Command and control
29 September 2003
2 April 2014
29 July 2013
1 July 2013
28 May 2013
28 March 2014
The departure of Sir Howard Davies as chairman of the Financial Services Authority (FSA) is expected to mark a significant juncture for the financial services regulator. Sir Howard described himself as a specialist in 10-way mergers, having successfully amalgamated incongruent predecessor bodies into a credible single regulator for the financial services industry. His critics decry his lack of action on market abuse and point to high-profile failures, such as Independent and Equitable Life. Sir Howard's successors, Callum McCarthy and John Tiner - chairman and chief executive respectively - are expected to bring a more aggressive style of leadership to the FSA. McCarthy has indicated an intention to pursue his regulatory priorities with "ruthless determination". The first fine of the new regime, £1.9m against Lloyds TSB for mis-selling, came last week.
A more general trend in regulation
This anticipated new style of regulation at the FSA is indicative of a more general trend in regulation in the UK, where regulators are increasingly deploying a wide range of powerful regulatory weapons to ensure compliance with relevant rules and codes. Regulatory enforcement action can inflict enormous damage on companies and individuals. Reputations, which take decades to build, can be destroyed at the earliest stages of a regulatory investigation.
In many cases, the regulators' powers go beyond those of the police to investigate ordinary criminal activity. Unlike the police, most regulators have the power to compel directors and officers to answer questions - there is no right to silence.
The FSA has recently consolidated its powers by signing a Memorandum of Understanding with the City of London Police. Under the new agreement, the police will arrest individuals who have failed to comply voluntarily with a request from the regulators to be interviewed. It has wide powers to investigate suspected regulatory breaches, including the appointment of inspectors, the right to request documents and information and search and seizure powers.
A new power conferred by the Financial Services and Markets Act 2000 (FSMA) gives the FSA the power to require an authorised firm to appoint a 'skilled person' - usually a ma-jor law or accountancy firm - at the regulated firm's expense, to review a particular aspect of the firm's business. This power has proved extre-mely effective in assisting the FSA to focus its limited resources on oth-er issues. In addition, in response to a string of high-profile failures - notably, the collapse of Barings - the FSMA has created an enhanced regime for the individual approval of a regulated firm's senior management and other key personnel. The FSA exercises direct regulatory control over these individuals, who can be subject to individual discipline resulting in financial penalties and public censure. Sir Howard has said that when things go wrong, the FSA will look directly to senior management and will hold them accountable.
Nearly two years on...
In December 2002, a year after it assumed most of its new powers under the FSMA, many City commentators dismissed the FSA as ineffectual. However, the level of fines imposed by the FSA over the past year - amounting to more than £11m for the year ended 30 April 2003 - should dispel any notion that the regulator is not prepared to use its extensive enforcement powers to impose financial penalties that also inflict reputational damage on high-profile firms. In August 2003, Northern Bank was fined £1.3m for money laundering control failings, which it had identified but allowed to persist. In April 2003, Lincoln Assurance was fined £485,000 arising out of the actions of an appointed representative firm. And the fine was only part of the story for Lincoln, which also endured a past business review of more than 12,000 customers and paid £7.3m in redress.
In his valedictory round of interviews with the financial press, Sir Howard indicated that 12 cases of suspected insider dealing and market abuse - colloquially termed the 'dirty dozen' - are to be determined by the FSA or by the courts over the coming months. These will be the first cases brought under the FSA's new market abuse regime, which was introduced to tackle abuse of the UK's financial markets against which the insider dealing legislation had proved largely ineffective (see main feature, 'Tough Talking', page 22). The market abuse regime creates a range of civil offences, the breach of which can be punished with a financial penalty and public censure. The FSA has additional powers to seek injunctions and restitution orders on those who transgress.
'A new regulator for the new millennium'
In January 2000, the FSA published a major policy report entitled 'A new regulator for the new millennium'. In it, the FSA set out its plans for a new "risk-based approach to regulation" to integrate and simplify the different approaches of the predecessor regulators. A core theme of this paper was that the FSA would aim "to maintain a regime, which ensures as low an incidence of failure of regulated firms and markets as is consistent with the maintenance of competition and innovation in the markets". It was stressed that this objective would not deliver a "zero failure" regime, in that the FSA would seek to focus its finite resources on the threats to its regulatory objectives.
The FSA's regulatory objectives, which are enshrined in FSMA, are: maintaining market confidence; promoting public awareness; protecting consumers; and reducing financial crime. As part of the new risk-based approach, the FSA has segmented its regulated firms into categories A-D, where A is high risk and D is low. The A category accounts for only 1 per cent of the regulated community. The vast majority of firms, some 89 per cent, fall within the lowest risk D band. The level of regulatory attention is determined by the risk category into which a firm is placed: high risk will involve "close and continuous" supervision, while those in the low risk group are more likely to be subject to a remote monitoring approach, essentially through review of complaints and regulatory reporting. The FSA explained that it would use a "regulatory toolkit" to influence the behaviour of individual institutions. These tools included: the FSA's authorisation powers for firms and individuals; perimeter injunctions and prosecutions; supervision of firms, including desk-based reviews and on-site visits; investigations; and discipline and restitution.
The FSA's risk-based approach, which was implemented during 2001-02, faces two new challenges. The first is evidence that consumers have not fully appreciated what a 'non-zero failure' regime can deliver. The Consumer Panel, for example, in its Annual Report for 2002-03, notes that expectations of regulation may be higher than can reasonably be delivered. In response, and in Sir Howard's last week as chairman, the FSA published a paper entitled 'Reasonable expectations: regulation in a non-zero failure world'. The paper reinforces the proposition that, in competitive markets, unsuccessful firms may fail, and that the FSA seeks to meet its statutory objectives in a world of imperfect information and with finite resources. The second and arguably more significant challenge is that presented by mortgage and general insurance regulation, both of which will fall within the FSA's regulatory remit by January 2005. Up to 38,000 firms involved in mortgage and general insurance business and broking are expected to seek FSA authorisation. With a current base of around 12,000 regulated firms, the FSA's finite resources will be sorely stretched to process such a potentially large volume of applications within a prescribed period.
Although the details have yet to be published, it must be expected that mortgage and general insurance firms will be subject to a much less rigorous application process, but with a greater emphasis on the post-application tools, such as desk-based reviews, perimeter prosecutions and investigations.
Lessons from the FSA
All UK regulators face similar challenges of extensive remit, yet limited resource. In a recent interview with the Financial Times, Andrew Proctor, the FSA's head of enforcement, said that the FSA "needed to be seen to be making a credible threat". He added: "The last thing you want is for a sector to think it is immune." To reinforce this, the FSA increased its budget for enforcement for 2003 from £16.6m to £19m.
All the indicators point to a more robust enforcement stance by the FSA against firms and individuals in all areas of its regulatory remit. This means that regulated firms and individuals face new and urgent challenges. A first step in meeting those challenges is for those firms and individuals to recognise the shift to punitive regulation and to seek to identify, manage and contain relevant regulatory risks by focusing scarce compliance resources on the matters that the FSA has said are its priorities.
Peter Bibby is head of financial regulation at DLA and was assisted in this article by associate Samantha Linsley