I was very pleased to accept the CISI’s invitation to speak as the vision of your institute of professional excellence, integrity and high levels of competence is one that we at the FSA, of course, wholeheartedly support.
In particular, the CISI has shown real interest in the RDR and has been a constructive partner as we’ve worked over the past four years towards a package of proposals that we believe will bring significant improvements for investment clients.
So I am sure you would be very surprised if I did not refer to the RDR, and I assure you that I will not disappoint. I will also cover a number of other issues which I hope will be of interest.
I cannot fail for example, to update you on a number of related European developments – of which there are many. While we have committed in this year’s Business Plan not to introduce any new discretionary policy initiatives, there are plenty of initiatives coming from Europe which will keep us all well occupied.
Wealth management Dear CEO letter
But first I want to give you a preview of a Dear CEO letter that we’re sending out on 14 June 2011. It is addressed to what we are describing as ‘wealth managers’. By this we mean firms that have agreements with predominantly retail clients to manage a portfolio of assets or investments, on either an advisory or a discretionary basis. We are aware that this definition covers a wide range of different business models, from major international private banks to smaller UK-focused firms.
What brings them together is an obligation to consider the suitability of the service they are offering to the client – and that has been our focus.
The letter follows a review of a sample of 16 firms, from across the spectrum. Our findings were serious enough to raise concerns there may be more widespread problems across the industry. This is why we’re writing now, to make our concerns and expectations clear.
Our findings are pretty worrying: for every five files we reviewed, we concluded that four had a high risk of unsuitability, or suitability could not be determined.
Two-thirds of the files reviewed were not consistent with either the firm’s house models, the client’s documented attitude to risk, or the client’s investment objectives.
We found the firms were not able to demonstrate suitability for a number of reasons.
These include the absence of basic know-your-customer information or a reliance on out-of-date information.
The firms were also not adequately recognising the risks that their clients were prepared to take, and there were inconsistencies between portfolios and the client’s attitude to risk, investment objective, investment horizon or the agreed mandate.
This was compounded by some firms not implementing MiFID client classification requirements.
A basic element of establishing suitability is of course the client’s financial situation. We often found no record of this, and a number of firms failed to obtain enough (or any) information on client knowledge, experience and objectives.
I’m sure you’ll agree these are the basic things that we, and clients, will expect all firms to be able to get right.
Our aim is to do a follow-up review of firms later this year, and in the meantime we’re involved in ongoing regulatory action with a number of firms. Some have already put in place major rectification programmes.
We will be working closely with trade associations on this, particularly with APCIMS.
So, our overall messages for wealth managers are clear: you need to look carefully at whether you are complying with our suitability requirements. You need to maintain good records and make sure you have the right controls and risk management systems to satisfy yourselves that you are complying.
RDR
The RDR is where the aims of the Institute and the FSA come together. The commitment to professionalism in the RDR, demonstrated by a combination of qualifications, CPD and adherence to codes of conduct mirrors the approach of the CISI and its Charter.
I am sure that all your members who are affected by the RDR are well on the way to where they need to be by 31 December 2012, so that you will lead the way on professionalism in the post-2012 world. As you recognise, we all have an interest in rebuilding trust in the financial services sector and central to that trust is being able to demonstrate knowledge and competence.
We are also acutely conscious that we still have more work to do. Our rules on platforms are, we know, eagerly awaited and work remains to be done on legacy assets. We, together with those with whom we are having extensive discussions, recognise the need for certainty, in order for systems to be redeveloped ahead of the deadline.
We are also very conscious of views around the need for firms to be able to offer simplified advice.
We’ll be publishing a further paper in the summer on the subject which will explain our thinking around a number of regulatory questions that have been raised with us. It will reflect the discussion we have had with a range of firms and trade associations and should help those of you who wish to offer simplified advice to do so.
European developments
We are often asked why we are going ahead with the RDR in advance of developments in Europe. I will repeat here that we feel that there are significant issues to deal with in the UK market, and we should not wait and depend on an uncertain European timetable before sorting them out.
We have had very extensive interaction and engagement with our colleagues in the European Commission and other Member States in recent years.
We have, for example, played an important role in the development of the proposed new EU regime for Packaged Retail Investment Products, or PRIPs. The Commission is proposing that this should be delivered through reviews of MiFID and the Insurance Mediation Directive. It should also introduce new requirements for Key Investor Information disclosure documents based on the model being implemented for UCITS funds.
We strongly support the aim of creating a level playing field for competing or substitutable retail investment products, including collective investment schemes, structured products (including structured deposits), life assurance-based investments and derivatives.
This is probably not surprising since we, of course, already apply consistent conduct of business standards across different retail investment products of different types in the UK.
With this in mind, we do have concerns over the fact that the Commission seems to want to deliver PRIPs through changes, on the one hand to MiFID, and on the other to the Insurance Mediation Directive, depending on the type of product or service that is being offered. We fear that this would result in divergence, allowing different selling standards to develop across different markets. This would seem to us to defeat the original object of the initiative.
So we remain very engaged as thinking develops.
Talking of MIFID, we’re still waiting for the draft legislation for its review: we now expect this to be pushed back until the autumn. In our joint response with the Treasury we supported much of what was in the Commission’s Consultation Paper.
That consultation raises a number of the same questions as we are tackling in the RDR – including whether ‘inducements’ should be banned for advisers and/or portfolio managers.
While it is not clear what the Commission really has in mind with this proposal, we welcome the idea that firms providing investment advice or portfolio management should not have their remuneration set in whole or in part by product providers.
