Financial Regulation

Written evidence submitted by Consumer Focus

Executive summary

Consumer Focus is the statutory organisation campaigning for a fair deal for consumers in England, Wales, Scotland, and, for postal services, Northern Ireland. We are the voice of the consumer and work to secure a fair deal on their behalf.

Consumer Focus has been active in the debate on regulation, developing sector-specific expertise on regulatory structures, cultures and methods and applying these in our work across the economy. We welcome the opportunity to contribute to the Treasury Select Committee’s inquiry.

Our assessment is that the proposed changes to financial regulation do not place the consumer at the heart of the new structures. Unless there is a significant change of approach, this will be a missed opportunity to remedy the lack of focus on consumers, which has long been a problem in this sector and its regulatory arrangements.

Effective regulation of financial services must include the following elements:

· The primary objective of the new CPMA must be to protect and promote the interests of consumers and the PRA must also have regard to consumer interests

· Regulators should ensure that industry becomes greatly more transparent and accountable with its customers and use reputational regulation as a tool for driving changes in the market

· The CPMA must tackle unsafe and unfair practices or profit structures before they become widespread and entrenched

· Responsibilities between the different bodies must be clearly defined and the government should periodically issue a strategic statement setting out what it expects regulators to deliver

· The engagement strategy should enable both consumer bodies and consumers themselves to influence the agenda and priorities of the new CPMA.

1 Introduction

1.1 Last year we published an analysis of six key regulators, including the Financial Services Authority, in our report Rating Regulators1. Our response to the Committee draws on this analysis and we use the indicators from the report throughout. Our assessment framework consisted of twenty indicators which together form the essential building blocks of a consumer focused regulator. These are:

1.2 Legal framework

– statutory objectives and duties enable the regulator to adequately promote the interests of all consumers

– responsibilities between different actors are clearly defined, without gaps or overlaps

– structures are sensitive to devolved contexts

– the right tools for the job

1.3 Culture and accountability

– translates statutory objectives into consumer-focused priorities and values

– embeds a consumer focus across all levels of the organisation

– transparent about its activities

– accessible to the general public, including disabled users

– works effectively in a devolved setting

1.4 State of readiness

– identifies likely sources of consumer detriment, both now and in the future, which shapes work priorities

– uses effective mechanisms to understand the consumer perspective and translate this insight into sound decisions

– works effectively with others, including with consumer organisations

– influences the wider regulatory agenda

1.5 State of action

– empowers consumers to help achieve regulatory outcomes

– has effective incentives to encourage compliance with its rules

– chooses the appropriate regulatory approach in the circumstances, and intervenes in a timely fashion when needed

– gives priority to, and intervenes effectively on behalf of, consumers who are vulnerable

– uses enforcement tools when appropriate to protect consumers

1.6 Impact and learning

– defines and measures its impact on consumers in terms of outcomes

– evaluates its work and embeds learning

2. Overall

2.1 What costs will the regulatory structure place on consumers?

2.1.1 Lack of competition has meant little competitive pressure on pricing and consistent profit margins. Consumers have faced a squeeze through negligible returns on savings and limited and expensive lending facilities while many financial institutions have had the advantage of state support and cheap access to money through quantitative easing. At the same time, regulation has placed burdens on consumers, often with little obvious impact on industry actions. Where regulation is needed to provide protection from banks’ irresponsible or inappropriate behaviour, we would expect the cost of this to be absorbed by the banks rather than passed on to consumers. Until such a time as markets are competitive and provide value for consumers, we would expect monitoring of issues such as margins and charges, with powers to intervene available and used where necessary to correct market failure.

3. Power, roles and responsibilities

3.1 Do the Government’s proposals appropriately assign roles and responsibilities between the different regulatory institutions?

– Statutory objectives and duties to enable the regulator to adequately promote the interests of all consumers and a consumer focus embedded across all levels

3.1.1 The House of Commons Regulatory Reform Committee has recommended that the Better Regulation agenda post financial crisis needs ‘a greater diversity of input, including more accountability to citizens and end users’.1 All three bodies need clear public interest and consumer representation at Board level, and all need to be clear that they are regulating in the consumer and citizen interest.

