Good afternoon ladies and gentleman - it is a real privilege to be invited to speak to you today at your annual conference. We at the FCA recognise that you are an important and successful part of the financial services landscape with 22.5m members, that you have a distinguished history as a mutual movement and that you have an exciting future ahead of you. And, not forgetting that we are less than two weeks’ into the new ‘post-MMR’ world, we recognise all the hard work and effort that has gone into making the Mortgage Market Review (MMR) a reality and thank you, and the BSA, for your help in achieving this.
Shaping your future involves understanding the nature of changing consumer tastes and how new technology is revolutionising how consumers can access financial services - it also of course involves understanding and responding to what the regulators are trying to achieve. I would like to use this speech to put forward the argument that properly effective regulation and sustainable businesses go hand in hand. To do this I will cover what feels different one year on from the start of the FCA, what we are trying to achieve, what our approach is, what this means for firms and what we see as the big issues for the building society sector.
So, what does it feel like to be one year old? From our perspective, we think we have achieved a lot in the new regulatory architecture and I would point to three aspects to illustrate this. Firstly, there are now two regulators focused on their respective conduct and prudential objectives so rather than balancing these objectives within one regulator, as the former FSA was required to do with its inevitable trade-offs, each regulator can pursue its own objectives without needing to compromise.
We, and I believe the Prudential Regulation Authority (PRA) would say the same, feel that this has given us the freedom to think more clearly what we should be doing and to put our energies in the right places. Conversely, we know that the new regulatory architecture – the FCA, PRA, and the Financial Policy Committee (FPC) – represents an additional burden for firms with different types of interactions, and it is incumbent on regulators to ensure that the system as a whole works as efficiently as possible.
Secondly, I think we have made some effective interventions that demonstrate the approach we are aiming for and I will come back to this later. Our recent work on arrears and forbearance found that to build on the progress so far, firms should challenge themselves to do more to deliver consistently good outcomes for borrowers - by better supporting and empowering front-line staff to make appropriate decisions at all stages of the arrears cycle, and providing greater flexibility of processes to support fair treatment of individual customers, based on their specific personal and financial circumstances.
We have found that, by working collectively with the industry on common problems and sharing what good practice is, we can get to a better outcome more quickly.
But it also asked firms to look to the future and consider the impact on customers who may be susceptible to arrears if interest rates rise and have appropriate strategies to treat them fairly. Crucially, we have found that, by working collectively with the industry on common problems and sharing what good practice is, we can get to a better outcome more quickly. And there are other similar examples across the banking, general insurance and asset management sectors.
Thirdly, and perhaps most importantly, I have seen a sea change in the attention being paid to the conduct agenda. Two or three years ago, conduct was something that most firms thought of as a compliance issue and so delegated it to compliance functions. Now, I would say that conduct is very firmly on the agenda of executive management and boards and we welcome that.
Part of the reason for this is that firms have come to realise the cost of getting this wrong in terms of potential regulatory fines, redress costs and litigation costs but also reputational damage. However, aside from managing the downside, firms are also realising the benefit of good conduct performance in terms of building customer trust. This is more than the traditional focus on customer satisfaction but about building a positive reputation for fairness.
Overall then, we feel that we have made a positive difference in our first year. Equally, however, we accept that we are not perfect and that we have more to do to show that we are a predictable, consistent, and measured regulator that is on the side of the consumer but engages and works with the industry where it can to solve issues. I should acknowledge at this point that some things will not work out as envisaged and the events surrounding the briefing of one of our pieces of thematic work on the treatment of longstanding customers in the life insurance sector is one of those. This is a serious issue for the regulator and I want to assure you that the enquiry set up to look at this is independent and that both the executive and our board are treating it seriously.
Moving on then to the question of what we are trying to achieve and what our approach is. In answering this I would start by saying that if the market worked perfectly and consumers were completely rational then there would be no need for us. In that world firms would treat their customers fairly because it was in their interest to do so and consumers would buy products and services that were in their best long-term interest.
In many other sectors we see this happening with companies that are trusted and provide good value products and services that consumers want, gaining customers and business from competitors that aren't so effective at this. We all experience this first hand and see for example how a company like John Lewis prospers while others don't.
