Winds of change blowing through Stratford

Introduction

The big message in the FCA 21/22 Business Plan (see FCA’s 21/22 Business Plan) is one of the winds of change blowing out of the Westfield shopping centre and West Ham FC, and into the FCA HQ. The world is changing, and the FCA needs to change with it. The message comes strongly top down from Nikhil Rathi, the external CEO appointed last year.

Change will come about in three ways:

• More innovation, particularly in the use of data. Another £120 million is to be invested in IT over the three years.
• More assertive regulation, and a willingness to test the limits of the FCA’s powers.
• More adaptive regulation.

The Business Plan should be read as work in progress on the transformation of the FCA. Historically, the Business Plan would be used to set out the new thematic reviews and detailed areas of interest to the regulator. There is no such detail in this plan. Nikhil Rathi wishes to set the direction of travel before filling in the detailed destinations on the regulatory itinerary. So the sectoral strategies are to follow next year. This document is about putting regulated companies under notice of a more assertive regulator, and driving change down through the organisation of the FCA itself.

The Business Plan for the first time enumerates a set of seven proposed metrics against which to measure the success of the FCA. This is an ambitious move, as the history of metrics in the public sector is littered with perverse consequences and embarrassing outcomes which cannot reasonably be laid at the organisation’s door. The FCA propose metrics on consumer benefits, refusal rates for authorisations, removal of permissions, reductions in numbers of calls to the FCA, and so on. Publication is a start, but the metrics need further thought. Explanation and context will be much more important than the bare numbers. It is worth remembering that, for the best known public sector metrics – central banks’ inflation targets and interest rates – far more effort is put into explaining and communicating the metrics than into the metrics themselves.

The change message is as much for FCA staff as for the regulated – particularly the point on a more adaptive approach. The document does not make for entirely comfortable reading for FCA staff. There are rightly warm words for their commitment, but there is also a clear expectation of cultural change within the FCA, summed up in the ambition for a “more adaptive” approach to the FCA’s work. This is consistent with the clear-out of FCA Executive Directors that the new CEO has led since his appointment.

A “more assertive” FCA

What does the Business Plan mean for regulated companies? Here we need to focus on the ambition to be “more assertive.”

1. Authorisation: the FCA anticipate a “tougher gateway” to the regulated arena, with closer scrutiny of new entrants and stronger oversight of fast-growing firms. This would be more welcome if it had come with a balancing commitment to reduce the FCA’s lengthy timescales for experienced senior appointees, and to improve their erratic handling of the process;
2. Streamlined decision-making: the FCA will consult on a package of measures on streamlining action on enforcement and supervision, and shifting the balance between decisions to be taken by the Regulatory Decisions Committee and by the FCA Executive. We need to see the detail in the consultation, but a rationalisation of the hierarchy of internal FCA Committees leading to decisions is long overdue;
3. Targeted litigation strategy: this builds on the early certainty delivered by the Business Interruption test case;
4. “Use it or lose it” approach to permissions: the FCA has already started a clear-out of unused regulatory permissions;
5. Publication of more data: FCA plan to publish more of the data available to them about individual companies from their regulatory role, as well as uphold rates from complaints to the Financial Ombudsman Service. This is intended to incentivise regulated companies to improve their performance, and to guide consumers in their choice of provider. In this sense it is an extension of the thinking behind the FCA’s publication of value measures. It remains to be seen whether that will be the outcome. To be fair, we lack details, and the FCA will surely consult before putting flesh on the bones here, but there is a risk that companies currently willing to share information with their regulator, on the basis that it will remain confidential, may become much less willing to share that information if it may be published for different purposes. At the least, some form of safeguard for commercial confidentiality will be needed.

The emergence of a more assertive regulator is a predictable response to the perceived failings of the previous FCA regime – slowness to tackle high profile cases of misconduct. I am still not sure that this perception was entirely fair, but it had certainly taken hold among politicians who take an interest in financial services, and in the financial press. As such the perception had itself become a major obstacle to the effective performance of the FCA’s duties. So it had to be addressed.

