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A brief history of regulation

Statutory regulation of the financial services industry started with the Financial Services Act 1986. All subsequent expansions of the regulatory regime can be traced to this development.

The Act provided for the creation of the FSA’s predecessor The Securities and Investments Board and five offshoot self-regulatory organisations responsible for the day-to-day regulation of their respective sectors. Much like the choice between DA and AR status, investment intermediaries at the time of the Act’s implementation in 1988 could be authorised by an appropriate SRO or directly by the SIB.

1997: New government, new regulator

The sea change between the Financial Services Act 1986 and the later 2000 Act was of course Labour’s 1997 general election victory. A major overhaul of the financial services industry soon followed, the first step of which was the merger of responsibility for banking supervision and investment services regulation under the SIB. In October 1997, SIB formally changed its name to the Financial Services Authority.

By June 1998 attention was shifted to banking supervision. Having granted the Bank of England full independence over monetary policy, responsibility for banking supervision – previously the prerogative of the Bank of England – was transferred to the FSA, paving the way for the Treasury’s decision to regulate mortgages.

Further territorial gains for the FSA followed the implementation of the second Financial Services and Markets Act in December 2001. This saw further consolidation of regulatory power in Canary Wharf, with the FSA assuming the responsibilities of the Building Societies Commission, Friendly Societies Commission, Investment Management Regulatory Organisation, Personal Investment Authority, Register of Friendly Societies, and the Securities and Futures Authority. The Act also transferred responsibility for compliance monitoring within these areas to the FSA, as well as the requirement to establish a Code of Market Conduct.

Statutory objectives and strategic aims

With several regulatory systems drawn under the FSA, FSMA greatly consolidated the FSA’s responsibilities to include:

  • Single authorisation, supervision and enforcement powers.
  • A single compensation scheme and single Ombudsman service.
  • Specific objectives for consumer protection and understanding.
  • Strong powers to tackle market abuse.
  • A focus on how customers are treated after the sale of a financial product.

How the FSA sets about achieving these aims is an issue of great contention. Authorised firms have criticised what they see as a lack of accountability within the FSA. While the FSA does not deny its regulations place a burden on firms, it has pledged to observe its own commitment to best practice standards, proportionality and its aim of being “easy to do business with”.

Five principles guide its work. These are:

Efficiency and economy An 11-member non-executive committee monitors the FSA’s purse strings, reporting to the Treasury every year.

Role of management From the outset, the FSA regime places responsibility with firms’ senior management and all rules are regulations are expected to be implemented by individuals in this position. In the case of mortgage regulation, this has been incorporated through the approved persons process.

Proportionality The most frequent criticism from brokers is that the FSA manifestly fails in meeting this goal. Though the FSA insists restrictions imposed on firms should reflect anticipated benefits for consumers and the industry, many are yet to be convinced. Adherence to this principle has prompted the regulator to produce cost-benefit analyses for its work, though this is another issue of contention. The FSA’s success in achieving its objectives is also reviewed and submitted to the Treasury annually.

Innovation The FSA is committed to allowing and encouraging innovation. Once again however, it has been accused of failing to follow its own guidelines and critics have baulked at the FSA’s self-stated commitment to “avoiding unnecessary regulatory barriers to entry or business expansion”.

Competition With the financial services industry contributing so significantly to the nation’s wealth, the FSA also has a vested interest in ensuring competitive advantage is not impeded. This includes working with international organisations and regulators to monitor compliance at a global as well as domestic level.

Intermediaries’ views on FSA regulationQ1: What is your firm’s attitude to being regulated by the FSA?

n Very positive 21.4% n Positive 45% n Neither positive or negative 21.4% n Negative 10.7% n Very negative 1.5%Q1: Do you think FSA regulation will increase consumers’ confidence in our market?

Q2: Do you think FSA regulation will increase the professionalism of firms in our market?

Q3: Do you think FSA regulation will lead to more complaints about our industry?

n Yes n No n Don’t knowSource: AMI Mortgage Intermediary Census, May 2005FSA-B-C: Understanding the jargonARROW, i.e. ARROW visit Advanced Risk Response Operating Framework – this term describes the assessment of authorised firms, and lenders and networks in particular. The FSA uses arrow visits to risk-assess firms individually.

