Last updated 7 April 2011
This document is annexed to our Analysis of responses to the The Architecture of Change consultation (Part 2)
1.1 The introduction of outcomes-focused regulation (OFR) by the Solicitors Regulation Authority (SRA) marks a step change in its approach to regulation and its relationship with the bodies and individuals that it regulates. OFR places an emphasis on achieving required outcomes for clients rather than simply compliance with detailed rules. Under OFR the SRA will be seeking to ensure that the individuals and firms that it regulates understand and meet their ethical and professional responsibilities and act in the best interests of their clients and in the public interest. The SRA has published a number of consultation papers and policy statements about the introduction of the new regulatory regime, most recently the November Policy Statement – Delivering outcomes-focused regulation – which set out how OFR and a risk-based approach to regulation are to be delivered.
1.2 As part of the November Policy Statement the SRA published an indicative cost-benefit analysis (CBA) which considered discrete aspects of the SRA's new regulatory regime. That CBA concentrated in particular on understanding how firms view the costs of OFR. That work proved immensely valuable in revealing a significant disparity between firms in their estimated costs. This reflected an evident lack of detail available on the OFR regime and also revealed some misconceptions around the SRA's regulatory requirements. The role of the Compliance Officer for Legal Practice (COLP) was one such misconception. The indicative CBA did not set out to reach a definitive conclusion on the costs and benefits associated with OFR. That was not possible at the time. Indeed, it remains impossible to reach such conclusions because:
- Firms' costs are extremely difficult to derive with any certainty for two main reasons. First, the new regime is not yet in existence, which means in turn that firms' costs can only be estimated. Our indicative CBA showed that this was not an easy exercise for firms. Second, it is difficult to identify the incremental costs of compliance, that is, the costs of complying with the SRA's regime to the extent it requires firms to do something they would not already do. Many of the SRA's requirements represent good business practice. The costs of complying with good practice are not imposed by the SRA except on those firms which would not choose to adopt it. Moving to a regime based on principles will ensure firms only comply with standards that are relevant to their practice. This should lead to savings but it is impossible to quantify that in advance.
- The SRA has developed, and is implementing, OFR as part of a much wider programme of change in order to transform itself into a more efficient and effective regulator in the public interest. In cost terms the largest element of this overall programme is the Enabling Programme which will see the modernisation of our outdated and operationally limited IT structure. The costs of the Enabling Programme are £22.11m. In order to minimise the incremental cost of change, we are implementing OFR, the licensing of ABS and the significant organisational structural and staff capability changes at the same time as implementing the Enabling Programme. It is very difficult to identify discrete ongoing costs associated with OFR for the SRA as our costs, moving forward, inevitably reflect the outcome of the overall change programme. However, the key indicators, in terms of future planned headcount and budget figures, indicate an overall headcount reduction as a result of the changes, and the investment in the Enabling Programme paying back over a five year period. One reason for this is that the internal reorganisation the SRA is undertaking will deploy the SRA's resources in a different way. The "costs"' associated with setting up new Supervision, Authorisation and Enforcement functions are offset by our ceasing to resource other existing business units—Caseworking is one such area that will be affected by this change of emphasis.
- It is generally the case with regulatory CBAs that quantification of benefits is extremely difficult. That has been our experience, especially given the scale of the regulatory changes ushered in by the Legal Services Act 2007.
1.3 For these reasons, it is not technically possible to present at this time a detailed, quantified CBA. The approach taken in this document remains high level in nature. This approach is fully consistent with regulatory CBAs done by other regulatory bodies when faced with significant regime change.
2 Approach to cost-benefit analysis
2.1 Cost-benefit analysis is a tool commonly used by government and policy makers to identify the economic impact of new regulatory or policy initiatives. CBA attempts to quantify where possible the costs and benefits for relevant stakeholders that may arise as the result of the introduction of new regulation. Quantification of benefits is however recognised to be extremely difficult. Regulators often need to be satisfied with understanding the quality of the benefits, without quantification. The purpose of CBA in such a case is to ensure that costs and benefits are identified.
2.2 The relevant costs and benefits are those that arise from the decision at hand, i.e. directly attributable to the proposed regulation. This presents challenges for two reasons: first, firms are not motivated solely by regulation; and second, regulation may seek both to create change and also to reflect best practice. Firms should aspire to best practice anyway. Costs associated with such standards are therefore a reflection of prevailing standards rather than an imposition by the regulator.
