Financial Conduct Authority - Treasury Contents

6  New powers

New Powers over conduct regulation

138. In the preface to the draft Bill the Government states:

    At the heart of the Government's proposals will be a more proactive approach to conduct regulation, with a clear focus on consumer outcomes. The Government welcomes the significant progress recently made by the FSA towards a more pre-emptive and intrusive model of conduct regulation, and looks forward to the publication of the FSA's launch document for the FCA in June.[161]

139. The Bill goes on to set out specific powers in relation to: product intervention, financial promotions powers and the early publication of disciplinary action (early warning notices). We consider these in more detail below.

Product intervention

140. It is proposed that the FCA have power "in product intervention [and] to direct firms to withdraw or amend mis-leading financial promotions with immediate effect".[162] The FSA has said that the product intervention and financial promotion powers are intended to "enable the FCA to act, and be seen to act, more swiftly to prevent retail consumer detriment".[163]

141. We have received mixed evidence on this proposal. Some industry representatives told us that for the FCA to take a more interventionist approach was not appropriate. For example, the Confederation of British Industry believed that such an approach would result in reduced innovation, although they did concede that:

    There might in theory be circumstances in which product regulation could be effective if used selectively, but they would be extremely limited. [...]

    Product regulation powers otherwise have the potential to reduce the availability and variety of products for consumers as firms become less likely to invest in developing innovative products or believe they will be penalised or restricted from developing products which do not align with criteria imposed by the regulator.[164]

This was echoed by AXA, who told us that:

    We are not in favour of the regulator being involved in product design or stipulating mandatory minimum standards. We think this should be reached through industry level agreement and codes of practice. Regulatory involvement in product design could also stifle innovation and the competitive market place. We are also concerned this power may create an uneven playing field where products are being sold in the UK by an EU entity on a cross border basis.[165]

142. Other industry representatives, however, were more supportive of intervention by the regulator. Philip Warland, of Fidelity Worldwide, told us:

    We in Fidelity do believe that strong intervention is needed. I think that the litany that the Chairman of the FSA talked about last week at the Mansion House dinner—£15 billion of redress over a period—just suggests that something isn't working. What they have done up until now is largely looked at how products are sold, how they are advised, and never really got involved in the governance of the product, what the product was aiming to do and was it aimed at the right target market.[166]

143. Consumer groups were generally supportive of the proposed interventionist approach to regulation. Peter Vicary-Smith, of Which?, told us the product intervention was necessary because of market-failure in financial services. He said:

    If we had a well-functioning market, we would not need to intervene against products in this way, because we don't recommend that kind of intervention in other marketplaces. It is because products are often poorly designed and then poorly marketed that we think these powers are necessary here.[167]

144. Consumer Focus largely agreed, but argued that the proposals do not go far enough:

    We strongly support extended powers to ban or place conditions on products, ban misleading advertisements, and publish warning notices. [...]

    But we think the proposed powers could, and should, be enhanced further still. [...]

    The areas where we believe stronger or clearer FCA powers could further reduce the chance of consumer detriment [include]: [...]
  • Stronger powers on disclosure of enforcement action
  • The removal of the regulatory principle of consumer responsibility which attempts to transfer responsibility from firms to consumers
  • The powers to undertake market studies where it does not believe markets are functioning in the consumer interest or where effective competition could be improved. [...].[168]

    145. It is crucial that the potential risks and benefits of products are properly understood. The case has not been made that the FCA will necessarily understand a new product better than a firm. We are mindful of the risks that product intervention can pose to competition and innovation. The FSA has been criticised in the past for being too slow to intervene and we welcome the FCA's willingness to respond quickly to issues of consumer detriment. We support the need for judgement-led product intervention by the regulator. We recommend that clear guidance be issued to firms when such powers are used. Their use should be sparing and the merits of each case very carefully considered before intervention. We reiterate our recommendation about the need for greater communication between the regulator and the firm concerned. This should reduce the need for such intervention.

    The need for more intervention?

    146. The rationale for a stronger conduct regulator has been made in response to a number of spectacular regulatory failures over recent years, including the mis-selling of pensions and mortgage endowment policies in the 1970s, '80s and '90s and the recent scandal concerning PPI. The Government's intention is to create a conduct regulator that will be more proactive and have powers to take early action to stop consumer detriment.