A more assertive regulator will sound right to these audiences, but the approach is not without risks:

1. I have already commented on the FCA’s inefficient handling of authorisations, but there are wider disadvantages to a strong gateway to new entrants. In short, it can become a major barrier to innovation. History suggests that regulators are cautious in their approach to new ideas – though to their credit the FCA have made good use of their regulatory sandbox in this way. A strong gateway can also incentivise market participants to stay outside the regulated arena, putting consumers at risk
2. Some streamlining of FCA decision-making is welcome, and it is probably the case that too many decisions went to the Regulatory Decisions Committee. Mid-ranking officials in a large organisation will naturally prefer the safety of a decision taken by a senior committee. But the Regulatory Decisions Committee is also a key check and balance on a very powerful regulator. If the Committee is taken out of the equation, there is one less defence against groupthink
3. The Business Interruption test case was, on balance, a success. Both customers and insurers got legal certainty much sooner than they would otherwise have done. But a strategy of selective litigation needs – well – a strategy. Litigation is a blunt policy tool. For example, this test case has also wreaked collateral damage to the law on causation affecting a wide range of commercial insurance policies quite unrelated to business interruption. Hundreds of policies will have to be re-written. In addition, further thought needs to be given to the conflicts between the FCA in its role as litigant, and the FCA in its role as regulator. A regulator has to be consistent and even-handed; a litigant does not. Indeed, litigation is by its nature adversarial.
4. It is not clear what the value to consumers is of tidying up unused permissions. This risks becoming a high profile distraction
5. Putting information in the public domain is not necessarily an effective approach to changing behaviour. Elsewhere the FCA notes that consumers do not always react as the FCA would wish to the information provided by companies.

So, there are a lot of questions to be answered about the nature of an assertive regulator. None of these hesitations amount to a strong argument against the approach. Just that the FCA should go down this route carefully and thoughtfully, mindful of the possibility that the outcomes may not be exactly as they would have wished.

How should regulated companies react to a more assertive regulator? So far, Sicsic Advisory has consistently advocated to its clients an open approach of proactive engagement with the regulator. We still believe that this is the best approach, but the arrival of an assertive regulator means that we need to add a rider to this. Regulated companies need to be prepared for a more rapid move to enforcement, greater use of the courts by the regulator to achieve its objectives, and a more direct approach overall. In practice, this means much greater interaction between legal and compliance teams – recognising that compliance issues may move more rapidly into the legal domain. And a more disciplined approach to the supervisory relationship. The FCA has been blurring the lines between supervision and enforcement for years, and this needs to be reflected in companies’ own approach.

General Insurance specifics

There are few specific references to general insurance in the 2021/22 Business Plan. For that, we will need to wait for the sectoral strategies. All the references are all well-trodden ground:

• The market study on GI Pricing is given as an example both of the benefits of competition regulation for consumers, and as an example of the FCA’s focus on fair value. Sicsic Advisory believe that many companies have a long way to go on this issue.
• Tucked away in the wholesale markets section is a significant announcement on Appointed Representatives. The FCA will tighten supervision of appointed representatives, with a view to much improved oversight of Appointed Representatives by their principals. It is clear that, as things stand, FCA see the risk of a gap in their regulatory standards where Appointed Representatives are at work, and are determined to close the gap. As we know, FCA has been dissatisfied with insurers’ oversight of Appointed Representatives since the thematic review many years ago.
• Finally the test case on Business Interruption receives a nod of approval under the “targeted litigation strategy.” There is also confirmation in the Budget section of the special £7.5 million levy on the insurance sector to pay for the Business Interruption case.

Wider market priorities

More generally in the Business Plan, the proposed Consumer Duty receives a prominent role in the FCA’s consumer priorities. The Business Plan also sets a date for the implementation of the Consumer Duty by July 2022.

The FCA’s all market priorities have a familiar feel: fraud, financial resilience, operational resilience, diversity and inclusion, sustainability and international co-operation.

For insurance intermediaries, it is worth drawing out a bit of the context on financial resilience. We know that the FCA had concerns about the financial fragility of some intermediaries highlighted by Covid. This Business Plan signals a continued more intrusive approach to the finances of intermediaries, in parallel with the recent Dear CEO letter on their handling of client money.

The announcement of efforts to reduce the burden of the Financial Services Compensation Scheme (FSCS) also has the potential to be transformative. CFOs will be all too familiar with the increasing cost of the FSCS. However, there are no easy solutions here. In the past, the FCA has looked at expanding the role of Professional Indemnity Insurance, higher capital requirements for intermediaries, and levies based on the perceived riskiness of products. None of them are ideal.

Sicsic Advisory has good offerings to our clients in the fields of operational resilience and sustainability. Both feature in the list of wider market priorities. FCA confirm that they will be paying closer attention to companies’ operational resilience, now that the strategy is public. Under sustainability, FCA flag up the proposed TFCD-based disclosure rules. We still believe that both these areas merit greater attention by regulated companies.