Will the FSA be steering your ship?

The big day is fast approaching. In one month's time, the FSA's regulatory regime will begin and its supervisory machine will move slowly into gear.

More than 9,000 new businesses - brokers and secondary intermediaries - will be brought into the FSA's fold as directly authorised firms. Many thousands will also feel the gaze of the regulator through being appointed representatives.

For brokers, many of whom have experienced only supervision by GISC, the FSA is an unknown and intimidating organisation. So what can they expect of the new supervisory regime?

Andy Watson is head of department of the FSA's small business division.

This division is responsible for the supervision of the smaller end of the mortgage and general insurance intermediary market - typically firms with a turnover of less than £3m.

The retail firms division is responsible for the supervision of brokers with a turnover of more than £3m, with the exception of the very large ones that are handled by the major retail group. Lloyd's brokers are handled by the wholesale markets business unit.

The nature of the supervisory contact that a broker receives will depend on its size and the division of the FSA that deals with it, says Watson.

The larger firms, handled by the retail firms division or the major retail group, will have a dedicated supervisor (or in FSA speak "relationship manager"), who will be the first point of contact for the firm.

In contrast, the smaller brokers will not have a single point of contact, but will deal with a contact centre. Watson says: "The contact centre can deal with a number of things. For example, it can handle queries they might have, they can direct the firm to the website where further information is. In most cases they should be able to respond to their questions, either immediately or they will do some research and come back to them."

The purpose of the FSA's supervisory brief is to ensure that firms are trading within the rules. But it also has a broad brief to meet four main objectives: maintain market confidence, promote public understanding of the financial system, secure appropriate consumer protection and reduce financial crime. Through supervision and where necessary enforcement, the FSA's aim is to identify and address risks that might threaten any of these objectives. Fundamental to this is gathering and assessment of information.

For larger brokers, a visit from the FSA is to be expected - known as a "risk assessment".

Watson says: "The relationship managers will assess the information we have from the authorisation process, plus other information submitted, and will then go on site to the firm and do a risk assessment. From that risk assessment there would typically be a risk mitigation programme put together, setting out the issues we've found.

Every firm supervised by the retail firms division or the major retail group will have a risk assessment - some will already have had one as part of the authorisation process.

Watson says the risk assessment process will continue through 2005. "It won't all happen on 14 January, it will be planned and phased to cope with our own workloads."

He also stresses that risk assessments will not be the only form of contact that the larger brokers will have with the FSA's supervisors.

"If issues arise on a day-to-day basis we'll be speaking to them," says Watson. "So there would be contact with these firms and, clearly, if there are problems which arise, either through analysing the information that we are sent or through other means, then we will go and see the firm on that particular issue."

He adds: "A lot of contact has already taken place prior to authorisation, so the larger firms have been in contact at some time with their relevant supervisors to discuss the likely issues."

Larger firms may also be the subject of an Arrow visit. These differ from the risk assessment visit in that they are more "focused", examining a particular theme, such as client money handling.

"Firms will always know well in advance and what information we need," says Watson.

As for the smaller firms, these present particular challenges to the FSA in terms of supervision given the diversity of the market - it includes brokers and secondary intermediaries such as vets and dentists.

"The numbers we're talking about here are extremely large, so the key to our strategy is to get data to inform the work we do, both at an individual firm level, but also to identify themes and cross-firm issues for us to tackle," says Watson.

The data will come from a number of sources, including insurers, market intelligence (such as whistle-blowing and mystery shopping exercises) and from the intermediaries themselves.

Watson says that the FSA will be creating electronic risk profiles of the smaller firms.

"Rather than actually going into every single firm, we will be able to understand from the data those firms that are selling the higher risk products or those that are disclosing they've got particular issues with their controls or capital, for example.

These profiles can then be used to determine which firms to visit, or more likely use for thematic work, he says. "We can identify a particular theme, sample some firms, draw some more generic lessons and then promulgate them out to the market."

He emphasises that the small firms will not be receiving routine visits from the FSA. "It doesn't mean that firms won't be seen, but that is not the general approach; they will not be seen by rote every two or three years. They will be seen because they're either high risk from the information we've received or they're helping us on some of the thematic work that we've decided to tackle."

Geographic visits will also form part of the FSA's supervision strategy.

Similar to thematic reviews, these visits will target a particular location to look at either a particular issue or undertake a more generic examination to see what the issues are.

"We've started doing these with IFAs. After the visits we'll hold a roadshow and will invite all firms in the area to attend. This will allow us to give feedback on the things we've seen and the issues coming out. It will allow the firms to think: "Do I have that similar sort of issue in my firm? Do I need to address it?" It's about education and communication."

He adds: "We don't want to be seen as a London-based regulator; we need to get a regional spread."

One of the first areas that the FSA will be investigating is the perimeter, looking at firms that are selling general insurance products but which are not authorised.

"If firms are within the supervision or regulatory parameter and they find the person next door isn't and is doing exactly the same business but should be regulated, then they're very keen to have that rectified," says Watson.

A second key issue for the FSA is to examine the authorisation data.

This will also be done at an early stage. "This will allow us to see the key themes arising from the authorisation process. It may well highlight some firms that are in the high risk spectrum of authorisation, but got through on the process. It may also show up some residual issues and concerns, which we will follow up."

Watson is keen not to commit to other areas that could be early targets for the FSA's supervisors, for example, will commission transparency and other Spitzer-related issues be prime targets for early thematic or investigative work?

"There's always talk about doing lots and lots of things. It's another thing on the table that we can decide to do but we haven't yet decided.

The regime doesn't come in until mid-January and there'll probably be quite a lot of water under the bridge between now and 14 January. You'll probably find there'll be another two themes that the press think we should be looking at."

What about client money given the controversy over risk transfer and co-mingling?

"It's a candidate. But there are other areas: complaints handling, adequacy of capital, and professional indemnity insurance. There're so many things we could look at and we have choices," says Watson.

Watson says that once the priorities are decided they will be communicated to the industry. "We want to be a transparent regulator and so in due course we will publish, either through things like the annual business plans or speeches."

Surprise visits are unlikely to form part of the FSA's armoury of supervision tools, unless there is "massive consumer detriment".

What lessons has the FSA learned from the supervision of other sectors, such as IFAs? Watson says: "It has shown us that we have to be proactive and set our own agenda in terms of thinking about the issues, identifying the issues and dealing with them.

"We can't just react to what I would call crystallised risk, problems coming through our door, either through firms phoning us up or being told about something. If we were going to do that, we couldn't deal with the sheer volume of every single lead. This is why we take a more thematic approach to regulation."