Vapid response? FSA shortcomings
18 November 2008
There have been two interesting revelations recently from Financial Services Authority (FSA) chief executive Hector Sants and FSA chair Lord Turner.
First was the admission that the FSA has been a “light touch” regulator; the second was that the FSA has been doing regulation “on the cheap”. It appears that both of these are about to change. From now on there will be no more Mr Nice Guy when the FSA supervisor calls, and firms will have to get used to forking out more pay for more regulators.
These changes raise some key questions on the interaction between regulator and regulated. Is the end of light-touch regulation the end for principles-based regulation? And what will these highly paid regulators do differently from their predecessors?
Not so long ago the FSA would bristle at the suggestion that using principles meant a light touch. As the then FSA chairman Callum McCarthy said in June: “There’s nothing light or soft about the use of principles. Indeed, I’d remind anyone so misguided as to believe that principles are less demanding than rules, that principles confer flexibility on the regulator.”
Those who have to apply the detailed guidance created by the FSA under the theme of ‘Treating Customers Fairly’ will attest to the truth of this statement. While the FSA cannot abandon its commitment to a principles-based regime without losing credibility, it has no need to do so if it wants to operate with a heavy touch.
Principles-based regulation will survive as a concept, but will continue to be laced with prescription. Detailed rules can be imposed as seen fit, a recent example being the introduction of the FSA’s short-selling measures.
Although branded by the FSA as being within “a principles-based philosophy”, there was nothing principles-based about the prohibition – an activity that was lawful one day and prohibited the next.
Even without specific rules, prescriptive guidance can serve a similar purpose. A current trend is for the FSA to set out what it considers to be good and bad practice in an area. Firms are wise to treat ‘bad practice’ as synonymous with proscribed behaviour.
Change is likely to be far more visible in the way FSA staff behave. There will undoubtedly be a more interventionist approach to supervision. News that the FSA is now interviewing those who have applied to hold certain “significant influence functions”, as the FSA terms it, is a good example of this, as is the increasingly early involvement of enforcement staff where supervisors have raised issues with firms.
Under the FSA’s risk-based supervision framework, institutions of systemic importance – the very institutions that have been at the heart of recent market events – already enjoy “close and continuous” supervision, according to the regulator. Notwithstanding this, the FSA feels that it did not have sufficient grip on the issues that led to or exacerbated the turmoil. This has been blamed in part on the discussions between regulator and regulated not being tough or challenging enough. The FSA’s view is that it needs better-quality and better-trained staff to have such discussions.
Those who have dealings with the FSA refer to the quality of supervision as variable, and it is not uncommon to hear of a lack of open and helpful dialogue with the regulator. Examples include outlining proposals to supervisors to no immediate response, only to receive later communication from the FSA that it does not consider the firm’s proposals to be consistent with regulatory requirements. When a firm looks for guidance as to how best it might alter its proposals, the FSA’s reply is often that this is a matter for the firm and that the FSA will only consider any proposals that are put to it formally – a sort of regulatory 20 questions.
Plainly this is unsatisfactory, and merely adding toughness and challenge to this mix will not help either the FSA or the regulated community.
This unwillingness to engage in open discussion may be an issue of self-confidence on the part of some within the FSA, an issue that better staff may help cure. Undoubtedly those at regulated firms will have to live with a greater challenge from supervisors, but they should also expect a greater willingness on the part of the FSA to engage in more helpful and responsive dialogue.
Carlos Conceicao is a partner at Clifford Chance