Good afternoon ladies and gentlemen.
I am here today to talk about the opportunities created by the government’s intention to establish a specialist regulatory authority focussing on consumer protection and markets: the Financial Conduct Authority.
The writing of new legislation and the subsequent benefit of having a more focused regulator, gives us the ideal opportunity to make significant improvements in the current regime.
With that goal in mind, I will focus my remarks today on five topics:
- the consumer protection agenda;
- the consumer protection ‘tool kit’;
- the markets agenda;
- the importance of Europe; and
- the FSA’s transitional arrangements.
Consumer protection
Turning first to the issue of consumer protection. Historically both the FSA’s approach and its powers have proved inadequate to meet the expectations of society with regard to protecting consumers in financial matters.
As I have said before, historically the FSA’s approach to conduct, as with prudential, was essentially passive and reactive. It sought to minimise failure through effective disclosure, relying on consumers to then make the right judgements. Interventions were primarily made to address identified failures through sanctions and redress.
The Treating Customers Fairly (TCF) initiative – a key element of the retail agenda from 2004/05 onwards – did focus on the importance of delivering appropriate outcomes for consumers and sought to challenge firms’ cultures with a view to preventing substantial failures occurring, rather than just relying on the deterrent effect of retrospective action. However, delivery was dependent on the FSA’s old supervisory approach which relied on the principle of senior management responsibility and the emphasis on high level systems and controls.
TCF, in many firms’ view, thus came to be seen as an initiative to equip management with the right systems and controls and the right intentions, but it failed to gain the traction of being based on more rigorous analysis and challenges to business model decisions. In practice it remained a reactive strategy.
The new FCA has the opportunity to build on the learning experience of the past ten years of the FSA.
The FCA will build upon the FSA’s new proactive consumer protection strategy, launched in March 2010. However, to succeed the FCA will also need new and stronger powers to be granted by Parliament.
Let me describe my vision of the FCA’s consumer protection agenda.
The strategy will be based on a proactive and intensive approach. It will have four key elements:
Addressing structural deficiencies in sectors and the market place as a whole which limit or impair consumer choice and experience.
Delivering intensive supervision of firms to ensure they are treating customers fairly. In particular, it will focus on point of sale practices, product manufacturing frameworks and firms’ governance and culture.
Making proactive product-based interventions, often on a thematic basis when sound business analysis shows the product is likely to cause more harm than benefit.
Ensuring that in the event failure has occurred, the appropriate level of redress and compensation is achieved, and where necessary taking action against firms and individuals to deliver effective ‘credible deterrence’.
This approach will be based on the premise that the degree of consumer detriment seen over the last decade has been at an unacceptable level to society and that a more interventionist style of regulation is justified.
Let me be clear however that taking on a regulatory approach that has at its centre a lower risk appetite and more proactive intervention does not mean the FCA will be seeking to eliminate all risks nor will it seek to absolve consumers of responsibility for their own decisions.
The FCA will not be a ‘no failure’ institution. Removing all risk-taking from consumers would remove individual freedom of choice and considerable benefits to society.
It is important to recognise that failure will, however, occur not just because of legitimate misjudgements by those who manage firms but also through deliberate wrongdoing. To ensure no failures occur through regulatory transgressions would require a far more intrusive – ‘inspection-based’ – regime, than either the FSA has operated or is envisaged by the FCA.
The FCA will be overseeing some 27,000 firms. Currently the FSA is using some 800 supervisors and specialists to carry out this task in respect of conduct issues. This resource delivers for smaller firms a four year cycle of thematic visits, but does not provide the resource necessary for regular in‑depth inspections. If we were to resource the FCA to deliver an inspection‑based model it would lead to a multiple increase in headcount. This would, in my view, lead to a cost base and fee levels which would be seen as unacceptable by industry and ultimately by consumers.
Currently 43% of firms authorised by the FSA, (some 8,000), only pay the minimum fee of £1000. This does not pay for any supervisory activity. It only pays for basic registration, the automated regulatory return system and limited access to a call centre for consumers and firms. There is no current intention to change this approach. In other words, in the future when a small firm fails, and when it is asserted that this is a failure of the FCA, we must realise the limitations of what £1000 of regulation can deliver.
May I digress briefly to an important and topical point. As I have said, the limitations of regulation need to be understood. The consequence of this is the necessity of an effective compensation regime: the FSCS. Such regimes undoubtedly have to be funded by industry and indeed they are the beneficiaries of ensuring that consumers trust the system. Nevertheless, it is right, following the financial crisis and recent events in relation to Keydata, that the funding methodology which lies behind the current regime should be reviewed. The FSA had previously announced its intention to conduct such a review in 2011. However, given the decision by government to review the structure of the FSCS and the fact that aspects of the deposit protection regime is under consideration by the European Commission, it does not make sense for us to commence this review until we know the conclusion of these initiatives. We nevertheless remain fully committed to undertaking such a review; once we have clarity.
