Select Committee on Treasury Minutes of Evidence

Memorandum submitted by the Financial Services Authority


  1.  This memorandum is submitted in advance of the FSA's appearance before the Committee on 16 October. We look forward to elaborating on it in oral evidence.

  2.  The memorandum:

    —  refers to the main aspects of the FSA's work during 2000-01;

    —  provides an update on preparations for the new regime;

    —  reports on progress on current regulatory issues, including follow-up to events in the US on 11 September.


  3.  The FSA published its Annual Report for 2000-201 on 22 June, giving a detailed account of its work during the year, and the Chancellor laid that Report before Parliament on the same day. The Report was discussed with industry and consumer representatives at the FSA's second Annual Meeting on 19 July. In their presentations to the Meeting the FSA Chairman and Managing Directors gave an overview of the FSA's regulatory priorities during the year. Stewart Boyd QC, Chairman of the Board's Committee of Non-Executive Directors, summarised the FSA's accountability mechanisms and the work of the Consumer and Practitioner Panels.

  4.  In terms of the FSA's finances, we set ourselves the task of building the new regulatory regime within a budget which is falling slightly in real terms. Our mainstream regulatory costs for 2000-01 were £157.8 million, which was below our budget of £162.5 million and just 2 per cent up on the previous year. We believe that this is evidence of our commitment to be economic and efficient in the use of our resources. The FSA will acquire additional responsibilities at N2 (for example, on money laundering and market abuse), which will require a small increase in costs.


  5.  The Economic Secretary to the Treasury announced on 12 July that the Financial Services and Markets Act 2000 (FSMA) would come into force and the FSA would acquire its statutory powers on 1 December (a date known as N2).

  6.  With N2 nearly upon us, we have been working hard to ensure our readiness. A lot of work has been completed, although there is still more to do. We have worked closely with the industry to help firms get ready for the changes. Two projects have been of particular importance in preparing for N2—finalising the Handbook of rules and guidance and "Grandfathering".

Handbook Development

  7.  Most of the single Handbook of rules and guidance, which sets out the requirements that regulated firms and individuals must follow and describes how we will use our powers under the new legislation, has now been completed and published. The remaining parts of the Handbook will be made at our October and November Board meetings in time for N2. Work also continues on those sections of the Handbook which come into effect after N2, relating to the regulation of mortgages (expected to come into effect at the end of August 2002) and credit unions (July 2002).

  8.  In producing the single Handbook we have carried forward many of the existing requirements of the old rulebooks. But we have also used the opportunity to develop greater consistency in the rules and guidance and to simplify and clarify wherever possible. The Handbook is widely regarded as an improvement on the previous rulebooks. Further work remains to be done over the coming years to review our rules in specific areas (eg disclosure) and to implement changes prompted by external developments (eg the revision of the Basel Capital Accord).


  9.  The new legislation provides that firms authorised to conduct activities under the existing legislation will automatically receive equivalent authorisation under the new regime (with similar arrangements for approved individuals and regulated products). This process is known as "grandfathering".

  10.  Preparing and recording the authorisations and communicating them to firms is a major task. Around 11,000 firms and an estimated 180,000 individuals are involved. In September we sent all firms statements setting out the activities which they are authorised to conduct. They then have three months to agree them with us. It is vital that this process should be conducted accurately and in a timely fashion, so that firms can continue to carry on business seamlessly, and in line with the requirements of the new regime.

  11.  At the same time, several other streams of work are now well under way. These are outlined below.

Money Laundering

  12.  From 1 December our ability to tackle money-laundering problems in regulated firms will be much improved. We will be able to carry out prosecutions under the Money Laundering Regulations. Our own anti money-laundering rules, made under FSMA, will come into force and will apply to the UK presences of regulated firms, wherever they are incorporated. This will allow us to impose financial penalties on, or make public statements in relation to, those who infringe. And finally, complying with our anti money-laundering requirements will remain a condition for continued authorisation for UK firms.

  13.  This contrasts with the present position, where we are not a prosecuting authority under the Regulations. We have no directly enforceable rules relating to money laundering, for banks, under the Banking Act. In addition, for banks which have presences here through the European passport, our role is residual. UK authorised banks need to maintain proper anti money-laundering controls as a condition for continued authorisation, as one aspect of proper internal controls. Under the passporting regime, internal controls (including anti money-laundering controls) are prudential matters and thus the responsibility of the home supervisor. But we do liaise closely with the home supervisors where we receive information to suggest non-compliance by their banks with prudential requirements. Any necessary remedial action is achieved in that way.

