Select Committee on Treasury Written Evidence


Memorandum submitted by Which?

1.  EXECUTIVE SUMMARY

  1.1  We welcomed the creation of the FSA that brought together the activities of the 10 previous regulatory organisations under one umbrella. However, we want to see some changes to the governance, operation and structure to ensure that the regulator better ensures that consumer interest is at the heart of its work. We are not calling for more regulation. Our goal is to promote more effective, proportionate regulation. We want a system of deterrents and incentives which can be applied to the retail financial system so that the interests of consumers, providers and shareholders are better aligned.

  1.2  We believe that if the FSA is to be a more effective regulator, it needs to become better at identifying detrimental practices in the first place—and then become a more aggressive enforcer.

  1.3  We welcome the FSA's recent announcement that it is to start looking more carefully at root causes of consumer detriment, and we share its analysis about the problems caused by the prevailing remuneration model. It is now vital that the FSA follow through on this analysis and take tough action to address these problems. The forthcoming FSA Retail Distribution Review, will be an important opportunity.

  1.4  We do not object to the move to principles based regulation/Treating Customers Fairly. However, we have concerns that the FSA is in effect devolving more responsibility to directors of firms without first ensuring that robust discipline and enforcement measures are in place to provide a deterrent against firms exploiting less intrusive regulation. In addition, Which? believes that any change to principles-based regulation should be accompanied by a cost-benefit analysis of potential detriment.

  1.5  A key current issue is regulatory costs and benefits. No one supports unnecessary regulation that adds no value. However, it is our view that allegations of overregulation and unnecessary costs are overstated. The industry lobbies have been able to portray standard business costs as new or additional costs of regulation. When cost sources are examined objectively, firms that were following good business practice would still incur most of those costs.

  1.6  In many respects, the FSA's General Insurance Conduct of Business regime has led to benefits for consumers. However, we have concerns that the protection that this regime offers is insufficient for some of the higher-risk products, notably the pure protection products.

  1.7  The Chief Executive of Which?, Peter Vicary-Smith, will be giving oral evidence on the work of the Retail Financial Services Group in conjunction with other colleagues from the group, including the previous chairman, Richard Lambert. We are aware that written evidence by the committee is being provided to the committee directly by the group.

2.  INTRODUCTION

  2.1  We saw the creation of a single retail regulator in the form of the FSA as being a significant success and milestone in our efforts to make retail financial services markets work in the interests of consumers and wider society. However, we are of the view that the structure and culture of the FSA is in need of reform if it is to meet the future needs of society.

  2.2  At present, we are concerned that the FSA puts its relationships with firms and issues of market confidence ahead of the interests of consumers. We would like to see the consumer interest be given equivalence to other more powerful interests within the financial system. We are not calling for more intrusive or expensive regulation. Indeed, we recognise that the cost of regulation will ultimately be borne by the consumer. Instead, our goal is to promote more effective, proportionate regulation. We want to see a system of deterrents and incentives which can be applied to the retail financial system so that the interests of consumers, providers and shareholders are better aligned.

  2.3  This response focuses on the three questions set out in the call for evidence. However, we would also like to bring particular attention to a number of key issues that the FSA highlight in their annual report.

  2.4  The problems with financial advice that the FSA depolarisation post-implementation research has identified are of particular concern. Which? is concerned that depolarisation has meant that consumers are increasingly confused about the advice that they are being given. In September 2006, we published the results of an in-depth study of 57 financial advisors and found that less than a third reached our benchmarks for good advice3[3] (This study is provided as a separate attachment). Tied advisers, who mainly work for high street banks and building societies, were the worst—just 16% passed all the standards. Almost half of the tied advisers Which? visited led researchers to believe they offer more choice than they do. While independent financial advisers (IFAs) came out better, they still fell short of the mark; less than half those visited passed all the benchmarks for good advice. These findings are of great concern and will require considerable attention.

  2.5  Which? has long highlighted the problems in the Payment Protection Insurance market. 4[4] Problems relating to poor selling practices and a lack of compliance in this market have been highlighted this year by the FSA in their thematic work in this area. The emerging thinking document published by the OFT in August, as part of their study of the effectiveness of competition in this market, has also been very critical of this market. Some tough action is needed to correct the clear problems that exist in this market. The problems that the FSA highlight with the sale of Critical Illness insurance are also of notable concern.

  2.6  A number of outstanding problems in the mortgage markets also need addressing. The serious problems that the FSA has identified in the equity release market will need to be tackled as will the widespread deficiencies that the FSA have identified with mortgage disclosure documentation.

3.  RESPONSIVENESS OF THE FSA TO THE NEEDS OF THE RETAIL FINANCIAL SERVICES CONSUMER

  3.1  Which? has a number of strategic aims for the retail financial services industry:

    —  Introducing strong market forces which lead to effective competition from the consumer perspective and "normalising" good behaviour and responsible practices.

