Intensive Supervision: delivering the best outcomes
Hector Sants
Speech by Hector Sants, Chief Executive, FSA Bloomberg 9 November 2009
(Используется материал, опубликованный на официальном сайте FSA – http://www.fsa.gov.uk/pages/Library/Communication/Speeches/2009/1109_hs.shtml# )
Good afternoon ladies and gentlemen.
We are now in the third year of an unprecedented financial and economic crisis.   Events have rightly warranted a debate on what should be done differently in the future.
The FSA’s response to the crisis, as has been acknowledged, has been the most open of all the participants, in respect of its willingness to analyse its mistakes, to publicly acknowledge them, and to learn from them.
The FSA in consequence, has evolved and has introduced a radically new approach; intensive supervision; designed to deliver our outcomes-focused philosophy.
The focus of my speech today, therefore, is on the progress of the FSA, as a national supervisor within Europe, in embedding this new approach.
Before doing so, a remark or two on the current debate on what is the right institutional model here in the UK.
Of course, there will always be different ways of drawing the dividing lines between authorities.  The one we have now between a micro-prudential regulator and the Central Bank resulted in one set of issues.  In particular, a ‘macro-prudential’ gap.

I can assure you, simply drawing the line elsewhere will only create another set of problems.  What is crucially important, however, is that we are able to deliver the regulatory outcomes society demands.  Achieving this is not, primarily, about structure.  It is about people, processes and outcomes.
What is important to me, personally, is that the FSA is defined by what it does, and not what it is called.
The focus of my remarks today, therefore, will be on how the FSA’s intensive supervisory approach is, in my view, the best way to deliver the required outcomes for society.
I think this is best understood by looking at:
* the results we are delivering on prudential and conduct issues;
* the reform we have achieved with regard to our significant influence function regime; and
* finally, the success of our credible deterrence agenda.
First, a brief reminder of what intensive supervision is and how it is designed to deliver outcomes. The FSA has moved firmly into the realm of making ‘judgements on judgements’.  This is different from how we operated in the past.
In the past, the FSA was primarily reactive, only making interventions on readily observable facts and adhering to the view that it should leave management to make its own decisions.
Intensive supervision, in contrast, focuses on the risks inherent in a firm’s business model and enables us to be proactive and not reactive to the management of these risks.
Our outcomes-focused philosophy requires supervisors to judge firms on the likely consequences of their decisions.
This means the proportion of our time spent looking at systems and controls will diminish relative to our focus on assessing the outcomes of a firm’s actions.  This will necessarily be controversial at times, as our view and the firm’s view will not always coincide.
This divergence of judgement can normally be resolved, but the FSA recognises that this new approach may create tensions and will certainly no longer be seen as light touch!
To enable us to deliver on this approach we have equipped ourselves both to forecast and test outcomes. This capacity is needed to enable us to effectively make judgements on the judgements firms are making.
The forecasting element requires in-house modelling capability, such as that we now have for capital and liquidity. This does of course require more data to be collected from firms.   And it will involve us looking more closely at the risks, both prudential and conduct, inherent in the product; from development to expiry.
The testing element requires supervisory resource to be devoted to an inspection-based approach to individual transactions.
In the conduct area, this requires greater attention to consumer outcomes, for example through the use of mystery shopping.
Critical to the success of this approach, in my view, is that the supervisor has an integrated view of the firm’s risk. I believe that recent events thoroughly support the proposition that effective risk identification requires single supervisory oversight, encompassing both prudential and conduct risk.
You only need to look at AIG to see the risks that fragmented regulation can bring. To undo the integrated approach to risk assessment, would be to return regulation in the UK to the dark ages!
Besides, it is illusory to think that the assessment of prudential and conduct risk can easily be separated, particularly at the level of an individual institution.
A single supervisory process is a necessity to resolve the inherent conflicts between conduct and prudential issues and to maximise the benefit of integrated risk analysis.
It would also be advantageous if the regulator wished to judge culture. A theme I will return to.
This new approach, as I will explain, applies equally to conduct as well as prudential issues. This is crucially important.
The recent debate has focused on the shortfalls of the prudential regulatory regime in the period prior to the crisis but what needs to be recognised is that reform is also needed with regard to conduct supervision.
Historically the FSA was, in practice, operating a ‘twin peaks’ system. The oversight of the domestic institutions focused on the ‘Treating Customers Fairly’ programme.
However, this focus has not delivered the outcomes that consumers deserve.
This is because ‘old style’ consumer protection regulation is, in my view, largely reactive not proactive.
It has focused on systems and controls, inspection, and then once failure occurs, facilitating the payment of redress.
For conduct issues, the integrated risk approach means that we can be more proactive not reactive by utilising the information derived from business model analysis to take proactive measures.
