III. STATUTORY OBJECTIVES AND PRINCIPLES
Introduction: the concept of statutory objectives
18. Clause 2(1) of the draft Bill requires the FSA
to act "so far as is reasonably possible", in discharging
its general functions, in a way which is compatible with its "regulatory
objectives", and which the FSA considers most appropriate
for the purpose of meeting them. The FSA's "general functions"
are defined as rule-making and advice and guidance, each considered
as a whole, plus determining its own general policy and principles.
The statutory objectives therefore do not apply directly to individual
acts of rule-making, advice or guidance; and they apply only at
the level of general policy and principles to the granting of
authorisation, permission, approval and recognition, and to investigation,
intervention and disciplinary action.
19. Clause 2(2) gives the FSA four regulatory objectives:
· Market confidence
· Public awareness
· Protection of consumers
· Reduction of financial crime.
Clauses 3 to 6 define each objective.
20. The order of the objectives is not intended to
be significant. According to the Progress Report, "the objectives
should normally work together rather than in conflict with each
other and prioritisation could give misleading signals about the
importance of the lower ranked objectives".
21. Clause 2 also sets out six principles, to which
the FSA must have regard in discharging its general functions.
They may be summarised as:
· Efficiency and economy
· Responsibility of business managers
· Proportionality of regulation
· Desirability of facilitating innovation
· Desirability of maintaining international
· No unnecessary distortion of competition.
22. Mr Davies explained to us
the practical effect of the statutory objectives and principles.
They act as an "effective discipline" on the work of
the FSA, and a "checklist" or "point of purchase"
for both the FSA Board and the outside world in holding the FSA
23. The Delegated Powers Committee strongly welcomes
the objectives and principles. "These provide a valuable
framework and discipline for the exercise of secondary legislative
powers [by the FSA] and open the way to judicial review proceedings
if it is considered that such powers are not being exercised properly".
24. We support the principle that the Bill should
set statutory objectives and principles for the FSA, to inform
its behaviour as it seeks to ensure markets of integrity and to
provide a yardstick for accountability. We agree that these should
be set at a high level of generality, so as to be adaptable to
changing circumstances. We agree that they should apply at the
level of general policy and principles, rather than applying directly
to every single act and decision of the FSA. We agree that they
should not be ranked.
DEFINITION OF CONSUMER
25. According to Clause 5(3), "consumers"
means "persons who
(a) use, or are or may
be contemplating using, any of the services provided by authorised
persons in carrying on regulated activities; or
(b) who have rights or
interests derived from, or otherwise attributable to, the use
of any such services by other persons".
26. The Treasury Select Committee saw advantages
in the proposed wide definition, given the scope under Clause
5(2) to treat different kinds of transaction, and different consumers,
in different ways.
The Treasury's Progress Report takes the same line. However it
admits that "consumer bodies are concerned that the special
protection needs of retail consumers appear to be subsumed, whilst
industry bodies are concerned that the need for lighter regulation
for non-retail customers will be overlooked".
It goes on, "The Government...will
consider ways in which the drafting of Clause 5 might be clarified
27. The National Consumer Council (NCC) consider
that the Bill should distinguish retail from wholesale consumers,
and treat them differently. As examples of such differentiation,
they cited in their submission to the Treasury the Unfair Contract
Terms Act 1977, and the draft EU directive on distance selling.
They suggested to us that the basis for differentiation might
be whether the transaction takes place in the course of the consumer's
business, or for private purposes.
The Association of British Insurers (ABI) observed to the Treasury
Select Committee that, whereas prudential principles apply equally
to wholesale and retail insurers, the conduct of business rules
applicable should be quite different. On the other hand, the Consumers'
Association cautioned against an assumption that the man in the
street has no interest in wholesale trade: "what happens
in those markets, the fact they are not corrupt and they are working
efficiently, does impact on consumers on the range of investments
and institutions they wish to trust".
28. Mr Davies distinguished three sorts of consumer:
professional traders, "expert end-users", and the man
in the street. He indicated that the FSA rulebook would differentiate
between them, allowing professional traders to "exploit each
other in private" while applying "the full range of
protection" to the retail consumer.
Mr Roe suggested that any attempt to categorise consumers according
to vulnerability would be imperfect, and that it was more reliable
to think in terms of a "spectrum".
29. In our judgment, concerns expressed about the
drafting of the definition of "consumer" are in reality
concerns that, despite Mr Davies's assurances, the FSA will fail
to differentiate adequately between different groups of consumers
in the way it approaches supervision and regulation. The Treasury
is to redraft the definition. We recommend that the Bill should
require the FSA to recognise the different regulatory needs of
the wholesale and retail industries.
