FSA's new operating methods

Building the New Regulator – Progress Report 2 (February 2002) and Our Approach to Performance Evaluation (January 2002)

These two documents shed some further light on FSA’s new operating methods, and give indications as to the areas upon which FSA is likely to focus.

FSA reports in Progress Report 2 that in 2001 it:

• Developed its strategic planning framework, setting out its aims and objectives for the next three years;
• Established how it would work with overseas regulators;
• Developed its risk assessment framework. This is the “Arrow approach to risk based regulation, described in the New Regulator for a New Millennium document and Progress Report 1, and expanded upon here.

FSA reiterates that it is concerned with risks to its four statutory objectives which may arise from markets, products, individual firms or externally. These are not necessarily the same risks as from a firm’s perspective. In assessing these risks, FSA is concerned with their potential impact and likely probability, and FSA’s response to them will be driven by:

• the significance of the risk to its objectives;
• the prioritisation of the issue in accordance with FSA’s strategic objectives;

and its choice of response in relation to specific firm or a wider sector will be driven by the principles of good regulation - the seven matters at section 2 FSMA to which FSA must have regard when carrying out its statutory objectives. FSA will seek to be proactive and use its powers pre-emptively by mitigating risks before they occur.

In Our Approach to Performance Valuation (January 2002), FSA states that it should seek to identify the biggest problem areas and come up with programmes to address them. This is consistent with its shift away from routine firm-specific regulation and towards thematic regulation. Each year it will seek to identify and publish sufficiently important themes, together with the specified outcomes which FSA is seeking. Current themes include:

• The impact of demographic ageing;
• Treating customers fairly;
• With-profits business.

FSA considers that its operating framework is risk based, with firms receiving a base level of supervisory activity with additional activity depending upon FSA’s assessment of the likely impact and probability of risk presented by that firm. FSA describes the “base level of supervisory activity for various types of firm in Appendix A of Progress Report 2.

The 80% of firms which FSA categorises as low impact will be subject to baseline monitoring (mainly analysis of returns), but together with

• visits in response to information provided.
• sample visits
• visits pursuant to themes.

A high impact firm, such as a major retail or wholesale institution, will experience what FSA describes as a “close and continuous relationship which will include:

• a dedicated FSA relationship manager
• a close relationship with management so FSA can anticipate risks
• annual on-site visits to assess risk, together with additional visits to test controls, or pursuant to themes
• an individual risk assessment and risk mitigation programme.

FSA’s risk monitoring will seek to identify:

• Concentrations of risk;
• Trends in risk;
• Emerging risks;

and will supplement this with a watch list whereby certain firms are reviewed monthly by FSA senior management. In assessing risk in relation to a material business unit, a firm or a group, FSA will use a common approach and will seek to assess business and control risk in terms of:

• Financial failure;
• Misconduct/mismanagement;
• Consumer awareness;
• Fraud/dishonesty;
• Market abuse;
• Money laundering;
• Market quality.

FSA’s overall assessment of a firm’s risk will be mitigated by strong controls and exacerbated by weak controls.

In Our Approach to Performance Evaluation FSA discusses how it will seek to produce evidence that it is making progress towards achieving outcomes that matter. FSA recognises that its four statutory objectives are of a very general nature, and that a comprehensive and fully accurate evaluation of performance is therefore not possible.

Having discussed appropriate performance measures for a public sector body, FSA says that it will evaluate its high level performance against stated objectives for each of its principal aims. FSA says that it will require to:

• Establish identifiable outcomes and measures of success;
• Focus on big issues, making clear how problems are identified and addressed;
• Produce easily understandable information.

FSA states that one of the objectives of this exercise is to enable it to produce “stories about how we have fixed important problems (section 4 para 1). FSA will select the areas of performance to measured, the criteria for determining success and the degree of publicity to be given to this process. One unintended result of this exercise may therefore be to encourage FSA to concentrate its activities in high profile areas where there is likely to be significant media interest - such as matters involving household names, obvious wrongdoing or consumer finance - in preference to less “headline grabbing areas.

For further information please contact Simon Morris on +44(0)20 7367 2702 or by e-mail at [email protected].