New regulatory approach

  14.  The FSA is making radical changes in its approach to regulation. We are developing an integrated risk-assessment framework which will help us analyse risks arising from a variety of sources—individual firms, the external environment and those related to consumer, product, industry or market issues. We have also introduced a new strategic planning process for 2002, starting with our analysis of the risks to our statutory objectives. This will help us decide where to focus our efforts next year. As part of implementing our new regulatory approach, we are devoting more time to issues which affect a whole industry sector or category of consumer, rather than focussing our attention on individual firms.

Organisational Structure

  15.  To help us operate as a single regulator at N2, we moved to a new organisational structure in April 2001. The new Risk Assessment Division is a key part of this structure; it will, for example, help us identify the main risks and opportunities we face. During the financial year 2001-02 we were joined by new colleagues from the UK Listing Authority, the Central Office of the Registry of Friendly Societies and, just after the year-end, the Government Actuary's Department. At the top of the Authority the Chancellor appointed Carol Sergeant as Managing Director in charge of regulatory processes and risk. John Tiner was also appointed this year, heading a portfolio focused on retail regulation and consumer relations. From N2 our staffing complement will be 2,300.

New responsibilities during 2002

  16.  Much remains to be done to prepare to take on new responsibilities in 2002. These will be:

    —  Regulation of mortgage lending—under FSMA the FSA will regulate certain aspects of mortgage lending (but not mortgage advice). The mortgage regime is expected to be introduced at the end of August 2002. The FSA's proposals include, among other things: a standardised disclosure document to be given to customers before sale, so that they are better able to shop around; rules covering the content of mortgage advertisements; and proposals for the fair treatment of consumers where they fall into arrears or face repossession. Consultation on the proposals finished on 14 September and the FSA is now analysing these with a view to publishing final rules by the end of 2001.

    —  credit unions—the UK's 700 credit unions will be subject to regulation under FSMA from 1 July 2002. Under the new regulatory framework, on which we have consulted and held a series of roadshows across Britain, credit union members will benefit from similar consumer protection arrangements as bank and building society customers. In August we published our proposed supervisory manual setting out how the regime will work in practice. This has broadly been welcomed by the credit union movement.

The developing reform agenda

  17.  The FSA has already identified, with others, a number of important policy areas on which work will need to continue beyond N2. These include:

    —  polarisation—in August 1999 the Director General of Fair Trading published his findings that the polarisation rules tended to restrict competition (the rules require advisers on packaged investment products either to tie to the products of a single provider or, as an independent financial adviser, to advise on the best product from the whole market-place). By agreement with HM Treasury, the FSA commissioned detailed economic research and, after full consultation, liberalised from April 2001 the arrangements in respect of stakeholder pensions and direct offer financial promotions. As part of follow-up work on potentially more radical changes for the longer-run we have published results from additional consumer and market research. The aim is to present proposals for public consultation in December 2001;

    —  best execution—(requirements designed to ensure that a firm obtains the "best price" in the relevant market for an investor when buying or selling investments on his behalf). We are consulting on ways in which this obligation should be reformulated to provide adequate investor protection in the new more diverse world of competing exchanges and alternative trading systems. Consultation closes at the end of October. A further paper setting out FSA's preferred policy approach will be published for consultation in the first quarter of 2002;

    —  broking commissions—following the Myners review of institutional investment, the payment of commissions by fund managers to brokers in connection with the execution of securities transactions for investors is also being reviewed by the FSA. This will look particularly at the practice of "softing"—the use by fund managers of the commission generated by client transactions to fund the purchase of other goods and services. Since commission is one of the costs of trade execution, this review will form part of the work on best execution. This has been agreed with HM Treasury, and was announced on 27 July 2001;

    —  with profits review—the FSA's with-profits review is now well under way, and is looking at the prospects for change in four main areas:

      —  the extent of discretion available to management over the operation of with-profits funds and how that discretion is exercised;

      —  improvements in the transparency of the published information in consumer literature and in the regulatory returns about with-profit funds;

      —  better information for policyholders about the progress of their investments, including improvements in the language used to describe returns, and greater clarity about investment strategies and the way in which terminal bonuses are determined; and

      —  the principles which underpin the requirement for firms to have due regard to the interests of customers and to treat them fairly.

