Memorandum submitted by the Financial
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
helping retail customers get a fair
promoting efficient, orderly and
fair markets, both retail and wholesale; and
improving our business capability
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.
B. OUR APPROACH
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
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.
C. HELPING RETAIL
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;
risk-based regulation, through firm-specific
and thematic supervision and policy.
We highlight below particular aspects of our
retail markets work programme.
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
we received orders for 11 million
hard-copy publications; and
our Consumer Contact Centre handled
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 toolsthe Financial Healthcheck
and Debt Testboth 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
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
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.
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
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.
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.
43. We have continued to work closely with
the other Tripartite authoritiesthe Treasury and Bank of
Englandto 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 Exercisewhich
started on 13 Octoberto test the preparedness of the Tripartite
authorities and the financial services sector in this area. Many
participantsmajor firms and infrastructure providers, government
departments, health agencies, service providers, foreign regulators
and other expertsare 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
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.