UK: Picking the Winners Through the Regulation Minefield

Last Updated: 29 January 2004
Article by Alan Edwards

The financial services industry is facing fundamental regulatory change. The ‘regulation minefield’ through which it must navigate itself will present extreme challenges to all players, hard on the heels of an economic recession and limited investment in the long term health of processes and infrastructure. CXOs are facing tough decisions as they strive to select the right strategic options that will equip them to chart the right course through the minefield.

What are the mines to be navigated?

One of the most significant legislative changes to be made to the financial services industry in recent years is Basel II, with a planned implementation at the end of 2006. With revised treatment for credit risk and the introduction of operational risk into the calculation of regulatory capital, added to enhanced supervision and market discipline through disclosure of risk events, the Accord will fundamentally change the industry on a global level.

Following the third Consultation Paper issued earlier this year, the Basel Committee has simplified aspects of the Accord and delayed finalising the details until the middle of 2004. The principal issues that still remain are:

  • Varying implementation stances between the US and Europe, which could lead to ‘regulation arbitrage’.
  • The potential impact on smaller organisations unable to implement advanced approaches to the measurement of risk.
  • The impact on organisations with no retail operations.

The scale of the impact of Basel II on each organisation will depend on the scale and scope of its operations and their choices regarding implementation, yet analysts predict that the implementation costs will be significant – in the range Ł5m to Ł150m for each organisation over the next three years. Get the choices and the implementation right, and the opportunity to reduce your cost of capital is plain to see from Figure 1.

Aside from Basle II, there is a plethora of other regulatory obstacles to be taken into account. The Financial Services Authority (FSA) has the laudable objective of maintaining efficient, orderly and clean financial markets and helping retail customers achieve a fair deal. They have been increasingly diligent in the execution of this mandate with around 170 Consultation Papers (CP’s) and Feedback Statements issued since 2000.

The Sandler Report provided the impetus to bring greater transparency and intelligibility to the financial services industry, and simplified products at better value for money. Drawing on Sandler, some of the FSA’s CP’s are having major structural implications on the industry, such as mortgage regulation and the structure of IFA’s and Tied sales forces.

Then there is the European Financial Services Action Plan, designed to create a single European Financial Services Market. The new Chairman of the FSA, Callum McCarthy, recently expressed concerns about the impact of this regulatory change on the City and suggested a delayed implementation as a result. We also have the move to International Accounting Standards to enhance comparability and transparency of corporate reporting; and those of us with US operations must address the requirements of The Patriot Act and Sarbanes-Oxley, which has introduced a new code of ethics, disclosure and prohibitions, post Enron & Worldcom.

The implementation demands of the Euro, at least, appear to be off the agenda for now but the bottom line therefore is that there is a veritable minefield of strategic choices to be navigated, and the decisions taken can make a real difference to shareholder value. Above all, compliance is going to take a huge amount of resource and focus. There will be winners and losers.


And there are more mines out there, concealed from view. Many financial services organisations have been struggling to come to terms with the existing requirements of the FSA in terms of selling practices, as evidenced by recent high profile cases of mis-selling, where fines have been publicly levied by the regulator.

So the minefield is not just about tomorrow’s regulatory change, but ensuring compliance with yesterday’s and today’s requirements. The true scope of the impact and the scale of the implementation challenge is dependent upon the fitness, scope and scale of your operations, your strategic choices and the compliance of your selling practices.

Rough waters

Unfortunately, to add to the challenge, the minefield is in rough waters. With the Asian Crisis, the ‘war on terror’, the Dotcom boom and bust and well publicised corporate scandals, economic downturn has been the order of the day and the financial services industry has been particularly hard hit.

Many firms have been downsized in the focus on cost reduction and little has been done to address the process and infrastructure challenges that the industry faces, other than an increase in the demand for outsourcing services. Fingers have been burnt by investment in channel exploitation and CRM initiatives, which have often failed to deliver sufficient return on investment.

The bottom line is that operational processes and infrastructure have received scant attention in recent years as investment decisions have become more difficult. Some organisations now face real agility issues.

The ‘Transformation Paradox’ is that at a time when CXOs are gearing up to invest, they will have to deliver benefits from change because of the substantial budgetary implications of regulatory compliance.