    147. During our inquiry the consumer groups have emphasised the need for a more proactive and empowered conduct regulator. The Citizens Advice Bureau said:

      There is an explicit recognition in the draft Bill and supporting documents that persistent and widespread consumer problems in the financial services sector are rooted, at least in part, in regulatory failure. This is illustrated in the FSA's Approach to regulation document that starts by recognising the low level of confidence in the financial services sector and how "conduct issues since 1990 have been a major factor in this". The FSA also reflects that it has not always been quick enough or tough enough to prevent or control consumer detriment. For instance, the regulator concludes on PPI mis-selling that "stronger action sooner could have limited the growth of the problem."[169]

    148. There is a clear need for a greater level of proactive intervention by a consumer focused financial services regulator. The ICAEW summarised the current situation as one where:

      Trust in the sector needs to be improved given the history of mis-selling and poor service standards. The volume of complaints received by UK financial services firms amounted to over 1.8 million in 2011, half of which were upheld. These outcomes are profoundly disappointing after around 25 years of formal regulation. They are bad for consumers, but also the many firms in financial services which are run on sound lines yet become grouped with those which are not.[170]

    149. A number of submissions from industry groups offered qualified support for the additional powers. The Financial Services Practitioner Panel wrote:

      We acknowledge that it will be useful for the FCA to have tighter powers to control any product that can and does do harm.[171]

    Philip Warland, Head of Public Policy, Fidelity agreed that:

      We in Fidelity do believe that strong intervention is needed. I think that the litany that the Chairman of the FSA talked about last week at the Mansion House dinner—£15billion of redress over a period—just suggests that something isn't working.[172]

    150. We recommend that the FSA place its more detailed proposals in the public domain and facilitate proper public scrutiny of its plans.

    Early Warning Notices

    151. The Government proposes to give the FCA the power (but not the duty) to disclose the fact that a warning notice has been issued to a firm—an early warning notice. The draft Bill sets out amendments to FSMA section 391 and makes is subject to a safeguard that the FCA can only publish a warning notice "after consulting the persons to whom the notice is given or copied" and stipulates that "The FCA may not publish information under this section if, in its opinion, publication would be [...] unfair to the person with respect to whom the action was taken (or was proposed to be taken)". [173] The FSA set out in its paper that:

      The FCA will also intervene where the product may be well known and of utility to consumers but the sales and distribution process of a firm does not meet regulatory standards and consumer detriment is occurring. Where the FSA has typically allowed firms to continue to market and sell products alongside programmes to remedy poor practices, the FCA may not. When the firm is a major supplier of a product which is commonly sold to consumers, the consequences of such action, which could disrupt consumer choice or access, will be weighed against the benefits of preventing further consumer detriment. [...]

      If this provision is enacted, the FCA will need to balance the advantages of openness with the need to respect private rights and due process. In this context, the government has indicated that there will be a requirement to consult the person concerned before issuing any information about the warning notice. This should ensure that account will be taken of, for example, any reputational damage which could occur as a result of publication of the information.[174]

    152. When we asked the FSA about this Margaret Cole indicated that the FSA view on this as:

      A rather small move on what I will call the transparency dial, if you like—the balance between fairness to individuals and firms and the public policy considerations around protection of consumers and putting as much information as possible into the public domain.[175]

    But she went on to tell us that the FSA would prefer to remove the requirement to consult:

      the proposal at the moment is that we should consult with the party that we are bringing the case against in every case where we might be going to publish a warning notice. We think that effectively undermines the power, because in each case there will be an argument and satellite litigation over whether we can publish the warning notice—arguments being to do with reputation.[176]

    153. This position received support from the Financial Services Consumer Panel who wrote to us that:

      We support the new power to enable the FCA to disclose the fact that a warning notice has been issued in relation to proposed disciplinary action, but we believe the requirement for the FCA to consult those involved—implying that the subject's consent could be required for publication—should be clarified to allow immediate publication without consultation where it considers there is a risk of consumer detriment. Without such a change the requirement to consult and allow representations could slow the entire process and lead to consumers continuing to make potentially irreversible decisions based on unsuitable or incomplete information, depending on the nature of the disciplinary issue.[177]

