Select Committee on Treasury Written Evidence

Memorandum submitted by the Financial Services Authority


  1.  This memorandum is submitted in advance of the FSA's appearance before the Committee on 24 October. We look forward to elaborating on it in oral evidence.

  2.  In our Annual Report for 2005-06, published in June, we reported on our work during the past year under three headings:

    —  helping retail customers get a fair deal;

    —  promoting efficient, orderly and fair markets, both retail and wholesale; and

    —  improving our business capability and effectiveness.

  3.  This memorandum summarises our approach to regulation and our work during the past year and highlights some recent developments, including on the topics signalled in the Committee's press notice of 12 September.


  4.  We want to promote effective working of markets to deliver benefits for firms and consumers. So we aim to work with the grain of the market. We introduce new rules, where we have discretion, only where this is justified by market failure and cost-benefit analysis. In practice this is where we judge that market forces will not rectify the problem, and where it is likely that the benefits of regulatory intervention will outweigh the costs. We look for opportunities to challenge the market to find its own solutions to market failure, using regulatory intervention only as a backstop. A recent successful example of this approach is our challenge to the market to establish contract certainty in the wholesale and commercial general insurance market, where it appears that the market is on track to find its own solution.

  5.  We operate a risk-based approach, which enables us to focus our resources and activities on the most significant risks to our objectives. Importantly, this approach accepts that some failure neither can nor should be avoided. Our approach is proportionate and is therefore more interventionist in retail than in wholesale markets.

  6.  We are also moving towards a more principles-based approach to regulation. This means fewer detailed rules and less regulatory prescription, and more flexibility and discretion for firms' senior management on how best to run their businesses in compliance with our regulatory requirements. This is illustrated by our new money laundering regime, which came into effect on 1 September. High-level provisions replaced the detailed rules in our Handbook, giving firms greater flexibility over how they identify and manage their money laundering risks. A further example is our Treating Customers Fairly work, where we are challenging firms' senior management to satisfy themselves and us that they are delivering the fair treatment of customers at different stages in the life cycle of a product.

  7.  We recognise the challenges this regulatory approach poses for our staff, in that it requires them to exercise greater judgement and to make decisions based on the outcomes the FSA is trying to achieve in financial markets, rather than focusing on monitoring compliance with detailed rules. We are now delivering a comprehensive training and development programme to equip them with the relevant knowledge, skills and behaviours.

  8.  In discharging our statutory responsibilities we are committed to striking the right balance between the costs of regulation and the benefits. In June, we published two reports on the costs to firms of complying with our requirements. Many of the rules which give rise to the greatest costs are being reviewed in work already under way. For example, we are combining the requirement to implement the Markets in Financial Instruments Directive (MiFID) with an exercise to simplify the rule book and make it more principles-based. We will consult on the new regime at the end of October.

  9.  We also recently published a report by Oxera on how to assess the benefits arising from the regulation of financial services. We are asking consultants to use Oxera's methodology to review the benefits of certain aspects of our retail conduct of business rules. We will report our findings in the second quarter of 2007.  Like other independent regulators and Government departments, in November we will publish our Simplification Plan outlining the progress we have made in cutting back unjustified regulations.

  10.  Looking forward, a significant number of areas are under review. By 2008 we will have reviewed activities which in total account for more than 80% of the administrative cost incurred by firms as a result of our rules. We will remove rules that are no longer effective or proportionate in correcting market failures and generally move towards a more principles-based rulebook. We will continue to introduce improvements to make it easier for firms and consumers to do business with us.


  11.  In helping retail consumers get a fair deal, we focus our efforts on what we consider to be the four main elements of an effective retail market, and develop our retail initiatives with these in mind:

    —  capable and confident consumers;

    —  clear, simple and understandable information from the industry and the FSA, available for, and used by, consumers;

    —  responsible firms who treat their customers fairly and are soundly managed and adequately capitalised; and

    —  risk-based regulation, through firm-specific and thematic supervision and policy.

  We highlight below particular aspects of our retail markets work programme.

Financial capability

  12.  We published the results of our Baseline Survey in March this year. As the Committee will recall from our earlier evidence, this survey was the largest of its kind in the world and enabled us to create a comprehensive picture of the extent to which people in the UK are able to: make ends meet; keep track of their finances; plan ahead; choose financial products; and stay informed about financial matters.

