Take a bow

British financial regulation

Jul 21st 2005
From The Economist print edition

The FSA listens and learns

AS CLIMB-DOWNS go, this was as graceful as you'll see. Britain's Financial Services Authority (FSA) said on July 19th that it would change the way it does business in order to give firms suspected of wrongdoing a better hearing. Sir Callum McCarthy, the FSA's chairman, accepted all the recommendations of a review commission set up five months ago in response to widespread criticism. He said that the watchdog was determined to reach a point where firms subject to its discipline could say, however grudgingly, that the process had been fair. With these reforms—give or take a few caveats—he will probably achieve his goal.

The catalyst for this first serious overhaul of enforcement in the FSA's seven-year history was an action for endowment-policy mis-selling brought by the regulator against Legal & General (L&G), a big insurer. Where many had muttered, L&G fought back. An independent review tribunal in January halved L&G's fine, from £1.1m ($1.9m), and criticised the FSA's procedures. It said that the main problem was the regulator's failure to distinguish adequately between those who investigated a case (its enforcement division) and those who decided on its merits (the quasi-independent Regulatory Decisions Committee, or RDC).

This will now be done, in several ways. All communications between the enforcement team and the RDC will be disclosed to firms being investigated. Lawyers from the enforcement division who have not taken part in an investigation will review its findings before these go forward to the RDC, as a sort of “reality check”. The RDC itself will add two lawyers to its strength so that it need not ask the enforcement division for legal help. And face-to-face meetings at which the enforcers and the firm in question make their oral pitch to the RDC will permit more flexible discussion, with no secret recourse afterwards by the in-house team to the RDC.

These are the main changes, and both financial and legal folk seem broadly pleased. L&G's chief executive, Sir David Prosser, welcomes them with no apparent hard feelings. So does Simon Orton, a partner in the law firm that represented the insurer, Freshfields Bruckhaus Deringer: “The FSA have really been listening,” he says. But a few questions remain.

The first is how it will all work in practice. Decision-making, however improved, rests on the quality of the investigation that precedes it, as the FSA knows. Margaret Cole, its new director of enforcement, will be taking a hard look at the troops at her disposal. There are plans to add a seasoned veteran of “complex forensic investigations” to the team, but one man does not a Scotland Yard make.

Then there is the decision to take settlements out of the RDC's remit and hand them over to senior FSA executives, encouraging early settlement by establishing a fixed discount from any penalty imposed. While it is right to deter frivolous contests, settlements are important, as Mr Orton points out, both because they establish a scale of penalties for future application and because they send a message about what is considered good practice. Both might benefit from an outside eye.

A final unknown is the cost of these changes. The FSA reckons that, while a smaller proportion of cases may be referred to the RDC, those that are will be slower and costlier. This is likely to add some £2.5m to the FSA's budget, about 1% of the current total, which might be recouped by raising the fees charged by the FSA to the firms it oversees.

Sir Callum insists that the FSA is determined to remain a risk-based regulator using administrative procedures to correct significant abuses rather than become an enforcer plodding laboriously through the courts. London's light touch is its contribution to the global debate on financial regulation, and one secret of the city's success as an international financial centre. With its own ungrudging acceptance of its critics' case for change, the FSA has given that regulatory model a new lease on life.

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