Joint Committee on Financial Services and Markets First Report


Introduction: the concept of statutory objectives and principles

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".[12]

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 competitiveness

·  No unnecessary distortion of competition.

22. Mr Davies explained to us[13] 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 to account.

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".[14]

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.

Consumer Protection


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.[15] 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".[16] It goes on, "The Government...will consider ways in which the drafting of Clause 5 might be clarified or improved."[17]

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.[18] 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"[19].

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.[20] 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".[21]

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.[22] 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.[23]

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.[24] This is not a matter for the Bill, nor one on which we have taken evidence; we make no recommendation.

Caveat emptor

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".[25] 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".[26] 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".[27]

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.[28] 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.[29]

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 skills".[30] 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".[31]

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".[32] The Minister told us that this provision was being redrafted.[33]

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 general public.

Definition of consumer protection; fitness for purpose

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.[34] 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".[35] The NCC are supported in this by the FSA Consumer Panel.[36]

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.[37] And in any case, as Mr Garry Heath, Director-General of the IFAA, pointed out,[38] 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 this area.[39] 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 the product.

  • There is a serious risk that product regulation would reduce competition and innovation, to the ultimate detriment of consumers.

Market Confidence

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".[40]

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;[41] 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.[42] The Minister told us[43] 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.[44] The NCC support this;[45] 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 an objective.[46]

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".[47] Mr Robin Hutton, Director of Regulation for the merchant banking group Singer & Friedlander, takes the Government's side on this.[48]

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,[49] and would impede co-operation with overseas regulators.[50] The Minister told us that ensuring competition was the primary task of the Office of Fair Trading (OFT), not of the FSA;[51] 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;[52] this goes beyond the requirement on the existing SROs to take account of compliance costs.[53]

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.[54] 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 business.[55] 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.[56] They added that compliance costs are difficult to disaggregate from the costs of good business practice,[57] 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.

Public Awareness

55. The IFAA welcome the public awareness objective,[58] which in their view will enable the FSA to fit consumers for their caveat emptor responsibilities.[59] So do the Securities Institute;[60] 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.[61]

56. The Minister put it to us that well informed consumers are "a source of competitiveness".[62] 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.[63]

57. The Treasury Select Committee observed that an essential part of public awareness is "Accurate, comparable information from product providers".[64] 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".[65] Mr Bernard Jones, Chairman of the IFFA, observed that performance can be much more important than costs and charges;[66] FSA Consultation Paper 15 Promoting public understanding of financial services raises the possibility of publishing quality comparisons as well.[67] The ABI said that many such tables are published already, and "the overall impact of this on consumers is not a lot".[68]

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.

Financial Crime

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 prevent financial crime, facilitate its detection and monitor its incidence". According to the Progress Report,[69] "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".[70]

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

13  Q 22 Back

14  Annex B, para 11 Back

15  Op cit, para 15 Back

16  para 4.8 Back

17  para 4.12 Back

18  Q 141 Back

19  Q 260 Back

20  Q 26 Back

21  Q 142 Back

22  Q 143 Back

23  Financial Promotion-a consultation document, HM Treasury, March 1999, Part 5 Back

24  Q 144 Back

25  Cl. 5(2)(c) Back

26  para 4.9 Back

27  para 4.10 Back

28  QQ 175, 180 Back

29  Q 151 Back

30  Q 148 Back

31  Q 339 Back

32  QQ 24, 32 Back

33  Q 101 Back

34  QQ 137, 149 Back

35  Q 153 Back

36  Q 339 Back

37  Q 159 Back

38  Q 168 Back

39  Q 187 Back

40  para 4.5 Back

41  Q 28 Back

42  Q 29 Back

43  Q 104 Back

44  Op cit para 23 Back

45  Q 166 Back

46  QQ 178, 263 Back

47  para 4.16 Back

48  Q 162 Back

49  cp Appendix 4, para 15 Back

50  Q 34 Back

51  Q 105 Back

52  Cl. 85(2) Back

53  see Treasury Press Notice 5/98 Back

54  Q 27, Appendix 7 Back

55  Q 196, cp Farrow Q 415 Back

56  Q 413 Back

57  Q 414 Back

58  Cl. 4 Back

59  Q 151 Back

60  Q 263 Back

61  Q 31 Back

62  Q 107 Back

63  e.g. Boléat Q 182, Ross Goobey Q 184 Back

64  Op cit, para 34 Back

65  Commons Hansard, 9th March 1999, col. 179 Back

66  Q 169 Back

67  FSA, November 1998, paras 4.18 - 4.19 Back

68  Q 181 Back

69  para 4.14 Back

70  para 4.18 Back

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Prepared 29 April 1999