Regulation in a changing world

Speaker: Christopher Woolard, Executive Director of Strategy and Competition
Location: City of London / Cicero event on Future of Regulation, London
Delivered on: 21 October 2019

Highlights:

• The FCA asks itself if its regulatory model is still the right one, and if it’s ready to respond to the changes we see coming down the track.
• The FCA will be issuing an open invitation for your thoughts and ideas on the future of its regulation.
• In deciding on the future of regulation, the first step is agreeing the outcomes in the market to be achieved

Note: this is the speech as drafted and may differ from the delivered version.

What outcomes do we want?

The subject of my speech today is the ‘Future of regulation’ – which sounds very grand. The truth, though, is that this work is rooted in the small, routine actions that most of us undertake all the time.

The vast majority of us engage with financial services every day of our lives. And we have expectations when it comes to the outcomes we get from these transactions.

For most of us it comes down to the ability to pay for goods and services. An opportunity to borrow, especially for a major purchase like a house or a car.

To save for retirement. To insure against things going wrong.

It’s being able to understand the products and services we buy, knowing that they will deliver consistently against that understanding.

For businesses, it's access to the capital that drives the real economy. And a wholesale market that functions well, providing for their needs, and those of other financial firms.

Ultimately, we want the financial system, and the firms and individuals within it, to be trustworthy.

We want the market to work well, to function as its customers expect. For both customers at home and for the UK as one of the world’s largest financial centres.

Globally we know this is a selling point for UK plc: a proportionate, predictable and well-designed regulatory system with high standards provides the basis for a competitive financial sector.

But the rules of the game have been shifting, especially in the 10 years since the financial crisis.

I don’t just mean the formal rules set at global, European and domestic level.

But also the unwritten rules – the expectations users of financial services have of the companies that serve them – and the wider context in which those interactions take place.

As the regulator of this vital industry, we need to not only respond to these changes – but also anticipate them.

To do that, we need to have an open discussion about the type of regulation that will best deliver for the public today and tomorrow.

This boils down to one simple question: what outcomes do we want from financial services?

Addressing this will require us to properly consider the environment we operate in, and to challenge some regulatory orthodoxies.

We may end up with a future that looks very different from the recent past.

But before we look forward, it is worth reminding ourselves how we got here.

The changing context

We live in turbulent times, and the context in which we work is characterised by change.

The shape that Brexit takes is clearly vitally important. Regardless of your perspective, and I should stress that the FCA takes no position on the substance of Brexit itself, leaving the European Union may provide us with an opportunity to do things differently.

But it is not the main consideration driving our thinking. Although it will shape the context in which we operate, there are other factors at play that in many respects are far bigger and mean we need to engage with this work now.

I’ll outline 3 in particular.

First, the first wave of post-crisis regulation is done. Firms are better capitalised and the personal responsibility of their leaders is more embedded. This is a good time to look at what has worked well, and what could be improved.

Secondly, there is a change in consumer need and attitude. Long-term low interest rates mean the search for return is stronger, just as the tolerance for loss lessens. Consumers are getting older, have less saved and inherit assets later in life.

And, lastly, innovation has gathered pace. We’re moving from an era of digitisation – services moving online – to a truly digital industry – one drawing on artificial intelligence (AI) and machine learning. This digital transformation is reflected in the new products finding their way direct to consumers over the internet (some good, some bad, some downright fraudulent).

The socio-economic, technological and regulatory change we’ve seen across financial services has, in many ways, brought great benefits.

The financial system is safer. Consumer credit is better controlled. And conduct, culture and customer outcomes are increasingly recognised and understood around Boardrooms.

But consumers also face new challenges.

Intergenerational change is placing new and different pressures on baby boomers, generation X and millennials. The ease of use of financial services presents a heightened risk of loss. And ordinary consumers are increasingly called upon to make more complex decisions about their finances, compared to a decade ago.

The pensions sector offers a clear example of this.

For many, saving for a pension used to simply mean joining a reputable employer and sitting back 40 years in a defined benefit scheme.

Today, though, most people rely on defined contribution schemes.

These pose questions about scheme strategy, fees and charges, defaults and lifestyling. All of which can make a huge difference to the final outcome a pensioner receives.

The Government’s ‘pension freedom’ reforms heralded a further change, sweeping aside the need to buy an annuity.

Consumers are faced with a further array of choices – whether to take tax free cash, have a drawdown plan, take the cash in full, or in part. To retire early, or keep working and stay invested.

And these decisions are overlaid with a series of complex tax policies.

In this context, advice and guidance become extremely important. But delivering this means reconciling a complex array of positions.

Consumers tell us they want help in making these decisions. But many don’t want, or are unable, to pay large sums for advice.

Most advisers tell us they’re not interested in handling small pots of money and many firms, while happy to sell products, don’t want the liability from advice when they get it wrong.

While regulators don’t want to allow crooks into the guidance space or let firms give advice by the back door.

