13.2 Financial regulation in the uk

Equitable’s sales force and non-prots policies. In January 2002, policyholders voted

in favour of the compromise rescue package and this was approved by the High

Court the following month, paving the way for a £250m cash injection from the

Halifax. The package was approved at the annual general meeting in May 2002.

Members were told that the company was solvent, but increased exit penalties were

announced in July 2002 and further cuts in the income to be paid to with-prot

annuity holders were made in November 2002.

The FSA was criticised for its failure to spot problems and to follow up issues

that had been uncovered, although it was partly excused because the problem had

developed during the period in which the FSA was being set up (between January

1999 and December 2000), during most of which regulation was being carried out

on the FSA’s behalf by its predecessor, the Personal Investment Authority (PIA).

The mis-selling of endowment mortgages also began well before the FSA came into

existence. The problems associated with the sale of endowment mortgages have been

explained in section 12.1.3. Early in 2000, it became clear that many endowment

policies would not meet the mortgage in full at the end of the period. Policyholders

were faced with either having to meet the difference at the end of the period or to

make top-up payments to the insurance company to ensure that the mortgage would

be paid off. Estimates of the number of those facing a shortfall in their policies

and of the extra amounts they would need to pay depended on the rate of bonus

assumed for the rest of the life of the mortgage. It was clear, however, that the prob-

lem was very large.

The FSA required all companies to calculate the position of all policies at assumed

rates of 4 per cent, 6 per cent and 8 per cent to maturity and to advise all policy-

holders of their position during 2000. They also specied that the letters should set

out all the available options to policyholders and should not give more weight to

the possibility of solving the problem by increasing the premium paid. Companies

were only obliged to look at policies taken out from 29 April 1988, the date that the

Financial Services Act came into force.

Was this just an unfortunate result of the change in economic conditions and a

case of ‘let the buyer beware’? After all, people could have opted for straight repay-

ment mortgages but chose the riskier endowment repayment method in the hope of

receiving a higher return. Yet things were not as straightforward as this. In October

2000, the FSA admitted that hundreds of thousands of people might have been mis-

sold endowment policies. It became clear that many policyholders had not been told

that their policies carried any risks. They had been allowed by the insurance com-

panies to understand that their policies would denitely pay off their mortgages.

People who believed they had been mis-sold endowment mortgages were able to

apply for redress to the Financial Ombudsman Service or, where the company that

sold the policy had gone out of business, to the Financial Services Compensation

Scheme. Some insurance companies pledged to make up shortfalls whether or not

the policies had been mis-sold. People sold endowment mortgages before 29 April

1988 had little chance of receiving compensation, although some companies agreed

to allow the Financial Ombudsman Service to consider on a voluntary basis com-

plaints of mis-selling before that date.

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Chapter 13 • The regulation of nancial markets

Although mis-selling appeared to have been widespread, the FSA refused to instig-

ate a case-by-case review of the problem, despite criticisms by consumer bodies and

the FSA’s own Consumer Panel. The FSA argued that such a review was not needed

because the vast majority of policyholders were better off than they would have been

if they had taken up a simple repayment mortgage. So, even if they could prove that

the risks were not explained, they would not be entitled to compensation. However,

critics argue that if people, realising that they had been mis-sold an endowment

policy, now surrendered the policy and converted to a simple repayment mortgage,

they would lose. The chief ombudsman at the Financial Ombudsman Service said

that, provided these consumers could show they were mis-advised, they would be

entitled to additional compensation for the loss.

On 15 July 2005, the FSA (2005) reported that an independent research report

had found that most consumers whose endowment policy was still linked to their

mortgage, and who were facing a shortfall, had taken some positive action to deal

with it. The 2.2 million households in this position had an average projected short-

fall on their mortgage repayment of £7,200 . Sixty-nine per cent of these had taken

action to address their situation and a further 14 per cent intended to do so in the

future. Just over a million households had restructured their mortgage, savings or

endowment; other action taken included seeking advice or pursuing a complaint.

If there remained unhappiness with its behaviour over issues such as these, the

FSA could certainly claim in its defence that it had taken advantage of the new

provision in the FSMA permitting it to penalise companies for market abuse, giving a

clear message to rms in the market that it will not tolerate the mis-selling of products.

It has ned several companies for mortgage endowment and other failings. This,

the FSA could maintain, will help to overcome problems with the nancial services

market in the longer term even if all individual problems are not picked up and dealt

with as speedily as they might be.

The FSA has also sought to overcome general problems by paying great attention

to the objective of consumer awareness. Firms are able to mis-sell products to con-

sumers only because of the high degree of consumer ignorance regarding nancial

services. Clearly, if the FSA could help to reduce consumer ignorance it would also

help to overcome market abuse. Nonetheless, high-prole failures in markets such

as the cases dealt with here continue to be a problem for market condence, the rst

of the FSA’s objectives. See Box 13.5 for a favourable view of the FSA’s performance

in its rst six years expressed in a leading article in the Financial Times in June 2006.

Box 13.5

The regulator judged

Most employers reward productivity. But it is the curse of regulators that, though they are paid to

regulate, the more rules they manufacture or enforce, the more likely they are to be criticised. On

the other hand, if a watchdog fails to intervene, it risks being damned for its inaction.

In the six years since it was formally created from a merger of other watchdogs, Britain’s

Financial Services Authority has largely neutralised this double-edged curse. It has earned a

reputation, both at home and abroad, as a successful ‘light-touch’ authority. Are such accolades

well-deserved?

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