Ready, aim ... FSA

We all know the FSA is on a mission. It has made no secret of the increased scrutiny to which it will be subjecting financial services firms following the scalding criticism it received over the banking crisis.

But now, as its inspectors storm the corridors of the consolidators for the latest ARROW site visits, the effect on this section of the broking community is becoming uncomfortably clear.

Privately, consolidators are fuming over the greater demands for information and stricter deadlines. As only the largest 5% of firms receive these intensive ARROW?inspections – the acronym stands for Advanced Risk-Responsive Operating frameWork – they complain that the FSA is creating a two-tier market where smaller firms get away with light-touch regulation at a distance.

So are the consolidators under unfair pressure, and should the spotlight be turned on smaller brokers, too – or should they just deal with it and stop moaning?

The heat is on

“They’re not necessarily asking for anything new, but for action to be taken more quickly and for us to go further than before,” explains one consolidator chief, who did not want to be named.

“We’ve always had to consider issues like data protection and risk management, but we feel now that the FSA is pushing us to deal faster and in more detail. There’s a marked difference. They are being tough in areas where they haven’t been tough before, and the rules are quite unwieldy. It doesn’t seem to be a level playing field. As consolidators, we are having to do a tremendous amount in a short space of time.”

In particular, the FSA appears to have toughened up on client money, terms of business agreements with insurers, and data protection. The watchdog is also making greater use of its power to demand that brokers obtain – at their own expense – reports from independent experts.

“The heat is being turned up significantly, but we don’t see that happening across the market,” adds the source. “We’re big enough to cope, but it seems unfair that they are concentrating on consolidators and not the rest of the market.

“Smaller companies are running their businesses in very, very different ways to how we do. We sit down every quarter to assess the biggest risks to the business and we have three lines of defence for each one. Ninety per cent of brokers wouldn’t know what I’m talking about.”

He complains that, in the long-term, the added burden of compliance will make it harder for consolidators to do business compared with smaller firms, which don’t face the same scrutiny but are still competitors, especially in the SME market.

“Naturally, if you’re concentrating so much, it has implications for the rest of the business – for business as usual, for acquisitions. At its most basic, we have to employ more people because it takes up more time. Our staff look out of the window and remember how it used to be – if this continues, consolidators could become a less appealing place to work.”

Oval group managing director Jeff Herdman says his firm has worked hard to develop a good relationship with the authority. “It has been a little frustrating to deal with numerous changes in personnel within the FSA, but it has focused us on repeating our business model to new people and teams within the FSA, which is never a bad thing.

“I would like the FSA to take a closer look at brokers and advisers of all sizes, and subject them to the same scrutiny as the assessments of larger organisations.”

Beachcroft partner James MacNish Porter, who specialises in insurance regulation, says the FSA is definitely taking a stricter view, and points to the increased level of financial penalties as evidence: so far in 2010, aggregate fines have reached more than 140% of the total levied in the previous eight years to 2009, and 20 of the 37 fines it has issued over £1m were issued this year.

He has some sympathy with the consolidators’ view: “Obviously, the market is in many ways less benign than it was at the last ARROW cycle. When you’re on the receiving end of an ARROW visit, it is a significant burden, and firms often feel it is just them. Firms have the same regulatory obligations, but the larger, more noticeable firms will receive a greater proportion of the FSA’s supervisory effort. The effect has always been that smaller firms, if they were so minded, could sail closer to the wind for a longer period of time.”

But MacNish Porter also suggests that increased scrutiny is simply a reflection of a company’s success: “Firms ask, ‘How come I’m being pulled up when not everyone is being pulled up?’ That’s because they’re big enough and successful enough for what they’re doing to be important to the FSA’s statutory objectives. Larger companies and those doing new things at the cutting edge of the market will face greater supervision.

“There could be an element of tall poppy syndrome, in that the aggregators are making such huge changes to the market. Increased supervisory attention is one of the consequences of that.”

Aiming at where the risks are

The FSA’s approach has been developed by thematic work across the sector. MacNish Porter says the watchdog is paying attention to capital reserves, controversial products such as payment protection insurance, and particularly corporate governance and culture. “One of the issues that came out of the Turner Review into the 2007-08 banking crisis was that it wasn’t the organisational structures that failed, but the culture within them,” he says. New questions on issues such as board effectiveness may mean more work, because firms do not yet have a ready-made answer, he adds.

Founder and chief executive of start-up Ataraxia (and former head of the Brokerbility network), Stuart Randall has spoken to the FSA about its approach and says that the regulator is open about the greater supervision of larger brokers.

