30 April 2007

The National Audit Office’s (NAO) economy, efficiency and effectiveness review of the FSA was commissioned by the Treasury and published on 30 April 2007.

Summary

We welcome the NAO's constructive and helpful report. We are pleased the NAO supports our developing approach to risk-based and principles-based regulation, recognising the progress we have made since we were established in 2001. It also identifies us as a leading regulator, and respected as a world leader in financial capability.

The NAO has developed a good understanding of the FSA and, specifically, the areas covered by their terms of reference:

  • performance management;
  • working with other domestic regulators;
  • influencing and representation internationally;
  • financial crime; and
  • financial capability.

We therefore find their conclusions and recommendations well founded and relevant. In most cases the NAO's recommendations for improvement are already within our current work plans, but they provide additional insights which we will consider in shaping the detail of our plans. We will, of course, consider carefully all of their recommendations.

We would like to thank the NAO for the diligent and courteous way they approached their work.

The notes below summarise our response to each of the recommendations in these five areas of our work.

Performance management

We welcome the recognition that our performance management system has improved considerably since we were established, and the finding that our performance tools and data gathering expertise 'are better than most of (the FSA’s) UK and international peers'. We also recognise that, notwithstanding our progress to date, we need to continue with further streamlining, embedding and integrating the different parts of the framework. This will ensure it is effective, giving our senior management information to support their decisions on priorities and what action to take.

Matching our resource allocation to risks to our objectives and improving the processes

We welcome the NAO’s strong support for our risk-based regulatory approach and for the systems for matching resources to regulation of firms. We note in particular their description of this approach as internally consistent, and their finding that we have a comprehensive system for dealing with wider risks to financial markets.

The NAO observe we need to do more to be able to assess more accurately the costs of some of our activities. We agree. As the report acknowledges, we are already planning to implement a full activity-based costing system which will allow us to build on our current understanding of the cost of our activities. We are developing our time-recording system to help us measure more accurately and analyse the cost of resources allocated to individual tasks. We will implement the new system in stages, starting this year, and completing in 2010. Each phase will inform the future development of the system in line with our transformation to principles-based regulation.

Our new Outcomes Performance Report

The NAO concluded that our Outcomes Performance Report (OPR) – which we launched on 23 April – is an important development. They supported its focus on outcomes and commented that we had approached its development in a sensible way. We welcome this support. The NAO has identified a number of aspects of the OPR on which we need to focus in future; we generally agree with their observations on these issues. In particular, they commented that the number of metrics we plan to use to measure our performance is large. Since the review was carried out, we have already reduced the number of metrics for the next Report from 111 to about 95. We believe a broad coverage with a relatively large number of metrics is required to provide insightful analysis of our performance in the full range of our activities. The OPR is very new, and is still being implemented and embedded and we are using this period to test it properly; because of this further experience we may decide to reduce number of metrics further. We plan to fully integrate the OPR with our quarterly management information during the course of 2007.

The effectiveness of our non-executive directors in reviewing economy and efficiency

The Financial Services and Markets Act, which established the FSA, requires our non-executive directors to review whether we are discharging our functions in accordance with decisions of our Board, using our resources in the most efficient and economic way. They do this, and are careful to maintain their formal statutory and separate role as non-executives in reviewing economy and efficiency. However, in practice the whole Board, including the Executive Directors, takes part in the discussion. We welcome the NAO’s conclusion that this practice is 'an appropriate development of the Board’s role'. We are mindful of the NAO’s caution that a future more narrow interpretation of this Act could lead to the non-executives considering economy and efficiency without the executive involved. We do not consider this to be a significant risk given the Board’s current operating model.

Working with other UK regulators

The NAO’s report praises the strength of our joint working relationships and the progress we have made, and are continuing to make, in achieving this. We agree with them that effective collaboration with other UK regulators is very important. They singled out the Office of Fair Trading (OFT) as the organisation that should be our main priority for future joint working, and noted that our joint Action Plan with the OFT, published in 2006, marked a 'step change' in our relationship with them. We agree that taking this forward is a key priority for us. We also believe that continued strong engagement with other UK regulators (such as The Pensions Regulator and Financial Reporting Council) is also essential.

Relationships and sharing regulatory techniques and expertise with other regulators

We and the OFT have tried to work together on areas of common interest and share our expertise. We welcome the NAO’s acknowledgement of these joint initiatives. We will continue to work closely with the OFT to implement joint working. For example, and as noted in the report, we have recently completed parallel projects on the sale of Payment Protection Insurance by financial institutions, the outcome of which showed effective joint working. Future plans for joint initiatives include a review of the retail distribution system for retail financial services products and the post-implementation review of depolarisation.

Future priorities for joint working with other regulators

While finding that our joint working with the OFT should be our main future priority in this area, the NAO also found that we should 'continue to coordinate with The Pensions Regulator (TPR) to ensure a clear understanding of (our) respective responsibilities for protecting the interests of pension scheme members and for improving their financial capability'. We recognise the importance of ensuring that consumers – in this case, members of occupational pension schemes – understand the respective responsibilities of different regulators. We have discussed this issue with TPR and will be working with them to improve the perception and understanding of our joint working in the future.

International influencing and representation

We welcome the NAO’s finding that we are 'a leading international regulator', with influence and effective engagement in European discussions, and that we have 'achieved important results in global coordination'. This supports our view that the significant time and effort which our chairman, chief executive and other senior management devote to these issues is effective. We accept that we can do more, with the Treasury, to communicate our strategy and the outcomes of this international work more effectively.