  13.  The headline results were:

    —  large numbers of people, from all sections of society, are failing to plan ahead for their retirement or for a rainy day;

    —  over-indebtedness is very severe for some and there are many more people who are currently just coping and so are vulnerable to an economic downturn or to a change in their personal circumstances;

    —  many people are taking financial risks without realising it because they struggle to choose products in a way that truly meets their needs; and

    —  the under 40s are, on average, less capable than their elders but carry much more personal responsibility than their parents' generation.

  14.  Building on the findings from the Survey, together with our partners we have launched a seven-point programme which aims to raise financial capability across the UK. The programme focuses on: improving financial capability among children in schools and young adults in further and higher education; providing employees with ready access to information in their place of work; helping new parents; and the provision of relevant, user-friendly and accessible tools and information, particuarly to help with planning ahead and with choosing products. We anticipate that these initiatives will reach more than 10 million people in the period to 2010-11.

  15.  The programme covers those who have limited involvement with the financial system, and so contributes directly to greater financial inclusion. An example of this is our work with young adults not in education, employment or training.

  16.  On money advice, we believe that the FSA can best add value by targeting further specific groups of consumers who are in priority need of relatively simple and straightforward advice (including the elderly, lone parents and those in social housing) and working through the existing intermediaries they know and trust. By leveraging existing networks and resources and building on the replicability and sustainability of the Innovation Fund projects, we are expanding the range of partners with whom we work to provide these groups with the help they need. This offers the prospect of reaching millions more consumers in our target groups. We are also discussing with other partners how the provision of money advice could be expanded further.

  17.  We welcome the announcement made by the Economic Secretary to the Treasury of a 10-year Government strategy on financial capability. We are working closely with the Treasury as that strategy is developed.

Information for consumers

  18.  Clear, simple and understandable information for consumers is crucial in helping them to make sound financial decisions. We approach the provision of information in two main ways: by making FSA information available direct to consumers; and by specifying the information which firms must give their customers at particular stages in the selling and advice process.

  19.  Our main direct channels of communication with consumers are our website, hard-copy booklets and factsheets and our Consumer Contact Centre. In the last financial year:

    —  our consumer website received two million visits;

    —  we received orders for 11 million hard-copy publications; and

    —  our Consumer Contact Centre handled 230,000 inquiries.

  20.  Earlier this year we ran three promotional campaigns: MortgagesLaidBare; Pensions Made Clear; and MoneyLaidBare. They generated over 600,000 visits to our campaign websites and extensive media coverage. Further campaigns will be undertaken in 2007 to promote the availability of our resources to consumers. We have also developed two on-line tools—the Financial Healthcheck and Debt Test—both aimed at helping consumers to understand their financial position and to take action. We worked with a range of organisations to make this available to consumers, including the BBC, The Pensions Service, Directgov, Citizens Advice and the Royal Bank of Scotland. Over 1.3 million consumers have now taken the Financial Healthcheck or the Debt Test.

  21.  We know that there is more we can do to make our information appealing, engaging, and appropriate for our audience. A new consumer website will go live before the end of the year and our booklets and factsheets will be revised by the end of the second quarter of 2007.

  22.  In addition, we have carried out a review of the information provided to consumers at the point of sale for investment products. We propose a radical simplification of our rules, which aims to provide greater flexibility for firms, reduce the amount of material provided to consumers and improve the content and prominence of key information.

  23.  In particular, we have considered a proposal to replace the current "Key Features Document" with a "Quick Guide" (a two page document setting out the answers to 10 key questions that consumers want, or need, to know at the point of sale). However, our research suggests that implementing the Quick Guide would involve significant costs for firms, yet very similar results in consumer understanding and behaviour can be achieved through good practice under the current regime. Recent testing has also shown that standards have generally risen since the review started, with many firms embracing similar concepts to those used in the Quick Guide, such as the use of simple layout, clear headings, a Q&A format and improved standout. We have therefore decided that the most proportionate action is to focus our efforts on making further improvements under the current regime. To support this we are developing a package of measures to promote good practice and reduce poor practice. We will consult on our proposals later in October as part of our plans to simplify our Conduct of Business regime.

The fair treatment of customers

  24.  The aim of our Treating Customers Fairly initiative is to achieve fairer outcomes for consumers. This continues to be a priority for us. As we indicated in our paper of July 2006, "TCF: towards fairer outcomes for consumers", we have conducted further work to assess firms' progress in implementing TCF and in developing TCF Management Information. This work also focused on the TCF aspects of the quality of investment advice.

