Financial Conduct Authority: all change in regulation

The Financial Services Authority’s Jeremy Heales explains how its successor, the Financial Conduct Authority, will help customers and seek to improve the integrity of the system.

In a major restructuring of how the UK’s banks and other financial services are overseen, the Financial Services Authority (FSA) is due to be split into two successors next March: the Prudential Regulatory Authority (PRA) and Financial Conduct Authority (FCA).

A formal launch document will be published in October but the basic concept is already clear.  Jeremy Heales is overseeing the formation of the FCA, which will mainly regulate how financial institutions treat their customers.

“One of the key drivers is to get regulators to focus [more] on prudential activities: the capital, the liquidity, the stability of the marketplace, which is what the prudential authority will do,” he explains. “So that’s a clear focus, and they will focus very much on the financial health of a firm and ensuring the stability of the market overall.”  In the medium-to-long term, this should minimise the cost to taxpayers.

Heales continues: “The other focus then is on conduct and the selling of products to consumers, ensuring that people get the best product, that they’re not being fleeced, and that when there are problems that they get redressed.”

This reform follows on from criticism of the FSA’s performance in the financial crisis and a Conservative Party manifesto commitment to separate out its functions.  The Financial Conduct Authority will have responsibility for around 27,000 financial services firms.  Of these, 2,000 will be dual regulated (e.g. the main banks), where the PRA will take the lead on prudential regulation while the FCA will oversee their conduct.

“We want to make sure that we have, and can get, better outcomes for consumers,” Heales explains, adding that this will involve more early intervention.  The
mis-selling of payment protection insurance is likely to cost the industry £9 billion but, in future, the FCA will “try to stop those things happening before it’s too late rather than clearing up the messes.”

In practice, the authority will focus much more on a firm’s business model e.g. questioning whether a product with a 50 per cent return constitutes abnormal profit-making and challenging senior managers on how they are planning their three-to-five year business cycle.

Consequences

The FCA will also have the power to ban financial products quickly and then consult with the firm and the industry on whether the decision was right.  At present, the consultation comes before the ban, which works against consumers’ interests.

This power will be used in a “professional and sensible” manner.  A firm will be questioned if it is selling a clearly unsuitable product to consumers who have little financial knowledge.  However, Heales cautions against a blanket approach.

“If you ban something, or stop something, to people who are struggling already, do you then put those people into an even worse position, going to an unauthorised money-lender?” he suggests.  “You’ve just got to think about the unintended consequences of taking an action, to not make things worse.”

Legislation on the authority’s new power of competition has been “drafted quite widely” and Heales and his team are now defining what that will mean in practice.  The Office of Fair Trading is separately working on how to tackle anti-competitive practices found in package bank accounts and mobile phone insurance.

Again, the FCA will be need to be wary about how taking action in one area could have unintended consequences in another area.  Closing down three or four independent financial advisors who are selling a particular insurance product could leave two other firms in the market and allow them to put their prices up.

In general, the FCA will want to be more open and transparent about what it will and will not do with its resources.  “Clearly, there’s always a trade-off between the cost that the industry and ultimately consumers will pay and how much politicians and [the] public expect us to be doing,” he notes.

The authority will not be able to visit and review every firm every year.  However, it does plan to build stronger links with firms and consumer bodies such as Which? magazine and trading standards services.  These “intelligence networks” will provide a more systematic way to identify problems at an earlier stage.  While the FCA has no plans to open an office in Northern Ireland, it does want to build up its contacts in all regions of the UK (not just London).

Discussions on closer co-ordination between the EU’s financial regulators are continuing and the FSA is “absolutely committed” to representing the UK’s interests in those talks:  “We know it’s really important to engage with Europe rather than being on the sidelines so that will continue.”

Culture

Reflecting on the crisis, he notes that the FSA has “quite a large number of legacy issues” e.g. the Libor case and interest rate swaps.  Since 2008, the regulator has tried to be “more rigorous in its approach to engagement with firms” and has also invested heavily in improving the capability and quality of its staff.

The relationship between firms and the regulator “still has a long way to go” to meet the FSA’s expectations.  In summary, the regulator is seeking a culture where firms:

• think in a more long-term way;
• put customers and consumers at the heart of their operations; and
• ensure that they have a culture of “doing the right thing” by reporting difficulties to the regulator and paying redress quickly to customers.

He was speaking a day after seven banks agreed to review the sale of insurance to small businesses, which followed an FSA investigation into alleged mis-selling by other banks: “We want more firms to do the right thing rather than us having to tell them to do the right things,” Heales states, “and that’s got to come from the top and the senior people across the organisations that we are dealing with.”

That said, the regulator cannot achieve that culture change on its own, and neither can firms, consumers or politicians.  All stakeholders must “come to the table and do their bit to repair the damage that has happened over recent years.”