    154. The consumer groups were clear in setting out that it was important that the FCA could issue an early warning notice in relation to an investigation which may take many years to take through the later stages of enforcement when meanwhile there may be considerable ongoing consumer detriment. Gillian Guy, Chief Executive of the Citizens Advice Bureau, told us:

      It is not seen as, "Well, let's wait and see what happens." It is actually that there needs to be a warning out there to stop the product going further.[178]

    155. We received a considerable amount of written evidence from industry expressing significant concerns. Objections to the proposals were principally raised in respect of the potential reputational impact of an early warning notice on the firm concerned which could lead to lasting damage to a firm with no ability to seek redress from the FSA. There were also worries about consistency with natural justice. The Building Societies Association told us:

      Advance publication of proposed enforcement action risks a new presumption of "guilty until proven innocent" in respect of regulated firms, which is unlikely to improve confidence in the regulatory system. The planned safeguards are inadequate; the reputational damage having already been done. As we understand it, the FSA often begins investigations that lead to no disciplinary action.

      Our concern is that, once information about proposed enforcement action is published, reputational damage will be done to the firm, irrespective of the outcome of the action and without the firm having had recourse to an appeal process.[179]

    156. The Financial Service Practitioner Panel told us:

      We also continue to be concerned about the Government's proposals for early publication of disciplinary action. We acknowledge that there will not be a duty on the regulator to publish, and the power will be subject to certain safeguards. However, we are nevertheless sceptical of how the safeguards will be operated, and whether all the implications will be considered. It may be that the publication of a warning notice may mislead consumers and result in detriment if they decide to exit a firm's product or service early, when in fact no issues are proved to exist. There is also the possibility of legal hazards for the regulator if the publication of a warning notice has led to losses for consumers, shareholders and staff. One example is the publication in 2010 of the FSA investigation into the activities of Gartmore fund manager Guillame Rambourg. There was a resultant outflow of assets and reduction in the share price of Gartmore, following which it was acquired at a lower price by the rival asset manager Henderson.

      It will be essential that at the very least, the safeguards on consultation and fairness on the publication of warning notices are complied with fully by the regulators. We would also like to see a commitment to a public review of the use of this power by the regulator, after a number of cases have been publicised.[180]

    157. The example of the Gartmore case was raised by a number of respondents. Margaret Cole told us "we did not announce our investigation at all. It was the firm doing that".[181] However, even if the FSA did not publicise the existence of the investigation, the Gartmore episode illustrates the potentially calamitous impact that an early warning notice might have on a firm given the market response in this case once the existence of an investigation had been made public. Margaret Cole told us that they would not be seeking to publish notice that an investigation had commenced but that this would be:

      [...] quite some significant way down our process for holding people accountable. It is a moment when we have looked at the case in detail, taken it to an internal committee and reached a conclusion that there is a case to answer.[182]

    She argued further that:

      By publishing brief information at that moment, we are not doing anything more than putting that into alignment with the criminal process or with the civil process or with the process that other regulators employ, like the OFT and Ofgem.[183]

    158. However we remain concerned that this analogy does not take into account the sensitive nature of the finance services market place and potential for an extreme reaction to be triggered by the publication of an early warning notice. Angus Eaton of Aviva, told us:

      Our fear [...] would be that that could be a tool that was used to publicise potential investigations and not used in a measured way. That itself could undermine the overall reputation of the industry as a whole [...] if this is a tool that is used in an unfettered way then we do have a fear that it is going to undermine the confidence in this industry that, of course, is already very delicate.[184]

    159. We note that many of the most egregious examples of such detriment in the past have related not to firm-specific issues but products. The issues around pensions mis-selling and PPI were industry wide not firm specific. Asked about the FCA being a regulator which would intervene on the basis of its judgement, Martin Wheatley, CEO designate FCA, told the Joint Committee on the Draft Financial Services Bill that "We will get it wrong and the test will be whether [...] overall we are being seen as delivering the objectives for the organisation".[185] The inability for a firm to obtain redress against the regulator further exacerbates the problem of limiting the incentives to ensure that the regulator is fair to firms as well as consumers.

