Journey towards a conduct regulator

Speech by Clive Adamson, Director of Supervision, the FSA at the Westminster Forum, London

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Good afternoon and many thanks to Westminster Forum for inviting me to speak. Today, I will be talking to you about our journey towards a conduct regulator, with specific emphasis on the FCA’s approach to the supervision of firms.

We are a little over four weeks away from the formal creation of the Prudential Regulation Authority (PRA), the Financial Conduct Authority (FCA) and the Financial Policy Committee. These three regulatory bodies come into existence at a critical moment in the history of financial services, propelled by the financial crisis and on the back of a series of unprecedented conduct failings, including the mis-selling of payment protection insurance (PPI) and the manipulation of LIBOR, which have resulted in an erosion of trust in financial services.

As conduct regulators, it is our job to fundamentally change the culture and conduct of financial services firms and the markets they operate in – and as a result, to inject trust back into financial services.

To do this, it is our intention to make sure that the FCA looks and feels different to the FSA. We will move away from a primarily reactive style to be a more forward-looking regulator, focused on understanding what consumers are really experiencing. This means we will have to make forward-looking judgements about firms’ business models, product strategies, and how boards run their businesses, if we are to be on the front foot and prevent customer detriment before it crystallises, rather than reacting to it only once it has occurred.

When things do go wrong, the FCA will have the appetite to act faster and more decisively, and robustly seek redress for consumers where this is due. We have seen some examples of this recently, particularly in the case of the mis-selling of interest rate hedging products to small and medium enterprise (SME) customers or in our use of mystery shopping exercises to assess the quality of investment advice provided by some banks and building societies.

We recognise, however, that being a more forward-looking regulator is difficult to achieve and many conduct regulators around the world adopt a more reactive approach. By making sure that we continually challenge firms to ensure their business models are based on a sound foundation of fair treatment of consumers, supported by a strong culture to deliver this, we believe we will be successful.

Ensuring firms continue to meet our standards

The starting point for this process is the categorisation of firms into four new supervision categories – C1, C2, C3 or C4 – according to their impact on consumers and the market, and recognising that we do not have a one-size-fits-all approach. C1 firms are those largest, most complex firms with very large client assets or trading bases whereas C4 firms are those smaller firms with simpler business models and products. We will be writing to firms in the next two weeks to let them know the category they will be in and what this will mean for them, including further details on what assessment cycles they will be placed under.

Overall, the new categorisation means we will have supervisors allocated to firms with the greatest potential to cause risks to consumers or market integrity. Ultimately, and recognising we only have limited resources, this will mean that firms moving into C3 and C4 will no longer have a dedicated supervisor. Nevertheless, it is our intention to have more supervisors ready to be deployed flexibly to deal with problems that arise and specific issues and products that have potential to cause – or are already causing – consumer harm.

Alongside this approach is the way firms will be supervised on a day-to-day basis. The FCA supervision model will be based on three key pillars – FSF, Event Driven, and Issues and Products.

Our forward-looking assessment of a firm’s conduct risks will be undertaken by the new Firm Systematic Framework (FSF). This is designed to answer the key question of ‘Are the interests of customers and market integrity at the heart of how the firm is run?’ and will involve:

  • analysing firms’ business models and strategies so we are able to form a view of the sustainability of the business from a conduct perspective and where future risks might lie; and
  • an assessment of how the fair treatment of customers and ensuring market integrity is embedded in the way in which the firm runs its business, from the ‘tone from the top’ through how culture is embedded across the firm, to how the firm manages and controls its risks.

The approach will be differentiated depending on the categorisation of the firm. C1 and C2 firms will experience the most intensive focus and shorter, one to two-year regulatory cycles. C3 and C4 firms will too have their business models evaluated, but more on a peer basis and on a four-year cycle, through a combination of risk profiling, which will determine which firms will be interviewed.

The second pillar is based on dealing with issues that are emerging or have happened and are unforeseen in their nature. This is what we have termed as ‘event driven work’ and will cover everything from mergers and acquisitions to whistleblowing allegations to spikes in reported complaints at a firm. For all cases, we will act faster and more decisively and secure customer redress, where applicable.

The final pillar is broadly termed ‘issues and products’ and will be largely driven by the analysis made of each sector by our sector teams. These dedicated teams are already working with front-line supervisors and other non-supervision staff to produce Sector Risk Assessments of conduct risks across all sectors. This will determine whether there are cross-firm and/or product issues driving poor outcomes for consumers or endangering market integrity, the degree of potential detriment and whether we should be undertaking any thematic pieces of work to assess/mitigate these risks.

