RESPONSE BY THE FINANCIAL SERVICES AUTHORITY
TO THE EIGHTH REPORT OF THE TREASURY SELECT COMMITTEE
SESSION 2003-04 (HC 71)
1. This note is submitted in response to the
Committee's eighth report of the 2003-04 session on long-term
savings. In response to recommendations which are for the FSA
we refer to the relevant paragraphs in the conclusions and recommendations
section of the report.
Improving Product Information - (conclusions and
recommendations paragraphs 3-6)
2. We agree with the Committee that "there
is a need for urgent action to re-balance the asymmetries of information
in the financial services industry by improving the information
available to consumers". This is reflected in our published
priorities. Our current work on product disclosure builds on
the principles we set out in CP170 in February 2003:
'By regulating the information given to consumers
at the point of sale - the disclosure regime - we seek not only
to ensure that the consumer is informed, but to help him or her
make effective use of the information provided
to improve consumer understanding must set priorities and focus
on material we have identified as central to the consumer making
a sound decision at point of sale
we must accept that less
3. Our approach to re-structuring the current
disclosure regime has been driven by our understanding, based
on extensive consumer research, of how consumers react to and
take in information when buying an investment. This research
has shown that visual appeal, simple language and clarity of layout
are often more significant factors in conveying messages to consumers
than the length of a document. So while we have been at pains
to stress that 'less is more', and encourage firms to be concise,
we have generally sought to avoid imposing an arbitrary limit
on the length of documents and thus possibly deny consumers adequate
information about the risks they are taking in buying complex
4. In CP 170, we proposed a new format for product
information - branded 'Key Facts'. This is designed to focus the
consumer's attention on key information that is likely to impact
on a product's suitability. Our aim is to ensure that firms set
out, in the first page (or at most two facing pages) of their
Key Facts, short bullet-point answers to four or five questions,
together with signposts to where the consumer can find out more.
5. We have started convening a working group
which we expect will meet shortly to explore further and constructively
the feasibility both of devising a short summary box along the
lines recommended by the Committee, and of developing and publishing
simple risk indicators for investment products. We will report
back to the Committee at the end of the year on our progress.
Fees and Commissions - (conclusions and recommendations
paragraphs 9 -15)
6. The FSA's aim in this area is to provide consumers
with the information they need about the cost of advice that will
help them in shopping around between different firms and in negotiating
fair deals with individual firms. Our menu system will play an
important role in this (see paragraph 10 below).
7. The Committee recommends a shift away from
commission-based sales. Our consumer research has shown that many
consumers prefer a commission-based method of remuneration to
payment by fees. The main reasons seem to be a reluctance to pay
for advice by way of a separate fee, and the fact that there is
no payment to be made under a commission system if a product is
not purchased. We would not consider a direct ban or limit on
commission to be a proportionate response to the risk of commission
bias. Instead, our plans for a menu will provide consumers with
the information they need to shop around and negotiate with firms,
so increasing competition. And it will encourage consumers to
think about the choice between fee and commission-based payments.
8. However, in the context of our work on Treating
Customers Fairly (TCF), we will be identifying good and bad practice
in how firms build TCF into the way they carry out their business.
One aspect of this will be a focus on the remuneration structures
within firms and the relationship between product providers and
distributors with the aim of ensuring fairer outcomes for consumers.
The outcome of this work will feed into our next TCF publication
which is due in the summer of next year. We will keep the Committee
informed of progress.
9. The Committee suggests that a fee structure
that contains a stronger linkage to subsequent investment performance
would help align more closely the long-term interests of the saver
and the industry. This is a matter for the industry. There is
no regulatory barrier to firms creating a fee structure which
is linked to investment performance. It is also common for on-going
charges on investments to be calculated on the basis of a percentage
of funds under management. This means that both the reward to
the fund manager and the level of trail commission payable is,
at least to some degree, related to the value of the fund.
10. The Committee expressed some concerns about
the structure of the menu, and recommended that "each client
should be given an explicit comparison of the total cost, in cash
terms, of buying a product on a fee basis and the total cost on
a commission basis over the likely life of the product."
Firms' menus will have to show whether they operate a fee or
commission paid service, or both. If firms do not offer a fee
option, they will have to make this clear. They will show the
maximum rate of fees charged for advice, and/or the maximum rate
of commission taken for various product groups, and the market
average commission for each group. They will also need to spell
out whether the service they offer includes on-going advice.
11. The menu will be given to consumers before
the advice process begins. At this stage, the firm will not have
sufficient information about the customer's circumstances to decide
which product or products would be suitable and so will not be
able to say exactly how much commission it will receive (the exact
amount will be given to the customer once a specific product has
been recommended and while the customer still has a right to cancel
the contract). Similarly, at the time the menu is given, the
firm will not know how long it might take to deal with the customer's
circumstances where the customer chooses to pay by fee.