Potential impacts

There will be more than a few ripples! Some small, medium and large sized players could be taken out, and there may well be some structural change in the industry as a result. The principal impacts will be as follows:


  • Harmonisation of risk cultures within the organisation
  • Management of operational risk
  • Compliance
  • Open disclosure & supervision


  • Response to structural changes with new markets/products
  • Process and infrastructure change
  • Capture and analysis of historical data


  • Cost of capital
  • Opportunity to release capital
  • Compensation reserves
  • Fines
  • Cost of compliance


  • Visibility of capital requirements
  • Market discipline
  • Compliance ‘outing’

Key amongst these impacts are the ‘softer’ issues of cultural change demanded by the need to maintain compliance with existing and new legislation, and to fully embrace risk management across the organisation.

Strategic implications

A holistic, strategic approach to the regulation minefield and the transformation demands on financial services organisations is essential to ensure that strategic choices are understood and tough decisions can be made, and justified. Setting clear business objectives with a clear understanding of the organisation’s ability to deliver and its capability to absorb the change, whilst maintaining the loyalty of your staff and customers, may sound like ‘motherhood’, but there is no escaping its virtue.

Industry implications

Consolidation is likely to re-emerge as we move to a more confident market, and we can expect more M&A activity generally. Yet organisations will also seek to acquire businesses unable to adapt or take advantage of the opportunities that the regulation minefield presents. There will be even more focus on the need to achieve successful M&A integration. We could also see an increase in the divestment of less attractive business units.

Outsourcing of financial services business processes and IT has accelerated in recent years with the increasing drive for cost reduction. This trend could continue further in the regulation minefield, as players seek to outsource problem-children. But be aware that alongside the existing challenges of making the outsourcing relationship work, there is now also the challenge that the FSA will not permit organisations to outsource their accountability for operational risk. Existing and future outsourcing contracts must be reviewed accordingly.

Outsourcing could contribute to an overall strategic response to the regulation minefield but, like cost-reduction, is not a strategy in its own right. Nor is it a panacea to solve the challenge ahead.

Steering a course through the minefield: from strategy to action

Defining your strategy and setting your key business objectives is an obvious starting point. But how do you turn that Strategy into concerted action? Funding will be at a premium. What new investments should you make? Which of your existing investments could and should be cancelled to release funds for new initiatives? How can you make, and justify, these decisions more effectively?

Portfolio Management is the key to this dilemma. Choosing, executing and governing a portfolio of investments based, for example, upon the criteria of strategic alignment, value, and risk, will enable you to:

  • Pick the winning investments;
  • Defer or cancel those that need to be; and
  • Make analytical sense of what is a complex problem.

Real-time, web-enabled portfolio management tools are now available to enable CXOs to conceptualise their investment portfolios, perform ‘what if’ analyses and support decision making to be taken in answer to the strategic question: How will we get there?

But should you instigate an all-embracing regulation change programme, or begin individual programmes tailored to specific regulations? Both approaches are valid provided the programmes are tailored towards the achievement of specific business objectives. However, to meet the challenges that you face, there must be clear consensus and accountability for each programme, supported by strong governance and effective engines of change. There is no escaping the fact that the agility of organisations to move from where they are today, to where they need to be is likely to mark-out the key differences between the winners and losers.


The regulation minefield is here to stay, its impacts are widespread and the challenge will be significant. Consolidation, demerger and outsourcing will gather momentum but are not a panacea.

The winners in the regulation minefield will be those who:

  • Are well positioned to respond, identify the opportunities and are agile enough to take advantage of them,
  • Take a holistic approach to strategy,
  • Take and implement tough decisions,
  • use a Portfolio Management approach to drive and govern strategy to concerted action,
  • Embed a culture of compliance and risk management in support of business performance,
  • Shape programmes of change towards the achievement of key business objectives and clearly define and manage the dependencies between them,
  • Apply consistent and rigorous management of benefits and change to deliver the business outcomes; and ultimately,
  • Increase the performance and compliance of their day to day operations so that they can mitigate the impact and take advantage of the opportunities that exist within the regulation minefield.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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