Making innovation work for firms and consumers

Yes, there’s far more interest in achieving good customer outcomes. But equally there’s none of the squeamishness of the past over the benefits of the best firms making profit in a competitive market. Nor the worst exiting markets.

Thank you. It’s a pleasure to join everyone and I’m grateful to Bloomberg for the opportunity to take stock on what’s been an eventful year for many of us.

So, as we look back, there was clearly a lot of positive momentum from industry in key areas like incentives for frontline staff; the fall in consumer complaints; and the work by Richard Lambert.

And, on top of this of course, there was the introduction of the FCA, with emphasis on moving forward in priority areas like ethics, crisis prevention and consumer protection.

So, for leaders in finance today – in business as well as regulation – the last 12 months have been dominated by significant change. And it’s in this context that I want to reflect on the evolution of the relationship between the regulator and industry.

Some here may recall Ronald Reagan, in the eighties, describing government’s attitude to the economy as the following: ‘if it moves, tax it. If it keeps moving, regulate it. And if it stops moving, subsidise it.’

I want to argue this morning that this relationship is now very different. In fact, I want to argue that the connection between regulators and the regulated, far from being the drag anchor described by Reagan, is instead evolving into a considerable strength of the UK economy.

The key here as I see it, is that we’re in a very different environment to, say, 1929 or the 1980s when attitudes in the official sector were more polarised. So you saw regulated capitalism in the thirties effectively giving way to neoliberalism in the eighties and nineties.

Today, in contrast, the FCA has a very clear statutory objective to make markets work well for firms as well as consumers. So, yes, there’s far more interest in achieving good customer outcomes.

But equally there’s none of the squeamishness of the past over the benefits of the best firms making profit in a competitive market. Nor the worst exiting markets.

In other words, there’s more balance today than there was in the aftermath of previous crises. And that can only be useful in terms of moving the relationship between firms and regulators forward.

But it’s also clearly wrong to pretend all has been resolved.

As we move into year two of the new regulatory structure we know issues remain that have the potential to frustrate, including many seemingly conflicted wish lists that need to be resolved.  

We know, for example, that some firms prefer the clarity of rules to broader principles. But at the same time want a more flexible regulatory environment. So, how do we resolve those two positions?

Equally, there are questions over innovation in the market, new products or business models. We want firms to have the freedom to break new ground. But we know there would be limited societal appetite to accept business failure if things went wrong as a result.

Where does this leave the financial sector as we explore the possibilities of technology and trends like peer-to-peer lending? How much oversight are we willing to accept?

And, another important issue, the social utility of financial services – particularly their ability to support those who are less confident financially, or have smaller investment pots.

How do we square the circle of selling often highly complex products to so-called unsophisticated investors - without then creating unacceptable risk on the one hand, or unacceptable cost on the other?

Industry stepping up to the plate

It’s an imperative for the UK’s financial sector to resist future temptation to enter into a regulatory race to the bottom when the good times roll.

If we’re to rebuild trust and confidence in the industry over the long run, creating stability and clarity of direction, it’s an imperative we reach agreed conclusions on challenges of this kind.

Two key issues here strike me.

First, the importance of the regulator being receptive to industry concerns and insights.

Second, the value of firms taking their own responsibility to move things forward. 

On the latter, one of the big risks if history is any guide, is that economic recovery gives way to over-confidence. And over-confidence gives way to lobbying by firms who want to unpick regulatory reform.

And in one sense this is understandable. As markets evolve, change is not just inevitable but is important.

But the see-saw nature of the relationship between industry and regulators over the years – increasing oversight in crisis, diminishing oversight during boom – is frankly unhealthy.

It creates friction. Ultimately it also affects the long-run stability of the marketplace.

So, even if you accept there were a multiplicity of factors involved in the last financial crisis – which there clearly were – it’s still possible to see the contributing impact of deregulation in areas like Glass-Steagall during the nineties and the big bang in the eighties.

In preventing a repetition here, it’s an imperative for the UK’s financial sector to resist future temptation to enter into a regulatory race to the bottom when the good times roll.

Instead the focus should be on continuous improvement. Are there areas where industry thinks domestic regulation can be developed, or even reduced, without creating destabilising crises? And if so, how? It’s important, I think, for firms to be specific.

Equally, it’s important for the FCA, as it looks to customer outcomes and its work with industry, to be receptive.

Advice

Scientists are heralding the advent of learning algorithms and self-improving artificial intelligence capable of previously unimaginable and impossible feats of accuracy and forecasting. What, if anything does all this mean for dispensing investment advice in the years to come?

And this brings me on to issue number two, the role of the regulator in moving things forward positively.

