Select Committee on Treasury Eighth Special Report


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…our efforts 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 is more.'

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 investment products.

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 their investment.

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 paragraphs 17-19)

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 and expenses.

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 introduced);
  • 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 "…has 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 accountancy.

Money Laundering - (conclusions and recommendations paragraph 24)

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 stages.

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 paragraph 37)

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

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