Authorisation The vetting process for firms and individuals. Firms are assessed for their ability to meet the threshold requirements. Individuals must pass the fit and proper test.

Depolarisation Introduced on June 1 “to facilitate competition in the market”. Following depolarisation, advisers may offer different scopes of advice – from the products of a single product provider or across the whole of the market. These changes have introduced several new terms including MFAs, WFAs, IFAs, SFAs (see below).

FA Financial adviser. The collective name for MFAs, WFAs, IFAs and SFAs.

Financial promotions An advert, website, telephone call or any other promotion inviting consumers to take a mortgage or other financial product. FSA regulations commit firms to the ‘clear, fair and not misleading’ test. The specific rules for mortgage promotions are found in MCOB3.

Firms Online Online system used by firms to submit data and application forms to the FSA. Firms Online communicates key reporting information data to firms individually and can be used to update the FSA of notifiable events such as appointing or removing an approved person.

FOS Financial Ombudsman Service. The complaints mechanism for customers of authorised firms.

FSCS Financial Services Compensation Scheme – for customers of firms which are no longer trading.

Handbook 8,000-plus pages of commandments covering every aspect of the financial service industry. The Handbook of Rules and Guidance contains the rules firms are required to follow and guidance on those rules. Available online on the FSA website, and also in a tailored version for mortgage firms.

ICOB Insurance: Conduct of Business sourcebook. The conduct of business rules for insurance intermediaries.

IDD Initial Disclosure Document. The document given to customers by firms summarising key information about the firm and its services.

IFA Independent financial adviser. This term can only be used by firms providing a whole of market advice service and offering customers the option to pay a fee for advice received.

IRR Integrated Regulatory Reporting. The FSA approach to capturing data from all authorised firms.

Key Facts documents Specified documents summarising key information customers need to know about firms, services offered by firms and financial products. These include the Initial Disclosure Document, menu (for investments), Key Facts Illustration (for mortgages) and policy summary (for insurance policies).

Know Your Customer Once called fact-finding. The requirement to obtain sufficient information about a customer’s personal and financial situation before giving advice. This also has anti-money laundering implications.

MCOB Mortgages: Conduct of Business sourcebook. The part of the FSA Handbook that contains the conduct of business rules for mortgage intermediaries and lenders.

Menu A document issued by financial advisers indicating the cost of advice. Payment options: fees, commission or a combination of the two. Specific to investment firms.

MFA Multi-tied financial adviser. They advise on a limited range of products from a number of providers.

Primary firm (insurance) A firm whose main business is the selling of or advising on insurance.

Pure protection contract (insurance) Long-term insurance contracts which do not normally have an investment element, e.g. critical illness, life insurance.

RMAR Retail Mediation Activities Return. Electronic form containing details about firms sent to the FSA by personal investment firms and mortgage and GI intermediaries.

SBPP Smaller Businesses Practitioner Panel. This provides input to the FSA on the regulatory impact on small firms.

Secondary firm (insurance) A firm whose insurance business arises as a result of its main business (e.g. car dealers, vets, dentists).

SFA Single-tied financial adviser. Advise on the products of a single product provider or group.

Small firm Broadly speaking, an FSA-authorised firm with regulated activity income of less than 3m though the definition varies according to type of firm.

Small firms division Division of the FSA responsible for supervising small firms with retail customers, i.e. mortgage and general insurance brokers.

Statutory objectives The FSA’s objectives as stated in the Financial Services and Markets Act 2000. These are market confidence, public awareness, consumer protection and the reduction of financial crime.

Suitability letter A letter sent by an adviser to a client after the fact-finding exercise. The letter recommends a financial product and explains why it is suitable.

Supervision FSA process of monitoring and regulating firms to ensure they are complying with regulations.

TCF Treating Customers Fairly. An initiative to ensure that firms meet the requirements of Principle 6 – to “pay due regard to the interests of customers and treat them fairly”.

Threshold conditions The minimum conditions a firm is required to satisfy to be given permissions for regulated activities.

WFA Whole of market financial adviser. Advice will be based on products across the whole of the market.