  25.  We identified and reported on some TCF issues of specific relevance to the mortgage and general insurance sectors. These issues are applicable more generally. For example in both sectors we have suggested that firms need to focus their efforts on treating customers fairly when designing new products and ensuring that literature provided to consumers is clear and understandable. In the mortgage sector we have also encouraged the industry to design remuneration strategies for mortgage advisers which reflect the TCF principle. In the general insurance sector we have encouraged firms to make progress in the production and use of management information to support the implementation of TCF.

  26.  We recently published a Discussion Paper (28/09) on the responsibilities of product providers and distributors for the fair treatment of customers. We encourage providers to design their products with greater care, to provide higher quality information, to monitor distribution channels more effectively, and to undertake better post-sale analysis of the performance of products. We also encourage distributors to scrutinise more closely information they receive from product providers to ensure that specific products are suitable for particular consumers.

  27.  We have built TCF into our training for our supervisors and have developed training for firms to enable them to improve and implement their TCF strategies. We work closely with the industry to encourage them to embed TCF in their business cultures and we have indicated that we hold senior management responsible for achieving this. During the year we have also worked with small firms to help them identify and tackle any gaps in their ability to treat their customers fairly, which has included launching a self-assessment tool.

  28.  Although much remains to be done, we have seen firms make progress. We have set a deadline of the end of March 2007 for firms to reach the implementation stage of their TCF work in a substantial part of their business, and we will measure the progress of firms against the six high-level outcomes for consumers which we have identified in this area.

Retail Distribution Review

  29.  Many of the issues we are addressing in the retail market are symptoms of more fundamental problems in the distribution of retail financial products. For this reason, we have announced a review of retail distribution.

  30.  In his speech at the Gleneagles Summit, Callum McCarthy set out some early thoughts on the areas for reform in the distribution of retail investment products, to be addressed by this review. These relate to the current business model, incentives including commission structures, professionalism of those distributing products and customer access to financial products. It is clear to us that there is appetite in the industry for major reform and we will work with the industry to help it find solutions. We also know that there are some areas where our existing rules and regulatory approach may need to change if we are to improve the efficiency of this market and deliver better outcomes for consumers.

  31.  In early November we will announce the scope and priorities of this review. In the second quarter of 2007 we plan to publish a Discussion Paper which will recommend solutions, whether regulatory or market-led.

Our risk-based approach to the retail market

  32.  We identify risks by monitoring information from a number of sources, including data from the market and our discussions with firms.

Mortgage and general insurance regulation

  33.  Over the past year we have used thematic work to review a number of issues, in particular how firms have met the requirements of our mortgage and general insurance regimes. Specific examples include our review of disclosure documentation, financial promotions and controls over appointed representatives in both regimes. Where we identified concerns, we have worked with the industry to improve standards.

  34.  Last November, we concluded a market review which found poor selling practices and a lack of proper compliance controls in firms selling Payment Protection Insurance (PPI). We found firms selling policies to customers who were not eligible to claim on them, as well as evidence of firms not explaining either the price or the main exclusions and limitations of the policy. In cases where we identified serious concerns we took action with the relevant firms and informed firms more generally about our findings. We are also engaging with trade associations to address these concerns and are working closely with the Office of Fair Trading on its study of competition in the PPI market. We will publish shortly the outcome of further work we have undertaken to assess to what extent practices have improved.

  35.  We are currently reviewing our general insurance conduct of business rules and plan to report on our findings in the first quarter of 2007.  In June this year, following feedback from the industry, we announced that we were widening the scope of this review to actively look for deregulation opportunities. We are considering the feasibility of a differentiated regime with a lighter touch for simple GI products, where there is little or no evidence of consumer detriment (eg motor and household insurance), compared to personal products (eg critical illness and payment protection insurance) where there is more scope for consumer detriment. To inform our thinking we have commissioned three pieces of consumer research to establish what use consumers make of point of sale disclosure documents. We will work closely with consumer bodies as well as the industry. We intend to consult on any rule changes that arise from the review in the second quarter of 2007, and make rule changes in the fourth quarter of 2007.