    —  Putting power in the hands of consumers and ensuring firms are held accountable by aligning the interests of shareholders/producers with those of consumers and society.

    —  A high degree of consumer protection, reducing the risk of mis-selling and other reckless behaviour by firms.

    —  Restoring confidence in the financial services industry, which at a time when the UK faces a pensions crisis, must be in the national economic interest.

  3.2  Our strategy for making retail financial markets work is based on a three-pronged approach.

    —  Better regulation: that is more robust, targeted regulation which addresses causes rather than symptoms of market failure;

    —  Better governance, accountability and consumer representation: to balance the explicit duties directors have to shareholders under UK company law (including self-regulation); and

    —  Making market forces work better so that competition has a chance to work effectively.

  3.3  Reform is needed in each of these three areas. Our major initiative "Time for A Change" (TFAC) [5]proposes a set of standards designed to promote better governance and leverage market forces to complement effective regulation.

  3.4  The FSA has a major role to play in achieving these strategic aims. Rather than solely chase after detriment, we believe that if the FSA is to be a more effective regulator, it needs to become better at identifying detrimental practices in the first place—and then also become a more aggressive enforcer.

Retail Distribution

  3.5  We welcome the FSA's recent announcement that it is to start looking more carefully at root causes of consumer detriment. The FSA has recently said that the current distribution system for financial services to retail customers "serves neither the producer of the services nor the consumer of the services".[6] In their opinion, the prevailing remuneration model is leading to product bias, provider bias and churn, with the consequence of significant potential consumer detriment. Training deficiencies have also been highlighted as another important problem. Which? has long argued that problems of remuneration and training are key sources of detriment in the financial sector and this development is therefore timely.

  3.6  It is now vital that the FSA follow through on this analysis and take tough action to address these problems. The forthcoming FSA Retail Distribution Review, will be a very important opportunity to do this.

Principles—based regulation

  3.7  The FSA is changing the way it regulates the industry trying to move from a rules based approach to one based on high level principles. Which? does not object to high level principles/TCF per se. It is a worthy aim that we share with the FSA. However, we have concerns about this approach:

    —  The FSA is in effect devolving more responsibility to senior management/directors of firms without first ensuring that robust discipline and enforcement measures are in place to provide a deterrent against firms exploiting less intrusive regulation.

    —  The FSA is not publishing data on individual firms' compliance with TCF. This means that consumers will not be in a position to assess the risks and benefits involved in entering a commercial relationship with a firm. This undermines the consumer protection and competition aims of the FSA.

    —  The necessary market forces to provide incentives to good corporate behaviour are not in place.

    —  Which? believes that any change towards principles-based regulation should be accompanied by a cost-benefit analysis of potential detriment. We are not aware that the FSA has conducted an impact assessment on the potential consumer detriment by replacing rules with high level principles. We believe an impact assessment is vitally important. In light of the better regulation environment, we would have expected the FSA to justify any changes to legislation with a cost/benefit analysis, including looking at potential impact on consumers. It is surprising that this has not been done.

  3.8  If the FSA is to ensure that firms do treat customers fairly, then a system of deterrents and incentives need to be created along with intelligent application of regulatory tools to the root causes of detriment.

Enforcement

  3.9  Senior management have to be clear that failing to treat customers fairly will result in serious consequences for the individuals responsible, the financial position of the firm and therefore its shareholders. Firms need to fear the FSA. They need to be certain that behaviour which is detrimental to the consumer and public interest is likely to attract the attention of the FSA and result in penalties which hit their bottom line. Only then do we think that shareholders will be incentivised to put pressure on directors of firms to put consumers at the heart of business.

  3.10  To provide this necessary regulatory, corporate and individual director level accountability we advocate a number of reforms connected to the enforcement process. These include:

    —  A more transparent enforcement process. We argue for a reform of the disclosure regime so that firms are required to publish information which would affect consumers' decisions to engage in a relationship with a firm (similar to the rights of access afforded shareholders under the Listings Regime). This could include complaints information or regulatory breaches.

    —  A clear, tough fines tariff.

4.  PROGRESS IN RELATION TO THE FSA'S BETTER REGULATION ACTION PLAN

  4.1  One of the key issues exercising the business community, regulators and government is regulatory costs and benefits. Which? believes in a common sense approach to regulation. No one supports unnecessary regulation that adds no value. However, it is our view that these allegations of overregulation and unnecessary costs are overstated. Industry lobbies have been able to portray standard business costs as new or additional costs of regulation.