May I in passing make a comment about the prudential responsibilities of the FCA. The FCA will have prudential responsibility for approximately 25,000 of its 27,000 firms; only 2,000 will be shared with the PRA. The FCA’s approach to prudential regulation should reflect its primary objective of consumer protection. It will, therefore, not specifically be focused on promoting the sustainability of these institutions. Rather, it should focus on ensuring that their capital and liquidity is sufficient to allow an orderly run off without material consumer detriment or impact on market integrity. In particular it should seek to minimise the call on the FSCS. This could be termed a ‘gone concern’ approach. There will, however, have to be some exceptions to this approach for the minority of institutions that it regulates, which could potentially have systemic implications if they were to fail either individually or as a cluster. An example of such a firm could be a very large asset manager.
In summary, the FCA’s role should not be one of advocacy or denial of consumer responsibilities but one which emphasises early and proactive intervention, a brave approach to enforcement and redress, and a determination to improve the consumer experience.
The consumer ‘tool kit’
May I now turn to my second topic: the FCA’s powers in relation to consumer protection: its ‘tool kit’.
To work the FCA will need stronger powers of intervention than the FSA currently has. I thus strongly support the concept of powers to intervene to ban specific products.
The government also, in my view, rightly envisages a greater focus on facilitating ‘efficiency and choice in the market for financial services’. This new objective for the FCA will emphasise the need for it to give consideration to financial inclusion and competition.
The Treasury’s consultation document raises the possibility of the FCA having formal powers to refer firms to the competition authority and to make formal market investigations to determine whether such referrals are necessary. I strongly support these proposals which would give added authority to the FCA’s role in improving market efficiency and ensuring consumers have a right and appropriate amount of choice.
However, these new powers will require both consumers and the industry to trust and have confidence in the FCA and its judgements. Underpinning this trust will need to be a commitment to transparency and accountability.
Central to this concept of increased transparency and accountability would be ensuring the FCA is truly trusted by consumers. In order to achieve trust I believe the FCA needs a new model of interaction with consumers. The FSA, as I have said before, has often been seen by consumers as remote and out of touch. This must change. The FCA will need to establish a robust and effective mechanism for understanding both consumer needs and preferences, and equally importantly, ensuring consumers feel that their views are both listened to and taken into account in the FCA’s decision-making.
Another key element of the FCA’s approach to policy-making will be striking the right balance between rules and principles. I have previously said that I expect the FCA to shift towards more detailed prescription, and I take the opportunity today to re-emphasise that point. Effective enforcement and redress requires clarity of responsibilities and a process which can stand up to clear external scrutiny. It is thus inevitable that a conduct regime will lean more towards rules than principles as this is a necessary consequence of its focused objectives. This however, should not be seen as undermining the need for firms themselves to have a strong cultural framework which encourages employees to behave in a principled manner.
In summary I believe a more proactive and also more accountable and more transparent approach to consumer regulation is the way forward.
If I may, however, digress to make the key point that this strategy will be an evolution not a revolution from where we are now. Critically, we have embarked on two key initiatives to deliver structural reform: the Retail Distribution Review (the RDR) and the Mortgage Market Review (the MMR).
The RDR is designed to establish an effective and attractive retail investment market. We realise it will involve considerable change in the industry but believe the final outcome will be a much improved market place.
I should however note that we do recognise that, whilst not specifically an issue which the RDR seeks to address, in order to ensure the financial market place is fully effective for investors, it is vitally important that a credible simplified advice service exists alongside the full advice offering. Ultimately it is for firms to introduce such services, but we are currently working with them and later in the year we plan to publish more detail on the regulatory framework.
The MMR is still at the stage of analysis. I am sure we all recognise the market place did not function well in the decade prior to 2007. Credit expanded by 200% but there was no consequent rise in the percentage of home ownership, nor was there an increase in first time buying. We do, however, recognise the sensitivity of the interaction between our actions and the public policy agenda.
To this end, we will publish a full impact analysis in the summer, both from the conduct and prudential perspective, with the intention of laying out our proposed framework in the autumn of 2011. No rule changes will occur before 2012. Our goal will be to reduce the possibility of consumer detriment in relation to affordability occurring without impacting the ability of the market place to offer affordable mortgages.
I would also like to highlight that besides the RDR and MMR, the FCA will inherit the FSA’s determination to deliver ‘credible deterrence’ and effective redress. 2010 saw a significant change in our fining regime, with the introduction of a new penalties framework which links fines more closely to income. In addition, the Financial Services Act 2010 significantly strengthened our ability to deliver effective redress as we saw in the recent Halifax SVR case. I am confident the FCA will continue this approach.
Markets and wholesale conduct
Turning now to the regulation of markets and wholesale conduct.
The government has indicated that it broadly sees the existing markets regulation framework as performing effectively. So it has proposed relatively little changes in this area: the Bank of England will take on prudential oversight of clearing and settlement, but the rest of the FSA’s markets regulatory functions, including the UK Listing Authority, will move together to the FCA.
