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Help is at hand

Networks were designed to help small firms cope with regulation and recent FSA findings underline their growing importance, says Gemma Harle

The past 18 months have not been good for small mortgage firms. One Financial Services Authority ann-ouncement has followed another in which small firms have been identified as miscreants that are failing to comply with the rules.

The most recent revelation came last month when the FSA announced that only 41% of small firms had managed to meet the March deadline for implementing its Treating Customers Fairly regime.

This followed an FSA statement at the start of the new year in which, having reviewed 252 mortgage firms, it found only one-third had sufficiently robust processes in place to provide customers with suitable advice.

The most significant failings were in smaller firms, with three-quarters of these lacking robust processes. These finding came only weeks after the regulator had to censure more than 200 brokers for using misleading advertising, particularly with regard to sub-prime deals.

The pattern of failure among small firms is clear. Whenever the FSA conducts an investigation into the performance of firms in the mortgage market, small firms are found to be struggling to come to terms with the regulatory regime.

There is a widespread misconception that small directly authorised firms have been able to sneak under the FSA’s radar and avoid the more onerous elements of regulation, but the FSA is eager to quash this idea.

Speaking at a recent conference for financial advisers, Stephen Bland, director of small firms at the FSA, warned that such myths risked tarnishing the industry.

“We are sending a clear message that small retail firms are not below our radar,” he said. “Our regulatory approach is based on giving help to firms that run their businesses while treating customers fairly and endeavouring to do the right thing, but coming down hard on those that don’t. Firms that are not trying to comply with our requirements should be aware that they could be visited at any time.”

Harsh words indeed, and intended as a warning to those firms that feel they can flout the regulations.

But the big question is whether small firms are trying to flout the regulations or whether they are simply finding it difficult getting to grips with a regime which is confusing to them – and one which is increasingly based on a set of principles rather than a book of rules.

I have seen no evidence that small firms are deliberately trying to avoid regulation so I can only conclude that they are finding it tough coming to terms with the requirements of statutory regulation.

Handing out warnings is all well and good but these have made little difference. The FSA can start dishing out more fines and withdraw the worst offenders’ right to trade, but will the big stick approach succeed where strong words have failed? I’m not sure.

That said, the FSA has to find a way to turn the situation around because if it doesn’t, the reputation of the advisory sector and that of the regulator itself will be at risk. It’s not an option for small firms to continue falling short of the mark because if they do, clients will lose confidence in the sector and buy their financial products elsewhere.

And they have plenty of choice, from traditional high street outlets to the new breed of internet providers and well-known brands such as supermarkets and retailers.

So what can the FSA do? With less than 200 staff in its small firms division, the answer would appear to be not a lot as it doesn’t have the resources to monitor and control every small firm in the country. Random visits are not likely to be an effective way to control thousands of brokers.

It has been suggested that the regulator needs to improve its communications with small firms and this will undoubtedly be a step in the right direction. But better communications will only deliver tangible results if the audience is willing to listen and able to act on the information that is being provided. The evidence suggests that small firms are not.

The only realistic option open to the FSA is to put more onus on organisations that are able to monitor and control the activities of small firms.

Networks are one option. They were designed with a single purpose, to provide regulatory support to small firms, and they have the staff and technology to monitor the activities of member firms. The FSA does not.

What’s more, the FSA in-vestigations that highlighted the shortcomings of small firms also found that networks are performing to far higher standards.

But if networks are the solution to raising standards among small firms, why did so many brokers decide to take the DA route on Mortgage Day?

Also, why are brokers switching to become DA firms and why doesn’t the FSA insist that small firms become appointed representatives until they can show they have the resources to go it alone?

The answer is that brokers are clinging doggedly to the concept of in-dependence. Some perceive that becoming an AR is abandoning the freedom to make choices, both in terms of products and the way they run their businesses. Others say that becoming an AR is expensive, as fees have to be paid to a network.

But perception and reality are different things. Many DA brokers maintain small, informal panels of providers which they use time and again for most of their business.

On the other hand, networks have extensive panels of providers with whom they negotiate hard to secure exclusive deals and enhanced proc fees. By providing brokers with comprehensive regulatory support, networks free them up to focus on what they do best – selling products.

And as far as costs are concerned, being DA is far from being free of charge. There is a significant cost in-volved in managing a firm’s regulatory activities and keeping up-to-date with regulatory changes. I believe AR status is the cheaper regulatory option for most small firms.

So why doesn’t the FSA encourage more small firms to join networks? Because it can’t. The FSA has to appear to be impartial and support brokers whichever option they take. But unfortunately, the FSA can’t provide every small broker with the level of support they need to raise their standards and operate in a compliant manner.

The time has come for the FSA to face facts – small DA firms are a problem. They are falling short of the necessary standards and if nothing is done to address the issue, they are in danger of fatally damaging the reputation of all financial advisers.

Mortgage clubs and packagers will undoubtedly argue that DA brokers should stay put and, if anything, more brokers should take the DA route. After all, clubs and packagers can provide an increasing level of support to brokers. And they are providing this support, but without taking any regulatory responsibility – that still sits firmly with brokers.

Clubs and packagers can only do so much – they can never hope to replicate the level of service provided by networks. For example, networks monitor and analyse every piece of business submitted and check all promotional activity. Clubs and packagers do not.

And DA brokers have to be mindful of any advice that might arise in their relationship with clubs and packagers. Brokers can be provided with a range of products but it is up to them to choose and then justify their recommendations.

Networks are not perfect but they are the best way for the regulator to raise standards.

For example, there is room for improvement in the technology used by some networks and smaller ones are struggling to recruit sufficient numbers of members to guarantee survival.

But these are relatively minor issues compared with those faced by smaller brokers and can be solved. Also, the FSA has seen that networks are doing a good job via its Arrow visits.

The industry needs to recognise that small brokers need help. If nothing is done about the situation and if the FSA continues to unearth poor practices and low standards, radical solutions may be im-posed, to nobody’s advantage.

We cannot afford for small firms not to meet the FSA’s next TCF deadline in December 2008. We have about a year to put remedial measures in place. The clock is ticking.


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