  In the first phase of the Review (to end August) a number of activities were undertaken to gather information and seek input to the scope of the Review, including publication of an initial Discussion Paper, an Open Meeting held on 18 June (including consumer and industry representatives), a programme of visits to interested external parties, and consumer research. The issues arising will be taken forward in a further series of Discussion Papers through to the end of the year, covering the key themes under the Review: Procedures for Handling Inherited Estate; Use of Plain Language; Disclosure & Regulatory Reporting; Unfair Contract Terms; and Governance & Discretion. A final report will be prepared by Spring 2002.


FSA follow-up to events in the United States

  18.  In the immediate aftermath of the terrorist attacks in the US, the UK authorities monitored developments in the financial markets and the wider economy very closely. In this context the FSA's purpose was to:

    —  help ensure the stability of the financial system—the FSA is in close touch with the US and other overseas authorities in order to help ensure the stability of the financial system. One of our first actions, on 12 September, along with the Bank of England, was to issue advice to firms (that they should continue to operate normally as far as possible) and consumers (that there was no major disruption to the UK financial system). We reinforced this advice when the US markets re-opened on 17 September;

    —  contribute to efforts to track down terrorist funding—the FSA reminded regulated firms that they should check their records for names of alleged subjects under investigation by the FBI and of their general legal obligations to report suspicious transactions. On 3 October, the FSA hosted a meeting between representatives of HM Treasury, the Bank of England, the National Criminal Intelligence Service and the Metropolitan Police to help co-ordinate action following the attacks in the US. The particular purpose of the meeting was to clarify the responsibilities and obligations of the industry and the authorities under anti-terrorism, sanctions and money laundering legislation and to explain how financial services firms can help government and law enforcement agencies in the task of tracking down terrorist funding;

    —  investigate potential insider dealing—the FSA is also investigating whether anyone—either the terrorist organisations themselves or others who may have had knowledge of what was planned—profited from the atrocities. Given the depth and variety of the markets in London this is a difficult task. We have focussed on trading in airline and insurance stocks and on oil prices. So far, in a number of cases where trading was high, we have been able to establish rapidly that there was a ready explanation. For example, a sizeable trade in the shares of a British airline turned out to have been on behalf of another airline, as part of an overall hedging strategy. We continue to work closely with the Recognised Investment Exchanges (such as the Stock Exchange), market participants and other regulators in this investigation;

    —  reduce market volatility—given the effect of the terrorist attacks on the markets and the economy as a whole, the FSA further relaxed the "Resilience Test" for life insurance companies on 24 September (which followed an earlier amendment to the test on 11 September). This tests the ability of a fund to withstand major falls in asset prices such as equities and can require insurance firms to sell shares for short-term technical reasons. In the current unusual market conditions the FSA recognised the action was needed to avoid such perverse effects. The resilience test was relaxed whilst seeking to ensure that insurance companies continue to manage their businesses on the basis of prudent assumptions. This work has been welcomed by the industry as a proportionate and helpful response by the FSA to highly unusual circumstances.

Marconi Plc and timely disclosure

  19.  The FSA became the UK Listing Authority (UKLA) in May 2000. The FSA's Listing Rules require listed companies, among other things, to announce without delay all relevant information which is not public knowledge concerning a change in financial condition, performance and expectation as to performance which, if published, would be materially price sensitive.

  20.  Early on 4 July 2001, Marconi requested a suspension of its Listing, announced the disposal of its Medical Systems business and that evening issued a negative trading statement. A full day suspension and a share price fall of about 47 per cent were the result. On 4 September, a further negative trading statement led to a share price fall of about five per cent and a further 25 per cent the following day. For statutory and policy reasons all the UKLA's investigations remain confidential unless disciplinary action results in public censure. However, Marconi disclosed on 28 September, in a filing to the Securities and Exchange Commission in the US, that the UKLA had initiated enquiries concerning the suspension on 4 July and the trading updates of 4 July and 4 September. As that filing pointed out, the UKLA may issue a public censure if it identifies a breach of the Listing Rules.

  21.  This case illustrates the need for companies to be mindful of their Listing Rule obligations, particularly in worsening economic conditions. The number of negative trading statements issued by companies has increased this year and a further increase is likely as companies assess the impact on them of the terrorist attacks. The UK Listing Authority sent a letter to all listed companies on 28 September 2001 reminding them of their obligations. Since then the rate of company announcements has increased significantly.