    160. We support giving to the FCA the existing ability of the FSA to issue public warning notices about specific products. However we are concerned that a general rule permitting the FCA to publish early warning notices in respect of specific firms, which in some cases could subsequently prove to be unfounded, risks unreasonable reputational damage to which there may be inadequate redress. We are also mindful of the risk to natural justice, given that in such a case the regulator may be investigator, judge and jury. We therefore recommend that the Government continue to consult on its proposed power for the FCA to issue early warning notices in respect of investigations into specific firms.

    Pre-approval of simple products

    161. The pre-approval of some products was discussed during this inquiry. Brewin Dolphin plc, Cazenove Capital Management Limited and Rathbone Brothers plc have told the FSA that:

      We would like to see enhanced protection for retail consumers in a simplified product range of the key building blocks which should make up the core, or in many cases all, of the savings of the vast majority of savers.

      [...] The product range could include simple cash products, personal pension plans, index linked and other savings bonds, gilts and ISAs holding some very basic equity funds.

      We suggest that National Savings can be used as a benchmark for these products, in terms of performance, price and the issuers' willingness to stand behind their products should they fail to do "what they say on the tin" or lose value below prescribed benchmarks. This will reduce chances of mis-selling or inappropriate product engineering for an audience which is likely to be lacking in financial education and financial resources.

      All such products would be developed to a prescribed formula and require pre approval from the FCA. The organisations providing such products will all have the financial strength to stand behind their products. They will not have hidden risks or hidden charges and where possible should be tax advantaged.

      [...] The more sophisticated requirements of private investors will principally be catered for by wealth managers, stockbrokers, and private banks, larger IFAs and fund managers, most of whom will be members of APCIMS, BBA [(British Bankers' Association)] and/or IMA [(Investment Management Association)].

      [...] The companies providing product or services to this group of investors should be vetted and approved by a joint body of FCA and practitioners (not unlike the old Stock Exchange membership) to limit the chances of failure or rogue operators.[186]

    162. We asked Martin Wheatley why the FCA had not adopted a system of pre-approving safe financial products. He told us that it was a question of resources:

      Pre-approval would place a large burden, so we would need a larger number of staff to do it, and a process between us and the market. I had experience of pre-approval of products in Hong Kong and the effect is that products get brought to you half-baked, because the industry wants to rush the products out. The regulator ends as up as the spellcheck for the industry, because they bring such poorly thought through products in the hope that they will have a place in the window. I think pre-approval is quite a difficult process and has many more negatives.[187]

    163. The Financial Secretary told us that he was not in favour of pre-approving financial products because it would stifle innovation. He also told us that it would risk creating consumer detriment as a result:

      Because you would end up in a situation where you have some huge organisation based in the FCA that would have to vet every single product that came on to the market. In the heyday of mortgage markets, I think there were something like 6,000 different products. Each one of those would have to be approved, and there would be a process of approving them, so that would potentially act to the detriment of consumers who want to shop around for a good fixed-rate mortgage or a tracker mortgage. I think the bureaucracy that would impose would be quite significant and there would be some consumer detriment to that.[188]

    164. Despite this, the British Bankers Association argued that "when considered in the round with the FCA's other more proactive intervention powers, the lack of any 'kite-marking' or similar may lead to very risk-averse behaviours which in themselves can under-serve consumers generally".[189] Christine Farnish, of Consumer Focus agreed, telling us that there would be a definite benefit to certain consumers of a pre-approval scheme:

      For mass market consumers we think it would be well worth exploring some sort of new arrangement. [...] We would very much like to see an attempt to try and produce some standard terms and conditions—minimum standards—for a suite of mass market products that most ordinary families and consumers need during their working lives, that could then be identified through some sort of mark or trusted brand, and that people could buy cheaply, easily, safely.[190]

    165. It has been reported that the FSA was considering the pre-approval of simple financial products as recently as September 2011 and has decided not to pursue it as a policy because of resource constraints.[191] We have seen no evidence to justify this decision. Given the evidence cited above from consumers and producers alike we would expect a much fuller explanation of any decision together with supporting data.

