In a consultation paper published in December 2008, the FSA outlined a number of proposals to extend the approved persons regime and set out how the FSA is enhancing its scrutiny of senior management competence. The regulator’s proposals included extending the definition of the existing director and non-executive director controlled functions to include certain individuals in parent companies.
The regulator also stated that it was looking to clarify the role of non-executive directors to reinforce that it will look at non-executives more closely where it believes they should have intervened more actively with a firm’s management. In addition, the proposals also seek to extend the definition of the CF29 – significant management function – to include all proprietary traders where they can exert a significant influence over a firm.
The FSA says it will also amend the application of the approved person’s regime to UK branches of overseas firms based outside the European Economic Area (EEA). As part of this work, the FSA says it has already started to interview more applicants for “significant influence” posts at high impact firms. Once in post, where individuals fail to meet the required standards the FSA says it will consider enforcement action.
The basic premise of the FSA Consultative Paper is to ratchet up the pressure on senior management of regulated firms. Responses to the paper had to be with the FSA no later than 31 March, and it is understood that feedback from firms was generally positive, with implementation likely to take place within the year. But the questions remain – what does this mean for principles-based regulation in general, and Treating Customers Fairly in particular? And what impact does recent thinking articulated in FSA speeches have on its own regulatory outlook?
FSA Proposals
First of all, the new regime proposed by the FSA merely builds on the development of the roles of senior management. This started some years ago with the introduction of Approved Persons holding Controlled Functions, and publication of Senior Management Arrangements, Systems and Controls – or SYSC to those who know it well. And, outside the remit of the FSA, non-executive directors were already under the spotlight with the Higgs provisions calling for proper selection processes and the Tyson requirements calling for better training.
After the Northern Rock review, one of the lessons learned was to increase the rigour of the FSA’s day-to-day supervision by focusing on the competence of firms’ management, specifically with regard to significant influence controlled functions. In other words, every senior management controlled function other than CF 30 – the Customer Function. As a result the FSA has reviewed its approach to these Controlled Functions to see where improvements could be made and to examine whether the regime reflected corporate governance structures within the industry.
Some changes have already taken effect. For example, since 1 October last year, the FSA has been exercising its right to interview more of those applying to provide significant influence functions at the largest firms. The watchdog has made it clear that those interviewed will be expected to take on their new roles with greater awareness of their regulatory responsibilities. The knock on benefit to the FSA is that its supervisors will have greater confidence that senior management will ensure that more principles based regulation becomes a reality in these firms. The regulator will seek to hold individuals exercising significant influence over authorised firms accountable for poor conduct at those firms with regard to regulated activities. Previously, for individuals holding significant influence Controlled Functions, the FSA tended to focus on cases of dishonesty or lack of integrity where prohibition or withdrawal of approval was the most appropriate outcome. In the future, it will consider the competence of significant influence function holders and will not be slow to pursue cases against individuals who breach the Principles and the Code of Practice for Approved Persons enshrined in APER. In these cases, fines will be levied where more appropriate than prohibitions.
What has changed?
As they say, a week is a long times in politics and three months is a very long time at the FSA. There seems to have been a flurry of speeches which have produced some extraordinarily memorable phrases that require closer scrutiny. The speeches are a litmus paper of FSA views and provide the ability to position concepts ahead of the written word – and it seems that some of those views are changing faster than the ink can dry on the copy.
Lord Turner has captured respect with the graphic phrases to clarify the shape of the future of regulation with comments such as the FSA needing “to take away the punch bowl before the party gets out of hand.”
Then we have Hector Sants, the regulator’s chief executive telling us that we should be frightened of the FSA. “There is a view that people are not frightened of the FSA. I can assure you that this is a view I am determined to correct. People should be very frightened of the FSA.”
However, terrifying senior management isn’t effective in changing behaviour or in endorsing principles-based regulation. Would it not be more constructive to evolve a mature compliance culture where regulatory professionals can have an honest and occasionally robust exchange of views with our regulators? And senior management can have confidence in making the right decisions to support proportionate and effective regulation within their firms?
In the same speech Sants also commented on supervision, which in the past had been evidence-based, risk-based and principles-based. Whereas the FSA would remain evidence and risk-based, Sants said that the phrase ‘principles-based’ had been misunderstood.
