to ensure that the authorities are better equipped to deal with banks and building societies in the event we were again to encounter such severe difficulties.
Recognising this is a global crisis with its origins in a set of global circumstances over which a national regulators influence is limited, there are however, undoubtedly lessons we can learn. It is clear that a number of banks, notably those that became dependent on wholesale funding, went into the crisis with business models ill-equipped to survive a stress of this severity, and we did not do enough to minimise this, a fact that we regret. We have introduced a Supervisory Enhancement Programme (SEP) to address this issue. We have already made many of the necessary changes, and we will complete SEP by the end of the year.
We will have a minimum supervisory resource for all high impact firms, to ensure the necessary focus and continuity. We need a culture that attracts and retains quality individuals, and which encourages decisive yet considered judgments. This can only be built through time and concerted action. We have also been clear that we need the right people in the right jobs: the right mix of career regulators and experienced market practitioners.
The more challenging and difficult task will be modernising the global regulatory framework. There is no question that this has been a global failure and that all elements of the framework, need to be looked at. We will play our role, working closely with colleagues around the world, to look again at the overall regulatory framework and the standards expected on capital, liquidity and risk management. We will be publishing a discussion paper next year to set out FSA’s views on the right global framework going forward.
I am happy to talk more about these events and to take any questions you may have, but I would now like to return to the main focus of my speech today – regulation & entrepreneurs.
Our aim is for the UK to have fair, efficient, orderly and robust financial markets where informed and capable consumers are offered the right products. Indeed, healthy and robust markets are vital if the financial sector is to play its role effectively in supporting real economic activity – that is:
- making commerce, and everyday buying and selling, easier;
- directing savings to where they can most usefully be invested – vital for the success of entrepreneurs;
- and allowing people to plan and make long-term financial decisions in confidence.
Pursuit of this aim is the main contribution the FSA makes to supporting entrepreneurship generally. Of course, the way we go about this directly impacts entrepreneurs in the financial services sector and it is on this aspect that I intend to focus today.
In pursuing this aim, and to achieve our statutory objectives of maintaining market confidence, promoting public understanding of the financial system, securing the appropriate degree of protection for consumers, fighting financial crime, we are required to meet six principles of good regulation. Three are just plain good sense: the need for us to be efficient, to be proportionate, and to place responsibility on regulated firms’ senior management. The other three are directly relevant to today’s topic. We are required to have regard to:
- the desirability of facilitating innovation;
- the desirability of maintaining the competitive position of the UK; and
- the need to minimise the adverse effects on competition that may arise from what we do and the desirability of facilitating competition between those regulated by the FSA.
As you can see, these principles lay the foundation for a strongly pro-competitive framework within which the FSA can operate, and which allows for creativity and innovation by regulated firms. They have allowed the FSA to develop its outcome-focused, and principles-based regime.
A regulatory environment which encourages firms to be creative, innovative, competitive and profitable necessarily requires that firms be free to take risks and make mistakes. An inevitable consequence of risk taking is that some firms will fail. So as regulators we are not trying to eliminate risk altogether so that there are zero failures. Not only is this not desirable, it is simply not possible. Rather we regulate to ensure that firms understand the risks they are taking, and that they manage those risks to an acceptable level - for the protection of consumers, cleanliness of markets and the maintenance of financial stability. We have recently witnessed the consequences when this is not the case.
How the FSA’s approach supports entrepreneurs
I would like to explore in a little more depth how the way in which the FSA goes about regulation contributes to an environment that supports financial entrepreneurs.
Firstly, we adopt a disciplined process to identify what the big risks are to the FSA’s objectives I touched on earlier. This is a risk-based approach. This means we do not approach all the firms we regulate in the same way. A small firm which is well run and which, because of its size or the nature of its business, poses little risk to consumers or financial stability will receive less attention from us than a firm which does pose significant risks; either because of the type of business it does or its size.
Where we do identify a risk we will always look for a solution that harnesses or enhances market forces. And where we decide regulation is necessary, we focus on achieving the right outcomes rather than the prescription of detailed rules. Focusing more on outcomes and principles gives companies the freedom to deliver our regulatory aims in a way that is most efficient for them and their customers. When it comes to controlling risks, firms may well develop approaches that differ in detail but are equally effective in terms of their outcome. In that case, they should be allowed to use these approaches rather than one arbitrarily laid down by the regulator.
The result of this approach is that to the greatest extent we leave entrepreneurs and business owners to do what they do best – that is build and run their businesses.
I should just say that we will never be a purely principles-based regulator. Sometimes detailed rules are necessary where we consider that a principle alone does not give sufficient clarity as to the standards we expect, or where we have to implement a European directive. But we do want to shift the balance of our regulation further in the direction of principles. This holds true, even given the market events we are all currently witnessing.
Some have confused or labeled our approach as “light touch”. This is misleading. The FSA is not light touch. In some important areas of financial services, for example, we regulate activities which are unregulated in most other countries: hedge fund managers, for example. In other areas, we have deliberately chosen a level of regulation which is more demanding than that adopted in some other countries. Indeed, we see good quality regulation as a selling point for the UK.
What the FSA does to help entrepreneurs
The past few weeks have been a vivid reminder of how reliant our economy is on financial services – especially in London and Edinburgh. In 2007, the financial services industry employed over a million people in the UK. And financial services accounted for 10.1 % of GDP, almost twice what it was in 2001. This places a lot of responsibility on our shoulders as the single financial services regulator. We have a duty to consumers and markets, and to maintaining the stability of the financial system.
