The FSA has published a speech by Hector Sants (CEO, FSA) entitled Delivering intensive supervision and credible deterrence.

At the start of his speech Mr Sants provides a brief resume of the causes of the financial crisis. The remainder of his speech focuses on the response of supervisors and market participants.

On the causes of the financial crisis Mr Sants refers to the speech that Lord Turner gave in January at the Economist’s Inaugural City Lecture (The financial crisis and the future of financial regulation) stating that this speech is generally thought of as a definitive account of what has happened. In addition Mr Sants states that in the UK the main gap in the regulatory architecture was macro-prudential, with local FSA supervisors primarily focusing on individual companies and the central bank focusing on interest rates. He also recognises that in the UK there was an inadequate depositor protection regime and bank resolution mechanism.

On the FSA’s supervisory response a key feature is greater supervisory resource of a higher quality. According to Mr Sants the FSA is on course to hire, by the end of 2009, 280 extra specialist and supervisory staff which represents a 30% increase in the FSA’s supervisory capacity.

On the FSA’s philosophy Mr Sants states that the approach has historically been characterised as evidence-based, risk-based and principles-based. The FSA will remain evidence-and risk-based but Mr Sants feels that principles-based has been misunderstood. He confirms that operating on principles alone is illusory, particularly as the policy making framework does not allow it.

According to Mr Sants principles-based regulation means moving away from prescriptive rules to a higher level articulation of what the FSA expects firms to do. In other words, it helps emphasise that what really matters is not that any particular box has been ticked but rather that when making decisions, executives know they will be judged on the results of those actions. When supervising firms the philosophy will be to judge firms on the outcomes and consequences of their actions and not on the compliance with any given individual rule.

In the future the FSA will make judgements on the judgements made by senior management and will take action if it believes that there is a risk to its statutory objectives.

The FSA calls the more direct style of supervision “the intensive Supervisory Model”. Mr Sants states that to see the full picture it is important to ally this with the FSA’s more proactive approach to enforcement, the credible deterrence philosophy.

Mr Sants then states that there is a view that people are not frightened of the FSA. This is a view that he is determined to correct.

Mr Sants then briefly discusses what the FSA’s mandate is. The FSA focuses on delivering credible deterrence in respect of its mandate under the Financial Services and Markets Act 2000. In particular the FSA focuses on market-related offences and issues relating to unauthorised activities such as boiler rooms. The FSA does not seek to be the responsible agency for prosecuting financial fraud in its conventional or wider sense.

On the delivery of supervision Mr Sants makes the further following points:

  • Effective delivery requires a comprehensive understanding of risk in any given institution. A comprehensive understanding of risk requires both prudential and conduct oversight responsibilities. Mr Sants disagrees that the twin peaks of regulation would have helped mitigate the current crisis.
  • That effective risk assessment of a firm requires industry knowledge and for that assessment to be set in a macro-prudential context. This was not done in the past, but will be done in the future.
  • The FSA’s intensive approach will mean a greater emphasis on outcomes testing relative to assessments of adequate systems and controls. In the past the FSA’s principal focus was on ensuring that there was adequate management information and controls in a firm and then relying on management to address the issues. In the future the FSA will switch resources to outcomes testing.
  • The delivery of supervision has to be done in partnership with responsible firms, shareholders and auditors.  

View FSA speech - Delivering intensive supervision and credible deterrence, 11 March 2009