FSA wants firms to prove product stress-testing

The FSA wants firms to demonstrate how they stress-test financial products and ensure customers understand how their investments will react in different market situations.

Quizzing firms about the way they test product behaviour in different market conditions could be part of a more "pre-emptive" approach to dealing with industry issues, Sheila Nicoll, director of the FSA conduct policy division, said last night.

Stress-testing means being clear about what the product does, who it is for and certain key characteristics such as the nature and scale of risks presented.

In a speech at the Scottish Financial Enterprise (SFE) last night, Nicholl said: "We may ask firms how they are stress-testing products to understand how they will behave in different market conditions and how that is then being communicated to consumers."

In January, the FSA first announced it was reviewing the area of stress-testing following a series of mis-selling scandals.

Then, Dan Waters, the FSA director of conduct risk and asset management sector leader said: "On stress testing, we have not seen firms adequately illustrate what they do to test products where it is appropriate to do so."

But last night, Nicholl gave the first indication the FSA would look to respond to what it sees as inadequate practices by putting in place a system of testing firms' stress-testing practices.

She added: "We have signalled publicly we are now exploring a wider range of tools in relation to "product oversight"

"This means we may take pre-emptive action in order to choke off problems before they become widespread."

The move is part of the FSA strategy to develop a regulatory approach which looks more deeply into the value chain steps of product governance, design and oversight by provider firms.

"Rather than simply waiting to see what happens after products have reached mass circulation to the retail public," Waters has said.

Last week, Chancellor George Osborne announced the Government would scrap the current tripartite financial regulatory system.

The FSA will be broke up by 2012 and its activities split between a new prudential authority, with Hector Sants as its chief executive, and a new Consumer Protection and Markets Agency (CPMA), primarily charged with conduct supervision.

But Nicholl said the shake-up did not mean a change of pace at the regulator, and promised more "sector-wide intervention" of the kind embarked on in the RDR.

"The radical nature of such a remedy requires a tremendous amount of work to justify such a course of action. But it is one that we will not shy from where we feel it is appropriate.

"This work will not cease with the implementation of the new regulatory structure - intensive and intrusive regulation is here to stay."