Equitable Life

  22.  Equitable Life closed to new business in December 2000 and its operations, apart from the with-profits fund, were purchased by Halifax in February 2001. Since then the FSA's work has focussed on the following areas:

    —  keeping Equitable's financial position under continuous review;

    —  issuing information to policyholders to keep them informed;

    —  holding discussions with policyholder action groups;

    —  monitoring IFAs' advice to those affected;

    —  assessing Equitable's selling practices relating to policies sold after the Court of Appeal judgement was delivered in January 2000;

    —  discussions with Equitable about its compromise scheme, taking into account legal advice received by Equitable and the FSA;

    —  commissioning and obtaining independent external legal advice on the extent of any misselling by the Equitable to non-GAR policyholders.

  23.  On 20 September, the Equitable published, for consultation, its proposed compromise scheme for policyholders. The FSA believes that a successful compromise would offer the best prospect of bringing stability to the with-profits fund and improving the outlook for policyholders. The Equitable will take account of the responses to the consultation in preparing a final version of the scheme for a policyholder vote to be held in late November. The FSA will review the scheme and give its views before policyholders vote. If the vote is favourable, the scheme then goes to the High Court for approval in the New Year, and if approved will become effective by 1 March 2002.

  24.  The FSA's concern is to ensure that the interests of all Equitable Life's policyholders are taken into account. We have commissioned and obtained independent legal advice on whether the Society may be exposed to potential claims for compensation arising from the misselling of policies to non-GAR policyholders. We have published this advice. Counsel concluded that there is the potential for claims, though the strength and potential value of such claims will vary according to the individual circumstances.

  25.  We have drawn these legal opinions to the attention of all life assurance companies so that they can assess their own position. However, the combination of circumstances found in the Equitable's case are highly unusual, and we do not believe it likely that examination of the issues raised in the opinions will reveal significant problems in the life assurance industry more generally.

  26.  In December 2000 the FSA Board initiated a review of the FSA's supervision of Equitable Life in the period since it took over prudential supervision of insurance companies from HMT in January 1999. That review, carried out by the FSA's Director of Quality Assurance with the help of external advisors, is now complete, and the FSA submitted the report to Treasury on 8 October. The Government has said that it will publish the report, but that its decision on when to publish will need to be considered in the light of the timetable for Lord Penrose's inquiry.

Independent Insurance

  27.  Independent Insurance Company Ltd went into provisional liquidation on 17 June 2001. Most of the individual policyholders have had their business transferred to other insurers without interruption of cover. The Policyholders Protection Board is assisting with the payment of eligible claims. Broadly, these are claims from individuals or partnerships, and claims under certain compulsory insurances. The Serious Fraud Office (SFO) is now investigating the circumstances of the company's collapse. The FSA remains in close touch with the SFO and the provisional liquidator.

The future of insurance regulation

  28.  The FSA accepts that change is needed in the way the insurance sector is regulated. We have already taken action in a number of areas and have:

    —  developed a pro-active, risk-based approach to regulation which is now being progressively applied to the insurance sector;

    —  brought together prudential and conduct of business regulation of life insurance companies;

    —  integrated the provision of actuarial advice (formerly in the Government Actuary's Department) within the FSA's Insurance Firms Division;

    —  started a review of with-profits policies and their regulation;

    —  declared an intention to move towards a more integrated approach to capital and reserving across the banking and insurance sectors; and in life insurance companies; and

    —  established a project team lead by John Tiner to define and implement the changes required to the regulation of the insurance industry, taking account of the lessons of recent cases, market developments, the implementation of the FSA's integrated risk-based approach to supervision and international best practice. The project will complete its work by September 2002.


  29.  Use of the consumer help website is up sixfold over the last year to 15,000 users a week. The helpline dealt with 180,000 phone calls during the year and just under 700,000 publications were sent out. Work continues on personal finance education (working with a major private sector employer and the Army, for example, to educate them about basic financial planning). A number of other areas of our work this year are highlighted in more detail below.

  30.   Comparative Tables—the FSA plans to launch its web-based comparative tables on 12 October. The first tables will cover unit trusts ISAs and other products will follow over the following weeks. We have consulted on adding mortgages to the tables in 2002. This is the first time that a regulator has brought together, in one place, authorative, easy to understand and comparative information based on a series of robust and objective indicators. The tables will also cover long-term investment products, including personal pensions, investment bonds, savings, and mortgage endowments. Consumers will be able to compare products on a like-for-like basis, helping them to draw up a short-list that can then be explored further. The aim is to shift the balance of power back towards consumers by helping them to shop around and make better-informed decisions.

