Memorandum submitted by Andrew Tyrtania
SUMMARY
— Avoid rules—stick to principles.
— Concentrate on competence.
— Competence must extend from those who
advise clients, to those in administration and ultimately and
most importantly to those in control of the firms.
— Competence must also be applied to those
in regulation.
— Regulators must monitor, communicate
with and advise firms.
I would like the committee to bear in mind the
following when considering any proposed amendments to financial
services regulations:
1. RULES OR
PRINCIPLES
1.1. The financial services market is by
nature dynamic and inventive. London and to a certain degree therefore,
the UK, relies on its dynamic nature to attract financial services
firms. This same characteristic however, makes it extremely difficult
to regulate by means of a system of written rules and regulations.
1.2. The principles-based approach is therefore,
likely to be most effective in controlling and restraining risks
in the sector, as principles do not need constant revision. To
be effective, a principles-based system requires competent individuals
within firms and within the regulator. I believe the current FSA
training & competence rules to be lacking in ensuring that
this is the case within firms. I also believe the current crisis
to be the first real test of principles-based regulation and a
wake-up call to the senior management of financial services firms
that they have not properly understood and acted on their obligations
under the Principles.
1.3. In some areas, rules are entirely appropriate.
But they will only be effective where they are recognised, understood
and enforced. The more rules we have, the less likely they are
to be recognised. The more complex the drafting of the rules and
the larger the rulebook becomes, the less likely they are to be
understood. Where rules exist the regulator must be capable of
interpreting rules, understanding the firms they apply to and
of giving appropriate guidance to those firms.
1.4. I recently heard Vince Cable speaking
at a debate organised by the Securities and Investment Institute,
at which he called for "more rules". As one of the examples
he gave to support his argument he cited the ludicrous multiples
of income that mortgage lenders have been offering in the recent
past.
1.5. Since the regulation of mortgage sales
by the FSA in the UK there has been and remains a requirement
(a rule) for the adviser to consider, and evidence, affordability.If
this rule had been adhered to, no unsuitable mortgage offers would
have been made in the UK. It doesn't matter what multiple of income
is offered, or even whether the applicant is "self-certifying"
their earnings. It's either affordable, or it isn't. Having the
rule alone doesn't make the system work.
1.6. The existing FSA Handbook is enormous,
complex, impenetrable and ambiguous.
1.7. I believe the Committee should encourage
FSA to maintain the principles-based approach. Work should commence
on a new rule book, structured in-line with the activities that
firms must seek permission to carry out, rather than the "type
of firm" approach that we have ended up with at present.
1.8. As firms develop and adapt, they change
type, they adopt or develop new products and their risk profile
changes.
1.9. There are so many rules that each firm
must adhere to that the individual compliance officers rarely
understand which rules apply to their firm, or to which individuals
within their firm. As a consequence, employees are presented with
huge and complex in-house compliance manuals—which they
never read.
1.10. In creating a new principles-based
and activity focussed set of rules, the new handbook must be simple,
concise and precise.
1.11. Principles can be applied to any situation,
but they require intelligent application. Intelligent application
should be cited as best practice and set as a benchmark for others
to aspire to or exceed.
2. ADOPTING A
COMPETENCE-BASED
APPROACH
2.1. The present FSA Training & Competence
regime focuses almost exclusively on those individuals advising
Retail clients. Examination standards are set and must be attained.
Competence must be regularly monitored and assessed.
2.2. Unlike threshold examinations, there
is however, little guidance provided to firms on what makes an
effective competence monitoring system. Some firms do it well—others
poorly. So standards of competence vary. Some people may be technically
competent, some may be consummate salesmen. Guess which become
whistle-blowers and which get listened to.
2.3. Retail products tend to be less complex
than those available between professionals, yet those who advise
professionals, or those buying investments on behalf of professionals
are subject to less or even no competence requirements.
2.4. As we go on up towards the ultimate
management of a firm—they move further away from clients
and further away from competence requirements. Is it any wonder
we get directors who don't understand how their firms have got
into difficulties, when below them are managers who don't understand
what the whizz-kids in the front office are really doing.
2.5. Talking to the senior management about
the risks in their firms we have a Regulator staffed by a body
of largely lawyers and accountants, rather than experienced financial
services practitioners.
