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Rock the boat

Leading commentators say the FSA is likely to rebalance its priorities in response to the Northern Rock debacle, with more focus on prudential supervision and less on conduct on business regulation.

The internal report into the FSA’s supervision of Northern Rock, released last week, identified four key failings including insufficient supervisory engagement with the bank and a failure to identify the vulnerability of the business model arising from changing market conditions.

It recommends establishing a new group of supervisory specialists to regularly review the supervision of high-impact firms to ensure procedures are being adhered to. The numbers of supervisory staff engaged with high-impact firms will be increased and the existing specialist prudential risk department of the FSA will be expanded.

Compliance expert Adam Samuel says this inevitably means that the FSA will move resources away from protecting consumers towards prudential supervision.

He says: “The Financial Risk Outlook makes it clear that the FSA is much more worried about companies going bust rather than treating customers fairly. If that is where it is focusing its attention, then we can expect consumers to get very badly treated and neglected. It will be diverting resources away from TCF.”

Samuel believes the report will lead to a change in culture at the FSA. He says: “The new regulator has to behave quite differently. It must challenge firms and itself. Senior managers will have to keep much closer tabs on high-impact business than before. Suspect training will have to be improved.”

CMS Cameron McKenna partner Simon Morris does not think the report will change the way the FSA regulates the industry as it states that the correct processes were in place but not followed properly.

He says: “What the review says is that its supervisory model is fine but that the supervision of Northern Rock was inept. That does not mean the model is broken. It is saying if the model had worked, things would have been a great deal better.”

Morris believes the report will lead to a more rigorous supervision of firms, with greater management oversight and training.

He says: “The supervision of Northern Rock was very careless and sloppy but it is a fair comment for the FSA to say that even if supervision had been carried out at an acceptable level, it does not follow that the outcome would have been different. We do not know what might have happened. It is speculation to say better supervision could have prevented it.”

In Morris’s opinion, the key change coming out of the review is the formation of a prudential risk department which he thinks will help to tighten the supervisory process at the FSA.

Beachcroft Regulatory Consulting managing director Richard Hobbs says unless the FSA increases its budget by charging more fees, it is inevitable that it will divert more resources to prudential supervision. He says this means there will be a reduction in resources and focus directed towards conduct of business.

Hobbs says: “You can see that the FSA is rebalancing its priorities and inevitably it will move away from conduct of business and towards prudential supervision.”

He says the main lesson for the FSA concerns the seniority of the people who carry out supervision. He says: “In the past, there was a hands-on approach where it was routine for senior staff to have direct contact with high-impact firms. The FSA has moved away from this approach in recent years, which was a bad idea. It has now admitted this was wrong. Directors of the FSA are going to have to start doing dayto-day supervision.”

Treasury select committee chairman John McFall says the FSA has essentially admitted a “dereliction of duty” and a fundamental change is needed in its management. Speaking on BBC Radio 4’s Today programme last week, he said: “There is a big agenda to ensure there is change in the FSA and, indeed, change in the financial services industry. This is not just a failure of the supervisors of Northern Rock, it is a failure of the FSA management.”

The Financial Services Consumer Panel says it is disappointed there was not more independent input into the internal review.

Chairman John Howard says: “The FSA concludes that even if supervision had been acceptable, it was by no means the case that that would have changed the outcome. This suggests that the events surrounding the failure of Northern Rock, including the sudden collapse in credit markets, were testing the limits of regulation anyway. No regulator can guarantee to prevent all failures. In those circumstances, a realistic compensation scheme which pays out quickly is vital to prevent another bank run.”

FSA chief executive Hector Sants says: “It is clear from the thorough review carried out by the internal audit team that our supervision of Northern Rock in the period leading up to the market instability of late last summer was not carried out to a standard that is acceptable, although whether that would have affected the outcome is impossible to judge.”

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