Principles based regulation – do we know how it will work?

Posted on Sunday, 21 May 2017
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4 minutes

We have been well informed by the Financial Services Board (FSB) that the new Regulation will be ‘Principles based’ rather than the current ‘rules based’. But do we know what that entails? What we do know is that it relates to treating customers fairly (TCF), and we also know what the six TCF outcomes are, but how exactly is the FSB’s Enforcement Department going to impose penalties without referring to sections of what are our current (and soon to change) insurance laws?

In looking at the most recent fines imposed by the FSB, in each case a specific rule was breached. The Enforcement Committee on 22 February 2017 imposed an administrative penalty of R2 million together with a costs order on Robert Fourie for contravening Section 80(1)(a) of the Financial Markets Act, No 19 of 2012. Another penalty imposed just a week or so earlier on Lombard Life (R150,000) was very different in nature, but was still based on a specific ‘rule’. In the Case of Lombard life, it contravened PPR (Long Term) Rule 16.1 (c)(ii) and (iii). 

The question to ask is “How would the FSB have worded an enforcement action based on a contravention of principles?”

In the UK, the financial services industry is a few years ahead of us, having formally introduced Principles based legislation in 2014. It is also interesting to note that the six TCF outcomes that we now know so well are also identical to those introduced in the UK. It makes sense, therefore to study some of the recent enforcement actions taken by the UK’s Financial Conduct Authority (FCA) to ascertain exactly how they make use of ‘Principles’ to sanction offenders. 

On 22 November, last year, the FCA imposed a financial penalty of £89,004 on Mr Carrimjee for breaching Principle 2 of the FCA’s Principles for Businesses. On 13 July, the FCA imposed a penalty of £2,632,000 on Towergate Underwriting Group Limited for, inter alia, breaching Principles 3 and 10. Just a month earlier, the FCA found that CT Capital Limited breached Principles 3 and 6. 

So what are these Principles? The FCA’s ‘Principles for Business’ are as follows:

  1. Integrity
    A firm must conduct its business with integrity. 
  2. Skill, care and diligence
    A firm must conduct its business with due skill, care and diligence. 
  3. Management and control
    A firm must take reasonable care to organise and control its affairs responsibly and effectively, with adequate risk management systems. 
  4. Financial prudence 
    A firm must maintain adequate financial resources. 
  5. Market conduct 
    A firm must observe proper standards of market conduct. 
  6. Customers' interests 
    A firm must pay due regard to the interests of its customers and treat them fairly. 
  7. Communications with clients 
    A firm must pay due regard to the information needs of its clients, and communicate information to them in a way which is clear, fair and not misleading. 
  8. Conflicts of interest 
    A firm must manage conflicts of interest fairly, both between itself and its customers and between a customer and another client.
  9. Customers: relationships of trust 
    A firm must take reasonable care to ensure the suitability of its advice and discretionary decisions for any customer who is entitled to rely upon its judgment. 
  10. Clients' assets 
    A firm must arrange adequate protection for clients' assets when it is responsible for them. 
  11. Relations with regulators 
    A firm must deal with its regulators in an open and cooperative way, and must disclose to the appropriate regulator appropriately anything relating to the firm of which that regulator would reasonably expect notice. 

Principles based regulation is not new. The argument put forward by regulators is that prescriptive standards have been unable to prevent misconduct and that that the ever-expanding rule books have never stopped the frequent response of “where does it say I can’t?” with continued miss-selling as a result. Indeed, some regulators believe that detailed rules increase the burden on the industry’s resources. 

The latest round of regulatory changes which, although still not implemented, are clear indications that the FSB is showing its teeth. Although the inevitable Financial Sector Regulation Act has been pushed out once again, probably to the end of this year, it does give financial firms a chance to get their act together. The Principles might not be the same as those in the UK, but they are certainly going to be similar. 

Now is the time for FSPs to review their governance policies to embrace these Principles and at the same time adhere to the proposed fit and proper requirements which clearly require an FSP to place the customer central to its ‘raison d’être’. 

Peter
Veal
Risk Consultant