– Responsibilities between different actors need to be clearly defined

3.1.2 There are a number of areas where there are overlaps of powers, roles and responsibilities (such as in relation to supervision of firms where PRA and CPMA or the Bank of England and CPMA have an interest). It is not clear how these will be resolved and which organisation’s objectives will apply. In others, there is a separation in relation to similar responsibilities which could compound current problems with consistency and co-ordination (such as the proposal for a split of licensing and prudential responsibility between PRA and CPMA, in addition to the existing separate system for credit licensing). And there is the blurring of the intended split between prudential and conduct responsibilities, with the COMA continuing to be the prudential regulator in those areas not covered by the PRA.

3.1.3 The overall system implies precedence, with the FPC and PRA having the stronger hand. The CPMA must have regard to the FPC and PRA objectives and is required to consult with the other bodies in relation to impacts on these but the obligation is more limited the other way. While we welcome the focused attention on consumer protection issues we are concerned that the separation of the area will see consumers sidelined.

3.1.4 Our experience across different sectors is that the high-level objectives of government are rarely fully articulated, even in statutes, with the result that decisions can too often be made on the basis of inter-organisational politics and individual regulators' preferences and cultures. This can create confusion, overlap and two significant gaps: a strategy gap and an accountability gap. These are dangerous enough when there is only one regulator, but their likelihood and impact are heightened in markets where there are two or more regulatory bodies, as will be the case in financial services.

3.1.5 We therefore propose that government periodically issues a strategic statement, setting out what it expects the regulators to deliver and what the government's own role will be. Implementation is then a matter for the regulators, working within the strategic framework set by government. This allows for clear accountability to the elected government, while making the most of the specialist skills and expertise within the regulator2.

3.2 Will there be unintended consequences of the Government’s proposals for regulation on the prospects for non–bank financial institutions?

3.2.1 Lack of competition in the market means the monetary financial institutions have an advantage over specialist institutions and that those institutions may be driven to more marginal business.

3.2.2 Increasing capital requirements may impact on institutions that are considered risky but may also provide greater barriers to others who are genuinely offering different models. These requirements should better reflect and differentiate on risk (and rate favourably other factors such as sustainability and financial inclusion). We also seek the application of guarantees and assurances to non-banks, with contributions also determined according to risk based on an assessment of trading activities.

4. The Prudential Regulation Authority (PRA)

4.1 Should the PRA be the lead authority over the Consumer Protection and Markets Authority (CPMA)?

4.1.1 The PRA must have regard to consumer interests. There should be no implicit hierarchy in how the regulatory structure operates. The CPMA must have sufficient tools, independence and powers to carry out its consumer protection functions, and in this respect they should be at least equivalent to those of the PRA.

4.1.2 Financial stability is fundamental to consumers in terms of the provision of low risk sustainable products and services that are both essential to their engagement with society and the economy and fundamental to the long term recovery and restoration of confidence. In many cases consumer and financial stability interests will coincide. When they don’t the matter becomes a public policy issue and should be referred to the Government of the day. For example, where a firm’s survival or the survival of the prevailing business model of firms may be impacted by consumer protection measures or risk measures, should it really be consumers or citizens that suffer?

5. Is it appropriate for the PRA (and CPMA) to adopt a judgements - based approach to financial regulation and supervision?

– Right tools, right people for the job, and a willingness to use them

5.1 It is important that a regulator is not only appropriately equipped but also ready to act. The FSA was characterised for a number of years by the mantra ‘we are not an enforcement-led regulator’, where supervision staff were reluctant to refer firms to enforcement lest it reflect negatively on them.1 While this has recently changed and enforcement actions and monetary penalties have significantly increased, powers in relation to mass harm and widespread practices remain largely unused, as do tools such as transparency that could empower consumers2. The post-crisis period saw a focus on prudential issues with consumer protection coming into focus much later almost as an afterthought.

5.2 The recession has seen significant adverse impacts on a market which was already not working optimally for consumers. Increased consolidation, barriers to new entrants, restricted availability of credit products, and issues around financial difficulties require a more pro-active response from the regulator both on a prudential and consumer level. The stated new approach to Retail Conduct of Business holds out the promise of intervention on price and products, recognising and responding to ‘some of the unique characteristics of retail financial services that call for a more intrusive approach’3 The new approach will require a culture change from the regulator and new skills and ways of thinking. The new regulator should not be the same body with a new set of clothes.