In addition to our conduct obligations, 23,000 firms will also be prudentially regulated by the FCA. Here, our overall aim will be, where possible, to reduce the impact on customers and the market in the eventuality that a firm fails. This is a shift from our current predominant prudential philosophy of aiming to reduce the probability that a firm fails. This approach means that we will be focusing a lot more on the ability to achieve an orderly wind-down of a firm’s business, including how resolution could be achieved.

We will adopt a differentiated approach depending on how we prudentially categorise a firm. So, firms will, in addition to the C1 to C4 categorisation, also be allocated one of three prudential categories – P1 firms are those whose failure would have a significant impact on the market in which they operate but we are not yet confident that orderly wind-down can be achieved. These will still be supervised on a going-concern basis with the aim of minimising the probability of failure. Firms that have a significant market impact but where an orderly wind-down can be achieved, will be categorised as P2 and supervised on a proactive gone-concern basis. Both will have a periodic assessment of their capital and, where applicable, their liquidity requirements – as well as how they meet our broader prudential requirements.

Those where failure, even if disorderly, is unlikely to have significant impact, will be categorised as P3s and supervised on a reactive gone-concern basis. For this group, we will be relying more on firms’ own assessment of their financial resource requirements and focus on monitoring returns and breaches that arise from inconsistencies and/or prudential failings.

Let me reiterate – for the vast majority of firms, our focus will be on managing failure when it happens, rather than focusing on reducing its probability.

Changes to supervising wholesale conduct

We view wholesale and retail markets as interconnected and therefore do not want to make artificial distinctions between these markets. This is because, at the end of many wholesale transactions, there is likely to be a retail customer. As such, we need to recognise that activities in retail and wholesale markets are connected and that risks caused by poor conduct can be transmitted and undermine both markets. Poor wholesale conduct is never a victimless act simply because it takes place between sophisticated market participants.

We do accept that the overall ‘caveat emptor’ principle should continue to apply to wholesale markets, which means that we do not generally intend to introduce the concept of consumer detriment and redress that we use in retail markets to wholesale markets. However, we will take a more assertive and interventionist approach to risks caused by wholesale activities, not just when retail markets are directly affected but also in order to enhance trust and confidence in the integrity of markets. The issues that have arisen in the LIBOR setting market are a sobering reflection on what can happen when trust is lost in what is overwhelmingly a wholesale market.

The three supervisory pillars I described earlier will apply to all wholesale firms.

New powers

The FCA’s new supervisory approach will be supported by new powers to make rules or ban or restrict sales of products that pose an unacceptable risk to consumers. In practice, this will mean that the FCA will be able to, without consultation, intervene quickly and ban products for up to a year in order to prevent or minimise harm to consumers in a transparent way before it becomes widespread. It will also be able to ban misleading financial advertising and promotions we consider misleading immediately and publish details so that industry is clear about what we expect. Fundamentally, however, our focus will be making sure firms are thinking about who they are designing products for, testing the products will perform as they expect, and then ensuring the distribution and marketing of those products gets them to the target customers, rather than those they are not intended for. 

Protecting the perimeter

As well as the new powers, the FCA wants to ensure that the right firms, run by the right people, selling the right products to the right consumers are approved to do business.

The process for this will be largely the same as it is now, but with some new elements. This includes new a new business model threshold condition to reflect the emphasis we will place on firms being able to demonstrate they have a viable and sustainable business model from April 2013. We will also aim to strike the right balance between ensuring high standards at the gateway to regulation and making sure we do not stifle innovation and appropriate levels of access to new participants.

One final element I would like to emphasise is the FCA’s risk-based approach to approving controlled functions, which we will carry over from the FSA. Ultimately, it is clear that management are responsible for running firms and ultimately firms fail because of the decisions taken by their boards and their management. What the FCA will be looking for is senior management to set the right tone from the top and ensure that this is being embedded across all levels of their firms. We also want senior management to be open and honest in their dealings with the regulator – and I am pleased to see cases where this is happening effectively. But let me be clear – where we find cases of individuals or firms misleading or providing us assurances that they cannot meet, we will take tough action, including enforcement action, where appropriate.


I hope that today I have given you more of an insight into how we are getting ready for the launch of the FCA and what this will mean for firms. With less than four weeks to go, we are excitedly putting the final touches to the regulatory framework. I am sure you will want to know more and I ask that you keep an eye out for our new website, which will be launched on 1 April.

Thank you.