Introduction
Good morning. I wanted to start with a quick thank you to the BSA for inviting me to speak here today – and to thank Chris and the wider team at the BSA for their engagement with the FCA over the last few months, and the FSA before that.
This is my first speech as Director of Mortgages and Consumer Lending, so it makes sense to begin with a broad overview of the FCA’s approach to supervising building societies. I’d also like to share our current views of the mutuals sector; not just the strengths, but also where we think there may be potential risks to consumers, and some of the areas that we plan to work on in the near future.
But before going into the detail, I want to reflect more broadly on where we stand now – six months after the official launch of the FCA. Even in this narrow timeframe, I hope that you are starting to see how very different financial services regulation will be going forward.
Many of the regulatory conventions that unwound in the build-up to the economic crisis are gone. We have replaced the reliance on disclosure, compliance and systems and controls - none of which ultimately inspired consumer confidence.
In their stead, the FCA will be operating a much more proactive agenda in three key ways.
- We’ll be exercising greater use of judgement.
- We’ll be more forward looking.
- And we’ll be more outcome-focused.
These three points summarise our approach to financial regulation, and give you a clear sense of our purpose for your own area of business. But let me explain a little more about what these mean for us.
To be judgement-based requires us to have a deep understanding of the sectors we regulate and what consumers are really experiencing. So, we will be curious to understand how a firm makes its money, what its business model delivers when compared to the expectations of its’ customers, what the product experience feels like and, overall, whether the culture and practices at all levels of the firm reflect the values that senior management set out.
To be forward-looking doesn’t mean we can predict the future or anticipate every issue that’s likely to arise. What it does mean is that we are more focused on the big issues that matter. We’ll use, with greater insight, data and intelligence to draw conclusions about firms or the markets they operate in, and then join the dots to identify and head off risks before they crystallise and cause consumer detriment or damage to market integrity.
This leads me to outcome-focused. This means that we will concentrate on what outcomes are being achieved for consumers rather than in a narrow way, on whether a firm complies with our rules. For example, it isn’t good enough to keep meticulous records of sales, if the ultimate outcome for the customer is walking away with a product that isn’t right for them.
All of these statements are easy to say but hard to deliver in practice, as I’m sure you will appreciate. But you should understand why these things are important to us, and for that, I’ll take you back to our objectives.
Our strategic objective, our goal or aim if you like, is to make sure that markets work well. Everything we do leads back to this, while our operational objectives of protecting consumers, enhancing market integrity and promoting effective competition, take it to the next level of detail. But when you put these together, they give the FCA a very clear mandate to make sure markets work well for consumers, and firms, of all shapes and sizes.
So although we are just six months in, we are very clear in our purpose, sharp in our focus and committed to delivering all three of our objectives.
Our approach to supervising building societies
I said at the start that I would talk about our supervision approach and how it applies to building societies. First, let me say that we see building societies as an essential and integral part of the financial services industry in the UK.
Building societies have come a long way since the formation of the first ‘terminating’ society in Birmingham in 1775, through the development of ‘permanent’ building societies in the 19th century, and the de-mutualisation in the 1980s and 90s. We recognise that the mutuality that lies behind building societies today is important in creating strong community ties in the regions they serve. And that this typically leads to a positive reputation for good customer service.
In contrast to the picture that is often painted of the banking sector, many societies are seeing increased profitability and new jobs are being created, building on the estimated 40,000 that are already employed by the sector. We appreciate that their lending is a vital component of the overall UK mortgage and savings market, given that a quarter of all new mortgages written in the first half of 2013 were with the building societies or other mutuals. The sector also holds one in five household deposits.
So this market has very specific strengths that require a very specific regulatory approach. To help achieve that, we have a new supervision model. A model that focuses on ensuring firms put the interests of the customer, and market integrity, at the heart of how they run their business.
In other words, for building societies, we will be focusing on whether this special mutuality means you have the interests of consumers at the core of your society; whether good customer service translates into good customer outcomes. We’ll also want to explore how firms in the sector respond and adapt their business models, in light of competitive pressures, including those that may come when the banks shift focus from repairing their balance sheets.
As you know, this will be done by a continuation of individual firm risk assessments, dealing with events that may lead to harm, and more thematic reviews – what we term Pillars 1, 2 and 3. These, however, will feel different from the past in four main ways.
