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Can new regulator improve on the failings of the FSA?

On February 17, the Treasury published its latest consultation document, called A new approach to financial regulation: building a stronger system. It sets out a number of laudable regulatory principles which will be at the heart of the new regulatory system. Few would quarrel with them.

The problem is that when one looks at the current and recent performance of the FSA, it is reasonable to ask whether the new Financial Conduct Authority will be able to live up to those principles, especially as the FCA will inevitably be staffed and run by more or less the same people who are now in the FSA.

It is instructive to look at the first two of those principles. The first is that the FCA must take responsibility for using “its resources in the most efficient and economic way”.

The second principle is that “a burden or restriction imposed on a person or activity should be proportionate to the benefits which are expected to result… Proportionality also means that the regulator must tailor its actions to the specific characteristics of the sector being regulated…”

Neither of these principles looks new or revolutionary. It is fair, therefore, to consider how well the FSA has done in practice to live up to them.

The FSA is a huge organisation and if it does not have the skills in house it is able to call on all the skills and brains in the UK. Yet it missed the problems at Northern Rock which caused that firm to collapse. Chief executive Hector Sants had to concede in public: “As we have already made clear, the failure of Northern Rock should first and foremost be attributed to the failure of its board and executive to create a durable funding model…Nevertheless, the FSA acknowledges that its supervision of Northern Rock…was not of sufficient intensity or appropriate rigour to challenge the company’s board and executive on their risk management practices and their understanding of the risks posed by their business model.”

In other words, the FSA ought to sharpen up its act. This is not a good example of the organisation using its resources efficiently and economically. Neither is it a good example of the proportionate allocation of its resources. What was the FSA busy doing while Northern Rock was going bust?

Look at HBOS. Up to the end of 2004, Paul Moore was its head of group risk. He was dismissed. Early in 2009, he gave written evidence to the Treasury select committee and became known as the HBOS whistle-blower.

In his written evidence, he said: “When I was head of group regulatory risk at HBOS, I certainly knew that the bank was going too fast (and told them), had a cultural indisposition to challenge (and told them) and was a serious risk to financial stability (what the FSA calls maintaining market confidence) and consumer protection (and told them). I told the board they ought to slow down but was prevented from having this properly minuted by the CFO. I told them that their sales culture was significantly out of balance with their systems and controls.”

As a result of his disclosures, the FSA felt compelled to issue a press release on February 11, 2009. It speaks volumes about the FSA’s own performance as well as that of HBOS. The FSA said that it had carried out a full risk assessment of HBOS in late 2002, in which “it identified a need to strengthen the control infra- structure within the group”.

Another risk assessment followed a skilled person’s report in 2004 and the FSA concluded “that the risk profile of the group had improved…but that the group risk functions still needed to enhance their ability to influence the business…”

After Paul Moore’s dismissal at the end of 2004, the FSA continued to pursue its concerns, and wrote to HBOS on June 29, 2006 – that is about 18 months after Moore’s dismissal – with yet a further risk assessment.

The FSA’s letter said there were still control issues and it would closely track progress in this area. In its letter, the FSA added that “the growth strategy of the group posed risks to the whole group and that these risks must be managed and mitigated”.

Not long afterwards, HBOS failed – a full six years after the FSA’s 2002 risk assessment.

That press release begs the question of what steps the FSA itself took to ensure the risks to the whole group were indeed managed and mitigated, and why, if the FSA did act, did HBOS still fail?

Again, the picture is of a regulator being inefficient and ineffective. It had spotted the problem but had not done anything effective about it. Both the examples of Northern Rock and HBOS suggest that the FSA was not allocating its resources appropriately or proportionately. The lesson in both cases was that it needed to sharpen up its act.

The HBOS case is particularly shocking. The FSA itself said in the press release quoted above that it was aware of the fundamental problem at HBOS – that of the group’s growth strategy posing risks for the whole group – but it plainly failed to bring about a sufficient change to prevent failure.

It will not do for the FSA to say in reply that it cannot be expected to eliminate the risk of firms failing, because it was on to the HBOS problem. It had all the powers it could possibly have needed to bring about a radical change. In the interests of the country, why did it not use those powers effectively?

We still await a report about HBOS and a full report about the Royal Bank of Scotland. It will not be a surprise if the general conclusions relating to the FSA’s own performance are that it failed to act properly or in time.

The fourth principle in the Treasury’s consultation document is that senior management of authorised firms are responsible for securing compliance with the regulatory framework. The FCA cannot be expected to replace the proper decision-takers.

The Treasury’s document goes on to say: “The FCA, however, will be expected to hold senior management accountable for ensuring that their firms meet regulatory standards and to be prepared to take action if they fail to do so”. There has been no significant action by the FSA in relation to the senior management of Northern Rock, HBOS, or for that matter, RBS.

When the FSA announced it had completed its investigation into RBS in December 2010, the FSA said its “review confirmed that RBS made a series of bad decisions … However, these bad decisions were not the result of a lack of integrity by any individual and we did not identify any instances of fraud or dishonest activity by RBS senior individuals or a failure of governance by the board The issues we investigated do not warrant us taking any enforcement action, either against the firm or against individuals”.

So why did RBS fail? When the FSA made its announcement, there was widespread outrage and disbelief that despite the finding of “bad decisions”, no one was found to be at fault.

Will things be different when the FSA becomes the FCA? To believe so would be a triumph of hope over experience.

