Somebody’s watching you

Scott Philipson

June 24, 2006

Well into the second year of being a regulated part of the financial services industry, it’s very clear we are in a constantly evolving situation – and a continuously improving one, we hope. Way back in October 2004, I don’t think many of us were talking about ‘Treating Customers Fairly’ (TCF), ‘risk-based approach’ or ‘principles versus rules-based regulation’ – we were too concerned about getting our Initial Disclosure Documents (IDDs) and Key Facts Illustrations (KFIs) right. However, as the Financial Services Authority (FSA) starts to come to terms with the vast influx of new, smaller firms it needs to police, so TCF and principles-based regulation have now become the bywords and the industry direction.

Better regulation

The idea of principles-based regulation is not unique to the financial services industry, but is being adopted across all regulated sectors of British industry. Speaking recently at the Confederation of British Industry’s (CBI) president’s dinner, Gordon Brown pointed out that it was a duty of government to reduce the administrative burden on industry caused by regulation and he explained how this is to be achieved.

10 regulatory bodies are to be abolished and then the remaining 35 merged into nine. At the same time, there is to be a moving away from ‘the old blanket approach of 100 per cent form filling and 100 per cent inspection that is inefficient and wasteful of time, to a new approach based on risk’. In our case, what the FSA views as ‘risk’ are things that threaten its four statutory objectives and 11 principles for business.

Although many in our industry might disagree with Brown that 100 per cent form filling is, in any way, being reduced, his remarks do reinforce the way that the FSA’s regulatory emphasis has shifted to a risk-based/principles-based approach, and put this within the context of how the rest of British industry and commerce are regulated.

Systems and controls

Two new important European directives are on the horizon – the Markets in Financial Instruments Directive (MiFID) and the Capital Requirements Directive (CRD) – and the FSA needs to implement the requirements of these directives regarding systems and controls. Details of consultation about the changes are set out in the FSA’s Handbook Development newsletter published in May, and feedback is due in the fourth quarter of 2006. Systems and controls are part of the FSA’s High Level Standards that apply across the board to all authorised firms, so whatever changes are made will apply to the mortgage and general insurance (GI) sector too.

Principles being upheld?

Standing on the shifting sands of the principles-based approach, systems and controls are a good strong rock to cling to, and can help to provide an answer to the problem of having to decide for ourselves how our own firms uphold the principles, rather than being able to rely on a set formula. TCF may seem very much like a trap that can always catch you out – because ‘fairness’ means different things to different people. The system is not rule-free, as we do have to abide by ICOB and MCOB, but there is scope for implementation and interpretation within individual firms. This is an area where there is a need for knowledgeable and competent senior management figures to ensure adequate systems and controls can be turned into a positive benefit to combat the ambiguities inherent in both TCF and the principles-based approach.

Closing the loopholes

If the systems and controls within a firm are used to connect up all the key elements of the compliant advice and sales process, produce prompts and checklists, and then provide a fully dated and timed audit trail, then there is far less leeway to wander off the straight and narrow path of TCF/ upholding all the other FSA principles and objectives.

One example, from Home Buyer Systems, illustrates this point very well. Take the example of an adviser that does a high proportion of non-conforming, self-certified business – this adviser could be putting vulnerable borrowers at risk, which is not treating them fairly. If you have a control system within the firm that looks at historical data, then a lot of customers may have been treated unfairly in this way before anyone spots it. However, Home Buyer has an early warning system within its compliance monitoring programme, which allows the compliance officer to intervene in such potentially ‘unfair’ advice and sales situations before they become a done deal. In this way, properly thought out systems and controls can support TCF and, furthermore, provide evidence for it.

In its list of forthcoming mortgage projects for 2006/07, the FSA has listed follow up work on how well small networks are controlling their appointed representatives, so this area continues to be the focus of the regulators concern

Quality and suitability of advice

In the true spirit of ‘joined-up thinking’, the previous section brings us to another hot FSA topic – the quality and suitability of mortgage advice. A factsheet was published on this topic at the end of 2005, and it is also listed as a forthcoming project for 2006/7 in support of (no surprise here) the TCF principle. The factsheet (based on research into mainstream lending at 36 adviser firms) identified key areas to concentrate on. The first of these was the need to keep consistent and detailed records of the needs and requirements of customers and of the reasons for the recommendation. The second was better and more consistent record-keeping about how the subject of affordability was discussed with and emphasised to customers. The third was the need for better training and competence (T&C) procedures, including better understanding of how firms must assess (even qualified) advisers for competency to give unsupervised advice; better record-keeping of how ongoing competency is maintained; and ensuring proper supervision of advisers that are not fully competent. With record-keeping prominent in all three of these, the usefulness of record-generating systems and controls is obvious.

Bubbling under

A few perennial topics have surfaced again recently, and are under scrutiny by the various trade bodies and stakeholders. Arising from a presentation by the FSA’s Michael Lord at the Manchester Expo in May, it appears that league tables for mortgage and GI firms are now back on the agenda, but not in any concrete form so far. Many would hope they stay that way.

Another idea that is at the very early stage of discussions with interested parties is the shift of adviser supervision to lenders. The justification for this is that lenders are part and parcel of the advice and sales process because they design the products and lending criteria. Once again, the satisfactory appliance of TCF appears to be the glue holding this idea together. Although little support for this move has been forthcoming, some fear that – if it ever happens – lenders may seize it simply as an excuse to eliminate the intermediary route and only offer direct-to-consumer products, to the detriment of the consumer.

Finally, the idea that packagers will come fully under the regulatory powers of the FSA has also resurfaced. In reality, the vast majority of larger packagers are already authorised with only some of smaller packagers staying completely outside either of the regulated activities of ‘advising’ and ‘arranging’. Once again, a principles-based approach by the FSA could see all packagers being required to become authorised, without any major re-writing of rules.

No retrospective regulating

It’s always good to end on a positive note, and hot off the press from the FSA is confirmation that it will continue to judge firms’ product sales and financial advice by the standards and rules at the time of the sale and not retrospectively. Stephen Bland, the FSA’s director of small firms, confirmed that there would be no retrospective application of later, more exacting standards of regulation, even under principles-based regulation. He explained: ‘This has always been and will continue to be our view on retrospective regulation’. In view of what has happened to endowments under the ‘no retrospective regulating’ policy, there can be no stronger reason to keep fully detailed records of your mortgage sales and advice transactions in a very safe place, and for a very long time.

Bill Warren, Compliance Director, Complete Mortgage and Loan Services


Richard Angliss, Managing Director, Home Buyer Systems

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