The three pillars of UK financial services regulation – and EuropeThree pillars form the regulatory structure. The Treasury establishes the parameters, the FSA then sets standards, monitors and enforces compliance, and the Financial Ombudsman Service provides access to redress for customers. The scope and nature of these organisations’ activities is significantly affected by one further element – the European Commission and the enormous underlying impact of European directives.

Despite major political setbacks such as the Dutch and French ‘no’ votes earlier this year, the Commission is fiercely protective of plans for a single EU-wide market for financial services. These were spelled out in the 1999 Financial Services Action Plan, and resulting directives are regularly welded into the UK’s regulatory framework. The Insurance Mediation Directive, for example, was approved by the European Parliament in September 2002 and passed to member states for implementation by January 15 2005. These requirements were adopted by the Treasury and the FSA into the general insurance rules.

More directives will follow and the UK mortgage industry should note with particular caution the August publication of The Costs and Benefits of Integration of EU Mortgage Markets. While the document lays out no concrete plans for implementation, it identifies mortgages as the biggest transaction made by most customers – the same argument used by the Treasury for UK mortgage regulation in December 2001.

Proposals in the EU mortgage paper

  • Review of the European Code of Conduct

A voluntary EU Code of Conduct exists for pre-contractual information on home loans. Much of this was incorporated into the IDD and KFI documents. The Commission proposes a review of this.

  • Compulsory advice
  • The paper notes mortgages are “complex high value products” and that advice is “sought more often than on most other financial services products”. The paper asks whether it should even be compulsory.

  • Changes to early repayment rules:
  • The Commission suggests consistency in the area of early repayment could facilitate integration.

  • APRs and calculation of cost elements varies between member states. The paper suggests some degree of standardisation could favour market integration.

  • Interest rate caps
  • Some member states have legally enforceable caps on interest rates designed to prevent excessively high interest rate charges.

  • Other issues
  • Proposals for cross-border consumer credit checking, possible changes to valuation processes and a review of European mortgage collateral and funding are also detailed.

    Treating Customers Fairly
    July saw the publication of TCF: Building on Progress – the FSA’s latest attempt to outline what its Treating Customers Fairly initiative means for firms.

    First unveiled in the run-up to Mortgage Day, TCF has developed from an abstract set of proposals to something the FSA clearly states must be built into every financial services firm from the boardroom down. Whether a firm is a pension provider, lender, insurer or mortgage intermediary, TCF must be a guiding factor in its activities.

    The FSA has been quick to point out TCF is not a new requirement for firms. There will be no clearly defined TCF-COB nor TCF Day, as this principles-based approach was, in its view, already founded in the Handbook’s Principles for Businesses. TCF is a direct descendant of Principles 6 and 7, namely:

    • Principle 6 – A firm must pay due regard to the interests of its customers and treat them fairly.
    • Principle 7 – A firm must pay due regard to the information needs of its clients and communicate information to them in a way which is clear, fair and not misleading.

    Understandably, criticism of TCF has been muted, with many intermediaries arguing that it encapsulates their existing approach to business. Nonetheless, TCF: Building on Progress outlined steps for firms to take in implementing TCF and the need to document how customers are treated fairly – from prospecting and the content of financial promotions right through to post-sales matters including customer feedback or complaints handling.

    As with the transition from the Mortgage Code to statutory regulation, firms are expected to perform their own gap analysis and log what they have done, and to consider all aspects of their business from the customer’s perspective. TCF: Building on Progress also highlights key themes for firms to consider. These include:

    • Senior management emphasis – TCF is not a project for compliance.
    • Proportionality – The FSA acknowledges TCF will apply differently to different firms. It expects firms to have asked similar questions but understands difference in how changes are delivered.
    • Remuneration – How do firms manage remuneration of advisers and staff.

    How do firms use management information such as complaints received and monitoring?

    Feedback from the Association of Mortgage Intermediaries revealed a broadly positively response to TCF in August. In most cases, firms strongly identified that the project is in line with their existing approach to customers. Over 80% said they were either aware or very aware of TCF, while over 70% said they have already built,or are building TCF into their firm.

    Whatever uncertainty firms feel over TCF, the FSA will publish details of positive and negative examples of TCF in practice in the months ahead. One certainty is that senior managers are expected to have addressed TCF, regardless of size or type.


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