30. We put it to Mr Roe that one way to avoid inappropriate
regulation would be to allow persons who felt that they did not
need the highest level of consumer protection to "opt out"
of certain regulations.
The Treasury is proposing something along these lines in connection
with financial promotion, whereby investment advertisements might
be allowed to be made without approval to "a defined category
of private investors"; the definition of the category might
include the investor giving written consent, or joining a register.
31. It was also suggested that FSA fees might be
so structured as to save wholesale traders from paying for the
high level of FSA expenditure on consumer protection demanded
by the retail trade; Mr Roe indicated that the FSA would have
considerable discretion as to their fee structure.
This is not a matter for the Bill, nor one on which we have taken
evidence; we make no recommendation.
32. In carrying out the consumer protection objective,
the FSA is to have regard to "the general principle that
consumers should take responsibility for their decisions".
This is a version of the time-honoured principle caveat emptor,
"Let the buyer beware".
33. According to the Progress Report, "The regulated
community have, for the most part, welcomed this provision. Consumer
groups have however suggested that it is unfair to place ultimate
responsibility on retail customers who are faced with difficult
decisions, often on the basis of little knowledge".
The Report suggests that this may in part be a misunderstanding:
"It seems that some have interpreted "general"
in this context as meaning "overriding", whereas the
intention is something closer to a presumption which is likely
to be qualified to varying degrees by particular circumstances".
34. Mr James Stretton, the Chief Executive of UK
Operations, Standard Life Assurance Co., supports the caveat
emptor provision. He argued that, if the FSA purported to
give consumers complete protection, it would inevitably fail,
disappointing the consumer and discrediting the system.
The Independent Financial Advisers Association (IFAA) support
caveat emptor (though they prefer the expression "consumer
responsibility"), particularly in the light of the public
awareness objective, which they welcome.
35. On the other hand, the NCC want caveat emptor
disapplied from non-business customers, or at least qualified"so
far as each individual is able by reason of his knowledge and
The FSA's own Consumer Panel would delete caveat emptor
altogether: "it is already covered by the previous two provisions
that the FSA should establish an appropriate degree of consumer
protection having regard to the differing degrees of risk and
the different expertise and experience of consumers".
36. Mr Davies said that, while this was an issue
on which reasonable people could disagree, the FSA Board favoured
an element of caveat emptor, since while they would do
all they could to prevent mis-selling, they could not in the end
prevent "mis-buying". He believed that the public's
expectations of the regulator were realistic at present; he did
not wish to see them raised to an unrealistic level by the omission
of caveat emptor from the Bill. However he acknowledged
fears that this provision as drafted might be taken not merely
to qualify the consumer protection objective, but to negate it
altogether. He proposed an alternative form of words involving
a concept of "due care and attention".
The Minister told us that this provision was being redrafted.
37. We recommend that the principle of caveat
emptor should feature in the Bill; but that it should be redrafted
in such a way that it could not be used to negate the consumer
protection objective and excuse exploitation of sections of the
Definition of consumer protection; fitness for
38. The NCC point out that the draft Bill leaves
consumer protection undefined, save for the caveat emptor
provision discussed above. They would like it defined in a way
which imports into financial services the "fit for purpose"
concept of the Sale of Goods Act.
They point out that, with most consumer goods, the consumer can
assess fitness for purpose soon after purchase; with financial
products, fitness or unfitness may take years to show. They do
not go so far as to demand a guaranteed return on any investment;
but "we still need to give them [consumers] protection to
make sure that they know what they are getting and that it is
a product that is suitable for their needs".
The NCC are supported in this by the FSA Consumer Panel.
39. Arguably there is an equivalent of the "fitness
for purpose" rule in the existing rulebooks of the self-regulating
organisations (SROs) which the FSA is to replace, in the form
of the "suitability" rule. This requires firms providing
personal financial services to tailor them to the circumstances
and needs of individual clients.
And in any case, as Mr Garry Heath, Director-General of the IFAA,
the analogy between a financial "product" and a product
such as a kettle is most imperfect.
40. An alternative approach would be to set out the
responsibilities of the industry more fully in the legislation.
Mr Roe indicated that Ministers would be open to suggestions in
One of the best protections for consumers is information; and
information is essential if they are to be held responsible for
their decisions. Disclosure also enhances competition and makes
it effective in the market place, since, without adequate information,
competition cannot be effective. We therefore recommend that
the Bill should require the FSA, in considering under Clause 5
what degree of consumer protection may be appropriate, to have
regard to the responsibility of authorised persons to make full
and prominent disclosure of the main characteristics of a financial
service which might affect consumer choice.