    166. We recommend that the FCA conduct a review of the merits and costs of a pre-approval scheme for financial products, and publish its findings. We also recommend that the FCA reconsider the scope for distinguishing in regulation between simple products which can be pre-approved for basic needs and more complex products, generally but not always more suited to sophisticated investors, which cannot.

    Price Intervention

    167. Measures in the Government's draft Bill will grant product regulation powers to the FCA as we considered above. One area that is not explicitly covered in the Policy Overview published with the draft Bill is the question of price intervention or regulation. Currently this would be a competition issue and so fall within the ambit of the Office of Fair Trading as the competent competition authority. The FSA set out in its paper regarding the FCA that:

      Where competition is impaired, price intervention by the FCA may be one of a number of tools necessary to protect consumers. This would involve the FCA making judgements about the value for money of products.[192]

    168. The Financial Secretary to the Treasury told us that:

      The Government has been clear that the FCA will not prescribe prices in the manner of some utilities regulators. In the financial services industry, in the absence of natural or granted monopolies, such an approach would not be proportionate or consistent with the FCA's competition remit. However, the FCA should be looking at comparative prices and other possible indicators of where competition is flawed.[193]

    169. The lack of clarity as to whether the FCA is intended to be a price regulator or indeed whether the legislation as proposed in the draft Bill grants it this power was highlighted to us by Which? who quoted their barrister, John Odgers, as follows:

      It is not clear whether, by not including in the Bill any specific provisions relating to price intervention, the Government intends the regulators to enjoy no such powers or whether it considers that price intervention is permissible under these rule-making powers.

      It seems to me to be desirable that a power of price intervention should be spelled out, if it is intended. Financial services regulators have not in this jurisdiction previously exercised that type of power, and might in future be loath to do so without a specific statutory authority, as the use of such a power would be particularly likely to attract a challenge.

      We would therefore welcome clarification from the Government on this matter.[194]

    170. There remains confusion about the role of the FCA in price regulation. We recommend that the Government clarifies whether it intends the FCA to play a role as a price regulator, the case for which has yet to be made. There should be adequate public consultation prior to any legislation on the role of the FCA as a price regulator.

    Consumer education

    171. There is great concern that consumers are not able to make informed decisions. Consumer focus told us:

      Consumers in the UK are among those most likely to describe themselves as 'knowledgeable' in theoretical market research polls but research show that they are among those least likely to know their rights across a range of markets. Meanwhile empirically levels of financial capability, functional literacy and numeracy remain extremely poor. [...]

      Compounding this lack of basic understanding is the complex nature of many financial product contracts despite years of effort by regulators to improve disclosure. [...]
    • the consumer documentation from a major high street bank for a personal loan requires degree level education to understand
  • the standard text describing a PPI product requires PhD level education to comprehend
  • it takes 55 minutes to read a standard consumer credit agreement, let alone understand it.[195]

    172. Some industry representatives told us of the benefits to firms of having a financially capable consumer base. The Institute of Chartered Accountants in England and Wales told us that this would become more important in the future as the financial requirements of consumers change:

      Demographic developments, together with the fiscal implications of the possibility of growth remaining low in the West for some years to come, suggest that Governments are likely increasingly to look to individuals to make greater personal provision for retirement and possibly other requirements, such as aspects of health care. That implies a need to raise the financial capability of the general population. Financial education will be an important part of this.[196]

    The Share Centre Ltd said that consumer education should focus on young people:

      If we have better educated consumers we will need less regulation. In this respect it is unfortunate that the resources available for financial education for young people have been so severely cut. It is in the interest of the financial services industry to see a small mandatory levy—probably totalling no more than £10m p.a., so that caveat emptor can reasonably resume its place in our industry.

    173. The role of financial education in schools and the national curriculum was the topic for a recent debate in the House of Commons. During this the Minister of State, Department for Education, Mr Nick Gibb said that "Young people need to be confident and competent consumers":

      We all agree about the importance of good-quality personal finance education and the critical role played by a sound grasp of basic mathematical skills. Support from the finance industry and a range of good resources play their part in supporting schools to teach pupils how to manage their money well.[197]

    174. Mr Gibb told the House that "the Government are currently conducting two reviews—that of the national curriculum [...] and that of personal, social, health and economic education, which includes financial capability".[198] We look forward to the results of these reviews.