Key differences in our new approach
Firstly, our firm-specific, Pillar 1 work will be focused more on looking at the primary drivers of poor behaviours, such as the firm’s business model, strategy, culture and front-line processes. Essentially, it is a shift from looking at how a firm controls itself, to how it runs itself. So, for example, when we look at how a firm is governed, we will be focused on the content of the discussions rather than the details of the governance structure itself.
We will expect the Board, and any relevant committees, to have identified the customer outcomes arising from business decisions. We’ll also be focused on whether the information reviewed by those governing the society is really designed to tell them whether good customer outcomes are being achieved.
To deliver this work, we will use different tools depending on the size and potential impact of individual firms.
For the largest mutuals – the C1s - this will be an overall evaluation once a year, moving to once every two years for the C2 building societies. This will be informed by a proactive review of management information, and regular engagement with both senior leadership, and those who have direct control of the customer-facing functions.
This approach will be complemented by ‘deep dives’ into certain areas of the business that warrant in-depth work. This may be a ‘vertical slice’ through the business; for example, looking at the cycle of a particular new product from design to delivery.
The ‘deep dives’ will be designed to allow us to form overall supervisory judgements; for example, whether the culture that has been set at the top is reflected in branches, in the back office and when customers complain. For the largest mutuals, we aim to conduct a ‘deep dive’ roughly once every six months and for C2s, once a year.
For the smaller societies, following regular proactive evaluation against their peers, we will employ periodic assessments where we see the risks. At a minimum there will be a touch point for these firms once every four years, although it could be more.
Second, we have placed additional resource into thematic reviews as the most effective way of delivering our conduct priorities, and we will be more transparent about what we are interested in before we start our work. In particular, to complement the four-year assessment cycle, smaller societies can expect to receive greater contact with the FCA than perhaps they have previously experienced, via this ‘issues and products’ work.
For example, we will continue to evaluate how all firms in the market are preparing for the Mortgage Market Review changes. We will be commencing our second wave of readiness testing shortly. And we will conduct substantive post-implementation testing after the new rules come into effect in April 2014, which will have strands of thematic work touching on lenders, intermediaries and other market participants of all sizes.
We will continue our arrears handling and forbearance management theme, where we are considering areas such as firms’ strategies when dealing with long-term arrears cases – including recent developments in practices – and whether firms are delivering fair treatment for mortgage borrowers who have experienced financial difficulty. In fact, as we speak, this fieldwork is well underway. Firms will hear from us on our findings by the end of the year, with wider communications happening shortly after (but, given Christmas, potentially early into the New Year).
Sometimes to be forward looking, you have to focus on the present and understand what’s happening in firms, and to their customers, in the here and now. How firms handle customer complaints is one such area.
There is rightly a lot of interest in how well firms deal with complaints from their customers; and there’s always the inevitable interest when the Financial Ombudsman publishes its data on upheld complaints. But between the start of a customer problem, and it getting to the Ombudsman, the firm chooses how to respond.
The amount of complaints that go to the Ombudsman suggests that something isn’t working in the way in which firms manage and investigate customers’ complaints. So, as signposted in our 2013/14 Business Plan, we are going to undertake a thematic review of complaint handling and management in major firms, including building societies.
The thematic review will identify why complaint handling is not working well for some consumers and address any poor practice within firms. We will use our new assessment approach to place greater onus on ‘senior persons’ to understand how effective their firm’s complaints handling process is, and how they use the complaints experience to identify and correct the systemic causes behind customers’ complaints.
We will conduct our review in two phases. Phase 1 will consider how firms identify, record and report complaints, and will be completed by the end of 2013. Phase 2 will commence in early 2014, and will consider firms’ approach to redress and root cause analysis. We intend to reach a conclusion on our findings from the thematic review, and provide recommendations, in Q2 2014.
It is 100% in the industry’s interest to ensure that when customers do complain, they have confidence their complaint will be recognised, that it will be investigated fairly in a timely manner and that redress will be paid where it is due. We are hopeful that this will lead to a reduction in the number of customers requiring the services of the Ombudsman to obtain the appropriate redress.
The third key difference I wanted to talk about was the change to the FCA’s internal structure to align with this new approach. As many here know, we have put in place sector-focused departments that are more clearly aligned to markets. The re-aligned departments better reflect how consumers interact with financial services. My area supervises mortgages and consumer lending, with a number of teams dedicated to building societies – headed by Charles Roe, whom you may have met already.
Fourth and finally, and to enable all this to happen, we are changing our own mind-set. As I’ve outlined, we are moving from being primarily reactive to more pre-emptive; and to identifying and tackling the big issues in firms or in sectors that drive good, or poor, customer outcomes.
