Untightening the tethers of regulation

Well, who would have thought it? Miracles do sometimes happen, it seems. OK, so far there has been no concrete evidence that the Financial Services Authority is actually going to admit it was wrong to overenthusiastically supplement the Insurance Mediation Directive but there have been positive signs. Not least of which has been the launch of the general insurance effectiveness review earlier this year, designed to take a serious look at the current state of regulation of the industry with a view to moving to a potentially more relaxed regulatory regime.

According to the regulator, the review is being conducted in line with a broad commitment to the government's Better Regulation agenda and is focusing on how far the general insurance regime, including the conduct of business rules, is delivering the intended benefits for retail customers.

In the words of Dan Waters, director of retail policy at the FSA: "We are seeking to introduce more principles-based regulation and simplification across the FSA Handbook as a whole in the context of our Better Regulation agenda. The GI effectiveness review presents a good and timely opportunity to look at the conduct of business rules in fine detail, from the viewpoint of restricting prescription to the point where it is only demonstrably necessary to meet our consumer protection objectives."

Radical departure?

Sounds promising but hold your horses. Despite the grand sentiments expressed by the FSA so far, the chances that we can expect a radical departure from the current set of rules are nonetheless slim.

Oliver Lodge is a member of Kinetic Partners and an expert on insurance regulation. "There is no way the FSA will fudge compliance with the directive itself," he says. "If its view is that it will have to have a particular rule to comply with the directive, they will stick with it through thick and thin. The only change they could in theory make - and it would be a significant change of tack - would be to adopt a 'copy-out' approach, but that's highly unlikely."

However, he points out, it is not inconceivable that such a change of tack could take place, and he cites as an example the approach currently being adopted by the regulator in regard to the Markets in Financial Instruments Directive.

This will replace the existing Investment Services Directive, which the FSA claims is the most significant European Union legislation for investment intermediaries and financial markets since 1995. MIFID essentially extends the coverage of the current ISD regime and introduces new and more extensive requirements to which firms will have to adapt, in particular in relation to their conduct of business and internal organisation.

Lodge says, "The way MIFID is being implemented by the FSA represents a material change in strategy in the way they implement EU regulations. Instead of a draft set of their own rules being produced first, they are copying out the EU rules directly and saying to firms: 'Get on with it.'"

Naturally there are considerable difficulties associated with this method, he explains: "One of the drawbacks of this approach is that it leaves a hell of a lot unclear... and the industry dislikes a lack of clarity even more than it dislikes gold-plating! So in theory with the IMD, they could tear up the current regulation and start again with a 'copy-out' approach."

And there's no doubt that considerable pressure is being put on the FSA to get MIFID right, with the Association of British Insurers one of a number of high-profile trade bodies strongly lobbying for a form of regulation guided by the industry itself rather than dictated from on high by the regulator. Of course, MIFID is far removed from the practicalities of statutory regulation of brokers, but it could establish an important precedent.

Any such dramatic reversal by those in Docklands is, however, not likely in the near future - if at all - for a number of reasons, in Lodge's opinion. "They might say they'll revisit this in two or three years' time when they've seen the extent to which the 'copy-out' approach is a success, and maybe apply it to the IMD," he comments. "But that's the bigger picture. On a more modest level they will respond to individual concerns raised by the industry, and they will take those concerns very seriously, examining whether the directive leaves them with any flexibility over that particular question, and taking into account whether any changes they make would impair the consumer protection they are there to deliver. All that will have to go through a full consultative process, however."

John Needham, a partner at CBS Littlejohn Frazer, agrees that substantial change is unlikely. He sets in context the current difficulties faced by brokers, asking first whether the implementation of the IMD has itself been over-zealous. "Quite quickly, if you compare the UK to its EU counterparts, you come up with the answer that it has," he says. "Some countries don't have any regulation in place at all, and some don't have the IMD in place, so the FSA seems to have gone over and above anything else in Europe."

A different platform

Needham is keen to point out, however, that much of the difference in approach taken by the UK is down to the background of regulation. "The FSA has started from a different platform. We have a different framework of regulation in the UK, which the FSA has looked to implant the IMD on top of. That has led to complications regarding issues such as client money and fiduciary duties. If we had a blank piece of paper we would have tackled it from a different angle - we could have implemented the IMD in a more straightforward fashion and stripped out some of the ancillary bits."

Despite such problems, Needham nonetheless feels that progress is being made since regulation was first introduced. "There's been a lot of feedback given through the roadshows and their various processes, including visits. They are really getting to grips with how things work, and they've been talking to the London Market Brokers' Committee and the British Insurance Brokers' Association, so there is a huge pool of knowledge there."

Is there any chance that real change can be expected, however? According to Needham, there is indeed a possibility if you put the regulation of insurance brokers within the wider regulatory context. "They're looking at moving to principles-based regulation and moving away from prescriptive regulation, so it's becoming much more an interpretative style of regulation than a prescriptive one. So you could co-ordinate (the move to a different style of regulation) with a shifting of the regulations in relation to insurance."

Backtracking

According to one London market expert, much of the present difficulty around insurance regulation stems from the fact that the regulators themselves never really understood the market, as they had no previous knowledge of it.

Says one observer: "Ask yourself why the FSA might be potentially backtracking. There was a recognition that there was a lack of knowledge of the insurance broking industry among staff at the FSA, which is clear from the fact that some of the rules don't fit the business of London market brokers." However, he adds, all is not lost. "Now they've got more knowledge of the market, you can see that they understand the situation that bit better and are more amenable to a relaxing of the rules, though of course there might be legal issues there as to just what they can do."

For some in the market, one of the main concerns about the outcome of the effectiveness review is not so much that change will not be forthcoming as that any relaxation of the rules will not be even. Steve White, regulation and compliance manager at BIBA, says this a major concern for the trade body, whose main worry over the review is that it will affect insurers but not brokers. "We oppose any change to regulations applying to insurers [and not to brokers] and will continue to do so," he comments. "It creates a commercial disadvantage for brokers and confusion for consumers."

Another difficulty is that in many respects it is simply too early to make a proper assessment of the impact of the current regulatory regime, say observers. Although most insurance brokers would laugh at such a suggestion, given that regulation has been affecting their bottom line for many months now, from the point of view of the authorities it is not necessarily the right time to sit back and take stock of the impact statutory regulation of insurance brokers is having.

Early days

As Lodge says: "One of the problems with the effectiveness review is that it is still early days to be confident about the changes brought about by the new rules. It has taken, and is still taking, time for the industry to get to grips with regulation. You only have to see what the FSA said to the insurance broking community about client money - that there have been really expensive and wide ranging failures there - and the FSA won't let go of this one. Measuring the effectiveness of the rules isn't possible unless there is general compliance with them."

Whatever happens regarding changes to regulation, one plea is coming from various parties: please be clear and keep people informed about what is happening. The FSA itself was not prepared to elaborate on any details of the effectiveness review beyond what is already in the public domain, and there is no doubt many people want more information.

"It's surprising that they haven't made a bit more noise publicly about this," says Oliver Lodge. "I know that things are happening, but they're doing it very quietly. Maybe they're coming at this reluctantly because they realise they've come to it a little early." John Needham also makes a plea for clarity. "One thing I would like to see, if there are going to be changes to the rules, is some clear guidance on the process," he says. "There has got to be absolute clarity on which bits of regulation are being reversed, or it will get confusing."

Whatever happens next, there is already confusion about just when the first meaty conclusions of the effectiveness review will be revealed. BIBA says it is expecting something by the end of the year, although the FSA says that it will report in 2007. Perhaps a clearer indication of the timetable would be a useful aid for businesses.