It may not be fair, he says, but it’s the way of the world. “It’s inevitable that they are going to concentrate more on larger firms, because they’ve got greater governance and greater facilities. They know that if they go into smaller brokers they will find things – nobody’s perfect – but they don’t want to become a compliance officer for smaller companies.

“The FSA tends to be harder on big firms because they should be documented and they should have systems in place, and if they find something, it’s a big find. If they slapped a £500 fine on a broker in Scunthorpe, that’s not going to make the front pages, is it? Censuring or fining a large firm or consolidator would always have a greater effect as an example to others.”

An FSA spokesman says: “We have certainly said for some time that regulatory scrutiny will get tougher, particularly for large firms. They are usually the most influential in any market and pose the greatest risk to our objectives. If a small firm fails, it has nothing like the potential effect of a larger firm. We’re a risk-based regulator, so we will concentrate our efforts where there is the greatest risk.”

The spokesman is unaware of any deliberate targeting of consolidators, but says firms that have grown by acquisition may need to demonstrate how well they had integrated those businesses: “Firms could potentially be using different IT systems or have different books of business, which need to be covered by the appropriate systems and controls.”

Other targets

More traditional brokers of a similar size to the largest consolidators are more accepting of FSA scrutiny. “The bigger you are, the more of a risk you are, so you’re going to be an organisation they visit regularly,” says Swinton chief executive Peter Halpin.

His firm has experienced three ARROW visits since the FSA regime began in 2005, the latest last October, and he has noticed the focus sharpening from broad corporate governance to more detailed operations.

He says: “The FSA have developed their own thinking on what they expect. It may in some respects feel more intrusive, but it’s the areas of focus that have changed rather than the visit itself.

“As a bigger company, more is expected of you, and it may be more difficult to demonstrate that you’ve got the controls in place and that you know what’s happening in the far corners of your empire. The challenge for an organisation like ours is being able to demonstrate that the right things are being done across the whole of the organisation and that management information is there at all levels.”

Meanwhile, smaller firms bridle at the implication that they are running their businesses less scrupulously, or are receiving a lighter touch. Ravenhall Risk Solutions, a broker based in West Yorkshire, is handled by the regulator through its small firms division.

Director Neil Grimshaw says that it often receives phone calls from the FSA asking for documentation, and it meets FSA staff at regional events. He believes the FSA might be right to aim resources at larger firms. “The FSA can regulate smaller brokers at a distance more effectively than they could larger firms.

“The consolidators and national brokers have many layers of management, and so they have complicated systems and controls that may require a site visit. We all need the same processes, systems and controls, but in a smaller firm they are less complex.

“As the compliance officer, I’m also at the coalface and I’m able to make sure things are being done properly as they’re being done. The heads of the consolidators are not there when policies are being administered, and have to rely on complicated supervision hierarchies to ensure compliance.”

Ramping up supervision of smaller firms is hardly what the industry needs right now, he adds. “The FSA already costs a lot of money, and anything that regulators can do to lower the cost of regulation to all brokers is welcome. If that means regulating smaller brokers at a distance, that’s a benefit to everyone. What’s the point in them coming to see us if they can do it on the phone?”

Wider worries

The consolidators are unlikely to find many across the industry supporting calls for greater regulation of smaller brokers.

Biba is fighting a battle for recognition by the powers-that-be which stresses that brokers are not banks, or insurers, and that they should be regulated in proportion to the much lower risk they pose. An already-unfair burden has been exacerbated by crippling increases in the Financial Services Compensation Scheme levy, which the Insurance Times Fair Fees campaign is fighting.

Biba has submitted figures to the Treasury showing that UK brokers already face far higher fees than their counterparts anywhere in Europe.

“The FSA has a very large number of firms to supervise, and it doesn’t have the manpower to visit everyone on a regular basis,” says Biba head of compliance and training Steve White. “I have sympathy with the consolidators, but there are wider concerns about the FSA and its replacement agencies about supervising our sector. We already have the mostly costly regime for brokers in Europe.”

Instead, White argues, the FSA and the two agencies that will replace it must be made to understand the brokers’ position: “The issue for the sector is to articulate to the authorities what sort of supervision we want.”

The disgruntled consolidator accepts that firms like his are more sophisticated, but not that smaller firms should escape tougher regulation because of the costs. “That’s hardly fair. In percentage terms, you could argue it would be the same. Why should smaller brokers be protected from the costs of the FSA in percentage terms? That’s not a level playing field … which was the point in the first place.” IT