Over the last year, as some here will know, the FCA has been holding a series of roundtables with industry, as well as consumer groups, to provide a temperature check on emerging concerns.

So, where are the major conflicts over regulatory direction, communication or policy? Is there any danger of consumers being affected by uncertainty around rules or maybe a lack of innovation? On top of this, are there concerns over retrospection? And, if so, where specifically?

This engagement will continue. But the FCA is also now fast tracking thinking on a few of the key concerns already raised by businesses.

There are three specific strands here I want to mention today: on advice, on disclosure, and on market innovation. 

On the first, investment advice, we know there are multiple challenges for industry.

The most pressing and immediate: question marks over how firms provide support or advice to customers without bumping up against the regulatory rulebook.

A key question in this debate is, where are the frontiers between ‘execution only’ on the one hand, full advice on the other? Is there more room for firms to offer investment advice that’s limited or focussed to a specific consumer problem?

And, crucially, if there is more room, how does the regulator support industry to deliver reform?

Greater clarity and certainty is undoubtedly a factor. So, firms want to know where the opportunity lies to provide support without straying into the realms of regulated guidance. But, what options are there here between a non-advised service and full investment advice?

And, another interesting question, what impact is technology likely to have on areas such as automated advice?

In the eighties, many academics were clear we didn’t have the hardware or knowledge to simulate human intelligence. 

Since then we’ve witnessed a series of incredible bounds forward in thinking. In the 90s we saw Kasparov beaten by IBM’s Deep Blue computer. A machine that was, at the time, capable of calculating some 200m individual chess moves per second – but even then couldn’t discuss the strategy it had employed.

Today, however, scientists are heralding the advent of learning algorithms and self-improving artificial intelligence capable of previously unimaginable and impossible feats of accuracy and forecasting.

What, if anything does all this mean for dispensing investment advice in the years to come? Can it be automated to deliver returns and security for consumers with straightforward needs?

And how then does the regulator and industry respond when technology is disruptive? Or, if firms instead prefer more traditional, face-to-face methods of support, where do the limits lie?

Over the last year, industry has talked us through most of these issues and asked for greater clarity of direction. We’ve listened and next month, we’ll be publishing a consultation paper around some of those big ticket, advice-related challenges.

Likely to be included is the scoping work we’ve done into new models of automated advice, as well as feedback from consumer research, industry workshops, meetings with trade associations and so on.

On top of this, there’ll be guidance offering greater clarity to firms around the broad expectations for supplying limited or simplified advice. And there’ll be a question posed as to whether more sweeping change is required. 

I’d encourage businesses here, and consumer groups, to provide feedback once it’s published – with one important caveat. This work shouldn’t be mistaken by firms as any kind of charter for either mis-selling or abdicating responsibility. 

Disclosure

The second, linked area, I want to touch on this morning is disclosure.

In the years building up to 2008, the official spotlight was, as we all know, very much on compliance. Effectively using rules to de-risk.

So, we saw FSA guidance grow by some 27% between 2005 and 2008.  A pattern repeated not just in the UK by the way, but around the world.

Why? Because at the time the crisp, bright lines of rules were seen to be more predictable – more business-friendly – than ‘difficult to interpret’ judgements over conduct.  

One of the unintended consequences of this focus, as it turns out, was the heavy reliance on instruments like unsophisticated disclosure to meet regulatory requirements.

So effectively, when faced with a breakdown of price efficiency or rationality, the standard response has been to provide more information and provide it more quickly.

If someone did not appreciate the risk of a product, we extended the description. If it looked too risky, we pushed people to the risk profile that allowed a sale.

People were required to tick the boxes – that they had high-risk appetites; that they had read and understood the terms and conditions; and that the decision was their own, that it was a non-advised sale.

And this is one of the reasons why we’ve seen such an increase in the length of terms and conditions associated with financial products. It’s now commonplace for bank accounts, insurance contracts, mortgages and the like to have terms and conditions longer than Hamlet.

A challenge here for us is that the majority of people do not read these documents. And, if they do, comprehension is often an issue. We know, for example, that some 20% of financial service customers do not understand whether a higher or lower APR represents a better deal.

Now it must be said, there’s no clean answer here on disclosure.

The FCA has done significant work in areas such as behavioural economics, which is already helping firms deliver better communications to consumers.

But in all probability, evolution is a more likely scenario here than revolution. Future progress has to be industry-led, as new technology and attitudes to transparency create different models of customer service. Our job is to work out what we need to do to then facilitate.