41. Some would go even further, and argue for "product
regulation", whereby the FSA would prescribe minimum conditions
for financial products and bar certain types of product altogether.
This would be a major change, and regulatory authorities have
hitherto set themselves against it. We too are unpersuaded of
the case for product regulation, for the following principal reasons:
- It could come close, or be seen to come close,
to product endorsement by the regulator. This might lower consumers'
standards of care.
- Whether a financial product is suitable depends
as much upon the situation of the consumer as on the nature of
- There is a serious risk that product regulation
would reduce competition and innovation, to the ultimate detriment
42. Clause 3 defines the "market confidence"
objective as "maintaining confidence in the financial system",
including financial markets and exchanges, connected activities,
and regulated activities. According to the Progress Report, "maintaining"
in this context includes "improving".
43. The draft Bill does not refer in terms to systemic
risk, i.e. risk to overall financial stability and the payments
system through the failure of a significant financial institution,
with adverse impact on the availability of credit, and on the
confidence of investors in the institutions which receive their
money. Mr Davies said he understood the market confidence objective
to relate mainly to maintaining fair prices and prudential requirements;
the FSA's responsibilities in relation to systemic risk were covered
adequately by a Memorandum of Understanding (MoU) between the
Treasury, the Bank of England and the FSA.
The Minister told us
that the FSA's responsibilities relating to systemic risk were
"embedded" in the proposed objectives, and that making
them a separate objective would add nothing; but that she was
willing to consider the matter further.
44. The MoU on financial stability is printed in
The FSA: an outline, October 1997, Appendix 2. It says,
"The Bank will be responsible for the overall stability of
the financial system as a whole". A Standing Committee of
Treasury, Bank and FSA representatives meets monthly to discuss
"developments relevant to financial stability".
45. In our view, playing a part in the management
of systemic risk is clearly a key function of the FSA, and we
would prefer to see a reference to this in the statutory objectives.
We recommend that the market confidence objective should refer
to "maintaining confidence in the soundness of the
financial system", and should be expanded to include a reference
to the management of systemic risk, in collaboration with the
Treasury and the Bank of England.
Competitiveness and Competition
46. Clause 2(3) says, "In discharging its general
functions the Authority must have regard to...
(c) the principle that a burden or restriction...should
be proportionate to the benefit intended to be conferred in general
by that provision;...
(e) the international character of financial
services and markets and the desirability of maintaining the competitive
position of the United Kingdom;
(f) the principle that competition between authorised
persons should not be impeded or distorted unnecessarily".
47. The Treasury Select Committee recommended that
the Government should consider the case for a fifth objective,
to improve competition.
The NCC support this;
but the example they give of what the FSA might do in pursuance
of such an objective, namely provision of comparative information,
is something to which the FSA is committed already (see below).
48. The British Bankers' Association (BBA) and the
ABI wish the non-disadvantaging of UK financial services in terms
of international competitiveness to be raised to the level of
49. The Progress Report says, "The Government
considers that including those elements [competition and international
competitiveness] in the principles will have a sufficiently pervasive
influence on the way the FSA carries out its functions, without
the need for additional objectives".
Mr Robin Hutton, Director of Regulation for the merchant banking
group Singer & Friedlander, takes the Government's side on
50. Mr Davies said that an objective related to promoting
UK financial services would cut across the remits of other bodies,
would involve the FSA inappropriately in commercial activities,
and would impede co-operation with overseas regulators.
The Minister told us that ensuring competition was the primary
task of the Office of Fair Trading (OFT), not of the FSA;
she also observed that increasing the number of objectives would
make it harder to hold the FSA to account against any one of them.
51. We agree with the importance of maintaining and
seeking to enhance the competitiveness of UK financial markets. Some of us
would prefer competition and competitiveness to feature among
the FSA's statutory objectives. However, the Committee is content
that competition and competitiveness should remain among the principles,
rather than being turned into objectives. Making competition
an objective would confuse the roles of the FSA and the OFT; making
the competitiveness of UK financial services an objective could
damage the FSA's relations with overseas regulators.
Regulatory Burden and Compliance Cost
52. One way in which the FSA could undermine the
international competitiveness of UK financial services is by imposing
undue regulatory burdens and compliance costs. The ABI told the
Treasury Select Committee that, in the light of the proportionality
principle, they believed that FSA regulation should be efficient,
cost effective and practicable. The FSA will be obliged to accompany
any draft rule with a cost benefit analysis;
this goes beyond the requirement on the existing SROs to take
account of compliance costs.
53. Mr Davies told us that two recent surveys (one
of them was the Australian "Wallis Report" of March
1997) showed London to be a low-cost regulation location at present,
and that there was no evidence that firms were moving out.
