Cicero Policy Briefer

Issue 3, August 2006

TCF and the shift to principle based regulation: building on progress?

By John Rowland

The FSA has repeatedly made soothing noises about the need to reduce the inflexibility and costs of its regulatory regime, especially in retail markets. John Tiner said in December 2005: 1

“…we aim where we can to change the [regulatory] balance significantly towards a more principles-based approach. We believe this can produce better outcomes for both consumers and the financial services industry by encouraging a focus on how best to act in a particular situation, rather than simply following a mechanistic process.”

The major strand of the FSA’s strategy outlined in its Better Regulation Action Plan is a shift away from the rigid rules-based approach adopted by legacy regulators, towards a more ‘modern’ principle based approach. The publication by the FSA of Treating Customers Fairly – towards fair outcomes for consumers might be a good time to take stock of how a flagship piece of principle-based regulation is shaping up.

TCF seeks to imbue the industry with a high-level focus on the needs of the consumer, rather than emphasising compliance with rules that tell firms exactly what they can and can’t do. What it actually means to treat customers fairly is somewhat loosely defined, but includes the following: 2

• firms designing products for their target market;
• firms providing clear information which equips confident consumers to make good decisions and to be able to question the advice and information they are given; and
• effective complaint handling when things go wrong, so firms clearly address the issues being raised by consumers and put things right where necessary.

At once such an approach seems both appealing but also, arguably, somewhat woolly. FSA Chairman Callum McCarthy admitted in a speech 3 that while, on the whole, chairmen and chief executives approve of this shift toward principle-based regulation, those at the coal-face of compliance – general counsel and compliance officers – are somewhat sceptical.

At least some of this scepticism will stem from the reality that while rules can be encumbering and unyielding, they also offer a comforting level of certainty and familiarity. On the other hand, principles are more flexible but also require interpretation, which inevitably introduces a level of ambiguity that some in the industry find troubling.

Given that the FSA demands a major change in the way firms go about their business, it is little surprise that the progress so far has been mixed. The FSA is giving the worst performing firms until March 2007 to show that they are taking TCF seriously. This is just as well, since the Financial Services Consumer Panel has voiced its concern that while there has been a lot of talk on TCF there has not been as much action. The FSA obviously expects there to be significant progress in going forward, but there are challenges ahead – not just for firms, but for the FSA itself.

Developing a regime that can adequately tell how firms are measuring up against the requirements of TCF without weighing down industry with requirements to compile masses of management information will be a key concern. TCF is already part of ARROW visits and is to be incorporated in the FSA’s future thematic work, but the truth is that the development of a metric of how fairly customers are being treated will be thorny, as TCF is not just about business processes (relatively easy to assess) but also outcomes (somewhat trickier).

This is further complicated by the question of TCF in complex retail supply chains. One difficulty is that while all firms in the supply chain have a duty to TCF, whether they are customer-facing or not, the lines along which this duty is disaggregated may be somewhat blurred. This could be a particular problem for smaller firms, such as intermediaries who distribute products manufactured by other firms.

Nevertheless, the intention to incorporate the need to be fair to customers at a fundamental level, rather than as a ‘bolt-on’, is a bold step and one that is worthy of close observation. However, this is a relatively novel and immature mode of regulation and the ultimate proof of the approach will be found in answering two questions: will it keep the regulatory burden on industry to a reasonable level? And, of course, will it secure better outcomes for customers, who after years of financial services scandals need to be reassured that industry is taking their needs seriously? It is probably too early to answer either of these questions, but the FSA is hoping that the answer to both will be yes.

1. From “Better Regulation Action Plan” (FSA, Dec 2005)
2. From “Treating Customers Fairly: Building on Progress” (FSA, July 2005)
3. Speech by Callum McCarthy, Chairman, FSA to The Smith Institute Breakfast Seminar, 21st June 2006

John Rowland can be contacted on +44 (0)20 7665 9530 or click here to email.

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