It is crucial that any re-designing of the UK regulatory model achieves a better result for individual users of financial services as well as improving the financial stability of the system as a whole.
Delivering this approach required a new operating platform which we have already implemented through our Supervisory Enhancement Programme.
This was completed in August 2009.  We have now:
* recruited a further 280 specialist and supervisory staff, increasing our supervisory capacity by 30%;
* implemented a new supervisory training and competence regime;
* introduced a new risk identification process;
* reformed our authorisation and significant influence function regime; and
* continued to make the necessary improvements to our organisational effectiveness, ensuring we are staffed by the right people, in the right jobs, with the right infrastructure.
However, I recognise that these reforms are only part of the answer.  Success will be judged by results; by outcomes.  I believe that we have achieved this over the last two years.
As a prudential regulator, for example, our work on stress testing, and analysing the individual business models of the major banks has been comprehensive.
The stress test involved a detailed review of their asset portfolios, income projections and funding strategies involving up to 100 FSA specialists per firm. Without this work the recent bank recapitalisations would not have been possible.
The new regulations we have introduced have also demonstrated our determination to take a tougher approach.  We are the first major regulator globally to tackle liquidity risk through stringent new rules and standards.
With respect to building societies, the FSA has not only subjected them to rigorous stress tests but also developed a new capital instrument, Profit Participating Preferred Shares (PPDS).  These permit building societies to raise core Tier 1 capital from outside investors.
In the case of West Bromwich Building Society the timely and complete conversion of the society's outstanding subordinated debt into PPDS enabled the society to remain a going concern.
Elsewhere in the deposit-taking industry, we have also worked to limit or reduce retail depositor exposures by forcing firms to exit the best-buy tables or the market completely and we have deterred several new entrants to the market.
With regard to the insurance sector we have introduced more comprehensive stress tests than ever before.  We have also worked on specific issues.
For example, with Pearl Group, we worked with management, its shareholders, lending banks and other regulators to put the Group onto a sounder financial basis.  This involved the injection of new equity and re-structuring of the Group's finances.
Whilst the life companies themselves within the Group were operating as normal and were soundly capitalised, we were concerned to ensure consumers were protected from any disruption arising from weaknesses in the Group's financial position. There are numerous other examples, but for obvious reasons, I can’t talk about them here.
In conduct, our more proactive approach will take longer to become visible as much of this work is about mitigating risks.
Our approach to pension switching, however, serves as an example.
Through business model and firm data analysis we detected an upward trend in the sale of self-invested personal pensions and switches of personal pensions more generally.
Shining a spotlight on an area such as this will in itself be preventative.  Nevertheless, we also fed these risks through our supervisory risk review and required a number of firms to take actions as a result.
Ultimately, this work may result in enforcement action against those firms whose outcomes we tested were not acceptable.  And as a result of publishing our assessment methodology, a number of firms volunteered to undertake large-scale past business reviews.
Another example is the package of tough measures we have taken to protect consumers when buying payment protection insurance (PPI) and mortgage PPI (MPPI).
At the beginning of the year we wrote to CEOs of firms asking them to stop selling single premium PPI with unsecured loans. An area of the market with the highest risk to consumers.
On MPPI we agreed an industry-wide package of measures for consumers, including refunds of around £60m. A result secured by discussions we initiated with trade bodies and relevant firms.
The proposal we set out recently for the major reforms in the UK mortgage market is another good example which demonstrates the value our integrated approach brings.
These reforms not only deliver value to consumers on specific issues but also deliver a set of conduct and prudential proposals designed to benefit all market participants.
Central to our intensive supervision approach has been the reform of our authorisation processes and significant influence function regime.
It is important to recognise that the FSA will not presume that the firms we supervise have learned the lessons of the past. There remains, I believe, an absence of the acceptance of collective responsibility for what has happened.
I personally remain unconvinced that all senior management have taken on board the need to change and operate in a genuinely different manner.
It is essential for the regulator to facilitate further behavioural change in the firms and individuals we supervise.
Our new regime ensures that individuals seeking to hold significant influence positions in firms we regulate are both technically equipped and demonstrate the required integrity.  Making these judgements is particularly difficult.
We will thus be publishing a Discussion Paper on this subject. We have, however, already put in place a rigorous interview process and a number of applicants have withdrawn as a result.
Some remarks, at this point, on an often neglected issue of the role of culture and ethics in delivering good regulatory outcomes.
I believe it is important to recognise that there are limits to what regulatory rules can achieve.
It would be a mistake not to recognise that some of the failures which have occurred have their roots in issues of culture and behaviour.