In an ideal world the same would be true in financial services so that firms who provided poorer value products and lost trust because they didn't treat their customers fairly would lose business until they either went out of business or competed their way back.
The reasons that this market solution doesn't work in financial services are a combination of a number of factors – many of the products are complex and hard for a consumer to fully understand, many are long term in nature and judging fairness by a consumer is difficult, consumer understanding is poor, there is substantial consumer inertia, consumers have behavioural biases, providers are not significantly differentiated and some markets are not sufficiently competitive. These are the reasons why a regulator is needed to act on behalf of consumers and investors to ensure that the financial services market operates fairly and, by so doing, redress the balance that is otherwise biased against the consumer.
So, what should we, as the regulator, be trying to achieve and what is the approach we should have? Essentially, following from the arguments I have made, we are about making markets work so that retail consumers achieve fair outcomes and wholesale markets operate with integrity. If these can be achieved then the market imbalance will be corrected and as a by-product, but a very important one, the trust in financial services that has been eroded and is so important for a modern growing economy, will be restored.
Our approach to achieving this is to be a regulator that is judgement-based, pre-emptive and pro-competitive and prepared to be tough when things go wrong. This approach though is based on an outcomes-focused philosophy.
I would like to explain further what this means and in particular what I mean by outcome focused. Regulatory philosophy has coined various phrases such as principles based, as opposed to rules based; intrusive as opposed to light touch and credible deterrence as opposed to the Governor's eyebrows. These may seem like variations on a theme but they do in reality encapsulate quite different approaches and this is true for an outcome-focused approach.
What it means is that we are fundamentally interested in what consumers actually experience as outcomes and then try to fix the causes of what is leading to outcomes that are not, or may in the future may not be, fair. This translates to a model where:
- firstly, we look at whole markets to see whether they are working in the interests of consumers and where market studies are the methodology to determine whether lack of competition is the driver of problems and where structural solutions may be needed
- secondly, at sectors where we use thematic work to look at specific problems where the right outcomes may not be being achieved and where changes in firms' behaviours may be needed, and
- lastly at individual firms where we are looking for key drivers of potentially poor conduct behaviour
This means at the firm level, particularly for the large firms that have the biggest consumer and market footprint, we are looking at how the interests of the customer and market integrity are at the heart of how their business is run – this means our focus is on the firm's business model, culture and front-line activities such as product governance and less on second-line controls. This focus on how the business is run, rather than how it is controlled, is a fundamental change and is directly linked to our outcome-focused philosophy.
What do we expect firms to be doing? We have said that we want firms to put consumers and market integrity at the heart of how they run the business. Unpacking this means that we expect firms to treat customers fairly while maintaining prudential strength and achieving an adequate return for their owners. In other words, we don't expect that the interests of customers should be subjugated either to prudential strength or the interests of shareholders.
This raises two questions: firstly, how should firms best ensure that customers are at the heart of how the business is run and secondly, how can the balance between customers, shareholders and prudential authorities be maintained on an ongoing basis?
So, what have we seen as firms have started to come to grips with these questions? We have seen that firms have reacted, perhaps not surprisingly, in a variety of ways, from strengthening compliance, to building in stronger consideration of customer fairness through the product life-cycle, to launching cultural and behavioural change programmes, to setting risk appetite, to changing incentive programmes and to thinking about business model changes. While I don't want to be prescriptive about what 'good' looks like I do want to make some observations about what we have seen and what seems to us to be the key elements of an approach that may work.
Fair treatment of customers is not, in my view, something that can be reduced to a risk to be managed.
I would start by saying that fair treatment of customers is not, in my view, something that can be reduced to a risk to be managed – that way leads conduct to be treated as a compliance question with ever expanding armies of compliance people checking that process has been followed – in other words a tick-box compliance approach. This is not in my view likely to improve outcomes for consumers. While I support a strong three lines of defence model, it seems to me that the conduct question is more a cultural and business model challenge and therefore should be firmly rooted in the first line.
The fundamental reason for this is that fair treatment of customers and proper behaviour in markets are inextricably linked with how businesses are run or, in terminology I have used before, it is about doing the right thing for the customer. The business model challenge – that exists for building societies as well as the rest of the financial services industry – is how to evolve current models into ones that are demonstratively 'safer' from a conduct perspective – these in my view are ones that have a lower cost base, so that there is less pressure to press for marginal income growth to support an inflated cost base; that don't overly rely on profits from back book customers to subsidise new customers; or have high degrees of cross-subsidisation between products; or rely on products that are highly profitable or that involve rapid growth rates.
