Regulatory Consulting’s Insight & Foresight Newsletter - April Review 2010

April Review 2010

Not long now to the big day! Will the Tories win and start dismantling the FSA, or will there be a hung parliament and that notion be consigned to the dustbin of history. Meanwhile the election caused a significant amount of activity where there is more than meets the eye. In the "wash up" days of the last parliament the Financial Services Act 2010 passed all its remaining stages and received Royal Assent. Two life offices published their pensions manifestos and the enforcement people at the FSA adopted a new tactic.

Beware of what you wish for

The parliamentary authorities rather elegantly reverted to an old title for the 2010 Financial Services Act, the same title as the 1986 Act and rather crisper than Financial Services and Markets Act. Since financial services without a market seems implausible the longer title always seemed a little redundant. However, that is not all that has reverted to 1986.

Section 404 of FSMA has been comprehensively replaced by powers to create a set of arrangements that will allow the FSA to establish "consumer redress schemes" of a generic kind. In practice the old s404 contained a similar power with the notable exception that the 2000 Act did not trust the FSA to set up such schemes on its own. Under the old s404 the FSA had to prevail on the Government of the day to seek an affirmative resolution of both Houses of Parliament, effectively a short debate and a division of the House on the resolution. Of course, since the Act went live in 2002 there have been precisely no such instances and no such schemes. The FSA relied instead on bi-lateral action with firms using its supervision and enforcement powers. The questions worth a moment's thought are why did Parliament put such impediments in the FSA's path in 2000 and why are they removed in 2010?

The factual answers are easy. The impediment, effectively making such reviews impossible, was a reaction to the SIB pensions review of the 1990s conducted under the powers of the 1986 Act. This produced a very poor outcome for consumers judged in the round. The combination of the SIB rules and both the bureaucracy of life offices and the reality of long-term record keeping produced horrendously expensive redress in terms of the administrative cost as a proportion of the whole. Consumers paid for it all so some received their legitimate redress at the expense of others. It was resolved this should never happen again, hence the construction of s404 in 2000.

Fast forward to 2010 and it seems that the Financial Ombudsman Service, embarrassed by its failure to foresee the extent of payment protection insurance complaints, nagged the FSA to get the s404 restrictions removed so that the intermediaries and insurers would bear more of the pain of redressing consumers. Sadly, the bigger picture seems to have been missed yet again. No one should condone the egregious behaviour of those who made easy money on PPI. But big consumer redress schemes will simply drag both the industry and its customers further down into an inefficient outcome where outsourcing service providers and a host of interim managers get rich on administering detailed scheme rules. On top of that, this is just one more nail in the coffin of an efficient retail financial services industry meeting the needs, rather than the wants, of consumers.

Why did Parliament change its mind between 2000 and 2010? Essentially, in the run up to the election, the new s404 is an apparent pro-consumer measure and no party wished to be seen to be anti-consumer. It would have been better if Parliament could have debated the deeper malaise that underlies mis-selling of retail financial products. Time did not allow for that. In consequence, we shall probably be looking at legislation in 2020 that again moves the boundary on generic industry reviews. But in the meantime the imbalances in the risk management of the regulatory regime between prudential and conduct risk will continue and the consumers' lot will not improve.

The Pensions Predicament

In fact two life offices did try to look at the underlying causes of consumer detriment in the retirement savings market, AEGON and Friends Provident. Both produced "manifestos" but they could not have been more different. The FP one could best be described as, well, er, blunt. It did not bother with an analysis of the reasons why it wanted change, It took those for granted and sought eleven changes to public policy straight off the reel. Its opening shot is that "Pension regulation and reform within the UK has historically been implemented on a knee-jerk, reactive basis with a revolving door philosophy emanating from each newly elected administration." Well that told them! In practice, the problem has been rather more that administrations cannot make up their minds and get the great and good in to review the problems of pension provision. Each time the plant is pulled out of the ground to see if its roots are OK. And all the while, the consumer protection police give it all a bad name.

AEGON by contrast produce a much longer analytical piece which addresses multiple audiences with carefully crafted prose and facts and figures. Common denominators are concerns that auto-enrolment will be counter productive; making it easier for people to get advice in the workplace and dealing with the negative messages the tax relief changes create. AEGON goes on to address public sector pensions. It links this issue to auto-enrolment and fails to distinguish adequately (as the Lib Dems have done) between the contractual rights of deferred scheme members and future benefits, although future benefits are the clearly stated target issue. This brings out just how hard the pension saving issue is. Some public sector pensioners have a reasonably good audit trail to how the Pay Research Unit (abolished by Margaret Thatcher of course) reduced their pay for the value of index linked defined benefits. Others do not have such a good audit trail and the merits of their cases vary. Whether linking the auto-enrolment issue to the question of public pensions is wise remains to be seen.

The auto-enrolment issue itself also illustrates the difficulties of trying to create viable public policy. Auto-enrolment is commonly regarded by behavioural economists as a key way to overcome the problems of under-saving and under-protecting. Coincidentally, it has a very beneficial effect on the problem the new section 404 of the 2010 Act is trying to deal with long after the causative event; it stops consumers failing to provide for themselves. Yet two life offices are worried about auto-enrolment. The argument AEGON puts forward is pretty powerful. Enrolling people earning less that £10,000 a year is asking for trouble while means-tested benefits are available, (FP want rid of means testing without stating whether they would adopt the expensive Lib Dems' route.) Indeed enrolling such people is effectively mis-selling. Should the new section 404 apply to the Department of Work and Pensions? Sadly, of course, it does not!

Despite their contrasting styles, these two manifestos are both valuable contributions to a debate life offices have tended not to invest in. The more that do, the more is the chance that their point of view will be factored into public policy. If that resulted in a market not unlike that of Australia then consumer redress schemes might not need to be legislated for.

You only have to ask

Last month Insight and Foresight complained about the FSA enforcement practice of fining shareholders and members of mutuals for the mis-deeds of their managers. April saw a change of tactic. (No linkage obviously, just coincidence!) In the case of Northern Rock a former deputy chief executive was personally fined over £0.5 million and the firm not at all. Why this approach in this case? Could it be that we are all the shareholders of Northern Rock and there is the small matter of a general election in which one party wants to abolish the FSA? Taxpayer bank rescues are the ultimate expression of mutualisation since the losses are spread around every taxpayer, not just those who elect to join a mutual organisation. So fining all of us for the failings of the management would have been an easy target for journalists. It will be interesting to see if this approach is confined to Northern Rock because of its particular circumstances or whether it marks the beginning of a change of tack by the FSA for the better.

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