FSA to turn Treating Customers Fairly principles into rules

The FSA introduced its TCF guidelines in July 2005, signaling a move towards a more principles-based approach to regulation.

But in feedback to its discussion paper on product intervention it published today, it says it wants to create one set of rules for firms, which will incorporate TCF and the FSA’s Principles for Business guidelines.

The FSA also says it remains of the view that a product intervention approach is an essential means of achieving an appropriate level of consumer protection.

The FSA, says: “We believe that it is necessary for us to make changes to our regulatory approach to consider the entire product life cycle, including product governance and distribution standards.

“We are already supervising firms’ product governance under our new intensive approach. In addition, we will take forward a single set of rules and guidance on product governance, including, for example, turning some or all of the TCF material into rules, and will consider additional interventions going forward.”

In January this year it published a discussion paper that explained its proposed new approach to the regulation of retail financial services.

In its feedback, it says: “We agree that the point-of-sale is a critical part of the value chain and is a key determining factor in whether consumer detriment will arise.

“However, we consider that product design and decisions made by product designers about how – and to whom – products will be distributed play a significant role in determining consumer outcomes.

“Our starting point is not a desire to dictate product structures to the market, rather to put right problems where competition and the regulatory approach have been ineffective in delivering on genuine customer needs.”

It says it is looking primarily at the product governance processes employed by firms, whether competition is working effectively for consumers, and whether firms are exploiting consumer behaviour.

Take for example the issue of "unfair" exit penalties on product. For very illiquid assets, for example, such provisions are essential to avoid a run. And when we talk of illiquid assets, we're talking potentially about everything - cash deposits are supported not by bundles of notes but by highly illiquid mortgages, and as we all now know, property can be damned near illiquid at times. So indeed are shares when a Lehman Brothers goes down and everyone runs for the exit door. In extremis, no private provider could now underwrite a product with no exit penalties. Certainly as a shareholder of such a business I would consider directors who do to be in breach of their fiduciary duties. So realistically, we appear to be bowling headlong for a state-controlled financial services system. That might be the best outcome some might argue, but does it fit with the mixed economy we supposedly have? I'd have thought that this is now the moment to have a Cameron-esque pause, and to consider exactly what the ramifications are, and where we as a nation really want to go. Can Andrew Tyrie pick this one up?

Solvency 2 – a step towards statism

Britain has one of the least regulated insurance markets in Europe but, despite this and even before Solvency 2, the state is heavily involved in running insurance businesses. Firstly of all, to set up an insurance company, an authorisation from the Financial Services Authority (FSA) is needed. From this moment on, the insurer must use government-approved accounting, reporting and actuarial standards. This means that basic tools of processing financial information are imposed by the political process.

The FSA also decides who can do the most important jobs in an insurance company. It is not the owner or the shareholders who have the final say on who will be the sales, risk or finance director, but a government agency approves individuals to perform such functions .

On top of that, all important meetings in an insurance organisation must be minuted and the FSA can review the minutes, check who said what and question them about it. This stifles internal discussions and challenge process because people are less willing to say what they really think when an FSA auditor can later be questioning them about this.

The regulator also approves every insurer’s principles of customer service . Under the “Treating Customers Fairly” regulation, insurance companies cannot freely change their claims handling processes, call centre procedures or complaints handling. Significant changes to those may require FSA approval.

Pricing of insurance services is at least partly regulated too. The recent decision of the Office of Fair Trading limits the use of some market information for pricing and underwriting. Similarly, the European Court of Justice prohibits (PDF)  the use of an important risk factor – gender – in pricing. The Transport Committee Enquiry may well result in additional government interventions.

The FSA also decides how insurance should be distributed. The FSA’s Retail Distribution Review will be a massive change to the way life insurance is distributed in the UK.

As if this was not already too much, in the near future, the FSA wants to regulate the terms and conditions of insurance contracts and be directly involved in product design and development.

State interference under Solvency 2

Solvency 2 comes into force in 2013, but it is already affecting insurance companies today. It introduces new requirements for management data collection and reporting. Even today, although the implementation of Solvency 2 is still in progress, large insurance companies send every day half a dozen e-mails to the FSA with data and information on the strategy, risks, governance and financial results.