However, whilst progress has been made in the global debate on prudential rules, this fundamental question of ensuring the development of the right industry culture, has not been adequately addressed - no doubt because of the difficulty of both defining the problem and the solution.
However, this must be tackled if we are to truly address all of the issues. Real reform requires both change to the regulatory rules and change to the industry’s culture.
Expressions of acceptable ethical frameworks exist in a variety of guises. There are numerous thoughtfully articulated industry codes.
The problem is not so much about defining the ethical framework but rather the issue of identifying and encouraging the right cultures which ensure their application.
The FSA believes that such issues are potentially so important to improving governance that we, as the regulator, should try to take them into account.
We recognise that there is no single ideal culture across the financial services industry, and that all cultures are likely to have good and bad aspects.
Our aim would, therefore, be to seek to facilitate the creation of good cultures and intervene when bad ones seem to be creating unacceptable outcomes.
There are two principal tools at the disposal of the regulator to influence culture: governance systems and people.
Going forward, we will be seeking to identify mechanisms for assessing the effectiveness of culture during our risk review process.  This would certainly include when assessing board effectiveness, looking at their impact on an institution’s culture.  However, I believe the key enabler should be our ‘fit and proper’ regime.
We all recognise that culture is driven by individuals and in particular senior executives who: ‘set the tone from the top’.
I thus strongly believe that our authorisation regime should seek to make a determination of an executive’s ability to set a strong ethical framework and to foster the right culture.
Our enforcement regime can also be used where we find cultures that are driving inappropriate behaviours.
As I mentioned earlier, our credible deterrence strategy is an important part of securing the outcomes we desire.   I spoke earlier of ‘dividing lines’.
I strongly believe that dividing responsibility for enforcement activity would invite a fragmentation of approaches and a ‘turf war’ between the different bodies involved.
This was apparent in the structure which pre-dated the creation of the FSA when the then multiple regulators struggled to speak with a united voice and lost authority as a result. Our credible deterrence philosophy complements our more intrusive and intensive style of supervision.
Critical to the delivery of this strategy is having a confident and concentrated enforcement function with clear responsibility and a strong appetite to investigate and punish misconduct and redress harm.
This is a commitment we have made and which we continue very demonstrably to make – by using all our powers, including criminal prosecutions, to bring about meaningful results.
I have made clear that when firms do not adjust their behaviours they can expect tough action from the FSA, either to require them to do so, or when that is not possible, to require them to mitigate risks their actions have created.
And yes, that does mean people go to jail.
Some points I would like to highlight are:
* In 2008/09 we imposed financial penalties of £27.3m which was an all-time high. So far this year we have imposed £19.8m which is greater than at the same point last year.
* In 2008/09 we prohibited a record 56 individuals from the industry and so far this year a further 29,  for a range of offences, from market abuse to mortgage fraud or failing to adhere to Treating Customers Fairly.
* We are bringing more criminal prosecutions than we have ever done before.
* We are also holding individuals to account and have imposed significant penalties and prohibitions.
* And when significant failures occur we will be rigorous and determined in assessing whether enforcement is warranted. Recent announcements by RBS and Lloyds demonstrate this point.
The recent case brought against GMAC-RFC Ltd where we imposed a £2.6m penalty and secured a £7m redress package, is a good example of credible deterrence in practice and what the FSA’s intensive approach can deliver for consumers.
It also reflects what we said in our recently published Mortgage Market Review about unfair mortgage arrears charges.
In closing, can I make some remarks about the future?
I believe today I have demonstrated how the FSA has evolved and is now a radically different organisation.  I believe that integrated supervision now has a proven track record of success.
Looking forward there are two concerns I would like to highlight.
The first concern is that a regulator must not be tempted by the signs of stabilised economic conditions to return to ‘business as usual’.
Regulators must be able to ‘go against the tide’. Politicians, and the industry, must resist temptation to apply pressure to return to ‘light touch’ regulation and row back the results intensive supervision is delivering.
My second point relates to institutional structure.
I can understand why, in the light of events, there is considerable debate about institutional structures but in considering any institutional changes, failing to take into account the lessons learnt from the last two years would be grossly irresponsible.
Society must not lose the benefits of the tough, hard learning experience the FSA has been through.  Furthermore, I observe that truly effective institutions are built on strong cultures and that strong cultures need time and experience to evolve.
More generally, there remains the possibility of tougher times to come for those we regulate.   Now is not the time therefore, to be diverting resource to looking at ‘structural questions’.  We must focus on the right outcomes and regaining the trust that has been lost.
Finally, may I return to the central theme of my remarks?  Namely that the FSA is defined by what it does and not what it is called.  I believe that I have demonstrated today that our intensive approach to supervision is delivering the results that society demands.
I hope you have found these remarks helpful and I look forward to taking questions.