Watchdog needs teeth

From December 1^st the UK has one of the most powerful financial regulators in the world. On that date the Government gave the Financial Services Authority full powers to regulate almost all of the financial deals we do every day. – except mortgage sales and credit unions which follow next July. Since October 1997 the FSA has existed in a shadowy form, poised to replace a plethora of financial regulators but only allowed to do so under licence. All that has now changed. There is one regulator, one financial ombudsman service, and one place to go for protection and, if that fails, compensation. The FSA should be a fearsome watchdog – it has sharp teeth that can close down or fine companies which break its rules. But will it use them?

Since its beginnings four years ago the top City watchdog has failed to spot or protect the public from a steady flow of financial scandals – the débâcle at Equitable Life, widespread mis-selling of endowment mortgages and pension products, and the collapse of three insurance companies. It has also refused to ban information in adverts that its own research has shown is useless, and failed to regulate an important new financial service.

All this inaction costs a lot of money. The FSA Annual Report reveals that its running costs were £196.3 million in 2001 – up 12.4% on the year before, though that is put down to its expanding role. This is not directly taxpayers’ money – the FSA charges the financial companies it regulates and makes a small surplus. But of course ultimately those costs are passed onto all of us through charges on our pensions, investments, and insurance.

So what do we get for our money? The Financial Services Authority is given four tasks by the Financial Services and Markets Act 2000 which set it up. They are, in order

1. maintaining confidence in the financial system

2. promoting public understanding of the financial system

3. securing the appropriate degree of protection for consumers

4. the reduction of financial crime

So the first task of the Authority is to maintain confidence in the financial system with protecting consumers relegated to third place. And the order is important when those two objectives conflict with each other. For example, suppose the FSA learned that a major bank or insurer was in danger of collapsing. Maintaining confidence would lead the regulator to keep knowledge of the difficulties to itself, play down the problems, and certainly not say anything that would lead to customers removing their money early. But if its main job was protecting consumers, then it would tell the truth about the company as soon as possible so people could get their money out and, equally important, so others would not put money in. Such action could cause the company to collapse earlier than it might have done. But at least the public would be told the truth, and the whole truth, by the regulator we all pay for.

Such a conflict played a part in the FSA keeping quiet for two years about the fundamental problems at Equitable Life, which it knew about from at least November 1998. Its silence allowed Equitable to carry on mis-selling pensions and investments for two years to tens of thousands of people without warning them of the company’s potential liabilities. 
Verdict: watchdog stayed in its kennel, quietly maintaining market confidence rather than protecting customers.

In 2000 the FSA refused to ban endowment mortgages or order the insurance companies that mis-sold them to review more than ten million sales and pay compensation when appropriate. In June 2000 it did make insurers warn five million customers that their endowment may not be enough to pay off their mortgage – even though many were sold on the basis that they would. Aggrieved individuals will be on their own in claims for compensation. 
Verdict: watchdog barked once but bit no-one.

During 2001, three insurance companies went bust leaving hundreds of thousands of people without cover on their house, their car, or their holiday. Eventually, most were offered alternative cover – but by the insurance industry not the FSA. Questions about what the regulator knew, and when, went unanswered. 
Verdict: watchdog looking the other way.

In summer 2001 the FSA decided not to use its powers to regulate a new internet service which allowed bank customers to access all their online bank accounts through a single independent website. Customers of the new service had to give it their passwords and almost all UK banks pulled out for security reasons. The FSA admitted it could regulate financial companies offering this service but chose instead to tell consumers to decide for themselves if it was safe and legal. 
Verdict: watchdog whined gently, then closed its eyes.

In September 2001 the FSA decided not to ban investment companies from selling us investments on the basis of their past performance even though the FSA’s own research had found that consumers could not increase their chances of picking a good investment by relying on information about past performance. The decision was taken partly on the advice of the insurance industry. 
Verdict: watchdog fed tainted meat and fell asleep.

The financially battered public pays a lot of money for this powerful watchdog. Let us hope that past performance is definitely not a guide to future achievements.

December 2001

e-mail Paul Lewis on paul@paullewis.co.uk