– Chooses the appropriate regulatory approach in the circumstances and identifies likely sources of consumer detriment

5.3 Changes to the regulatory approach are needed to:

– detect systemic risk issues before they become entrenched

– enable early intervention in relation to unfair practices such as the mis-selling and unfair terms and conditions associated with PPI

– investigate models that are unfair, hamper choice and obstruct good personal financial management, such as the hidden charges model in the provision of current accounts

– consider areas where uncertainty and lack of control over payments negates financial capability

If this is not done then the consumer protection role is brought into conflict with the financial stability objective. Unsafe and unfair practices or profit structures need to be tackled before they become the foundation of a firm’s or industry’s business model, and not after, when the damage is done and the challenge could potentially damage the soundness of firms or the sector.

6. The Consumer Protection and Markets Authority (CPMA)

6.1 Do the reforms provide adequate protection for the consumer?

– Statutory objectives and duties enable the regulator to adequately promote the interests of all consumers and the regulator gives priority to and intervenes on behalf of vulnerable consumers

6.1.1 The regulator should have clear statutory objectives primarily focused on the consumer interest.1 The FSA currently has five objectives that are not weighted. The discretion as to which has priority is left to the regulator. Objectives should be clear and unambiguous and where there is more than one they should be prioritised so that there is sufficient guidance to, and accountability of, the regulator.

6.1.2 We propose the CPMA’s primary objective should be protecting and promoting the interests of consumers.

6.1.3 To support this objective the regulator should have regard to broader public interest considerations that align with the consumer interest such as

– promoting financial inclusion, and in particular the interests of vulnerable and disadvantaged consumers, by encouraging access to suitable and affordable products and services

– Acting to maintain and develop essential service provision

– Driving and facilitating innovation that promotes choice and fosters good personal financial management

– promoting an economically, environmentally and socially sustainable market and services

· Chooses the appropriate regulatory approach and has effective incentives to encourage compliance with its rules

6.1.5 The ambition of regulation must be to change the culture and norms of industry so that businesses start to act in the spirit of the governing rules rather than seeking to merely meet the letter of those rules and test the boundaries of what they can get away with. It is important that high level principles such as Treating Customers Fairly (TCF) actually deliver outcomes. More guidance in this area may be necessary, with some clear incentives or disincentives applied to encourage behavioural change. Similarly a ‘wider implications’ power must be operable, effective and utilised to deal with the significant economic and social consequences of detrimental practices.

6.1.6 Issues such as PPI showed that the regulator was slow in acting and the industry was slow to respond to the regulator’s warnings, allowing the harm to continue. Enhancing the own initiative variation of permission (OIVOP) powers to enable supervision to feed into regular review of authorisation of firms and to maintain standards will be significant in the CPMA’s ability to provide effective consumer protection and to promote a sustainable market that better serves the public interest.

6.1.7 The PRA and CPMA framework needs to outline clearly how they will be able to deliver outcomes where the FSA has been unable to do so.

– Uses mechanisms to understand the consumer perspective and translate this into sound decisions

6.1.8 Our perception is that under the previous model the regulator and the industry framed issues in the same way and there was a distinct absence of the perspective and experiences of the public, both consumers and citizens. One way of improving this area is to increase investment in consumer research and to include qualitative and deliberative as well as quantitative research, along the lines of Ofcom’s Consumer Experience Report and Citizen Juries. Another is to ensure the staff and board have relevant expertise.

6.1.9 The new regulator has to reinvent itself and look at how it communicates and interacts with the broader community. It needs a diversity of staff from different backgrounds who are more attuned to the varied interests of consumers.

– Works effectively with others, including consumer organisations

6.1.10 The regulator needs to adopt best practice in engaging with consumers and consumer bodies. The Financial Services Consumer Panel is seen as one of the FSA’s strengths and it is important that thought is given to how it can most effectively function in the new structure. The new regulator also needs to engage more widely with other representative organisations particularly those working in the areas of financial inclusion.