  31.   Past Performance in advertising—in September the FSA announced a three-point plan designed to improve the way in which past performance data in advertising is presented to consumers. This was in response to the report of a Task Force (which included industry and consumer representatives) set up by the FSA to examine the issue. The plan proposes to intensify the scrutiny of the presentation of past performance information; to introduce new rules to strengthen advertising standards and clamp down on misleading claims; and to assess the feasibility of standardising the use of past performance, risk and price information in advertisements. Work will begin immediately and we will discuss with all interested parties how we can build on the existing safeguards.

  32.   Treating Customers Fairly—continuing our efforts to ensure consumers get a better deal, we published a study in June which considered the standard of customer service provided throughout the lifetime of the product and the on-going relationship between the firm and customer. Among other things, the study found:

    —  a failure to provide relevant information to customers during the life of a product;

    —  persistence of jargon in some product literature;

    —  the sale of complex, opaque products to consumers where the associated risks are not properly identified; and

    —  poor standards of complaint handling by some firms.

  Actions to tackle the problems include a campaign to replace jargon with plain language; a review on unfair clauses in contracts; and a policy review of the information provided to customers after they have brought a product. Work on these is currently being planned.

  33.   Stakeholder Pensions—in time for the launch of stakeholder pensions in March, the FSA developed a regulatory regime to cover the promotion and marketing of stakeholder pension schemes, including product disclosure information and cooling-off rights. The Occupational Pensions Regulatory Authority is responsible for monitoring the provision of schemes by companies. As part of our supervision of the early stakeholder market, we have:

    —  obtained details of marketing plans from all stakeholder scheme managers;

    —  continued to take a close interest in how pension companies operate in the stakeholder market and the products they offer;

    —  monitored the implications of stakeholder for the capital adequacy of the provider firms.

  Our consumer-directed work on stakeholders has included the development and publication of decision trees; the publication of a consumer factsheet containing decision trees (240,000 have been distributed to date); and the development of interactive decision trees posted on the ConsumerHelp website.

  34.   Complaints and Compensation—the FSA has now published final details of its requirements on firms to have formal procedures in place for handling consumer complaints. Where a consumer is not happy with a firm's handling of a complaint, they can take it to Financial Ombudsman Service. During the year, significant progress has been made on the establishment of the Financial Ombudsman Scheme and the Financial Services Compensation Scheme:

    —  the Financial Ombudsman Service (FOS) will be the new one-stop shop replacing various complaint schemes that operated under the old regime;

    —  in December the Financial Compensation Scheme will fully replace eight existing arrangements that provide compensation if a firm collapses owing money to investors, depositors or policyholders. In September the FSA published the final rules for the scheme, which will also come into force at N2.

Enforcement Activity

  35.  Often in liaison with the criminal authorities, the FSA investigates and prosecutes those responsible for conducting financial business outside the law. We use civil and criminal powers and those responsible can be imprisoned. One conviction this year resulted in a prison term of two years and nine months. We have also used our powers to secure restitution of funds to investors. More specifically, during 2000-01 we:

    —  instigated three criminal prosecutions for offences under the Banking Act 1987;

    —  investigated 376 cases of suspected contraventions of the Financial Services Act 1986, the Banking Act 1987 or the Insurance Companies Act 1982; and

    —  concluded nine sets of High Court cases and obtained orders for restitution or compensation in favour of more than 360 investors and depositors.

  39.  Further regulatory action has been taken against a number of firms during this financial year. For example:

    —  Winterthur Life United Kingdom Ltd—was fined £500,000 for breaches which resulted in the mis-selling of mortgage endowment policies. Around 10,000 customers may be affected and the firm has set aside approximately £10 million for redress;

    —  Pearl Group—two Pearl Group companies, Pearl Unit Trusts Ltd and Pearl Assurance Plc were fined a total of £100,000. The two companies have paid £345,854 in compensation to 1617 customers. The fines were imposed for not carrying out customer share orders on a timely basis and for failing to establish and maintain procedures to achieve this;

    —  Royal London Mutual Insurance Society Ltd—was fined £400,000 for breaches of rules relating to the sale of investment products, including endowments, to customers. The company is expected to provide about £15 million in compensation to around 65,000 customers.

10 October 2001

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