Pensions reform

  36.  In the light of the Pension Commission's second report in November last year, and the Government's White Paper in May, we have been working with the Government and The Pensions Regulator to assess the potential regulatory implications of the options for a national pension scheme. As we said to the Committee in May, the nature of the regulatory regime will depend on the Government's decisions on the design of the model. We have outlined some of the regulatory implications of the different design options in our response to the White Paper (which we published). Our main message remains that the simpler the design of Personal Accounts and the simpler the choices consumers have to make, the fewer the risks to consumer protection, consumer understanding and market confidence.


  37.  We aim to promote efficient, orderly and fair markets, and to ensure that UK markets are internationally attractive and sustainable. The UK is the most international capital market centre in the world; FSA-authorised firms account for over three-quarters of the hedge fund assets managed by European-based firms, the London market is the largest for internationally traded insurance and reinsurance, and the UK banking industry has the third largest volume of assets and deposits in the world and the largest in Europe.

  38.  Our approach to regulation is driven by the need to achieve our statutory objectives in a way which is proportionate and consistent with innovation and competition in the financial sector. This approach is an important and positive contributor the UK's position as a leading global financial centre. A Corporation of London survey of the City, published in November 2005, found that London and New York have moved further ahead of Europe as the only genuine international financial centres, and London is marginally ahead of New York. The survey identified the quality of the UK's regulatory environment as one of the main factors which makes London so competitive. 25% of respondents to a London Stock Exchange survey of December 2005 said the UK's standard of regulation and corporate governance were the most important factors in the decision to float on the Exchange's markets.


  39.  As we have explained to the Committee on other occasions, a significant proportion of our policy formulation is driven by initiatives originating in the European Union. We are bound to implement European legislation and the FSA and HMT (as the principal UK negotiator) aim to exert maximum influence at the development stage. In implementing EU legislation through our rules, our approach is not to impose obligations beyond what is required by directives unless this is necessary to achieve our statutory objectives and can be justified by cost-benefit analysis.

  40.  Now we are nearing the end of the process of implementing the Capital Requirements Directive, the most significant measure on which we are currently working is the Markets in Financial Instruments Directive (MiFID), due to be implemented by November 2007.  This will have a major impact on a wide range of firms in the UK. We have been working closely with the industry to develop a proportionate approach to implementation. As mentioned above, we will consult shortly on our proposals for a fundamental reform of our conduct of business rules, which will include the relevant MiFID changes. We also plan to publish separately our assessment of the overall costs and benefits of this Directive. Looking further ahead, the most significant Directive on the horizon is Solvency II, designed to establish a risk-based capital regime for insurance companies across the EU. We are closely involved in preparatory work for the Directive, in particular through our membership of CEIOPS (the Committee of European Insurance and Occupational Pensions Supervisors), on which John Tiner represents the FSA.

  41.  The FSA devotes considerable senior management and other resources to the work of the "Lamfalussy" committees (the Committee of European Securities Regulators, CEIOPS and the Committee of European Banking Supervisors). These committees play a key role in advising on the substance of European financial services regulation and in promoting supervisory convergence.

Exchange consolidation

  42.  The future ownership of the London Stock Exchange has been an important question over the past year, as has been the potential combination of Euronext, LIFFE and the New York Stock Exchange. We have been keen to ensure that the market and the exchanges' stakeholders are fully aware of the longer-term implications of a takeover, including where regulation of the exchanges' markets would take place. As long as the London Stock Exchange and LIFFE remain UK exchanges we will continue to seek to ensure that they meet our regulatory requirements. We remain neutral about the nationality of any future owner. We support the Government's proposal to enable the FSA to veto disproportionate rule changes proposed by recognised bodies.

Financial stability

  43.  We have continued to work closely with the other Tripartite authorities—the Treasury and Bank of England—to enhance the ability of the financial services sector to respond to financial crises and major disruptions and to uncover issues needing attention. Currently, to improve the capacity of the sector to cope effectively with a pandemic flu outbreak, we are leading a six-week Market-Wide Exercise—which started on 13 October—to test the preparedness of the Tripartite authorities and the financial services sector in this area. Many participants—major firms and infrastructure providers, government departments, health agencies, service providers, foreign regulators and other experts—are working with us on the design and delivery of the exercise. We will publish a summary report on the key lessons learned within a few weeks of the end of the exercise. We will follow this up with a series of workshops and seminars in the new year to reinforce the messages and promulgate them more widely.


  44.  By early 2007 we will have set out our future plans, and our view of the main challenges facing us, in our Financial Risk Outlook, International Regulatory Outlook and Business Plan. We will provide the Committee with copies.

October 2006

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