[1]

Is it a case of too little, too late? The Financial Services Authority (FSA) plans to get tougher and come down harder on those who breach its rules. To that end, it's beefed up its comments to the outside world and is hiring more staff in anticipation of needing extra hands on deck to deal with miscreants.

But of course on May 7th, the FSA's days could well be numbered. An incoming Tory administration would theoretically spell the end for the FSA. The Conservatives want to introduce a split regulatory system, with the Bank of England regulating the banks and a new Consumer Protection Agency to safeguard the interest of the consumer.

With that threat looming over it, the FSA is making every effort to argue that things can only get better and that it can step up to the regulatory mark. That means no more Mr Nice Guy, according to FSA chief exec Hector Sants who has called time on "light-touch" or "principles-based" regulation. Whats needed now is an "outcomes-based" approach he told Oxford University's Saïd Business School last week.

The first step in putting things right lies in admitting and accepting that they went wrong in the first place. To that end, Sants is positively penitent. "At the end of the day you'd have to say the results were not acceptable to society and therefore it is right that we should change and step in earlier,” he said. "The old FSA's reactive philosophy focused on ensuring firms had the appropriate systems and controls. Judgements were rarely made on the consequences of management actions.

"[There] was the inability to spot and prevent major risks from crystallising, resulting in damage to consumer and market confidence and ultimately consumer harm," he added.  "Even though in these situations we have delivered redress, firms have continued to make substantial profits from exploiting market failures. Fines and past business reviews are proven not to be a sufficient deterrent. Essentially, our focus has been too late in the product lifecycle to ensure that we identify potential issues early enough to prevent consumer detriment."

A change in approach

So a entire change of philosophy is called for, he argued. "A regulator must be willing to place themselves between consumers and harm. We will only achieve this by taking a proactive stance,” he said. "A successful consumer protection strategy must restore consumer confidence in the financial market place A key element of restoring that confidence is that the consumer can trust the regulator. This strategy will restore trust in the regulator and will benefit everyone, consumers and providers."

Sants new “outcomes-based” approach would see the FSA intervene directly if it thinks a particular financial product is likely to be mis-sold and "take a view" as to whether it should be allowed. This will be supported not just by official onsite visits of banks, building societies and other financial services providers. "There will also be a greater willingness to test outcomes through mystery shopping and on-site visits," promised Sants.

It's all about a change from reactive to proactive thinking, he argues. "[The old-style] was a retrospective form of regulation. Intervention needed to be based on observable historical facts,” explained Sants. "The new outcomes-based approach is centred on intervening in a proactive way, and judging the future decisions of firms based on business model and other analysis. We will now seek to proactively intervene earlier in the product chain to anticipate consumer detriment and choke it off before it occurs.”

Working in practice

That all sounds sensible in theory, but clearly the effectiveness of the strategy can only be judged in itsexecution.  “The mechanism for achieving this has three key strands,” argued Sants. “First, seeking to improve the long term efficiency and fairness of the market. This builds on initiatives we have recently undertaken such as the Mortgage Market Review.

Second, delivering intensive supervision of firms. The new supervisory approach will ensure firms treat their customers fairly and will equip the FSA to intervene earlier in the development of retail products. Interventions of this nature which necessarily involve us making a judgment on potential detriment will need to be based on sound business-model analysis and integrated firm-risk assessment. Third, in the event that failure has occurred we will secure the appropriate level of redress and compensation (when justified), and achieve effective credible deterrence by taking tough action against firms and individuals who have transgressed."

All of this is going to come with a price tag as the new approach will by necessity be resource-hungry. So it's not surprising than that the FSA is making a pitch for an extra £41 million of funding to hire an extra 460 staff for a crackdown in insider dealing.

As for that Tory threat of extinction for the FSA, Sants was diplomatic enough to steer clear of direct comment. But he did distance the FSA from taking all the blame for lax regulation contributing to the economic crisis. "Poor risk management was a key driver of the crisis," he insisted.

"My personal view is that if we really do wish to learn lessons from the past, we need to change not just the regulatory rules and supervisory approach, but also the culture and attitudes of both society as a whole, and the management of major financial firms. At the heart of the challenge is the need to restore trust. In particular society's trust in the regulatory authorities and financial market participants.”