Learning objectives
1.8 Regulation of financial services
During the second half of the 1980s, the government of Margaret Thatcher initi- ated an ongoing programme of legislation aimed both at the liberalization and reg- ulation of the financial services marketplace. The Financial Services Act 1986 was aimed at defining and regulating investment business, as well as promoting compe- tition in the marketplace for savings. The focus of the FSA 1986 was the conduct of investment business and the accompanying provision of advice. As such, it excluded products such as mortgages, credit card loans, general insurance and short-term deposits, which were subject to separate legislation. In May 1997 the then Chancellor of the Exchequer, Gordon Brown, announced his decision to merge banking supervision and investment services regulation into the Securities and Investment Board (SIB). Later that same year, the SIB was renamed the Financial Services Authority (FSA). In December 2001 the Financial Services and Markets Act was implemented, whereby the FSA became the UK’s highest single financial serv- ices regulator. As well as being responsible for the regulation of banks and securi- ties, it also assumed responsibility for the following organizations:
● Building Societies Commission
● Friendly Societies Commission
● Investment Management Regulatory Organization
● Personal Investment Authority
● Register of Friendly Societies
● Securities and Futures Authority.
The scope of the FSA was widened further with responsibility for the regulation of mortgages in 2004 and general insurance in 2005. The FSA is an independent non- governmental body which operates as a company limited by guarantee and is financed by the financial services industry. The FSA has a Board which is appointed by Her Majesty’s Treasury, and the FSA is accountable to Treasury Ministers and, through them, to Parliament. The Financial Services and Markets Act lays down four statutory objectives for the FSA, namely:
1. Market confidence – maintaining confidence in the financial system
2. Public awareness – promoting public understanding of the financial system 3. Consumer protection – securing the appropriate degree of protection for
consumers
4. Reduction of financial crime – reducing the extent to which it is possible for a business to be used for a purpose connected with financial crime.
The FSA seeks to achieve its objectives by way of a vast array of rules and direc- tives, the contravention of which can result in a range of penalties. It is of the essence that all those involved in financial services provision have a sound grasp of the rules that apply to their particular product sector and functional discipline. The rulebook of the FSA spans an enormous gamut from issues of strategic, overarching signifi- cance, such as solvency margins, to matters of fine detail, such as the nature and wording of individual advertisements.
An area of particular significance in a marketing context concerns the develop- ment of regulations regarding the distribution and sale of financial services and the integral issue of financial advice. The 1986 Act led to the introduction of what might
be termed the doctrine of polarization. In practice, this meant that financial advice, and any resulting sale, must be provided by one of two variants of advisers. Thus, the concepts of Independent Financial Advisers (IFAs) and Tied Agents (TAs) was initiated. IFAs were to act as de facto agents of the consumer, and were bound to give
‘best advice’ in response to the consumers’ financial needs from all possible sources of supply in the marketplace. At the other ‘pole of advice’ were the TAs, who could give advice and sell products purely from one company. TAs were of two primary forms, namely Company Representatives (CRs) and Appointed Representatives (ARs). The CRs worked directly for the financial services company upon whose products they gave advice and sold products. This could be either as a salaried employee or as an adviser paid on a commission-only basis. Appointed representa- tives, on the other hand, were staff under the control of a separate company that had a distribution agreement with a given life insurance company. For example, The Cheshire Building Society is an AR of Norwich Union, which means that the finan- cial advisers employed by the Cheshire can only give advice on the products sup- plied by Norwich Union.
Through polarization, it was intended that the consumer interest would be best served in that consumers would have absolute certainty whether they were receiv- ing completely independent advice or advice on the product of just one company.
Prior to this time there was a plethora of ad hoc distribution arrangements, and con- sumers were often unclear regarding the degree of independence that was attached to the advice they received. In practice, the introduction of polarization resulted in a somewhat unedifying scramble for distribution as life companies vied with each other to attract AR and CR arrangements. In the short term, it did nothing to reduce the costs associated with advising on and selling investment products. Moreover, the need for each company with a TA form of distribution to have a full product range available for its agents to advise on and sell did nothing to improve the effi- ciency of the industry. Arguably, the reverse happened as companies filled out their product ranges with products, some of which were sold in extremely low volumes and offered relatively poor value for money. Standards of financial advice were also slow to respond to the spirit of regulation. Indeed, the mis-selling of personal pen- sions was at its height between 1987 and 1991, resulting in the so-called ‘pension mis-selling scandal’ which to date has cost the industry in the order of £15bn in com- pensation and allied administration costs. Other examples of consumer detriment have arisen since the 1986 Act, including the mis-selling of mortgage endowments and a number of investment schemes.
In 2005, following a lengthy period of consultation, the polarization rules were revised to permit a form of multi-tied distribution. To quote the FSA (www.fsa.gov.uk):
from 2005, tied advisers selling any type of investment (not just stakeholder schemes) will be able to offer the products of more than one provider if they are tied to a company which has adopted the products of other providers in its range.
A critical step forward in improving the consumer interest was the introduction of new rules regarding the training and competence of advisers in the early 1990s.
This acted as a watershed for the industry by introducing more exacting standards
of knowledge that financial advisers and their managers could demonstrate. It also resulted in a significant increase in the costs of employing an adviser. As a conse- quence, there was a dramatic fall in the number of people involved in advising and selling life and pension products between 1991 and 1996. Some estimates have sug- gested that this number collapsed from the order of 220 000 to about 50 000 during the 5-year period. This has had the effect of forcing incompetent and unproductive advisers out of the industry, and has thus raised the standard of professionalism of the typical financial adviser.
The preceding commentary and views of just one narrow aspect of financial services regulation are intended to demonstrate the paramount importance that the authors attach to students and practitioners having a sound appreciation of the regulations that apply in their respective countries and industry sectors. Some examples of how the regulation of insurance business is approached in a number of other countries are given in Box 1.1.
Box 1.1 International approaches to insurance regulation
USA:In the USA, each individual state has its own regulator. Their titles vary, depending on the state, and include commissioner, superintendent or director.
In some states, governors appoint the commissioner; in others, the general public elects commissioners. The commissioners from the various states together form the National Association (NAIC) to promote uniformity in regu- lation. Other officials with some oversight functions include the representatives of guaranty funds and certain federal government agencies.
Australia: In Australia, the APRA, or Australian Prudential Regulatory Authority, is the integrated prudential regulator of the Australian financial services industry. It was set up in 1988, and oversees banks, credit unions, build- ing societies, general insurance and reinsurance companies, life insurance com- panies, friendly societies and most members of the superannuation industry.
The APRA is funded primarily by the industries it supervises.
Singapore:In Singapore, the Insurance Supervision Department is the pri- mary regulator of the Monetary Authority of Singapore (MAS). The Insurance Supervision Department (ISD) administers the Insurance Act, its main objective being the protection of policyholders’ interests. ISD adopts a risk-focused approach in the prudential and market conduct supervision of insurance com- panies. ISD carries out its responsibilities by way of both off-site surveillance and on-site examination, and works with foreign supervisors as part of a holis- tic supervisory approach. In its standards development role, ISD works closely with industry associations to promote the adoption of best practices by the industry.
South Africa:The Financial Services Board (FSB) was established as a statu- tory body by the Financial Services Board Act (No. 97 of 1990) and is financed by the financial services industry itself, with no contribution from government.
It supervises the control over the activities of non-banking financial services and acts in an advisory capacity to the Minister of Finance.