Peter Hamilton is a barrister specialising in financial services at 4 Pump Court


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There are 14 comments at the moment, we would love to hear your opinion too.

  1. “Will things be different when the FSA becomes the FCA? To believe so would be a triumph of hope over experience”.
    No Peter, there will be no difference. The FCA will be staffed and controlled by the same people who are known as the FSA at present.
    They will have the same mindset which sees them pursue IFAs to the grave whilst at the same time finding any wrongdoing at the banks can not be pinned on anyone in particular. If and when the FCA fail it will once again be because of “collective intellectual failure on a global scale” not anything of their doing or lack of it.
    The only thing that will change is the stationery and on the name above the door the S will become a C.
    All for a cost to the industry of Billions.
    Did I mention their bonus system?

  2. Lautro, FIMBRA, PIA, FSA all FAILED next FCA.
    Another huge stationary cost for the industry…sorry the consumer to pay.
    Over 80 life assurance companies closed to Uk new business fewer IFA’s, probably be reduced by another 55% (25% pre RDR and 30% post RDR when IFA’s find they can not generate enough Fees to pay the FCA & FSCS levies and a sufficient income to make worth while).
    When will they learn.

  3. They were concentrating on seeing how they could get rid of the Independant sector for the benefit of the banks, instead of concentrating on the bigger picture. IFA,s can only use what is available to them where as the banks just done what they liked, hence the crash. They designed and moved the products around to suit them and we all suffer. The architects of the failure are still getting their bonuses and the people(FSA) are still getting their mega bucks for destroying the iFA sector.

  4. “Will things be different when the FSA becomes the FCA? The answer is certainly no! As the FCA will be manned and headed by the incompetent people who were the FSA.
    For things to improve they need to recruit from bottom to top in people with industry experience, who understand how the adviser/client relationship works and are able to make commercial decisions based on value and benefits to the clients.
    The FSA, and I am sure the new FCA, will keep with the civil service mentality that it is okay to waste taxpayers, insurers and inevitably clients money as they the FSA/FCA are not answerable to anybody for squandering this money.

  5. The main question I pose is -will the new regulators repair the faults of the FSA.? I run a National Support Group for home income plan
    victims and the elderly were badly let down by
    the previous regulators such as the Securities and Investment Board and FIMBRA. The FSA took no action and finally consigned my communications to them to file without responding

    The problem seems to be that their is no retrospection in Acts.

  6. I think there will be substantial and siginificant changes. I’m no statistician but I think the immediately measureable changes will be in the order of 33.33%. Now that’s a huge change in anyones book, a whole third. What an incredibly creative solution for re-organizing one of the most pointless quango’s. Just change FSA to FCA!!! Amazing, a third of this entire white elephant is re-organised and modernised at the stroke of a pen. I have a feeling that this re-structuring phenomenon could catch on. It’s great to know our regulators are such pioneers of such forward thinking, right at the cutting edge of regulation technology.

  7. Incompetent Regulators Awards Team 14th March 2011 at 2:53 pm

    It will only imrpove if they sack everyone in the F-Pack system and replace them with experienced staff who have been in the industry for many years and have morals!

    P S And you don’t need an army of 4000 to do it either.

  8. FSMA 2000 is bad law and known to be bad law. Gordon Brown would not even release his legal opinion; such was his confidence in the FSA legitimacy and that of FSMA 2000.

    What we must have is the right of appeal to the courts and for the FSA to be actionable in the courts. 1,000 years of common law, natural justice and the courts will do the rest!

    There should be no place for an unaccountable unelected quasi judicial regulator in a modern democratic society governed by the rule of law.

  9. Pigs will fly first.

  10. No, the FCA won’t be any different from the FSA. We know that because it’s going to be all the same people in the same office with the same agenda and accountable only to its own board, which means in effect as totally unaccountable as is the FSA.

    How such a transition is going to cost, according the Hector Sants, £50m is beyond comprehension and beyond any reasonable standard of morality. But what does the FSA care? It’s all, as always, other peoples’ money, so to hell with the naysayers ~ we’ll just carry on doing whatever we want to and anyone or any body that dares to object can go jump off a cliff or be trampled underfoot like some tiresome and inconsequential insect.

    Accountability? Sheila Nicoll’s smug smirk of untouchabiliity at last weeks TSC hearing said it all.

  11. Well, the FCA could hardly do a WORSE job than the FSA.

    Equitable, Independent Insurance, HBOS, RBS, the original equity release schemes, lack of rules originally on transfering pensions from DBSs, allowing mutuals to rip off their policyholders and demutualise, allowing stupid multiples of income on mortgages, producing statistics that even a 14 year old maths student can see are wrong to support their position etc. etc.

  12. “Can new regulator improve on the failings of the FSA?”

    Improved number and quantum of failings? Only time will tell but as regulation has demonstrably failed I wouldn’t like to place a bet on any positive changes.

  13. peter of course makes the points that the IFA community has been making for years, as can be seen by the comments on here.
    The FSA, FSCS and FOS all employ law firms and Barristers at huge cost to us.
    Are the Lawyers so selfish that they cannot see what they are doing in acting for these unaccountable overpaid people, when the law society itself quotes the plight of IFA when looking at the proposed Law society ombudsman??

  14. Same boss, same staff, same ethos & almost the same name. = What change is anyone really expecting?

    I wonder if it is difficult for the Treasury and their political masters to understand this equation?

    Does anyone else feel that Mark Hoban sounds like an FSA spokesperson reading a script?

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