Yesterday (18 March 2009) the FSA published their long anticipated paper ‘A regulatory response to the global banking crisis.’ This is more commonly known as The Turner Review, and has been broadly welcomed by the industry, politicians and the media.
Turner believes that the FSA has already put in place, or at least initiated, many of the domestic measures needed to respond to the crisis. However, there are a number of recommendations around issues such as capital adequacy, credit rating agencies and cross-border banks (globally and within Europe) which cannot be implemented without international co-operation. The Turner Review will be used to inform the UK negotiations in the G20 meetings in early April. “Lord Turner’s review will only succeed if other countries follow his lead” (FT – 19 March)
There is a recognition that historically the FSA has focused too much on firms’ systems and controls as opposed to the sustainability of the business models of the regulated firms and the quality of their decision making. This will change and potentially have a significant impact on the industry.
This long and complex paper contains some detailed economic insight and theory, however, we have sought to translate it to consider the following:
- What does it mean in the context of helping consumers achieve a fair deal?; and
- What does it mean for the way financial services firms respond to and manage regulatory risk?
The vast majority of the review considers what went wrong with the regulatory framework and then explores and presents a long list of actions required to create a stable and effective banking system. The key points are summarised below under the following headings:
- FSA supervisory approach;
- Remuneration;
- Product regulation in the mortgage market; and
- Firms’ Risk Management and Governance
FSA supervisory approach
The FSA’s Supervisory Enhancement Programme (which was launched last April, primarily in response to Northern Rock) is already delivering a substantial change in terms of increasing the number, and improving the quality, of people dedicated to supervising firms. This will lead to more effective, intensive and intrusive supervision, resulting in the FSA having much greater visibility of the issues in firms and the risks they present to the FSA achieving its statutory objectives.
The FSA mantra will no longer be ‘show me’ but ‘prove it to me – and don’t do it if you can’t’.
This means that firms need more help in managing their regulatory risk if they are to keep the FSA satisfied that they do not pose risks to the financial system. For example, ARROW visits will require a great deal more preparation. In addition, companies can expect much closer scrutiny on a day to day basis and will need to respond to many more regulatory requests and requirements.
Remuneration
Turner takes the view that remuneration and bonus policies “were considerably less important” in provoking the crisis than inadequate approaches to capital, accounting and liquidity. However, the FSA is already taking action regarding the ‘bonus culture’.
A new UK remuneration code (possibly to be implemented by November 2009) and a global agreement on remuneration is to be sought to avoid incentives for undue risk taking and to ensure risks are more closely aligned to remuneration decisions. This is likely to affect not only senior management but also customer facing staff. It will have a significant impact on the way firms set their business targets for revenue and profit and ultimately the way they behave and treat their customers.
Product regulation in the mortgage market
There was some speculation before the report that ‘product regulation’ would be introduced by the Review. The FSA did not go this far but they intend to look at the possible regulation of mortgage products with a review to be reported by Q3 2009. Current regulation is focused on advising on, selling and the administration of mortgages rather than the features of the products themselves. The FSA’s particular concerns relate to the affordability of the mortgages – that is Loan to Income (LTI) ratio – and the exposure of consumers to potential negative equity, being high Loan to Value (LTV) ratios. Possible regulation might include limits on the LTV, which means home buyers having to put forward higher cash deposits than previously, and limits on the amount of the loan that can be offered in comparison to a borrower’s income.
Firms’ Risk Management and Governance
A separate review, the Walker Review, reporting in Q4 2009, will look at improving the professionalism and independence of risk management functions, embedding risk in remuneration policies and improving the skill level and time commitment of non-executive directors. Companies will be expected to look very carefully at these issues.
Huntswood