An appointment with FSA complexity

Here we go, the first of 50 action-packed, death-defying, edge of the seat regulation articles this year. Happy New Year by the way.

The FSA has now published its Consultation Paper 159 on the extension of the appointed representatives regime to cover the mortgage and general insurance markets.

By the time of FSA regulation in October 2004, all intermediaries dealing with mortgages and/or GI must elect to either become directly authorised by the FSA or become an appointed representative of one or more principal companies. There is no third option.

The principal company must be directly authorised by the FSA and typical principals will be insurance companies such as Friends Provident, IFA networks such as Misys, and the new leaner, meaner networks such as Network Data. The principal company accepts contractual responsibility in writing for the AR&#39s activities.

Let us start by looking at some key issues that are not the subject of consultation. If you intend becoming directly authorised, don&#39t bother responding to CP159 by saying you don&#39t think the AR regime should be extended to cover mortgages and GI – it is going to happen.

The FSA, in its Executive Summary para. 1.6, says: “We have concluded…” that the ARs may have more than one principal. The option of a single principal has effectively been ruled out on the grounds that it would be anti-competitive.

So don&#39t bother disagreeing with what the FSA describes as this &#39key policy issue&#39 of multi-principals – it is going to happen. An AR will be able to have up to 13 principals, each covering one of the &#39substitutable&#39 product categories (see box). As of now there can only be one principal for investments, but up to two for mortgages and up to 10 for general insurance.

You are not obliged to have 13 principals and the reality may well be that the majority of brokers that choose to go down the AR route may only have one principal company, and that principal is authorised to deal in the different product lines sold by the broker. You cannot be an AR for some product lines and directly authorised for other product lines.

So it is a black and white picture – you are either an AR for all the products you sell or you are an IFA.

As you can see from the list of substitutable product lines, term assurance has now come in from the cold, having been previously excluded and ignored by the GISC.

&#39Substitutable&#39 is a very ungainly word, but it does succinctly reflect the logic behind the FSA&#39s thinking and it is at the heart of its overriding concern for consumer protection. The FSA is adamant that the principal for the product line in question should be responsible for all activities of the AR in connection with the sales of that product line, including advice.

To demonstrate this, let&#39s imagine a hypothetical situation where an AR has one principal F for fixed rate mortgages and a different principal D for discount mortgages. The AR advises the customer to take out a discount mortgage, this is arranged and completed, and there is a formal complaint some months later (when interest rates are rising) from the customer who says they had really wanted a fixed rate. Which principal, F or D, does the FSA communicate with?

Principal F will say the AR&#39s advice in this case is nothing to do with them as they are only responsible for customers taking out a fixed rate mortgage, which was not the case here. Principal D will say that the discount mortgage provided was the best discount product available at the time, and that it is not responsible for any advice (or lack of advice) on fixed rates as it is does not deal with that product line.

As the fixed and discount rate products are deemed to be substitutable i.e. either could have been appropriate for the customer at the time, the FSA is adamant that there will be only one principal involved and that the principal will be responsible for the advice given.

This is a bit convoluted, but then so is most of CP159. Consumer protection is met because the FSA will have a clearly identifiable target for its investigations and any subsequent action such as recompense to the customers, fining the principal firm and banning an AR or the principal from conducting business.

As one means of enforcing this protection, a principal of an AR will need to ensure that its written contract with the AR prevents the AR from having another principal for business which could reasonably be offered as an alternative.

The list of 13 substitutable products lines shown then start to make some sense (particularly if they were called non-substitutable products).

You cannot in theory have a customer complaining they were sold a fixed rate when they really wanted an equity release mortgage, or a customer complaining about a term assurance policy when they really wanted to insure their car.

CP159 reiterates a number of times that the rules only involve dealings with private customers and it is looking for responses on how to deal with commercial lines of business.

Also included in CP159 are changes to the existing AR regime applying to investment firms and anticipated changes to the FSA rules generally as a result of the CP121 consultation on depolarisation. And for good measure the FSA has to take into account the EU&#39s Insurance Mediation Direction.

With so many balls in the air, it is a pretty impressive juggling act and you have to give the FSA a round of applause.

As with CP146, we will be preparing a downloadable response to CP159 from www.mortgagestrategy.co.uk in time for the March 31 deadline.

Next week we move on to CP160 – insurance selling and administration.

&#39Substitutable&#39 products

Investments

•Investments

Mortgages

•Mainstream mortgages

•Lifetime mortgages (equity release)

General Insurance

•Term and critical illness

•Medical and dental

•Income protection

•Long-term care

•Buildings and contents

•Motor

•Travel

•Legal expenses

•Pets

•Extended warranty – motor