Bill Warren is compliance director at Complete Mortgage and Loan service (CMLS)
Complete Mortgage and Loan Services
Not many readers, I’m sure, will know the Financial Services Authority’s (FSA) 11 high level principles off by heart, so here’s a condensed version of what they contain. All the principles relate to the ‘firm’ and they fall into three groups: how the firm runs itself, how it deals with its customers, and how it deals with the FSA. In this first group (principles one to five) firms must conduct their business with integrity, skill, care and diligence; they must control their affairs and have proper risk management systems; they must have adequate financial resources; and must observe proper standards of market conduct. In the second group (principles six to 10), the firm must treat customers fairly; communicate with them in a way that is clear, fair, and not misleading; manage conflicts of interest fairly; give them suitable advice; and protect their assets adequately. The final principle is about open and honest communication with the FSA. ‘Treating Customers Fairly’ (TCF) is perhaps the best known of these, mainly because the regulator is spearheading its move to principles-based regulation with the TCF concept, but we should all be familiar with many others in our day-to-day dealings with customers and the way we run our businesses.
Affirming the FSA’s aim
In his foreword to the FSA’s ‘Better Regulation Action Plan’, published in December 2005, John Tiner affirmed the FSA’s aim to shift the current hybrid of high level principles and detailed rules and guidance ‘significantly towards a more principles-based approach’. This latter aim is now being continually reiterated in major speeches and announcements, so we can be sure that principles-based regulation will be implemented as soon as it possibly can be.
The mortgage and general insurance sectors are relative newcomers to regulation, and many senior management that are responsible for upholding the 11 high level principles may be feeling it is a bit unfair to land them with a new sort of regulation when they have only just got to grips with the old one. However, the idea of ‘better regulation’ (of which the FSA’s principles-based regulation is part) is not new. Regulation is not confined to the financial services sector: it exists across all industry sectors, and there is a substantial amount of new regulation generated by the EC to add to whatever our own government imposes. However, the detrimental effects of too much regulation are understood, and for at least 20 years there have been efforts to improve and streamline regulation to enable industry, and especially small businesses to function better.
What started life in the mid 1980s as the Enterprise and Deregulation Unit finally became the current Better Regulation Executive in May 2005 – which coincided with Gordon Brown announcing his Better Regulation Action Plan ‘to boost flexibility and enterprise’, which would replace the old regulatory model with a risk-based approach. Seen in this wider context, the FSA’s move to a more principles-based approach is part of an overall policy to reconcile the needs of safeguarding consumer interests while still allowing businesses to operate without being strangled by red tape, or excessive additional regulation-related costs.
As so much of the information on principles-based regulation comes out of the FSA under the TCF banner, it makes sense to use this initiative to understand the wider concept. In a speech delivered in July, Clive Briault – the FSA’s managing director, retail markets, summarised many of the issues surrounding TCF, as part of the wider principles-based approach. The most important reason for adopting principles-based regulation is viewed as achieving a better outcome for consumers, investors and markets.
In the TCF initiative, the delivery of six consumer outcomes is identified. In summary these are: consumers are confident that they are dealing with firms that have TCF as central to their corporate culture; products are designed for, and marketed to specific groups of consumers; consumers get good information during and after the sale; all advice received by consumers is suitable and takes account of their circumstances; products and services are and continue to be what consumers have been led to expect; and that consumers do not face post-sale barriers with regard to the changing of products, providers, claims submission or complaints.
Four delivery mechanisms for principles-based regulation to achieve these outcomes are outlined. The first is senior management commitment to, and responsibility for, upholding the principles and the second is that principles-based regulation should allow firms more flexibility to deliver fair customer treatment in a way that is consistent with their commercial objectives. Thirdly, providing flexibility rather than prescribing detailed processes should enable forms to compete and innovate more effectively. Finally, the delivery mechanism can be reinforced by the FSA through its work on improving consumers’ financial capability, more principles-based supervision, and enforcement action against firms and their senior management that fail to uphold the principles.
Areas where rules are going to be reduced include conduct of business rules, Financial Promotions and complaints handling – but many detailed rules must remain because of the obligation to implement EU directives that are heavily prescriptive rather than principles-based. It is also fully understood that regulated firms must be provided with ‘predictability’ – i.e. that the goal posts stay in the same place. Once the rules have been reduced, this predictability will be provided in various non-prescriptive ways, including examples of good and bad practice and case studies. Greater use will also be made of specific industry codes of practice and guidelines, and the FSA is revisiting how far it can accept that a firm following its own sector’s code of conduct/ guidelines is meeting its minimum standards in that area.
Serious concerns
This issue of predictability is where the most serious concerns about principles-based regulation are focused. In his foreword to the joint FSA and Financial Services Practitioner Panel (FSPP) report into the cost of regulation, the FSPP’s chairman, Roy Leighton, states that he hopes a more principles-based approach to regulation will help to reduce costs as it will enable firms to decide the best processes for themselves to demonstrate a satisfactory outcome. However, he voices the following reservation: “There is a real and growing fear among practitioners that the FSA and its staff will fail to supervise and enforce against principles in the manner and spirit that it says it will. As a result, firms will not have sufficient confidence to exercise their own judgement.” Going back to the Clive Briault speech, the FSA does recognise that confidence in principles-based regulation can only be achieved by a highly trained supervision team that delivers consistent rulings, and part of the FSA’s own internal preparation for principles-based regulation has been investment in the recruitment and training of high quality professional supervision staff.
Looking at the shift
A good example of the move to a more principles-based approach can already be found in the final notices issued to firms that have gone though the full enforcement process. These always headline the firm’s failures in terms of the principles that have been transgressed, before any mention is made of rules. The principles cited most frequently are those that relate to conducting business with due care, skill and diligence; having adequate systems and controls; treating customers fairly; communicating in a way that is clear fair and not misleading; and informing the FSA about matters it needs to know about. The emphasis that enforcement final notices place on the principles demonstrates how principles-based regulation is going to work in general. In other words, in future, regulated firms should be relating everything they do (and how they record it) much more strongly to how they are upholding the principles, rather than how they are abiding by the rules.
Most change is hard to accept, and change imposed by the regulators could be resented by those that view the new approach as something designed to catch them out in a sneaky, underhand way by removing all the rules. This is far from the case, and the FSA is on record as absolutely not looking to catch firms out by finding some aspect of their behaviour that falls slightly short of meeting all its requirements. Taking a more positive view, although principles-based regulation will present a big challenge to senior management and compliance officers, the greater flexibility for every firm – especially the smaller ones – to find their own way of upholding the principles should bring enormous benefits in terms of greater productivity and higher levels of customer service.