2.3 It is also important to distinguish between 'one-off' and 'ongoing' costs and benefits.
2.4 In order to conduct a CBA there are first a number of basic things that should be decided:
- Who are the relevant stakeholders to be considered when assessing costs and benefits? In this case, the stakeholders are firms, the SRA itself, firms' clients and society as a whole.
- What will happen with and without the change in regulation as distinct from what will happen before and after regulatory change?
3 Assessment of costs and benefits
3.1 The general approach to including relevant costs and benefits is described above. This section looks at costs and benefits for each of the immediate stakeholders—the SRA, firms and consumers.
3.2 Although the analysis is presented by stakeholder, the analysis considers the impact of OFR on
- the demand for legal services,
- the supply of legal services,
- competition in the market, and
- the outcomes that OFR is seeking to achieve.
The costs of OFR
3.3 This section identifies the sources of cost for relevant stakeholders regarding the introduction of OFR. As noted above, the relevant costs of OFR are those that will be incurred over and above the current regulatory requirements.
Cost impact on the SRA
3.4 The SRA will incur upfront costs of implementation and subsequent ongoing costs. The key impact of OFR on the SRA will be in the redistribution of resources to deal with changes in regulatory requirements. It is planned that SRA resources will be moved away from existing casework functions and towards the newly established authorisation and supervision functions.
3.5 The introduction of OFR requires reasonably significant changes to the way the SRA works and how it regulates firms. The SRA needs to ensure that it has the right skills, systems and processes in place to effectively implement OFR. The introduction of new ways of working will entail expenditure in new functions, but this will be offset by ceasing to spend money on the old ways of working.
SRA structure and skills
3.6 The SRA is developing and implementing a new organisational model around three key operational functions: authorisation, supervision and enforcement.
3.7 This involves
- a reduction in overall headcount from 640 to 560 employees,
- movement of some existing staff into new functions,
- recruitment of new staff with appropriate skills, and
- staff training to cover skills gaps.
3.8 Whilst the overall budget and costs of the SRA are well understood and planned, it is more difficult to draw out of the overall costs those attributable solely to OFR as opposed to those associated purely with other aspects of the change programme. In practice this is impossible as it would be possible to categorise many aspects of costs as flowing from a number of elements of the overall programme. Much of the new organisational model, in particular those which relate to ongoing costs, involves a redistribution of costs from existing SRA functions.
3.9 The reduction in headcount flowing from the overall change programme will offset some of the upfront costs of implementing OFR.
3.10 Costs will arise as a result of
- employing more highly skilled staff,
- staff training, and
- sourcing expertise to deliver entirely new functions such as the Risk Centre.
3.11 Through the Enabling Programme the SRA is undertaking a fundamental change to its IT and process systems in order to be able to
- provide consistent, timely, joined-up and reliable management information, and
- make simple day-to-day processes (such as data collection) automatic.
3.12 The SRA had already identified a need for significant systems improvement; these costs are not therefore a part of the implementation of OFR and should not be included in the OFR costs.
3.13 Given the headcount reductions that are being implemented, ongoing costs are likely to be significantly lower than the costs associated with implementation. The main effect of OFR will be to change the distribution of work across the SRA, rather than increasing the overall work load and therefore resource requirements.
3.14 Authorisation is a new function which will consider applications from individuals to become solicitors, and role holders in authorised bodies and from organisations, to be authorised to provide legal services. Although it will be a new function, Authorisation will take on some work already done by the SRA in existing departments.
3.15 A risk-based approach to authorisation will require more information from firms. Collecting and checking this information will be an additional ongoing cost. It is planned that this will at the outset be offset by corresponding decreases in the work undertaken by existing SRA functions and, over a longer period, decreases in other areas such as Enforcement.
3.16 Under OFR, the SRA will introduce a dedicated supervision function which will deal with the oversight of firms post-authorisation. There will be dedicated relationship managers for high-risk firms, while lower-risk firms will be managed by supervision teams. Any issues relating to a specific firm will go to the relevant team.
3.17 As with Authorisation, there will be a cost to the SRA associated with the new supervisory team structure. There will be some costs associated with employing new employees who have experience in operating a relationship-building approach. The resourcing for this function will come from a mix of existing staff currently employed in other parts of the SRA and new recruitment directly into the function.
3.18 Under OFR, there will be an Enforcement function with a remit to take transparent, proportionate and consistent action in accordance with the SRA's Enforcement Strategy and published decision-making criteria1.
3.19 The Enforcement function will take disciplinary action against solicitors and other regulated individuals, conduct litigation and deal with appeals.