Influencing European financial supervision

Overall, the NAO is very positive about our approach to working in Europe, and notes other stakeholders’ views that we are effective in our engagement. They are also positive about the way we are able to influence proposals at an early stage and remain alert to emerging issues. They conclude that we could do more to explain our strategy and responsibilities. We agree the communication challenge is difficult. However, we believe we have the correct level of resource devoted to EU work. It may well be that our stakeholders do not fully understand the extent and level of our involvement, the respective roles of the Treasury and the FSA, and/or the sensitivity of making strategic considerations and private, as yet unresolved, discussions and negotiations public. We welcome the Treasury’s proposal to further clarify our respective roles and responsibilities in Europe, which should help correct some of these perceptions. We will also continue to use our International Regulatory Outlook, as the NAO recommends, to explain our engagement in Europe.

Influencing financial supervision outside the European Union

We welcome the NAO’s recognition that we have achieved 'important results in global coordination' and their acknowledgement of the high regard in which we are held by other regulators for 'thought leadership on issues such as risk-based regulation'. They urge us to take advantage of opportunities for promoting greater coordination between international financial regulators. We already devote significant time and resources to working collaboratively with other regulators, both on specific projects and on the supervision of firms more generally, and will continue to do so.

Financial crime

We are pleased to see the NAO’s support for our recent decision substantially to restructure our management of our financial crime work, to give a clearer focus and enhance the effectiveness of our approach. The NAO concludes that we need to review how we assess firms’ management of their financial crime risks, and improve the training we provide for our supervisors on financial crime. We agree and we already have plans to make improvements in these areas.

Resources applied to combating financial crime (including counter-terrorist finance)

The NAO noted that we spend just under 10% of our overall resources on work related to our financial crime objective. They concluded that we do not need to increase this significantly, but we can improve the effectiveness with which we use this resource. We have recently restructured the management of our financial crime work and have established a new Financial Crime and Intelligence Division, which will enable a much more efficient and focussed use of our resources. We have also recently agreed a slight increase in our budget for financial crime, to support some specific work on various work streams. This includes support for developing a supervisory regime for firms under the Third Money Laundering Directive, examining how firms and consumers manage security of personal financial data, and reviewing anti-money laundering controls in the private banking sector.

The NAO has also recommended we consider how we could give greater weight to financial crime risk in our regulation of small firms. We are already reviewing the operation of the risk model for financial crime risk. To date, we have dealt with financial crime risk in small firms through a combination of alerts based on verified intelligence and theme work. Towards the end of 2006, we completed some work on financial crime risk in small firms and have now published some notes on best practice and a self-assessment tool for small firms on our small firms website.

Integrating our work on financial crime with our other supervisory work

As part of their fieldwork, the NAO surveyed our supervisory staff. They concluded the profile of financial crime was not high enough with our supervisors, and the effectiveness of training could be improved. We agree and are taking steps to make improvements. The new Financial Crime and Intelligence Division will be the focal point for intelligence gathering and dissemination of information to supervision staff. The division will search for new and innovative methods for keeping supervisors fully informed on financial crime matters.

The integration of our work on combating financial crime (including counter-terrorist finance) with other agencies in this field

We welcome the NAO’s recognition of important achievements in our joint working approach with other UK agencies involved in combating financial crime. Such collaboration will continue to be central to our work in this area.

Our communication and information sharing with business about financial crime

We welcome confirmation through the NAO report that regulated firms support our risk-based approach to financial crime. We will continue to adopt this approach.

Our use of our enforcement powers and penalties

The NAO comments favourably on our financial crime work which uses our proportionate approach to the use of our enforcement powers. This proportionate approach characterises all our enforcement effort.

Financial capability of consumers

We welcome the NAO’s description of us as a world leader in financial capability and the finding that international bodies regard our baseline survey as a model for their own work. We also welcome their acknowledgement of the work we have done to explain clearly the benefits of improved consumer financial capability to society and to the market. We note their positive comments on the range of targets in each of the seven priority areas which we have developed.

We are pleased to see the findings that we have highlighted the issue of low financial capability in the UK and played a major role in placing it on the agenda of government and the financial services industry. The NAO also recognise that we have then provided vital coordination and direction to deliver real outcomes for consumers.

We welcome the NAO’s acknowledgement of our efforts to focus on consumers’ needs and to be inclusive. We welcome the confirmation through the NAO’s report that our partners in this financial capability work view their relationship with us positively.

Overall allocation of resources to financial capability

The NAO recommends that we should 'aim to quantify the costs to society and the financial services market of low levels of financial capability' to assess whether we are allocating resources effectively. We have not measured the costs of low financial capability to the consumer, preferring to continue with a programme of work to address a clear social need and deliver against our public awareness objective. We do not believe it is in the best interest of consumers for us to commission this type research ourselves as this would divert resources away from delivery on the ground. However, where research already exists, we will use it to inform our future priorities.

We have set out in ‘Delivering Change’ a five-year programme of work for our seven priority areas, with targets which the NAO finds to be 'impressive'. We agree with the NAO’s finding that measuring outcomes and changes in behaviour is inherently difficult. But we will continue to develop how we measure the effects of our programme to ensure that money is put to best use. In doing so, we will take into account the NAO's helpful suggestions for additional ways to measure progress.

On working with other organisations on financial capability

In the area of financial capability, we have set out very clearly in our consumer communications the skills people need to take control of their finances (see, for example, dos and don'ts on moneymadeclear and the context of workplace seminars). We also see scope to build on the debate that we have initiated between the industry and consumer groups and explain ourselves those things consumers should do to help to secure a fair deal in the retail market. This is an issue which, of course, goes beyond financial capability.

We will set out in plenty of time detailed plans for resource allocation and delivery after 2011. Our intention has always been to rerun the baseline survey every four to five years. So we welcome the NAO’s recognition that our baseline survey is comprehensive and professional and the finding that other international bodies regard it as a model for their own work. We will continue to use this survey to inform our future priorities.

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