The creation of the FCA, however, provides an opportunity to take a fresh look at how wholesale conduct issues are addressed. This is an area where the FSA has undertaken a number of pieces of work over the years, but initiatives in this area have been somewhat overshadowed by our focus on market abuse.
Defining wholesale conduct is itself challenging. Broadly, in my view, it covers firms’ behaviour in relation to market activities and to their dealings with ‘informed clients’. Failings in this area often reflect systems and controls weaknesses at firms and many relate to failures to manage conflicts of interest in various forms.
The FCA must be prepared to intervene early to deal with emerging wholesale conduct issues, particularly where these have a link to retail markets and consumers. If necessary, the FCA should also be prepared to develop additional regulatory requirements for wholesale market participants where market discipline alone is not delivering appropriate standards.
The likely increased focus by the FCA on wholesale conduct needs to be achieved whilst continuing to recognise the difference between investor protection and consumer protection. Central to effective wholesale markets, and indeed the operation of stock markets for retail investors, is the premise that an informed investor equipped with the full disclosure of risks is entitled to make mistakes; and a recognition that an investment necessarily can lead to losses as well as profits. A key challenge for the FCA will be to retain this distinction which underpins the success of London both as an international market place and as a mechanism for providing retail investors with access to a variety of financial products.
In the markets area, the FCA will also build on the credible deterrence strategy that the FSA has followed successfully since its adoption in 2007. This strategy has shown particular success in relation to criminal prosecutions for ‘insider dealing’ and it should be expected that the FCA will continue to vigorously pursue such cases in the future.
European context
May I now turn to Europe. As of 1 January, the EU created three new European Supervisory Authorities. These will be the key policy making fora in the EU, leaving the FSA and its successor bodies primarily acting in a policy influencing and national supervisory role.
It is vitally important, therefore, that the UK organises itself to effectively influence decision-making in the wider European framework. A key success measure of the new UK regulatory landscape will be its impact in Europe.
At this point may I also highlight the importance of co-ordination. Each EU Member State has one voting seat on the three new ESAs and the FCA will be representing the UK’s interests within the authority responsible for markets and securities, which I am sure you know is termed ESMA. However, it is important to recognise that the EU’s structure for financial regulation is organised around activities and does not map exactly to the UK’s regulatory structure. As such, each ESA will cover both prudential and conduct of business issues. It is vital, therefore, that we achieve effective domestic coordination and cooperation between the regulatory authorities to ensure the UK’s views are best represented.
The importance of effective coordination is not limited to engagement with the European regulatory framework. So, may I digress briefly to the domestic structure. In moving to a domestic structure where prudential and conduct regulation is no longer integrated, it is clear that we need to ensure effective coordination between the new bodies. We are aware of industry concerns about an increased regulatory burden, and about having to meet different and possibly conflicting standards. It is in the interests of the regulators, the industry and consumers that the new bodies coordinate effectively. We envisage making this a reality through a number of mechanisms, including:
- a memorandum of understanding;
- domestic colleges for joint working on the supervision of individual firms;
- cross representation on policy boards; and
- legal provision for information gateways.
I should also add that the FCA will need to build effective coordination mechanisms with a variety of other elements of the regulatory system, notably the Financial Policy Committee. The focus to date has been on the interaction of the FPC with the prudential regulator. However, many of the tools the FPC use will also have conduct implications. The FCA will have to devote time to understanding these linkages.
Next steps
That is all I want to say about the emerging thinking on the regulatory philosophy and supervisory approach of the FCA. I would like now to spend a moment on how the FSA is taking forward the transition to the new regulatory structure.
In preparation for the transition, the FSA will be moving to a new management structure in April, replacing the current Risk and Supervision business units with the Prudential Business Unit and Conduct Business Unit. It is important to stress that the FSA will remain as a unitary entity until formal cutover to the new structure, expected end 2012 or early 2013.
The management teams of the new business units are now working to produce a detailed transition plan to ensure the FSA is ready once the legislation is enacted, to cutover to the new structure. This pathway will involve a progressive move to a ‘twin peaks’ approach. We will keep you informed of these plans as we develop them.
A key output of this transition work will be a more detailed articulation of the FCA’s regulatory philosophy which we will publish in the summer. We will launch the publication of this document with our own conference.
Concluding thoughts
I hope you have found my remarks helpful. Before formally concluding I should perhaps emphasise that these observations reflect the FSA’s thinking to date. I look forward to Martin Wheatley’s arrival in September to take on the role as FCA CEO designate. I am sure Martin will have his own personal views on this topic.
But let me for the time being conclude with the following two points.
Firstly, the regulatory reform programme presents us with the unique opportunity to make changes to financial regulation to deliver real benefits to society. I believe creating an FCA with the powers and philosophy I have just described would fundamentally improve the market place for the benefit of both consumers and firms.
Secondly, let me return to a theme I have previously put forward. Good outcomes for society from regulation are less dependent on structure than the underlying regulatory philosophy and the quality of the judgements made. As we move through the transition period, I can assure you that the FSA’s staff will remain focused on the quality of our judgements and that this culture will be taken forward to the successor bodies.
Thank you.
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