He said: “To suggest that we can operate on principles alone is illusory particularly because the policy-making framework does not allow it. Europe, in particular, has a particular penchant for rules and in any case in a number of key areas such as prudential they are indeed necessary. Furthermore, the limitations of a pure principles-based regime have to be recognised. In the future the FSA will seek to make judgments on the judgments of senior management and take action to prevent risk to FSA statutory objectives. This is a fundamental change. What principles-based regulation does mean and should mean, is moving away from prescriptive rules to a higher level articulation of what the FSA expects firms to do. In other words, it helps emphasise that what really matters is not that any particular box has been ticked but rather that when making decisions, executives know they will be judged on the consequences.”
Has the industry misunderstood what principles-based regulation means? Were we not guided to our conclusions by the FSA itself? Why has the emphasis on principles-based regulation – then MORE principles-based regulation – driven us firmly in one direction only for us to be told we had misunderstood it? It seems that the “outcome” for the regulated community – “outcome” being popular FSA-speak these days – is that we will have to tackle both principles-based regulation and prescription and hope that they pull in the same direction.
Things are further complicated by a significant loss at the senior level of the FSA. The FSA is to lose its principles-based TCF champion, Sarah Wilson, director of Treating Customers Fairly – who resigned from the FSA shortly before Sants made his landmark speech.
Sants then added more pressure on non-executive directors – at a time when the Consultative Paper on this topic was still being consulted on. He said “Non-executives will need to commit more time and raise their technical skills to exercise rigorous oversight. While these changes will warrant more support and compensation for these individuals, non-executive directors will also need to be more willing to challenge executives. Non-executive directors will need to become more like full-time ‘Independent Directors’. However, even with all these changes to supervision and the wider oversight process, the principal responsibility for managing firms responsibly laid with the management themselves.”
Some non-executive directors have begun to consider asking for danger money. Hants must be applauded for spelling things out so unequivocally, and it is now even clearer that senior management will have to withstand closer scrutiny from their boards.
What this means for TCF
In a survey of Compliance Officers conducted by The Consulting Consortium immediately after Sarah Wilson’s resignation was announced, two in five believed that the FSA’s interest in TCF would quietly go onto the back burner as too much emphasis had been given to it at the catastrophic cost of banking supervision. However, the remainder of the sample felt that the level of interest would remain the same, partly as so much had been made of the subject and that the FSA would look foolish to about-change on such a major plank of its policy.
So, on one hand, we are ramping up expectations and the role of the non-executive director and the focus on senior management to behave responsibly and be accountable for what happens on their watch. Somehow those expectations of maturity and judgement do not sit comfortably with telling these same people that they “should be very frightened of the FSA.”
On the other hand we apparently have misunderstood principles-based regulation and we are now going to have both principles-based regulation and prescripted rules. In terms of TCF, it is unclear how these diametrically opposed approaches can be reconciled.
However what is clear for senior management is:
(a) no more lip-service on the issue of TCF. It is not going away, just mutating and waiting round the corner; and
(b) there is every need to fill any gaps in processes, procedures, culture. Do it fast, do it now if not already done and use effective tools to demonstrate what your firm has done – as if you don’t have the evidence you cannot prove it happened.
Surprisingly, some firms are still a huge way from even the most basic application of TCF. A colleague with over 20 years expertise in regulation and three professional qualifications had a shocking incident with a major UK bank involving a potential breach of the data protection act and breaches of numerous FSA rules. After over two and a half hours of sheer frustration on the telephone she was told that her call was not a complaint, that customer services could not put her through to the complaints department or the compliance team – despite her telling them repeatedly that she was a compliance officer and a director of the Compliance Institute. Some 10 weeks later, there has been no substantive investigation, no explanation and no record of the calls she made. If a feisty regulatory professional cannot get a fair hearing, it makes one wonder about how the average person is treated. TCF in practice, satisfactorily embedded into the firm’s culture? I think this particular firm’s board is one that needs to read this article and a few more of Sants’ speeches. n
Joanne Smith, chief executive & creative officer at The Consulting Consortium