3.20 It is likely that the total number of cases dealt with by the SRA will reduce due to
- the SRA's new powers to fine individuals and firms,
- the ability to make decisions relating to ABS internally, and
- the work undertaken by other functions, such as Supervision, to identify issues at an earlier stage and working with firms to rectify problems without the need for formal enforcement action.
3.21 This reflects the redistribution of work performed by the SRA away from enforcement towards authorisation and supervision. It is expected that the enhanced authorisation procedures and supervisory relationships with firms will reduce the overall requirement for enforcement.
3.22 The majority of the costs referred to above will be offset through the redistribution of staff from the existing SRA functions.
3.23 There are a number of factors which are strong indicators that the ongoing costs of the SRA post-implementation are unlikely to exceed current ongoing costs:
- the programme being undertaken by the SRA, which will reduce total headcount from approximately 640 to 560 employees and implies an overall reduction in staff costs. This does however need to be balanced against the requirement for a differently-skilled staff mix which may result in an increase in average staff costs;
- the intention that OFR will ultimately result in a more efficient SRA. This comes via the implementation of streamlined, more efficient processes that will—in the long run—result in cost savings.
Cost impact on firms
3.24 OFR and risk-based regulation will result in an increase in the information required from firms. Firms generally already collate and provide some of this information for other purposes (for example, securing insurance or bank loans). Much of the information that will be requested by the SRA is also related to systems and processes that firms should already have in place under the existing regulatory framework (although it is not specifically asked for by the SRA as part of, for example, the authorisation process). Even though firms will have much of the information requested, the SRA recognises that the retrieval and provision of information will entail some costs.
3.25 The SRA is already an entity-based regulator. Regulated firms already carry the responsibility for, and the cost of, regulatory compliance. The new regulatory framework will require firms to nominate a Compliance Officer for Legal Practice (COLP) and Compliance Officer for Finance and Administration (COFA). The purpose of a COLP and COFA is to provide a strong focus within the firm to ensure compliance and a key point of contact for the SRA on relevant issues. It is likely that many firms already have individuals employed who are performing the tasks of a COLP and/or COFA. Even where firms do not have dedicated individuals responsible for undertaking the roles as defined in the new arrangements, the responsibility for the activities associated with ensuring regulatory compliance will be allocated and be undertaken.
3.26 Some firms have indicated that the introduction of a COLP might require significant expenditure on new systems to enable the COLP to take responsibility for the firm's compliance with the SRA's rules. However, this can largely be attributed to a misunderstanding about the scope of the COLP's role, which was understandable prior to the publication of the final version of the Handbook containing the post-consultation COLP requirements. A COLP's responsibilities will include ensuring that the firm puts in place appropriate systems and controls for compliance and to oversee the operation of these systems and control. The ultimate responsibility for a firm's compliance will remain with the managers of the firm, as it does now.
3.27 The introduction of the new supervision function at the SRA to provide a consistent contact point for regulated firms is a key change to the relationship between firms and the SRA. The nature of this relationship will vary depending on the risk score for the firm.
3.28 There are unlikely to be any significant costs associated with this change.
3.29 There are unlikely to be any identifiable costs associated with the implementation of complying with the SRA's enforcement procedures. This is because enforcement actions are undertaken on a case-by-case basis and it is not foreseeable that a firm will implement systems and processes to deal with the possible enforcement action in the future. The potential for incremental costs of enforcement for firms as a result of the introduction of OFR are therefore considered as part of ongoing costs.
3.30 Once a firm has the systems and processes in place to meet the SRA's requirements, there will be some ongoing costs associated with ensuring continued compliance. For CBA purposes, this incremental effect needs to be identified—is the ongoing cost of compliance in an OFR regime higher or lower than in a detailed rules regime?
3.31 Under OFR, firms will be required to provide information on at least an annual basis to demonstrate continued compliance with the SRA's requirements.
3.32 Once this system is established, keeping and maintaining records should not imply significant additional costs.
3.33 Where firms require increased supervision because they have been designated as high risk by the SRA, there may be costs (e.g. loss of fee-earning time) associated with the need to dedicate more time to meeting SRA staff and responding to information requests than with lower-risk firms.
3.34 As noted above, the incremental costs of enforcement are largely unknown. It would not be legitimate to include the cost of enforcement proceedings for firms within the incremental costs of OFR as these costs represent a failure by a firm to comply with OFR rather than the cost of complying with OFR.