We have however, expressed concern that the Commission seems interested in only placing inducements restrictions on independent advisers. If only one type of adviser is subject to such restrictions, we fear that this could distort the market.
As you can imagine, we have said that we would like the Directive to go further and stop product providers from setting the remuneration of all investment advisers and not just those who provide advice on the basis of an independent and fair analysis; investment advice should be provided without any potential for bias.
We have also argued that some ‘inducements’ should be permitted. So, for example, product providers should still be allowed to provide training on the features of products for investment advisers and portfolio managers.
The MiFID Review consultation suggests standards that should be met for advice to be labelled ‘independent’.
We support this overall approach and have suggested that the Commission consider making sure that firms that do not provide independent advice have to make this clear.
The Commission’s MiFID Review consultation also, of course, raised the question of whether the new Directive should strengthen powers for competent authorities to oversee investment firms’ design and development of products.
On 14 June 2011 we published the Feedback Statement to our Discussion Paper on Product Intervention.
This is the latest stage in the debate on how we should intervene earlier in the value chain to prevent detriment to consumers and re-affirms our commitment to acting in all parts of the product life cycle.
We consider that product design and decisions made by product designers about how – and to whom – products will be distributed play a significant role in determining consumer outcomes. We have already intensified our approach to the supervision of product design and ongoing management, and will be considering additional interventions.
Responses to the Discussion Paper will also feed into our thinking around the approach of the Financial Conduct Authority in the new regulatory architecture – a point I will come back to in a moment.
But before I leave European developments, I should also mention work on investment funds.
Even as we are still in the process of implementing UCITS 4, which is due to come into force very shortly, we are moving on to UCITS 5. It will, in turn, be influenced by the negotiations of the detailed implementing measures for AIFMD. We are closely involved in the preparation of ESMA’s draft advice on this, which should be published for consultation next month: we would urge all of you who are interested in that to engage with the detail of the consultation, which is not just about hedge funds, but about a wide range of types of fund that do not come under the UCITS banner.
So that’s where we’re at on some of the key European policy issues in my conduct space.
I am, of course, conscious that there are numerous others covering important prudential, capital and markets issues which my FSA colleagues are very actively engaging with.
Time simply doesn’t allow me to go into all of them here, particularly given that there were a couple of more issues I want to comment on.
Exchange traded products
The first is a product that has received a lot of attention recently, with everyone from Terry Smith to the IMF focusing on them and issuing warnings about them: exchange traded products.
You won’t be surprised, I hope, to hear that the FSA is also taking a good look at these, and we have been working with our colleagues from elsewhere in Europe, and, indeed, on them for some time.
Exchange traded products are obviously a large and rapidly growing part of the European financial market.
We share the many of the concerns that others have highlighted – such as whether marketing and promotional material actually adequately explains the differences between different fund structures and strategies; and, the risks involved with those that rely on swap counterparties
I think the key point here is that while exchange traded products are at the moment a relatively small part of the market, they have the potential to grow.
In line with the new conduct strategy which we launched a year ago, and which will be an important foundation for the development of the Financial Conduct Authority, we are now committed to intervening early where we identify potential risks and will not wait to act until after the risks have crystallised. This is the approach we are aiming to take with ETPs.
We are also conscious that many of these products are developed outside the UK and are passported in, so as well as focusing on what we can do in terms of supervision, and communication, and, where necessary, adapting rules, we are working very closely with our colleagues from elsewhere in Europe.And the key point for anyone who is already involved with these products, or may plan to do so, is to make sure first that you understand the product and the risks involved. Then you need to make sure they are risks that are appropriate for your client and that your client understands what is involved.
Compensation
Before I finish I want raise an issue which I know is very important to you – the funding of the compensation scheme.
I realise the huge potential cost there is for firms that may have done nothing wrong, when a firm that has provided poor advice or mis-sold products goes out of business but its customers require compensation.
What we need to do now is make sure the funding mechanism behind the current regime is as fair as it can be, especially in the light of the financial crisis and recent events following the failure of Keydata.
We’ve said we’ll review this in 2011.
But the government has recognised that the development of the new regulatory architecture for the UK will require a review of the structure of the FSCS. This coincides with the fact that some important aspects of the deposit and investment compensation regimes are being discussed at EU level.
It does not make sense for us to begin a formal consultation until we have more certainty as to where things stand.
But we are still committed to the review. We will carry on engaging with trade associations so that we fully understand and can take account of your concerns. And we’ll keep you informed as this develops.
Regulatory reform
Having touched on regulatory reform, I would just say a few more words on the subject, although I don’t intend to go into a great deal of detail.
Suffice to say that, following events focusing on the PRA’s approach to banking and insurance, on 28 June we are holding a conference focused on the FCA’s approach. Associated with this, we will be publishing a document which sets out our latest thinking on the overall philosophy of the FCA.We are very open to the views of all our stakeholders on the key questions such as, what should success look like for the FCA, what should interaction with the FCA feel like, and how can it deliver appropriate consumer protection.
So we’re keen to hear views and we look forward to that opportunity to engage with you and hear what you have to say. If you have not already signed up, you will find details on our website.
I am conscious you have been very patient in listening to a pretty wide-ranging overview of a number of the regulatory challenges that we all face – but I am also conscious that there are a number I won’t have covered, so if you would like to ask me questions about them, that is fine.
Let me just leave you with the thought: in thinking about regulation, past, present or future, in the UK, in the EU, or internationally our guiding principle should be doing the right thing for the customer.
We think that is a good guiding principle for your business, too.
We look forward to following that principle in close cooperation with organisations such as the CISI.