However the danger of firms engaging in "regulatory arbitrage",
i.e. moving business around in order to evade regulation and compliance
cost, should not be ignored. Mr Alastair Ross Goobey, Chief Executive,
Hermes Pensions Management Ltd, observed that geographical location
was becoming increasingly irrelevant to the conduct of wholesale
Mrs Angela Knight, Chief Executive of the Association of Private
Client Investment Managers and Stockbrokers (APCIMS), and Mr Mark
Boléat, Director-General of the ABI, raised the prospect
of retail business moving abroad too, particularly to other parts
of the EU.
They added that compliance costs are difficult to disaggregate
from the costs of good business practice,
though Mrs Knight observed that substantial cost can arise from
changes to rules and regulations.
54. We recommend that the FSA's Annual Report
should address the regulatory burdens and compliance costs of
UK markets compared with overseas jurisdictions.
55. The IFAA welcome the public awareness objective,
which in their view will enable the FSA to fit consumers for their
caveat emptor responsibilities.
So do the Securities Institute;
they suggest that the FSA might report its progress towards this
objective to the Secretary of State for Education each year. Mr
Davies said that others in the industry were also supportive.
56. The Minister put it to us that well informed
consumers are "a source of competitiveness".
She observed that any attempt to raise public awareness in this
area starts from a very low base. Among our witnesses, we found
general agreement that public awareness is low, but some doubt
as to how far it is possible to raise it.
57. The Treasury Select Committee observed that an
essential part of public awareness is "Accurate, comparable
information from product providers".
In the Budget speech, the Chancellor said, "The FSA will
now publish league tables of costs and charges in savings, insurance
and pension products, to guarantee a better deal for consumers
and to avoid the mis-selling of the past".
Mr Bernard Jones, Chairman of the IFFA, observed that performance
can be much more important than costs and charges;
FSA Consultation Paper 15 Promoting public understanding of
financial services raises the possibility of publishing quality
comparisons as well.
The ABI said that many such tables are published already, and
"the overall impact of this on consumers is not a lot".
58. We welcome the public awareness objective.
It is important to be ambitious about bringing a wider understanding
of financial services to the public. We recommend that initiatives
taken to achieve this objective and the criteria used to assess
progress should feature in the FSA's Annual Report.
59. The reduction of financial crime objective is
defined in Clause 6. In considering it, the FSA is to have regard
to "the desirability of...regulated
persons taking adequate measures...to
prevent financial crime, facilitate its detection and monitor
its incidence". According to the Progress Report,
"Some were concerned that this appeared to impose a burdensome
and disproportionate obligation on firms....the
Government appreciates this concern and will re-consider the drafting".
60. Since the Treasury is reconsidering the drafting
of this objective, we make no recommendation.
Social-ethical objectives and principles
61. The NCC urged the Treasury to add to the list
of principles "the need for reasonable access to financial
services for those who have difficulty getting access to products
appropriate to their needs". The Treasury Select Committee
said, "We believe that the Government's agenda for extending
access to such financial services as savings and pensions will
involve the FSA in issues of social and financial inclusion. The
FSA will want to develop adequate and sensitive systems for monitoring
and regulating, to encourage innovative products suitable to the
markets being served and to ensure that providers and consumers
will not face unnecessary obstacles in gaining access to these
particular markets". According to the Progress Report, "The
Government is strongly committed to working with a range of agencies
and private bodies in combatting financial exclusion and expects
that the FSA's role will bring it into contact with various aspects
of this work. We believe however that adding to the FSA's objectives
is unnecessary and could distract from the core role of the FSA
as a financial regulator".
62. We recommend that the FSA should not be given
additional objectives. This would make life unnecessarily
difficult for a regulator responsible for prudential supervision,
and would damage lines of accountability. If the Government wishes
to impose social or ethical obligations on financial service businesses,
it should do so directly; it might then wish to involve the FSA
in monitoring delivery. This is broadly the approach being followed
in the USA.
12 Treasury Progress Report,
March 1999, para 4.15 Back
B, para 11 Back
cit, para 15 Back
Promotion-a consultation document,
HM Treasury, March 1999, Part 5 Back
175, 180 Back
24, 32 Back
137, 149 Back
cit para 23 Back
178, 263 Back
Appendix 4, para 15 Back
Treasury Press Notice 5/98 Back
27, Appendix 7 Back
196, cp Farrow Q 415 Back
Boléat Q 182, Ross Goobey Q 184 Back
cit, para 34 Back
Hansard, 9th March 1999, col. 179 Back
November 1998, paras 4.18 - 4.19 Back