UK: FSA Gives Further Guidance On Principles - Based Regulation

Last Updated: 3 November 2006
Article by Simon Morris

This week saw the publication of two documents which provide indications of the shape of regulation to come:

  • Callum McCarthy’s (FSA, Chairman) speech to the Financial Services Skills Council 2nd Annual Conference "Principles-based regulation – what does it mean for the industry?"; and
  • Discussion Paper 06/5 - "FSA confirmation of Industry Guidance".

Callum McCarthy in his speech reiterated FSA’s determination to move to a more principles-based regulation. Significantly he introduced the idea that FSA intends to establish a "condition of predictability". This is aimed at alleviating concerns that principles-based regulation could lead to enforcement action against firms based upon a retrospective imposition of standards.

He also emphasized the following, mirroring many of the recent comments made by John Tiner and Dan Waters (FSA Director of Retail) on principles-based regulation :

  • There is no prospect of FSA moving to a regime based entirely on principles.

    This reflects the comments John Tiner made last month in his speech at the APCIMS Annual Conference in Barcelona when discussing the move to a more principles- based regulation in the context of MiFID. He stated that as part of the move towards such regulation FSA is committed to "intelligent copy out" when implementing MiFID i.e. it will copy out the text of the directive adding interpretative guidance only where it is needed to avoid placing unintended additional obligations on firms. However, he acknowledged that while MiFID did contain provisions in some areas (for example risk warnings) which could be described as principle based, it also contained high levels of prescriptive rules (for example monitoring). Moreover, he did not foresee Europe moving to entirely principles-based regulation in the near future.
  • FSA will be paying more attention to outcomes rather than the mechanisms for getting there and the responsibility senior management must take in this.
  • The basis for enforcement action will change as the focus will be on breach of principles rather than detailed rules.
  • FSA has to be prepared to answer firms’ questions on the interpretation of standards and there will be greater contact between FSA and the senior management of the firm.
  • The removal of detailed training and competence rules for the wholesale market in November 2007, to coincide with the implementation of MiFID. FSA intend to publish a review of the training and competence rules for the retail market in February 2007.
  • The benefits a more principles-based regulation will bring to firms, in particular a reduction in administrative costs.

As part of this move to principles-based regulation FSA has also set out plans to encourage greater use of industry guidance. Discussion Paper 06/5 sets out FSA’s view that, although industry guidance will not replace rules, FSA will not take action against a firm which has complied with certain recognised guidance. FSA intends to recognise industry guidance in three different ways as follows:

  • Safe harbour: FSA will create rules in the Handbook to give this industry guidance effect on the FSA and third parties (e.g. consumers);
  • Sturdy breakwater: this will prevent FSA from taking action but will not impact on the rights of third parties to do so. This would hold similar status (but not the same e.g. FOS will not be required to consider industry guidance) to FSA’s own guidance; and
  • Implicit recognition: this has no legal effect on the FSA or anyone else. The recognition is "implicit in (FSA’s) inaction because the industry has found a solution to address a market failure."

The approach is not without risks to firms:

  • Industry guidance does not go through the same statutory process, including consultation and cost benefit analysis, that formal FSA guidance is subject to.
  • FSA has stated that firms will only have the comfort of a sturdy breakwater if it is appropriate for them to follow the guidance. It is the responsibility of the firms and their senior management to determine whether a piece of industry guidance is relevant and whether to follow it.
  • Where firms are not a member of their industry body, they may not be able to avail of additional advice etc surrounding the guidance.
  • Some trade bodies may choose not to provide industry guidance and this might disadvantage markets with low levels of representation.
  • The industry guidance must be made publicly and freely available, this may mean a loss of benefits for members of industry bodies.

FSA is looking for feedback to the Discussion Paper by 31 January 2007.

In conclusion, FSA’s move away from "box ticking" regulation, will involve an intensified reliance on senior management in FSA regulated firms. Senior management must now consider every part of the firm's business and product cycle to evaluate whether its processes are compliant with FSA’s principles. This is made an even more difficult task by the recent approach of FSA’s to principles-based regulation which sees an emphasis on campaigns. A good example of this is Treating Customers Fairly. There was no formal consultation on this, instead FSA drip fed information through speeches, website guidance etc. Senior management had to judge what steps their business needed to take based on very loosely expressed requirements from FSA. The question remains of whether FSA will tolerate an inevitable diversity of outcomes resulting from a more principles-based regulation in circumstances where it could previously expect uniformity.

This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to

Law-Now information is for general purposes and guidance only. The information and opinions expressed in all Law-Now articles are not necessarily comprehensive and do not purport to give professional or legal advice. All Law-Now information relates to circumstances prevailing at the date of its original publication and may not have been updated to reflect subsequent developments.

The original publication date for this article was 02/11/2006.

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