Sunday, March 06, 2011

FSA Chief Envisions New UK Financial Conduct Authority as Interventionist, Consumer-Driven and Primarily Rules-Based

The role of the Financial Conduct Authority under the UK’s new financial regulatory regime should emphasize early and pro-active intervention, strong enforcement and redress, and a determination to improve the consumer experience, in the view of Financial Services Authority Chief Executive Hector Sants. In recent remarks, he said that budget concerns will probably prevent the FCA from being an inpections-based regime. He also noted that the FCA will hold the UK’s seat on the new European Securities and Markets Authority.

The Government proposes to replace the FSA with three new bodies: The Financial Policy Committee will be a macro-prudential regulator ensuring the stability of the financial system. The Prudential Regulatory Authority will oversee banks and other financial institutions. The Financial Conduct Authority will regulate financial firms across the entire spectrum of financial services. Mr. Sants noted that, after the changeover, the FCA will be overseeing some 27,000 financial firms, with prudential responsibility for approximately 25,000 of the 27,000 firms, with oversight of only 2,000 shared with the new Prudential Regulatory Authority.

In the view of the FSA, the pro-active and intense regulation envisioned for the FCA will be based on the premise that the degree of consumer detriment seen over the last decade has been unacceptable and must give way to a more interventionist style of regulation. At the same time, the senior official assured that this new approach does not mean that the FCA will be seeking to eliminate all risks, nor will it seek to absolve consumers of responsibility for their own decisions.There will be four key elements of the new regulatory approach. First, the FCA will address structural deficiencies in sectors and the market as a whole which limit or impair consumer choice.

Second, the FCA will intensively supervise firms to ensure that they are treating customers fairly, focusing on point of sale practices, product manufacturing frameworks and firms’ governance. Third, the FCA will make pro-active product-based interventions when sound business analysis shows the product is likely to cause more harm than benefit. Fourth, the new regime will ensure that, if a financial firm fails, the appropriate level of redress and compensation is achieved and action is taken against firms and individuals to deliver effective credible deterrence

Mr. Sants does not envision the FCA as an inspection-based regime since budgetary concerns involved in inspecting 27,000 firms would be insurmountable. Providing the FCA with sufficient resources to deliver an inspection based model would lead to a multiple increase in headcount that would, in turn, lead to cost and fee levels that would be seen as unacceptable by industry and ultimately by consumers.
The FCA’s primary approach to prudential regulation should be consumer protection, emphasized the FSA chief, and not promoting the sustainability of these institutions.

Rather, the FCA should focus on ensuring that their capital and liquidity is sufficient to allow an orderly run off without material consumer detriment or impact on market integrity. He called this a ``gone concern’’ approach. There will, however, be exceptions to this approach for financially systemic firms, such as very large asset managers. In order to carry out its consumer protection mission, the FCA will need stronger powers of intervention than the FSA currently has. Mr. Sants supports the concept of power to intervene to ban specific products.

The Treasury’s draft legislation raises the possibility of the FCA having formal powers to refer firms to the competition authority and to make formal market investigations to determine whether such referrals are necessary. The FSA official supports these proposals, which would give added authority to the FCA’s role in improving market efficiency and ensuring consumer choice. However, he cautioned that these new powers would require both consumers and the industry to trust the FCA and its judgments. Underpinning this trust will need to be a commitment to transparency and accountability. The FCA must establish an effective mechanism for understanding both consumer needs and preferences, and equally important, ensuring consumers that their views will be taken into account in the FCA’s decision-making.

Another key element of the FCA’s approach to policy making will be striking the right balance between rules and principles. The senior official expects the FCA to shift towards more detailed prescription. Effective enforcement and redress requires clarity of responsibilities and a process which can stand up to external scrutiny. It is thus inevitable that a conduct regime will lean more towards rules than principles as this is a necessary consequence of its focused objectives. However, this should not be seen as undermining the need for firms themselves to have a strong cultural framework encouraging employees to behave in a principled manner.

Regarding market regulation under the new regime, the central bank will regulate clearing and settlement, while the rest of the FSA’s markets regulatory functions, including the UK Listing Authority, will move to the FCA. In the view of the FSA, the creation of the FCA provides an opportunity to take a fresh look at how wholesale conduct issues are addressed. This is an area where the FSA has undertaken a number of pieces of work over the years, but initiatives in this area have been overshadowed by a focus on market abuse.

Wholesale conduct is defined as a firm’s behavior in relation to market activities, said Mr. Sants, and to their dealings with informed clients. Failings in this area often reflect systems and controls weaknesses at firms and many relate to failures to manage conflicts of interest. He emphasized that the FCA must be prepared to intervene early to deal with emerging wholesale conduct issues, particularly where these have a link to retail markets and consumers. If necessary, the FCA should develop additional regulatory requirements for wholesale market participants where market discipline alone is not delivering appropriate standards.

The increased focus by the FCA on wholesale conduct needs to be achieved while continuing to recognize the difference between investor protection and consumer protection. Central to effective wholesale markets, he noted, and more broadly the operation of stock markets for retail investors, is the premise that an informed investor equipped with the full disclosure of risks is entitled to make mistakes.

The FSA also expects the FCA to build on the credible deterrence strategy that the FSA has followed successfully since its adoption in 2007. According to Mr. Sants, this strategy has shown particular success in relation to criminal prosecutions for insider dealing and the FCA will continue to vigorously pursue such cases in the future

As of 1 January 2011, the EU created the European Securities and Markets Authority (ESMA) as a key EU policy making forum, leaving the FSA and its successor bodies primarily acting in a policy influencing and national regulatory role. In light of this development, Mr. Sants said it was vitally important that the UK organize itself to effectively influence decision-making in the wider European framework.

While the FCA will be represented within ESMA., noted the official, the new EU financial regulatory regime is organized around activities and does not map exactly to the UK’s regulatory structure. As such, ESMA will cover both prudential and conduct of business issues. It is vital, therefore, that the UK achieve effective domestic coordination and cooperation between the regulatory authorities to ensure that its views are best represented.

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