12. On trail commission, the Committee states
that it is unacceptable for IFAs to receive trail commission whether
or not they are providing any real on-going advice to the client
and that clients opting to pay for financial advice via fees should
be given the explicit option of paying an annual fee for any on-going
advice they receive rather than having trail commission paid from
13. An IFA must describe the services it will
provide to clients in the terms of business document it must currently
give out before a transaction. This requirement will also apply
in the menu. A description of those services would normally state
whether ongoing advice will or will not be provided. The payment
of trail commission is sometimes presented for the purpose of
on-going advice, but in fact no product provider makes the payment
of trail commission dependent upon an IFA maintaining contact
with a client. We welcome the work commissioned by the ABI on
the role of commission and specifically the role of trail commission
and measures which might foster on-going advice.
14. When the menu is introduced, if a client
chooses to pay for an IFA's services by a fee our rules will require
the firm to ensure that the full value of any commission it subsequently
receives, whether trail or otherwise, is passed on to the client.
There are, however, some serious practical difficulties in expecting
firms to account for very small amounts of trail commission.
To get around this problem we have provided a facility for the
client and the firm to agree that the firm may retain trail commission
up to an annual amount agreed with the client.
15. The Committee asks us and the industry to
collect and publish regular data on the relative cost of buying
major products on a fee and commission basis and the percentage
of savers opting to pay via fees or commission.
16. As outlined in paragraph 10 above, a feature
of the menu will be the inclusion of information about the average
commission paid for the various groups of mass-market products.
These "market averages" will be calculated by the FSA,
published on our website and updated annually. We decided against
including an equivalent market average for fees in the menu for
a number of reasons. These include the fact that, as with other
professions such as accountants, fees can be calculated in number
of different ways (eg per hour, or as a flat fee) each of which
would have to be reflected in the average and that there may be
greater variations than with commission on the fees commanded
in the market according to regional location or a firm with a
well known name. Furthermore, whilst commission data can be collected
from a small number of product providers, data for fees would
have to be collected from a large number of individual IFAs, which
could make the process disproportionately onerous and expensive.
In the light of the Committee's request, however, we will consider
further whether it is possible to produce figures for average
fees in a way which is cost effective.
With-Profits - (conclusions and recommendations
17. The report refers to the FSA's programme
for reform of with-profits, commonly referred to as "Principles
and Practices of Financial Management". The aim of our reform
programme is to promote transparency in with-profits and improve
information provided to consumers.
18. The introduction of Principles and Practices
of Financial Management (PPFM) is one component of our much larger
package of reforms for with-profits and should not be thought
of as an umbrella label for the proposals set out in CP 207, Treating
with-profits policyholders fairly (December 2003). See paragraph
22 for further detail on our wider reform programme.
19. Since April 2004, with-profits firms have
been required to produce a document called a PPFM for each of
their with-profits funds. These publicly available documents capture
the way in which a firm uses its discretion in running its with-profits
business, and must cover areas such as amounts payable under a
with-profits policy; investment strategy; business risk; and charges
20. The requirement to produce a PPFM was driven
by a desire to introduce greater transparency and better governance
arrangements in the with-profits sector. Our intention was that
the PPFM would be used by market analysts, IFAs and sophisticated
investors to help them improve their understanding of how a particular
fund is run and decide whether to recommend investment. It is
no surprise therefore that a number of expert witnesses cited
in the report questioned whether PPFM would be of direct benefit
to policyholders, since it was not our intention that this group
should be the primary audience for PPFM.
21. However, the PPFM contains essential information
and, to ensure that this information reaches a wider audience,
we have proposed that firms also be required to introduce consumer-friendly
versions of the PPFM from mid 2005. Our consumer testing of these
documents has shown that they can help increase consumer understanding
of how a with-profits fund is run. In addition, we recognise that
consumers also get their information about different products
from other sources, such as the media. In this respect, both PPFM
and the consumer friendly version should prove helpful in informing
wider market commentators.
22. Besides PPFM and the consumer-friendly versions,
other components of our reform package to drive up transparency
and improve information provided to consumers include:
- the requirement for with-profits
firms to report to with-profits policyholders on whether they
have complied with their PPFM obligations (from end of 2004);
- the requirement for the new with-profits actuary
to report publicly on whether in his/her opinion the firm's report
to policyholders can be viewed as having taken policyholders interests
into account in a reasonable and proportionate way (from the end
of 2005 - one year after the new actuarial functions have been
- guidance on governance standards for with-profits
business to underpin the new reporting requirements to policyholders.