So to support this more ‘organic’ approach, if you will, we’ve agreed to grant waivers to product disclosures that don’t follow FCA guidance to the letter – if firms can work with us to prove they are better for customers. A sensible move I think and one that opens the door, potentially, to greater innovation around disclosure in future.

On top of this, we’re also reviewing guidance and rules to check they’re genuinely supporting customers to understand financial products, including the ‘with-profits disclosure document’.

And looking further ahead, to the latter part of the year, we’ll be pulling together this work into a single paper, alongside a consultation on potential handbook changes.

Again, I’d encourage firms to engage here – either direct or through the roundtables we’re running next month – so we can achieve the greater clarity and consistency that many consumers and firms hanker after.

Project Innovate

London, in particular, has become a European trend-setter. Its booming tech scene, accelerators and primacy in financial services combining to create a marriage made in innovation-heaven.

Finally this morning, a word on one of the most important pieces of work currently emerging at the FCA: a project to help support industry innovation: from smaller start-ups to mass market with new models.

Three broad questions here that we’re bringing together.

First, how do we encourage innovation in the financial service market?

Second, do we do enough to promote competition and create room for new entrants into the market, particularly those with novel business models?

And, third, does FCA regulation more broadly serve the needs of innovative businesses?

In scope here, a number of important areas, including: digitalisation; big data analytics; venture capital; virtual currencies, crowd funding; and peer-to-peer – many of which are (or indeed have already) transformed finance in improbable timescales.

Mobile banking technology, as an example, was first introduced in Kenya in 2007. Since then, its expansion across the globe has been electrifying.

So, last month, we heard the banking industry talk of physical visits to branches falling by some 80% over the last decade.

On top of this, some of the biggest banks now have corporate clients authorising over a billion dollars of payments at a time on tablets and smartphones. And in retail, the broader mobile payment market is expected to be worth some $721bn by 2017.

Clearly it’s important for regulators to be ready for this world, including the tech-led developments that are likely to change the face of finance in the years ahead.

Already this year, there’ve been around a dozen tech flotations in the City, raising a combined £1.7bn. A third higher than the total for the previous 12 months.

In financial technology specifically, global investment more than tripled over the five years to 2013 – up to $2.97bn. The UK and Ireland were the fastest growing incubators in the world here, developing at an annualized rate of some 74% since 2008 – set against 23% in Silicon Valley.

And London, in particular, has become a European trend-setter. Its booming tech scene, accelerators and primacy in financial services combining to create a marriage made in innovation-heaven, with the emergence of names like WorldRemit, Monitise, TransferWise, Nutmeg and many others.

What has become increasingly obvious, as the dust settles on this latest wave of progress, is that it’s an imperative for regulators to be standing on the right side of progress. And this is one of the reasons why the FCA has launched Project Innovate.

A key objective of the programme is to make sure positive developments – by which I mean the ones that genuinely promise to improve the lives of consumers or clients – are supported by the regulatory environment.

In other words, we want an FCA that creates room for the brightest and most innovative companies to enter the sector.

So, priority areas here might include the likes of mobile banking, online investment or money transfer, where we’re seeing innovations such as apps that allow you to take a picture of a bill and make payments with a tap of the smartphone. The possibilities opening up for consumers are extraordinary – and it’s clearly important they can be developed in the UK.

To help this happen, the FCA is opening its doors to financial service firms (large and small) who are developing innovative approaches that aren’t explicitly addressed by current regulation – or where the guidance may be ambivalent. 

This engagement has already begun with a number of start-ups, as well as organisations like Tech City UK and Level 39, coming in to talk to our policy teams.

Following on from this, we will be pulling together a scoping document exploring how innovation can be supported more effectively. That paper will focus on FCA expectations of firms, as well as specifics around advice and support for businesses bringing new models of financial service to market.

In the meantime, we will be opening up a hub in our policy team which will pull together FCA expertise to support innovators in two distinct ways.

First, by providing help to firms who are developing new models or products advice on compliance so they can navigate the regulatory system. Second, by looking for areas where the system itself needs to adapt to new technology or broader change – rather than the other way round.

On top of this, we will also be launching an incubator to support innovative, small financial businesses ready themselves for regulatory authorisation.

Conclusion

So, a great deal of activity here as we look to build more productive relationships in and across the industry.

Clearly there’ll always be tensions. And that’s not necessarily a bad thing by the way.

But it’s important for the FCA to strive for greater transparency and clarity where we can. Just as it’s an imperative for firms to learn the lessons of the past and suggest positive solutions to challenges where they can.

Three decades on from that scepticism of the 80s, we are overdue a new context to this relationship.  We are beginning to find this I think.

And we are, perhaps more than ever before, finding the right distance between regulator and regulated.