This is illustrated by our intention, in the autumn, to publish a discussion paper to have an open dialogue on what ‘fairness’ means in the context of changes to mortgage contracts under our principles, and the suitability of the current regulatory framework to deliver adequate consumer protection.
I’d now like to briefly cover how we prioritise resources to deliver what we’ve set out to do.
As you will be aware, we have put into place a new conduct and prudential firm categorisation system, which will mean we have supervisors allocated to firms with the greatest potential to cause risks to consumers or market integrity.
Ultimately, this will mean some firms, including many of the smaller building societies, no longer have a dedicated supervisor. Instead, we want to have more supervisors ready to be deployed flexibly to deal with problems that arise, along with specific issues and products that have potential to cause – or are already causing – consumer harm.
I think it is important to say we do continue to maintain specialist supervisory resource and will continue to work with all societies through our routine interactions, as well as on specific thematic projects.
It is also worth flagging that within our scope we have 23,000 firms who are being prudentially regulated by the FCA. This figure includes some subsidiaries of building societies, who we will supervise with an intensity proportionate to their prudential classification.
Here, our overall aim will be to reduce the impact on your customers, and the market, in the eventuality that a firm fails. This is a slight shift, but an important one, from the old regulatory philosophy of aiming to reduce the probability of failure.
Given the dual-regulated nature of building society groups, we continue to maintain close working relationships with our colleagues at the PRA, and have open and honest conversations with them – while operating within our separate objectives.
As you will have heard, our supervision work will be supported by new powers. These new powers permit us to make rules, ban, or restrict sales of products that pose an unacceptable risk to consumers.
In practice, this means that the FCA will be able to, without consultation, intervene quickly and ban products for up to a year to prevent or minimise harm to consumers in a transparent way before it becomes widespread. It also means we’ll be able to ban financial advertising and promotions immediately and publish details so that the industry is clear about what we expect.
But I want to reinforce the fact that we won’t be using these powers casually. Fundamentally, our first focus will always be to make sure firms are thinking about who they are designing their products for, testing that the products will perform as they expect, and then ensuring the distribution and marketing strategies used get these products to the target customers.
This focus has great relevance to the building societies sector. We‘ve recently seen a move by some societies to offer more niche lending products, such as shared ownership or equity, as well as bridging finance. There are also those who think that equity release may be ‘the solution’ to the interest-only maturity issue.
We know that, by virtue of their size and way of operating, many societies can offer more flexible underwriting than your average high-street bank; which in turn can advantage borrowers with legitimate needs.
But as I’ve made clear, we expect societies to be evidencing to themselves and to their boards that these products are reaching the intended borrowers. We would also expect the associated risks built into these more complex and innovative products to be appropriately managed by people with the right level of expertise.
More widely, we also remain interested in the changing distribution models in mutuals, and how they may translate in practice for customers. We are seeing particular changes in the post-RDR investments and complex savings space, and through the increased use of unregulated mortgage packagers.
Finally, we are mindful of the strength and resilience of IT infrastructure across financial services, including for mutuals - who we appreciate are constantly balancing operational costs against member benefit.
So where next for us?
You will all have received a letter explaining some of the new processes and how your firm will be supervised. Many of you will have experienced our new approach in practice, as the roll out continues. The next notable interaction for many larger societies will be a ‘deep dive’; for smaller firms it may be through thematic work, along the lines of which I have already mentioned.
Summary
Now in summary, I said at the start that we hope these regulatory changes can ultimately help restore confidence in financial services. They represent a new way of operating and will take time to bed in. But there is also a strong public and political expectation on firms to start thinking for themselves about how they make their money and the way they do business. Firms need to ensure that the interests of their customers, and market integrity, are genuinely at the heart of what they do.
Senior management need to set a strong cultural tone from the top, translate this into easily understood business practices, and support the right behaviours through performance management, employee development and reward programmes. And they should check that this is really happening as they envisioned.
But we’re realistic about the task ahead and recognise that this will be a journey – not just for us, but for the entire financial services industry. There are areas that are very new for us – such as our objective to promote effective competition in the interests of consumers. We are also gearing up to take over the regulation of Consumer Credit in April 2014, which will more than double the number of firms we regulate. Coincidentally, my area will supervise these firms when they come over.
We will continue to listen and engage with the industry, including through trade bodies such as the BSA, so we can be in the best possible position to act early, to use our judgement on emerging issues, and to keep an eye on the long-term benefits and outcomes for consumers and the market. We look forward to your continuing support.