6.1.11 A regulator needs to consult widely and decide openly on the basis of its consultation and information gathering. Consultations need to be clear and in plain English and mechanisms for getting input should consider outreach rather than only relying on written responses. Responses to public consultation should be published1, as well as any other information or evidence taken into account in decision making. It is sometimes difficult to see the weight of evidence behind decisions and there is the perception that decision making is very much behind closed doors.

– Defines and measures its impact on consumers in terms of outcomes

6.1.12 Outcomes should be related to on the ground benefits to consumers. For example, supervision of the TCF principles monitored whether firms had policies in place in relation to customer services, such as dealing with customers in financial difficulty, but made no assessment of whether these were applied in practice. While the programme was stated by firms to have some impact on greater consumer consideration in product design and markets it has not influenced complexity and pricing structure.

6.1.13 Apart from sparsely used enforcement action there appear to be no disincentives for inadequate compliance with the TCF principles, there was limited feedback, and no incentives or accolades for those who did comply. This must change in the new structure.

– Evaluates its work and embeds its learning

6.1.14 More could be done by the regulator to evaluate the work and embed learning. This includes defining outcomes to be achieved and monitoring them through consumer research. Complaints information and the firm’s reports to the regulator are also (or could be) rich sources of information from which to identify problem areas and firm’s performance against these. The complaints information currently available needs to be monitored and analysed to inform further actions.

6.1.15 The outcomes performance report currently produced by the FSA provides a good basis but needs more work in terms of how outcomes are measured. Once defined, we welcome reviews of these impact measures by the National Audit Office.

6.2 Transparent about its activities

6.2.1 The FSA has been a reluctant reputational regulator. It does not reveal details of investigations until concluded, nor does it provide information about the firms that are not satisfactorily complying with requirements.1 The regulator should be open in its investigations and regulatory activity and therefore accountable. Positive steps have been made recently with the requirement on banks to publish complaints data but more and better information is needed so that consumers can make real choices and businesses are more motivated to treat their customers fairly. Reputational regulation may, in itself, help develop a trusted brand approach in the industry.

6.2.2 A culture of publishing and analysing complaints and enforcement actions to identify emerging risk and as a window on the industry is vital. It will also promote understanding of the role of the regulator. Performance measures are currently published by the Food Standards Agency in their scores on doors initiative and also by Ofgem as part of their quality of service reporting. These empower consumers to make informed choices about service provision.

6.2.3 We are supportive of the view that the CPMA ‘names and shames firms which break the rules. This will act as an incentive for firms to improve their behaviour.’2

6.3 Accessible to and engaging with the general public

6.3.1 Engagement needs to provide real opportunities for consumers to contribute to the work on the CPMA. Its engagement strategy should provide:

· Opportunities to engage in the CPMA’s corporate planning processes to allow consumers to help shape the priorities of the Authority

· A "consumer radar" of emerging issues and areas of detriment

· The ability to work both with representative bodies and directly with consumers themselves

6.3.2 In order to be accountable to the public the regulator needs to be accessible to the public and provide information in a timely and comprehensible way for a range of audiences, not just for the industry.

7. To what extent will the regulatory and administrative burden increase for those firms who now have to deal with two regulators?

7.1 We do not support unnecessary regulation, as this is not in the consumer interest. However in the financial services it is not helpful to talk about regulation as a ‘burden’, given that the case for intervention here is to correct substantial market failure, provide safeguards against any repetition of past industry irresponsibility and remedy a significant imbalance of power between industry and consumer.

7.2 In assessing this issue, the full cost-benefit analysis needs to be taken into account. Cost benefit analysis to date has often looked purely at whether there are measurable benefits to consumers and then quantified the costs to industry. Qualitative and quantitative measures are extremely hard to balance. Disincentives to unfair behaviour and the subsequent cost savings in supervision and enforcement this might entail are seldom considered, nor the relative cost burden in terms of a proportion of firms’ profits.

7.3 Effective regulation will promote a better market place with more efficient product and service provision. Reduced risk taking may impose restrictions on current activities but will shift the industry itself to develop better operating models. The current system rewards inefficiency and entrenches advantage.1 It is those models not responsive to change and geared to serving their own purposes, rather than the stability of the market and the interests of consumers, who will be impacted most with a movement towards a more sustainable regulatory model. New entrants and those who are more flexible and better able to innovate will be in a better position to serve the market.

22 September 2010