We believe the principles of good regulation, and the risk-based, open and accountable system of regulation we have developed gives us a framework for balancing these difficult priorities.
Crucially, it allows a mixture of many different business models and size of firm to operate in the UK. We believe this variety, both of product offering and size of firm is vital in giving consumers and businesses choice, and in facilitating innovation and competition.
One fundamental aspect of our regime is that unlike in some countries, we apply our regulation in exactly the same way to UK and non-UK firms. This is a long established principle that partly explains why the UK has always been a popular location for international firms. Provided firms and their management meet our requirements for authorisation, we are delighted to welcome them to the UK where they can compete on the same terms as everyone else.
Indeed, our system of regulation is recognised internationally as a good model to follow, with the UK regarded as a good place in which to do business. Much of the strong growth Scotland has seen in financial services in recent years has come from overseas investment. Edinburgh, like London, is an international financial centre in more ways than one. Ensuring that it stays this way, and that the business environment is favourable to overseas and British entrepreneurs and investors relies on a respected regulator. A respected regulator runs a proportionate and fair regime, but is also prepared to take strong action against people not prepared to meet the rules of the marketplace.
We use enforcement action as a deterrent to improve behaviour and make examples of poor practice. Increasingly this targets individuals – as I said earlier one of our principles for good regulation is senior management responsibility. And we take action against all sizes of firm, large or small.
At present we are focusing our enforcement efforts on areas where many small firms operate. One is mortgages, where we have fined and banned several mortgage brokers this year. Most recently we fined the partner in a mortgage broker £100,000 for exposing 1,500 customers to the risk of unsuitable advice.
We are very aware of the need to maintain the UK’s credibility as not only an open marketplace, but also a clean and fair one. This can give entrepreneurs and their investors confidence that they are entering clean markets in the UK, with a level playing field.
Help for small firms and reducing unnecessary burdens
We are well aware that regulation places costs on firms – in time, money and other resources. And we are also well aware that these costs are felt more keenly by smaller firms with fewer staff. No regulator is able to escape this fact, and I want to reassure you that we try to keep these costs to a minimum. We are committed to operating as efficiently as possible while fulfilling our duties to protect consumers and maintain market confidence. We are always looking to improve how we run our business.
And we continue to provide extensive regulatory support and help for small firms. This includes our free roadshows and surgeries, our contact centre which deals with thousands of regulatory questions from small firms each year, and the wide range of help on our website tailored for small firms.
Raising capital
We also recognise that of particular worry for small firms and entrepreneurs at the moment is access to capital. Venture capital and financial support for start-ups is vital for the industry’s future, and for the success of the economy as a whole.
We welcome the continued presence of the private equity and venture capital industry in the UK, and its success as the most developed market outside the USA. We maintain an effective and proportionate oversight of private equity in the UK, bearing in mind the significant variation in the level and form of regulation in different jurisdictions around the globe. As with everything we do, too much regulation can prevent the market from working efficiently, while too little can damage market confidence. So, we look to strike that difficult balance, and will continue to monitor the private equity market.
Prospects for the future
Eventually we will emerge from the current turbulent conditions although it is difficult to predict when. There will be opportunities for entrepreneurs, and once confidence returns, there will be few better places for them than here in Edinburgh. With a 300 year history of innovation and a highly skilled workforce with extensive financial services experience, Edinburgh has a head start on most places.
It is fitting that the FSA’s only office outside London is here. The office will have doubled in size by the end of this year. And I am delighted that two of the FSA’s senior advisers are now based in Edinburgh. Some of you may know Graeme Hardie, and Ron Baxter - both experienced practitioners who have joined us from industry - who are a great resource for my colleagues up here to have on hand.
The office is also a great resource for FSA-regulated firms in Scotland. From the office we offer free “surgeries”, where firms can book a time to come and speak to one of us about any regulatory issue they want to. This is one of the many ways we are open to talking with and helping entrepreneurs and smaller firms grow their business and succeed in the regulated environment.
One thing the events of the past 15 months have not altered is the facts all developed economies face. Demographic and market trends will lead to a larger retail market. People are having to take more personal responsibility for their financial futures, and an ageing population faces a growing need for financial products and advice.
We have a national programme to improve financial capability that should in time increase consumer involvement with the market. The government-sponsored money advice service will also provide more opportunities for entrepreneurs to develop services and advice to help meet consumer needs. And our retail distribution review, which will publish its report next month offers the opportunity for a more sustainable financial advice sector that better meets the needs of its customers, with more room for creativity and innovation in services.
All modern, knowledge-based economies are now competing in an increasingly globalised world, and Scotland, like the rest of the UK needs not only to retain jobs in financial services, but also to create news ones.
We realise that the regulatory framework is critical to the success of small firms and we will continue to work with you to get the balance right to enable this. We recognise that cost, barriers to entry and credibility are all issues we have to keep on top of to enable us to be a regulator that encourages a culture in which entrepreneurs can thrive.
There is a lot of pressure for more regulation at the moment, given the recent events. But you can be assured, we intend to stick to our guiding principles that I have spoken about today, of proportionality, and outcome-focused regulation and ensure that these pressures do not result in the over–burdening of small firms.
Thank you for your attention. I would be happy to take any questions you may have.