City's cry of pain over rising cost of regulation

One year on, the Financial Services Authority stands accused of damaging competitiveness

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City's cry of pain over rising cost of regulation

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Sir Howard Davies, the chairman of the Financial Services Authority, has a birthday to celebrate on Sunday – his noisy, demanding and alarmingly fast-growing regulator will be one year old.

He probably isn't expecting lots of cards and presents – he quipped about the FSA's official inception on 1 December 2001 that "if there were parties, we weren't invited", and feelings in the City have not become any fonder.

Financial services companies, which have been most exposed to the FSA's reforming zeal, have delivered their first progress report on the body which will not provide much cause for celebration.

Donald Brydon, co-ordinator of the report, said it was a "cry of pain" from companies that are struggling to afford and comply with the FSA's new and plentiful rules and the cascade of reviews it has launched in the past 12 months.

The complaint in City circles is that the FSA, having come under fire early in its life from accusations that it failed to spot problems at stricken Equitable Life and Independent Insurance, has now burdened companies with amounts of red tape which could undermine the competitiveness of the Square Mile.

Mr Brydon, who chairs the Practitioner Panel of companies which audited the performance of the super regulator, said the general feeling across the board is that "it is almost too much".

"There are more and more rules, taking regulation into new areas. Unlike early expectations that it would be a bit like Y2K – with a bulge of expenses that would then die down – now the expectation is that it is going to get worse," Mr Brydon said.

If the burden in terms of costs and time does increase even further, as the FSA pushes through plans to extend regulation into areas such as general insurance, it is hard to see how companies, especially small ones, will cope.

The Practitioner Panel, made up of 14 banks, insurers and fund managers, has discovered that more than one-third of small firms spend 10 per cent or more of their total costs on complying with regulations.

Most of these compliance costs are generated by the FSA and come from its demands that companies should train new supervisors and apply rules to previously unregulated parts of the market such as mortgages.

Larger companies, with larger resources at their disposal, have found it easier to cope with the FSA's demands. But they too have been affected by demands on certain organisations to review their entire mortgage endowment books to establish whether there has been mis-selling and by the FSA's many requests for reams of information to feed into reviews such as its months-long look at the with-profits industry.

Only 15 per cent of large companies said the bill for obeying FSA rules cost them 10 per cent or more of their total costs.

Nevertheless, nearly half of the chief executives of large and small companies surveyed said these levels of costs were excessive. It is hardly surprising that companies moan about the costs of any regulation. But the number of executives complaining has risen from 35 per cent when the panel canvassed City views in 1999, before the various financial regulators were merged under the one, over-arching roof of the FSA.

One of the chief drivers of costs for companies and apparently one of their biggest headaches is the FSA's deceptively-named Handbook. The two-inch thick tome sets out the principles by which companies are expected to operate, but the reality is many don't understand it and find it almost impossible to get speedy and useful clarification from the FSA.

Paul Smee, head of the Association of Independent Financial Advisors, a sector which is being subjected to a bewildering amount of change by the FSA, said: "The FSA's procedures are labyrinthine. IFAs find it very difficult indeed to get straight answers out of it."

Companies find this particularly frustrating as they perceive a shift under the new regulator. This is towards putting the burden increasingly on companies to make sure their customers understand every aspect of the product they are buying and away from asking customers to decide for themselves whether they want to take on risk.

Mr Brydon, who is also chairman of Axa Investment Managers, said: "In the Financial Services and Markets Act, which established the FSA, it says consumers have a responsibility to take reasonable responsibility. That seems to have disappeared from the lexicon now."

The Practitioner Panel report found most companies, already struggling to cope with falling stock markets and a bottoming out of confidence among private investors, think the FSA champions consumers at the expense of ensuring the marketplace allows companies the freedom to thrive and compete.

Predictably enough, this is not a view held by all. The Consumer Association has made an official complaint to the Treasury about the FSA's refusal to launch a full-scale review of endowments after the discovery of pockets of mis-selling. MPs last week accused Sir Howard of being "asleep on the job" for his failure to deal with the implosion of the split-capital investment trust sector in the past six months.

Sir Howard and his team had to get used early to being in the position where they do not usually win with the various and often conflicting groups the FSA represents. Yesterday he refused to comment on the first comprehensive survey of his body's performance, but the FSA issued a statement saying it was a "valuable insight".

It conceded it has "not fully met expectations" in helping companies understand the Handbook and has promised to look into whether some businesses really are struggling with the expense incurred in following its rules.

City feedback on the FSA is not entirely negative. The Practitioner Panel found companies back its tough stance towards cracking down on dodgy financial dealing under its new wide-ranging enforcement powers, which gives the FSA the authority to close companies down and impose potentially crippling fines.

Most in the City also favour the FSA's risk-based approach to regulation, which allows it to allocate most of its resources to policing businesses which are most volatile or are very large and so would adversely affect many customers if they went down.

The body has not yet flexed its muscles fully, but it has come out quite well in comparison with regulators in other countries. Philip Middleton, head of retail banking at Ernst & Young, said: "You can argue that the SEC in the US has gone too far towards liberalising the market and is now paying the price in the form of Enron and WorldCom etc. While for the UK, Brussels is far more of a threat of a regulatory straitjacket than the FSA, which seems to have got the balance about right."

Mr Brydon also points out that the FSA, despite being the most powerful financial regulator in the world, agreed to be scrutinised by his team. "No other regulator in the world has subjected itself to that, especially only one year after it merged all sorts of different regulators together when you shouldn't expect it to be perfect," he said.