This includes the desirability of an element of independent judgement
over the assessment of a firm's compliance with PPFM and how it
handled any conflicts of interest between different groups of
policyholders and also shareholders, where applicable;
- work on enhanced disclosure at and post point
of sale. This work includes the replacement of the Key Features
document with Key Facts, which will improve clarity and transparency
at the point of sale. We aim to publish the next CP on disclosure
in the first half of 2005; and
- greater transparency over the financial strength
of with-profits firms with the introduction of realistic reporting.
23. The Committee points to critical comments
made in the Penrose Report into Equitable Life. These comments
need to be read in the light of Lord Penrose's overall conclusion
about the FSA's programme of reform, noting that it "
sought to anticipate many of the lessons drawn by the inquiry"
and that the work so far "..has reflected a major comprehensive
reassessment of the requirements of an efficient regulatory system
for the insurance sector."
24. Against this background, Lord Penrose's concerns
appear to centre on the inadequacy of rules expressed in relatively
high-level terms without effective supervision. While the FSA
places great emphasis on the responsibility of the senior management
of regulated companies to run their businesses in accordance with
our rules, this must be accompanied by vigilant and intelligent
monitoring by the regulator. We have recently published a report
that reviews the progress that retail firms across all sectors
have made in delivering their obligation to treat customers fairly
and considers next steps that firms need to take. It also describes
the targeted supervisory work on fairness that we will be carrying
out in 2004/05.
25. Lord Penrose also expresses doubt that with-profits
can exist without mystery. It is important here to distinguish
between mystery and discretion; the latter being a central characteristic
of the way in which with-profits is operated. This characteristic
need not operate against consumer interests, so long as the discretion
has parameters that are adequately described in a company's PPFM
and is exercised in accordance with these and with the other obligations
to which with-profits firms are subject.
26. The report cites a figure of £161bn
for assets invested in closed funds out of a total with-profits
market of £365bn. Analysis of our year-end returns for 2003
shows £191bn of assets are invested in closed funds (both
with-profits and non-profit) out of a total market value of £940bn
for long term assets. Measured in terms of liabilities, the with-profits
liabilities in closed funds amount to £84bn out of a market
total of £333bn for with-profits liabilities.
27. Notwithstanding these figures, closed funds
are a significant and growing issue for industry, consumers and
the regulator. The potential impact on consumers is something
that we are particularly concerned about and we agree with the
Committee that a high priority must be placed on ensuring that
policyholders in closed funds are treated fairly. Consumers in
all with-profits funds, open and closed, should benefit from the
introduction of PPFMs and the forthcoming consumer-friendly versions.
Our consumer research shows that policyholders should gain a greater
understanding of this complex product from the Consumer Friendly
PPFM, but we will keep under review whether these documents actually
deliver this objective in practice.
28. In response to the Committee's interim report
into Mortgage Endowments, we noted the difficulties that arise
in relation to the sale of closed funds and in particular, the
feasibility of transferring policyholders out of closed funds
at no cost. Market-based solutions are now beginning to emerge
(by way of third party acquirers seeking to achieve efficiency
gains) and we are encouraged by industry participants' appetite
to engage with the challenge of safeguarding the fair treatment
of policyholders in these funds. We are in dialogue with a wide
variety of industry players about their plans in this respect.
Our current consultation on fair treatment of With-Profits customers
includes requirements for firms to notify policyholders when a
fund is closing to new business and limiting the deductions firms
can make - including in the form of MVAs - when policyholders
leave a fund. In addition, we will be extending our programme
of targeted supervisory work on the treatment of policyholders
in closed funds later this year and into next.
29. We welcome the Committee's recognition of
our reforms to the Appointed Actuary regime. These should improve
the effectiveness of actuarial advice in protecting policyholders'
interests as from the end of this year (in advance of any reforms
stemming from the Morris review). Senior management of firms have
a responsibility to treat policyholders fairly, and should not
be focused purely on the interests of management and shareholders.
30. More non-actuaries are becoming involved
in safeguarding policyholders' interests, for example as a result
of bringing policyholder liabilities within the scope of the audit
and through independent input to governance (noted under point
22) where our guidance indicates that this can be provided by
persons other than actuaries, such as those with experience of
consumer protection, the life industry, regulation, the law and
Money Laundering - (conclusions and recommendations
31. Under Treasury's Money Laundering Regulations
2003 (which replaced the 1993 Money Laundering Regulations with
effect form 1 March 2004) and our Money Laundering Rules, there
is a legal obligation on financial services firms to verify their
customers' identities. However, neither the regulations nor the
rules specify exactly how identity verifications should be undertaken.
