Monday, October 29, 2012

Martin Wheatley Tells UK Parl. Commission that Proper Outcomes for Investors is Key to New Twin Peaks Financial Regulation

Martin Wheatley, UK Financial Services Authority Managing Director, and Chief Executive-designate of the new Financial Conduct Authority, told a Joint Select Parliamentary Commission on Banking Standards that the FCA will be guided by achieving the proper outcomes for investors and consumers of financial products. The FCA will have the ability to look closely at the financial products being designed and provided and, in extreme cases, use new regulatory powers to ban products

Andrew Tyrie MP, Commission Chair, asked how the FCA will know if a financial product is the right financial product for investors. Mr. Wheatley said that the FCA will not have a product pre-approval regime, adding that the Authority will not stand in the way of people innovating and taking new products to market. When something goes wrong, he noted, the FCA will step in and ask of the product is the wrong product for the investor class it is being sold to. It is all about outcomes, he said, getting the right outcomes for investors and consumers of financial products. He noted that good financial products sold badly become poor outcomes for investors. It is question of whether investors are getting good or bad outcomes. For example, some complex products could be appropriate for some investors, he noted, but not for others. The FCA will not say that a financial product is unsuitable in all circumstances. It will often be an individual facts and circumstances decision. The FCA will look at a firm’s governance, its target market and how it is selling to that market.

Asked if there should be a benchmark of plain vanilla financial products, the Director said that it would be difficult for the FCA to bless plain vanilla products because even those products could have bad outcomes for investors and consumers if sold in the wrong way and to the wrong market.

Asked by Chairman Tyrie if the FCA would create a safe harbor for a product, the Director said that the FCA could do that but it would be at a high cost since the agency would have to go through a great amount of detail and bring a great amount of expertise to bear in order to give such assurance. It would not be possible to develop this expertise on every financial product before it is launched, he said, nor would the FCA do it randomly. The FCA would do it if the agency perceived a financial product was causing bad outcomes for investors.

Lord Lawson emphasized the need the for reform of incentive-based compensation regimes, such as bonuses, at financial firms.  The Director noted that a compensation regime of incentives focused on short-term profits led to excessive risk-taking at financial firms. A change in accounting standards could help by discouraging the booking of profits up front on long-term trades and linking bonuses to that. Accounting standards could require amortization over a longer term. He also said that legislation capping bonuses that can be paid would be helpful in changing the current culture, as well as requiring that bonuses be paid over a longer period and that there be clawback of bonuses under certain circumstances. In addition, as a best practice, the FSA is asking financial firms to design their incentive compensation regimes  to produce good outcomes for investors. This would be outside of statutory intervention.

Andrew Love MP, noted that insider trading is widespread but extremely difficult to prosecute, adding that the UK does not bring as many enforcement actions for insider trading as the US. Mr. Wheatley noted that the FSA is taking a robust approach to insider trading and taking on complex and difficult cases. He noted that, under the UK sentencing structure, UK courts do not give as high a sentence for insider trading as US courts. There are two main differences between the US and the UK in this area, he said. First, in the UK, wiretaps are not available to the authorities in insider trading cases and, second, because of high sentences in the US, often someone will turn state’s witness.

Baroness Kramer noted that whistleblowers seem to have more incentives in the US and asked if the FSA has looked at enhancing the use of whistleblowers. The Director said that the FSA has not looked at the incentive structure, but added that the FSA does have whistleblowers come forward and does provide protection, but it is not at the same scale as in the US. Chairman Tyrie noted that the Commission is looking into legislation to enhance whistleblowing, adding that the central question is what incentives can be provided without creating a moral hazard.