FTAdviser.com

Advertising

When the FSA first issued its proposals requiring certain regulated firms to record telephone conversations and electronic communications, its reasoning was that the availability of such records would deter potential abusers of the financial markets from inappropriate behaviour and would also enable the FSA to act against such behaviour with a greater likelihood of success. Many trade bodies were not convinced by this rationale and continue, now that the final rules have been made, to have serious doubts about what benefits the FSA’s requirements will deliver.

Briefly, the FSA’s May 2007 consultation proposed that banks, stockbrokers and investment managers should keep records of communications with clients or market counterparties for a period of three years, with “communication” including not only phone calls but also faxes, emails and instant messaging. Following its standard consultation process and subsequent detailed discussions with various trade bodies, the rules made by the FSA in March 2008 incorporated certain changes – records need only be kept for six months, mobile phone calls need not be recorded (at least, not for the time being) and fund managers acting on a discretionary basis need not record their calls.

While these changes are all to the good and have been welcomed by the market, the fact remains that the FSA has put in place a set of requirements that have very considerable costs attached to them and in respect of which the FSA is unable to give any clear indication of anticipated benefits.

Before covering some of the cost/benefit issues which have been at the heart of industry concerns over the FSA requirements, it is worth making a couple of points clear. First, market participants have no quarrel with the FSA giving a high priority to efforts to counter market abuse – after all, maintaining clean, efficient and transparent markets is vital to the business flows which make London such a dynamic financial centre. What the market is less sure about, however, is whether the FSA’s chosen weapons in the fight against market abuse are the right ones. Second, many firms in the wholesale markets already have telephone recording systems in place. While these have generally been installed for commercial reasons, such as settling trading disputes with other firms, the records produced have also been available to regulators. However, most firms operating in the private client market have not so far seen any commercial need for telephone recording.

As mentioned before, divergent views about the balance of costs and benefits associated with recording have been at the heart of the discussions between the FSA and trade bodies. In its original consultation, the FSA estimated the costs of its proposals at £3-4m for one-off costs and £3.5-4.5m for annual ongoing costs. By the time the final rules were published, the FSA was prepared to concede that these figures were too low and suggested instead £9-14m for one-off costs and £6-11m for annual ongoing costs. The fact these significantly higher figures relate to a less wide-ranging regime than initially proposed highlights just how inadequate the original figures were. What is also worth noting, however, is that the revised figures are the regulator’s own “best estimates”, which are themselves considerably lower than cost estimates supplied by firms in response to a FSA questionnaire and interviews with FSA consultants.

If FSA and industry views have diverged on the costs of telephone recording, the difference has been even greater as regards its likely benefits. To begin, the FSA has not made clear exactly what ill it seeks to address through these new rules – although “market abuse” is generally agreed to be an evil, the absence of evidence that UK markets are being materially impacted by it means that many firms have regarded the FSA’s proposals as utterly disproportionate, the proverbial sledgehammer to crack a nut.

Further, the FSA’s explanation of what it hopes to gain from recording has been weak – it has only been able to say that introducing a taping requirement “may” raise behavioural standards amongsmarket participants, “may” increase the information available to the FSA in pursuing market abuse cases and “may” increase the probability of successful enforcement. Indeed, even in its original consultation, it conceded that “it is difficult to estimate the extent to which recording of voice and electronic communication itself adds to the benefits of cleaner markets”. Given this rather lukewarm statement of the benefits of recording, it is not surprising that many firms believe the costs they will have to bear as a result of this initiative – such as the costs of installing/maintaining recording equipment, responding to FSA data requests, changing in-house procedures, amending client paperwork – are simply not justified.

Industry also believes the FSA has overplayed the deterrent effect that an increased chance of getting caught is likely to have on market abusers. While the new rules are likely to mean that more inadvertent and “plain dumb” bad behaviour is identified, it is unlike to capture the types of deliberate and systematic manipulation that is so damaging to market health. Individuals engaged in these sorts of activities will now know exactly which communication devices are being recorded and will be able to shift their business to unrecorded means of communication such as personal mobiles, home phone numbers, email, instant messaging and chat accounts and, of course, that most obvious of fall backs, a quick visit to the local pub.

Beyond the cost/benefit equation, there is a range of other issues identified by firms and trade bodies which the FSA appears not to have given sufficient thought to. Most obviously, the FSA has forged ahead with its own plans in spite of an EU-level review of recording requirements in the financial services industry being scheduled to begin towards the end of this year. The FSA’s view that it cannot simply sit on its hands awaiting European developments seems to indicate complete disregard for the competitive interests of UK firms which may, if European requirements end up diverging from those set in the UK, have to finance yet another round of systems and procedural changes. Among the other issues raised during the consultation process which have also received scant attention from the FSA are concerns about the human rights, data protection and client confidentiality aspects of storing large quantities of data, some of which may be financially sensitive although completely irrelevant from a market abuse perspective; concerns about the possibility of recorded data being subject to discovery in the event of legal disputes; and concerns about other domestic and overseas regulatory bodies regarding such data as a general archive and using it for vaguely-defined “fishing expeditions”.

Because many of firms currently have either no or very limited recording arrangements, the bulk of the costs associated with implementing the FSA’s new requirements are likely to fall on them. By and large, these firms are not engaged in the large scale trading of sophisticated financial instruments which characterises the wholesale market; they act for private investors, the vast majority of whom are more likely to be among those whose interests are harmed by market abuse than amongst those perpetrating it. Given this, is it any wonder that such firms remain unconvinced by the FSA’s case for introducing recording requirements?

David Bennett is chief executive of Apcims