The financial services industry, through the Joint Money Laundering
Steering Group (LMLSG) of some 16 trade associations has, over
many years, developed good practice guidance which outlines a
variety of means that can be used to identify an individual.
32. There is wide recognition, as the Committee
notes, that the present approach to identification can be improved,
including in its impact on customers. We are leading a review
involving all the stakeholders (consumers as well as the industry,
law enforcement, government and others). We expect this to result
in the development of a simpler regime that will streamline the
process for firms and customers while retaining the value of identification
in the fight against crime.
Speed of the enforcement process - (conclusions
and recommendations paragraph 25)
33. We have conducted an 'end to end' review
of the Enforcement process which was divided into 3 parts and
published the results on 15 July 2004 . Separate teams looked
at each of the case referral, investigation and decision making
34. Although we concluded that the criteria for
referring cases could stay as they are, we have tightened up the
process and made it more streamlined. We have made or are in the
process of making a number of changes to the management and conduct
of investigations to ensure that they stay focused and transparent
and are currently working on improving our IT capabilities. We
are considering how to tighten the procedures of the Regulatory
Decisions Committee (RDC) but we also need to ensure that the
outside world is better informed about the RDC and has more realistic
expectations of it.
35. Over the last two years we have reduced the
average time taken to complete an enforcement case by around 30%.
As a result of the new arrangements, we expect that time to reduce
further. Implementation of the changes is well under way and speedier
results are already occurring in investigations we have conducted
this year. Our investigations into Shell and trading in Marks
and Spencer plc shares are recent high profile examples.
Financial Ombudsman Service - (conclusions and
recommendations paragraph 26)
36. As part of the two-year review of the Financial
Services and Markets Act, Treasury asked the FSA and the Financial
Ombudsman Service (FOS) to review the circumstances in which the
FSA takes regulatory action instead of individual cases being
determined by the Ombudsman and to consider whether Ombudsman
decisions should be subject to some form of appeal in specific
circumstances. FSA and FOS issued a joint consultation paper
on 2 July.
37. The consultation paper sets out proposals
to clarify the differing roles and responsibilities of the FSA
and FOS when ''wider implications'' cases arise. It explains how
and when the FSA may deal with such cases through the use of regulatory
powers and it sets out proposals to improve the coordination between
FSA and FOS in cases with wider implications. FOS proposes to
build on its existing Industry Liaison Group arrangements which
should provide a more formal mechanism to achieve input from stakeholders.
38. The consultation paper concludes that there
are significant disadvantages and practical problems with a general
appeals process against Ombudsman decisions. The consultation
closes on 1 October and we will publish the conclusions of the
review later this year.
Public Knowledge of the FSA's role - (conclusions
and recommendations paragraph 27)
39. Our policy is to target our communications
at particular groups of consumers who need help. This means that
consumers get reliable, clear and up-to-date information at the
right time to help them take specific decisions. Two high profile
areas where we have done this include mortgage endowments and
the pensions review. On mortgage endowments for example, more
than 33 million copies of our factsheets were distributed to help
consumers understand how their mortgage endowment worked and to
explain the options open to them. We believe this targeted approach
has more impact on consumers than general advertising campaigns
which are not linked to particular concerns or issues consumers
may have. In addition, our consumer website is a significant
source of information about the FSA and financial services from
a consumer point of view. We are looking at ways in which we
can raise awareness of the service we provide consumers - e.g.
our comparative tables - more effectively.
Public Forum - (conclusions and recommendations
40. The Committee recommends the creation of
a forum so that the industry, the regulator and consumers can
establish a collective, forward looking joint agenda. As John
Tiner said in evidence to the Committee on 23 June, a forum could
be helpful but not one which repeats work already being done in
other collaborative forums. We already have in place effective
mechanisms to engage in dialogue with Government, industry and
consumer groups. This happens generally through for example,
the Practitioner and Consumer Panels and regular contact with
consumer bodies such as the Consumers' Association and the NCC.
It also happens in specific circumstances through for example,
the Financial Capability Steering Group which brings together
all the relevant stakeholders. In the context of Treating Customers
Fairly, we will shortly establish a Consultative Group made up
of industry and consumer groups to help us take forward our work
in this area. So, collective action between the main players is
extensive and will continue.
41. The range of issues proposed for this forum
is very wide, including broad issues which affect consumers' confidence
in long term savings and incentives to save and invest. If such
a forum were established we would play our part. Given the wide
range of issues it would cover, including many outside our responsibilities,
it would not be appropriate for the FSA to take the lead or chair
such a forum.
Financial Services Authority
21 September 2004