3.35 As noted above, firms had some difficulty in estimating the costs of OFR due to uncertainty about the detail of the requirements that would be implemented by the SRA.
3.36 It is evident from our indicative CBA that, at that time, firms differed markedly in the costs they foresaw arising from OFR. This is not surprising given the lack of available detail mentioned above. In addition, firms will encounter difficulties in separating out the real costs of compliance from costs that would have been incurred in any event as a matter of good business practice.
The benefits of OFR
3.37 This section sets out the identified benefits for relevant stakeholders regarding the introduction of OFR. As noted previously, in most cases it is difficult to quantify the benefits of regulatory change. However, where possible, we have included performance measures that indicate the anticipated benefits of OFR.
Benefit impact on the SRA
3.38 It is expected that OFR will result in significant benefits for the SRA primarily as a result of an improved regulatory approach.
3.39 Under OFR, the SRA's approach will shift from regulating firms reactively—for example, in response to complaints, identified instances of non-compliance or financial difficulty—to risk-based regulatory action.
3.40 The SRA will have a greater ability to identify potential issues before they become a significant problem (for example financial difficulty of firms) and work with firms to resolve these issues quickly and with minimal disruption.
3.41 A key outcome of the better regulatory approach is that the SRA itself is undergoing significant transformation in terms of the way it works, how it interacts with firms and the outcomes it delivers for consumers.
3.42 The new authorisation process will involve an increase and change in the type of information provided by individuals who apply to become solicitors or managers of firms and from organisations who apply to be authorised to provide legal services. The SRA will seek to ensure that entrants to the legal services market are appropriately vetted and assessed.
3.43 While the revised authorisation process under OFR will increase the workload of the SRA, it is planned that this will be largely offset by decreases in the volume of formal enforcement action. The increase in the level and detail of information provided by firms will also greatly assist the SRA in achieving its regulatory objectives by enhancing its risk management processes.
3.44 The aim of the supervision function is to encourage and support firms to deal with their own risks, improve standards and provide the required outcomes for clients. The changes being made are designed to increase confidence and trust in the SRA as a regulator with a related increase in confidence and trust in the legal profession. The level of supervision performed by the SRA will depend on an assessment of a firm's risk and will be tailored to the nature of the firm and its work.
3.45 It is anticipated that the new approach to supervision will, like the enhanced authorisation process, reduce the level of formal regulatory actions undertaken by the SRA.
3.46 We believe that the combination of more effective authorisation, a supervision function that will be more effective in achieving ongoing regulatory compliance in firms and the existence of a credible deterrent in the enforcement function will lead, over time, to a reduction in the level of formal regulatory actions. This will provide a significant benefit in the public interest and in the interests of clients as well as reducing the overall costs of enforcement action.
Benefit impact on firms
3.47 The introduction of OFR will generate benefits for firms primarily due to the greater flexibility it will enable firms in complying with regulations.
Benefit impact on consumers
3.48 Consumers of legal services will be the key beneficiaries of the new approach with its central focus on the outcomes achieved for consumers, consumer protection, the quality of consumers' experience of legal services and enabling consumers to understand what they should expect from their legal service providers.
3.49 The adoption of an outcomes-focused approach by the SRA will benefit consumers in a number of different ways:
- increased rigour in ensuring that only firms or individuals who can demonstrate their likely compliance with regulatory obligations are authorised to operate in the legal service market;
- focusing attention on high-risk issues that may cause consumer detriment in terms of standards of service or holding of client money; and
- reducing opportunities for fraudulent behaviour and loss of property.
3.50 In addition to the stakeholder benefits identified above, there are a number of additional potential benefits of OFR related to the impact on competition and the demand for legal services.
3.51 The additional flexibility that firms will have as a result of OFR may have a positive impact on competition due to innovation in the delivery of legal services rising over time. Firms will compete with each other based on achieving positive outcomes for consumers and in the public interest rather than merely obeying prescriptive rules. OFR provides firms with flexibility to address client needs through alternative methods of service delivery.
4 Next steps
4.1 As a next step in the CBA process the SRA will undertake further work in 2011 to gather additional information about the baseline costs for firms in complying with the current regulatory requirements. This information will provide important comparative data for the SRA when it is able (in 2011 and extending into 2012) to gather more precise data from firms about the actual costs (both implementation and ongoing) of operating under OFR. It is expected that this work will enable the SRA to identify whether there are any specific areas of disproportionality and to consider options for addressing these—either through changes in the arrangements or the SRA's approach to operating them.