2.6. The committee should encourage FSA
to adopt a competence-based system of management controls, and
to extend that system to all employees of the firm. The regulator
itself should adopt those same principles, develop best practice
and disseminate that throughout firms.
2.7. There are competence models that can
be followed and they can be applied to anybody, at any level within
any firm. They could even be applied to health service professionals
or possibly even to those charged with child-protection issues!
3. THE ROLE
OF THE
REGULATOR
3.1. As mentioned previously, the current
crisis is a wake-up call to the senior management of financial
services firms within the UK. Enforcement action may be necessary,
but a witch hunt will be of little value.
3.2. The regulator asks firms to adopt "open
and honest dialogue" with its regulator. Unfortunately the
obligation is not mutual. When firms seek guidance on the interpretation
or application of rules they are too often told "I'm sorry,
that's for you to determine". As one grows old, hopefully
one also matures. A mature approach when faced with a question
you cannot answer is to admit that you do not know the answer.
But the obligation doesn't end there.
3.3. Regulatory staff must be prepared,
trained for and empowered to jump to the aid of firms asking for
help. They should visit and work alongside firms to develop a
mutual understanding of their business, the risks within it and
to formulate systems and practices that the firm can adopt to
meet the Principles and control their risks.
3.4. The incentives are mutual. If firms
are better controlled, crises like the present one are less likely
and businesses with better risk controls become less risky businesses
and therefore attain a higher market value.
IN CONCLUSION
Senior management often fail to understand how
to control the risks within their businesses. They see rules as
barriers and that culture trickles downwards from the top. Compliance
is still too often viewed as a necessary evil and unwarranted
expense.
So compliance officers, many highly skilled
and competent, sit between a workforce burdened with too many
rules and a management that views them as an unwanted overhead.
The FSA should use the current ARROW system
to engage with management at all levels within firms. They should
champion the empowerment of their own staff to help firms seek
solutions to the industry's common problems.
We do not need a radical solution or thousands
of new rules, we just need the methodical application of common
sense. If you do not understand something—don't sign it
off!
My background and interest in the issues are as
follows:
I have been a practitioner in UK financial services
since 1989, having operated under all of the regulators since
the 1985 Financial Services Act, namely LAUTRO, FIMBRA, SFA,
IMRO and FSA. I am poacher turned gamekeeper, now working as a
compliance consultant to the asset management industry.
Early on in my career I was exposed to the pre-regulation
hangover of poor sales practices in the provision of retail financial
advice and found these objectionable. This included being guided
by the firm I first entered the industry with, to transfer a senior
accountant away from his firm's employer pension scheme to a personal
pension plan.
I therefore, migrated to firms operating at
a higher level of professional standards and acquired relevant
industry qualifications along the way.
I moved from personal financial advice into
investment management, acting as both a private client discretionary
investment manager and as fund manager for collective funds (broker
funds and unit trusts).
Prior to the problems in the split capital investment
trust sector in the UK, I worked for a large regional stockbroker
that was one of the top three players in split-capital investment
trusts. One of my last activities within the firm was to edit
and produce "The Investor Guide to Investment Trusts",
a title taken over from S.G. Warburg. Within the firm my investment
analyst, our investment director and myself had developed a system
of analysing the shares of the split-capital trusts that properly
illustrated their risks and potential returns and allowed us to
provide predictable returns and to avoid the high-risk shares.
We were invited to join the "magic circle" that existed
within the industry, so that we would get the shares we wanted
for our clients as long as we also took the shares that the issuers
wanted to sell to us. We declined. No-one from that firm was ever
called to assist the FSA with its investigations.
At my previous employer I designed and implemented
a risk-based system for controlling the investments entered into
by portfolio managers on behalf of clients. It is not rules based,
it does not limit risk by using numbers, it relies on assessing
the competence of the portfolio manager to understand his client's
needs, objectives and tolerance of risk, and to understand and
properly utilise the investment he is considering. It allows for
creativity and changing products. To date—it works.
I have met and worked alongside investment managers
and financial advisers both good and bad. Very few have been inherently
bad people, but some have been ill-informed, uninformed or misguided.
I recognise that you do not create a low-risk
product by combining together many hundreds of high-risk mortgages.
The best simile I can muster is that it's like trying to increase
your chances of winning the National Lottery by buying lots of
tickets, all with the same numbers.
February 2009
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