Last year, on this occasion, I used the opportunity to set out the three themes of the FSA's work: promoting efficient, orderly and fair markets; helping the retail customer of financial services to get a fair deal; and making the FSA itself more efficient and hence easier to do business with. Those themes remain, and will remain, at the centre of our work. If there were such a thing in regulatory policy as an eternal verity, they would be our eternal verities. But, you will be relieved to know, I do not want to reprise what I said last year. Instead, I would like to use this occasion to review the present position of the financial services sector, and consider two of the many challenges which it faces. And, having described the challenge, I will set out how we at the FSA will respond.
3. Harold Macmillan, when Chancellor of the Exchequer, famously remarked that the most difficult thing to predict was the recent past – something which has not changed, as revisions to ONS statistics remind us. In the spirit of starting by tackling the most difficult of forecasts, namely where are we now, let me start by looking at the state of financial services in the UK.
From the industry's viewpoint, the position is one of strength: business and financial services make twice the contribution to the UK economy of manufacturing industry; financial services show strong and growing net exports, up 9 per cent in 2004; the very fact that the UK has a positive balance of trade in financial services is worth stating – it distinguishes the UK from the US, Japan or France. The banking sector is thriving, with British banks showing high returns on equity, and capital ratios healthily above any required by regulation. The life companies, which suffered from their exposure to equity markets when the FTSE halved, have benefited both from the recovery in equity markets and from the rebalancing of their assets. The realistic reporting of assets and liabilities, which we have required, shows significant improvement in their underlying financial strength. For general insurance, London continues to be one of the largest insurance markets in the world for wholesalerisks. I would add that general insurers and reinsurers, having until recently enjoyed abenign stage of its cyclical life, may well - post Hurricane Katrina -provide a vivid illustration of Harold Macmillan's dictum. The British asset management industry remains a global leader, with profitability improving, in part in line with rising markets, in part in response to the often painful measures taken to reduce costs. The markets and exchanges based in the UK remain attractive targets for investors, just as – and because – they remain attractive trading venues.
All these are, of course, indicators of the profitability and international competitiveness of the financial services industry. We at the FSA are much concerned that the British industry should be and should remain profitable and successful. That is part of our statutory responsibility for preserving confidence in the financial system. But we are even more concerned that the industry should serve its customers well – which is also part of our statutory duties, in terms both of confidence and of consumer protection. In a competitive industry there is no conflict between the two objectives, which is why we at the FSA are committed to promoting efficient, orderly and fair markets, and always seek to guard against the danger that regulation acts as an impediment to innovation or competition.
As a broad generalisation, I would say that the wholesale financial services markets are characterised by significant, even fierce, competition, with a range of providers of services competing for the business of for the most part informed and competent potential customers. These happy circumstances allow us to adopt lighter touch regulation where we can rely on the precept of caveat emptor – a principle which has informed our recent statements on the trading of debt instruments; and has enabled us to encourage the industry to develop its own solutions (as we have done with bundled services for asset managers, and are doing for contract certainty in the insurance market), and generally to keep regulatory intervention as a backstop.
The position in retail financial services is very different. There is often a disparity between the knowledge and capability of the provider of the retail financial service and of the user of the service such that much less reliance can be placed on the principle of caveat emptor, and there is a correspondingly greater requirement for regulatory intervention in the retail compared to the wholesale market. I should make clear that the FSA's aim is to promote an efficient market for financial services in the retail market just as in the wholesale market – hence our concern to improve financial capability, to promote relevant and understandable information about financial services, and to encourage responsible behaviour on the part of those who provide those services: the behavioural conditions needed to make an efficient market. But until these conditions are met there will be a stronger case for regulatory intervention in the retail than exists in the wholesale market.
That then is my starting point: a financial services sector which is one of Britain's most successful sectors in terms of international competitiveness and profitability; a wholesale market which is for the most part both efficient and competitive, and where regulatory intervention can therefore be – and is – limited; and a retail sector with real obstacles to developing an efficient market, where our regulatory interventions are aimed both at moving towards a more effective market and in the meantime providing in various ways a measure of consumer protection which is much needed.
We are also acutely aware of the costs imposed on the sector by regulation and its consequences for industry and consumers. We know that, to the firms affected, it does not actually much matter where particular regulatory initiatives originate. What matters is the cumulative cost and strain placed on management teams to cope with the aggregate impact.
10. Where it is within the FSA's discretion to do so, we continue to be concerned to reduce regulation where its existence is not matched by its benefits. Most recently, this has involved our suggestions for removing prescriptive requirements in the areas of individual authorisation, training and competence and anti-money laundering in favour of a more, but not exclusively, principles-based approach. And early next year, our cost of regulation study will enable us to focus on other areas where the costs of the regime may not necessarily be justified by the benefits.
There is a clear shared interest between regulator and regulated in achieving a regime pitched at the right level. We need the help of the industry in defining that level. That's why I have challenged the industry to also come forward with views on the areas which could benefit from re examination. I am pleased that the Association of British Insurers, for example, is responding with what promises to be a thoughtful and constructive analysis of where regulation might be evolved to the benefit both of the industry and consumers. I hope that this will also examine the role that the industry too must play in delivering a more competitive retail financial services market. I repeat my encouragement for others to take a similarly constructive approach.