Moving on to culture it is certainly my view that having the right culture is essential for achieving good conduct performance. This is not though a fluffy view of vague corporate aspirations or value statements, but a need for a more hard-edged embedding of business practices that define how decisions will be made through the firm at critical points of engagement with customers or dealing in markets. There are key drivers that re-enforce the right conduct-focused culture with the most important being clear and ongoing leadership from the top of the organisation, constant re-enforcement, incentive structures, effective performance management and penalties for not doing the right thing.
The other key aspect of front-line business management is product design. 'Good' here involves understanding the needs of particular customer groups, working through what a fair outcome means for a particular product, stress testing how the product performs in different scenarios, whether it constitutes good value to the customer, how it will be sold, whether consumers' behavioural biases are being exploited in the sales process and how post-sales service over the product lifespan will be designed.
The final aspect of what 'good' looks like is governance. As I said earlier, we are pleased that the conduct agenda is now more firmly at the board level. Our expectations though are high – although we are not expecting the board to approve every product as that would be both unrealistic and confuse their role with that of executive management, we do think that boards should understand how and where the firm makes money, what the conduct implications of that are, how customer outcomes are tracked across the product life-cycle as well as the more traditional oversight over control functions.
Having given some views on what good looks like, and clearly this is an evolving picture, I would like to set out my views on some of the big issues facing the building society movement. Rather than stray too widely, which you might feel would be a little presumptuous, I am framing my comments from the perspective of the FCA as the conduct regulator. I have five points to make that I feel are generic across the movement:
- Firstly, responsible lending. This is a key concept at the heart of the MMR reforms and we believe that it is important for both consumers and firms that this is not lost sight of. I think we all recognise that this could happen if consumers' experience is impacted by some over-enthusiasm for the details of their expenditure and we all need to retain a focus on the benefits of the reforms.
- Secondly, giving value to all your customers. The uniqueness of the mutual model is that the benefits of a sound business model flow to members rather than shareholders. From a conduct perspective I think that this should mean all member customers should obtain value - that is savers and borrowers, existing and new. In this regard, how clear is your communication to backbook savings members that they could be better off switching to a new account paying a higher rate of interest with similar terms and conditions?
- Thirdly, maintaining discipline over risk. Here I am referring to the choices that some societies may be making to go up the risk curve in reaction to the intense competition in the lower loan-to-value (LTV) and better credit worthy borrowers and the space being created for smaller lenders, which may be able to act more nimbly, to deliver more bespoke and personal underwriting.
- Fourthly, governance. The mutual model, both of business and governance, has come under criticism as a result of the well-publicised issues around the Co-operative. I am not in the camp of those who say that the mutual model has inherent weaknesses as I have seen as many good and bad examples of governance in the PLC world as there have been in the mutual world. However, the events surrounding the Co-op should be a wake-up call for mutuals and it is important that governance is self examined to make sure that it is up to the task. In particular, mutuals should guard against the assumption that their supposed ethical principles are, in themselves, sufficient to guarantee good conduct performance.
- Fifthly, exercising any changes to mortgage contract terms in a manner which is fair for borrowers against our regulatory framework. Building on my Dear CEO letter late last year, we are opening up a debate on this topic through our upcoming discussion paper which will invite views from the industry, consumers and other interested parties about whether our current regulatory framework ensures fairness to consumers, provides an appropriate degree of certainty to lenders and borrowers and allows the market to operate in a way that is sustainable for all participants.
I would like to return in conclusion to the proposition I set out at the beginning of this speech – that effective regulation and sustainable businesses go hand in hand. I believe that the style of regulation that I have emphasised here that is predictable and measured with an approach that is judgement based, pre-emptive and pro-competitive will, if we succeed in carrying it out with the quality and professionalism we aspire to, help achieve the fair treatment of customers that lie at the heart of truly sustainable businesses. Once again, many thanks for giving me your time this afternoon and I and my colleagues look forward to continuing the constructive relationship we have developed with you.