    175. Outside the school system, the Money Advice Service (MAS) is an independent body, set up by the Government and funded by fees raised from financial services firms regulated by the FSA. It has two core strategic objectives:

    • To enhance the understanding and knowledge of members of the public of financial matters (including the UK financial system);
    • To enhance the ability of members of the public to manage their own affairs. [199]

    176. The FSA told us that the work of the MAS is valuable to consumers, firms and the regulator:

      We support measures included in the draft Bill that require the FCA to agree and publish a MoU with the Money Advice Service, replacing the current voluntary arrangement. We believe the Service will be a further useful source of intelligence and early warnings for the FCA on potential problems in retail markets.[200]

    177. However, we received evidence outlining concerns that about the funding, expenditure and strategy of the MAS. Smaller industry practitioners in particular were keen to avoid duplicating costs. The smaller business practitioner panel told us:

      The industry is already funding the Money Advice Service (MAS), so it seems that the FCA should be doing less than the FSA has done to engage directly with consumers, as much of the role should now be undertaken by MAS. As it is, we are also concerned about the lack of cost control and accountability of MAS.[201]

    178. The Financial Secretary said that he supported the MAS as the organisation to educate consumers on financial matters:

      I think there is a challenge here about how we make sure we equip consumers to buy products and services, and that is why I am a very big supporter of the Money Advice Service, which helps there.[202]

    179. We support the aims and objectives of the Money Advice Service to provide generic advice. Wider understanding of financial services will benefit the economy as well as consumers. As with all public bodies, it is important that the MAS is seen to be providing value for money. This is especially important as the MAS is funded by industry levy, the burden of which is likely to be ultimately passed to consumers. It is important that the work of the MAS is not duplicated but complemented by any work of the FCA in the area of consumer responsibility. We recommend that the MoU between the FCA and MAS be published in time for the introduction of the Financial Services Bill. The FCA and the MAS should work with the Department for Education to help ensure that young people receive at school the basic learning tools and skills required to make sense of financial advice later in life.

    161   HM Treasury, A new approach to financial regulation: the blueprint for reform, June 2011, p 30 Back

    162   Financial Services Authority, The Financial conduct Authority: approach to regulation, June 2011, para 1.9 Back

    163   Ibid., para 4.1 Back

    164   Ev w43 Back

    165   Ev w33 Back

    166   Q 1 Back

    167   Q 178 Back

    168   Ev 74 Back

    169   Ev 49 Back

    170   Ev w63 Back

    171   Ev w7 Back

    172   Q 1 Back

    173   Draft Financial Services Bill - Schedule 8, Part 6, Paragraph 24 Back

    174   Financial Services Authority, The Financial conduct Authority: approach to regulation, June 2011,paras 4.15 & 4.5 Back

    175   Q 136 Back

    176   Q 136 Back

    177   Ev w15 Back

    178   Q 179 Back

    179   Ev w84 Back

    180   Ev w7 Back

    181   Q 136 Back

    182   Q 136 Back

    183   Ibid. Back

    184   Q 46 Back

    185   Oral evidence taken before the Joint Committee on the Draft Financial Services Bill on 10 November 2011, HC 1447-xiii, Q 999 [Baroness Wheatcroft] Back

    186   Ev w135 Back

    187   Q 134 Back

    188   Q 257 Back

    189   Ev w74 Back

    190   Q 181 Back

    191   Chris Pond, Speech to Social Market Foundation, September 2011 Back

    192   Financial Services Authority, The Financial conduct Authority: approach to regulation, June 2011, box 2 Back

    193   Ev 87 Back

    194   Ev 64 Back

    195   Ev 72 Back

    196   Ev w63 Back

    197   HC Deb, 15 December 2011, col 995 Back

    198   Ibid., col 992 Back

    199   Further information about the Money Advice Service may be found at: Back

    200   Ev 61 Back

    201   Ev w27 Back

    202   Q 232 Back

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    Prepared 13 January 2012