  4.2  Costs "attributed" to FSMA regulation arise from a number of sources and the existence of FSMA and FSA does involve real additional regulatory costs for firms. However, when cost sources are examined objectively, firms that were following good business practice, which would naturally include things like information disclosure, would still incur most of those costs regardless.

  4.3  The most objective way to measure regulatory impact is to identify costs over and above those costs which firms would incur anyway as part of operating in the market and providing a decent service to consumers.

Deloitte "Cost of Regulation" Report

  4.4  We believe that the Deloitte report into the cost of regulation reinforces much of our assessment. One of the main conclusions from the report was that "much of what regulation requires is, in fact, regarded by firms as good business practice".[7]

  4.5  The study concluded that incremental costs in the wholesale sectors covered were relatively low. In contrast, the incremental costs in the retail sector covered were higher. Deloitte explain this contrast by arguing that a more detailed regulatory regime was established in the retail market because of the clear evidence of significant market failure.

  4.6  Which? would dispute whether Deloitte's study supports the idea that there are significantly greater incremental costs in the retail sector. There is no question that there has been significant market failure in the retail pensions and investment sector. However, it does not necessarily follow that incremental costs are directly correlated with the level of detriment. Firms who were behaving fairly and transparently towards retail consumers should already be undertaking the same steps and performing the same checks and balances required by regulation.

  4.7  Regulation serves to codify what should be good business practice and acts as a proxy for effective market forces. In other words, consumer focused firms ought to be "self-regulating" their behaviour throughout the retail supply chain[8] so as not to exploit the advantage they have over retail consumers. If incremental costs are defined as costs over and above those associated with the normal course of business or good business practice, then a functioning consumer focused retail market would not be burdened with significant additional costs. It is possible that firms reporting higher incremental costs may have a more "reckless" attitude to conflicts of interest and risks throughout the retail supply chain.

Real Assurance Risk Management Study—"Estimation of FSA Admisistrative Burdens"

  4.8  The Real Assurance Risk Management study, conducted for the FSA, estimates that total costs of reporting to the FSA for the financial services sector are around £600 million a year (approximately 0.5% of industry costs). The study identified the top 20 rules which individually account for 1% or more of total administrative costs. [9]Looking at the top 20 rules, it is interesting that rules relating to money laundering are the single biggest component—over 40% of total estimated costs. It can be inferred from this that the so called burden associated with conduct of business rules is quite low.

5.  THE INITIAL EXPERIENCE OF FSA REGULATION OF THE GENERAL INSURANCE INDUSTRY

  5.1  In many respects, the FSA's General Insurance Conduct of Business (ICOB) regime has led to benefits for consumers, especially in terms of product disclosure and redress. However, we still have some concerns about the regime.

  5.2  Our key concern is that we don't believe that the same regulatory regime is appropriate for all general insurance products. The ICOB regime means consumers can be sold insurance products on a non-advised route, without the consumer knowing whether or not they have been advised until the end of a sale. This may be appropriate for lower-risk products such as home and contents cover, or car insurance, but higher risk products, especially the pure protection products such as Income Protection or Critical Illness, should have been given a higher standard of protection with stricter advice requirements unless the consumer specifically asks for a non-advised sale.

  5.3  In a Which? report, published in June 2004, we highlighted the problems that consumers faced when trying to purchase insurance to protect themselves in the eventuality that they could not work. This research explained that because of the complex and high-risk nature of these products regulation should not treat them in the same way as other general insurance products. The situation research into financial advice that Which? published in September 2006 clearly highlights that, even with the protections given under the new ICOB regime, the scope for consumer detriment that is being caused by inappropriate sales of protection products still exists. In our study, 76% of advisers visited for protection advice failed to advise researchers of the risks associated with income protection should their income fall. [10](Both these articles are provided as separate attachments.)

  5.4  As a result of the considerable scope for detriment surrounding protection products, we continue to argue that the FSA should treat protection products with a higher importance than other general insurance products.

September 2006



3   http://www.which.co.uk/press/press_topics/product_news/which_magazine/financial_advisers_571_94442.jsp Back

4   Which? "Protecting your income", March 2005. Back

5   Which?, "Time for a Change: Discussion Paper", Which? 2005. Back

6   Speech by Callum McCarthy, Chairman, FSA, Gleneagles Savings & Pensions Industry Leaders' Summit. Back

7   Deloitte, "The Cost of Regulation Study", p 1. Back

8   Much of the detriment which occurs in retail financial services we attribute to the conflicts of interest which can be identified along the supply/distribution chain. Back

9   See Table 1: Top Twenty Administrative Burdens, FSA Briefing note BN022/ 06, 28 June 2006. Back

10   http://www.which.co.uk/press/press_topics/product_news/which_magazine/financial_advisers_571_94442.jsp Back


 
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