We end up in a stand-off where no one is happy.

Is it any surprise, then, that although regulators, politicians and firms agree that consumers should make informed decisions about their finances in retirement, most end up focusing on their 25% tax free cash, neglecting to make a plan for the remaining 75%?

The truth is that the fundamental way in which the bulk of the population interacts with financial services is changing.

As consumers take more responsibility for their financial lives, their demands on the financial sector – and the bodies that regulate it – change.

Orthodoxies must change in response.

In particular, I’d argue we need to think about simplification for consumers, not adding layers of rules or advice in some kind of cat and mouse game.

While some of these issues are not new, the way they are now coming together is. And it’s time to think about what future we want to forge for ourselves.

How did we get here?

A diagnosis of why we are at this intersection could fill 3 or 4 speeches.

Some would say there has been an over-reliance on neo-classical economic theory. Not enough behavioural economics. Competitive pressure prioritised over consumer protection.

Others point to the failure of light touch regulation a decade ago. Or blame the volume of regulation and the way it’s overloaded firms.

The answer, some believe, lies in a Duty of Care. Some see detailed rules as the only way to harmonise a global system. Others argue rules are too prescriptive.

And in the background, the debate around how to get the best from innovation, whilst also guarding against new risks, rages on.

The reality is that we have a lot of actors on the stage – industry and regulatory alike – with differing statutory or commercial goals, many of which may be legitimate, but possibly unsynchronised.

The question of retail investments offers an elegant example here.

If consumers only invested via a bank deposit account within the Financial Services Compensation Scheme (FSCS) limit, we could guarantee protection against any exposure to loss. But that would almost certainly not be the right answer for their pension savings, or for more sophisticated investors with the means to bear risk.

And when risk and return are higher, consumers can and will lose money – this does not necessarily imply any sort of failure from industry or regulator.

The problem is that consumers now have the option to invest in high risk, high return products, even if they don’t have a sophisticated understanding of those risks.

The future of regulation

So how do we strike the right balance between these competing pressures?

There’s no easy solution. But we do know what the components of an answer might be.

The first thing we have to acknowledge is that we live in a very different world to the one in which our rules were framed.

We have to ask ourselves if our regulatory model is still the right one, and if it’s ready to respond to the changes we see coming down the track.

We can’t answer these questions alone. It’s vital that our approach has the confidence and consent of our stakeholders and the wider public.

So over the coming months we will be engaging in a public conversation.

We will be issuing an open invitation for your thoughts and ideas, as well as setting out some of our own. And we’ll publish detailed papers, including an analysis of future market dynamics, a Discussion Paper about our Principles, and a Consultation Paper on the Duty of Care.

Rightly, we don’t know exactly where this conversation will take us.

But one thing is already clear – we are moving from a narrower compliance with the rules, to a focus on delivering the outcomes we want for the users of financial services.

This means doing things differently.

What does this look like in practice? I believe there are a few key factors.

The first step is to clearly state what outcomes we want to see in markets.

This is a complicated question, and one which may require us to face up to some hard truths.

Most of us don’t want to think too much about the products we buy or services we use. But we know if we don’t shop around we may get a worse deal.

Firms’ pursuit of profit is a healthy part of the market. But we don’t expect them to take advantage of loyal customers through excessive charging, or base their entire business models on behavioural biases.

Firms have a responsibility towards to their customers. But we don’t operate a ‘zero-failure’ regime. And consumers need to know that risk comes with return; in particular purchasing products outside of the regulatory boundary means you’re more likely to lose out.

This thinking also applies to wholesale markets: how should the market best function to serve its clients?

Deciding which outcomes we want to see will provoke debate. But it’s a necessary conversation, and the answer we reach will drive our approach.

It’s also a critical part of being accountable – being explicit about the outcomes we’re aiming for will help the public judge if we’re being effective.

This transition has already begun, and you can expect our Sector Views and Business Plan next year to be much more outcomes-focused.

The second step is to use everything available in the regulatory toolkit Parliament has given us.

In recent years, we have used our tools and powers more creatively in things like the Senior Managers Regime, Project Innovate and price caps.

Nonetheless, we must face up to the fact that disclosure has been the go-to solution of regulators and politicians in the UK and Europe for the last 20 years, making up the bulk of our requirements. But behavioural economics suggests its impact is limited.

We also have to think about cost effectiveness when it comes to delivering outcomes.

For one, regulatory cost is typically passed to consumers through higher prices. A ‘lighter’ solution like disclosure may have some positive impact, but may not solve the root of the problem. Where problems persist, we will ultimately have to return with a more interventionist solution.

In the meantime, consumers may still be harmed, and public confidence eroded. Firms will have invested in better disclosure, only for us to go further later. Far better, cheaper and more effective to go for the ‘tougher’ remedy sooner.

The demand from the public is clear – they don’t care if a set of rules has been followed, they care about the outcome they receive.

We’re already putting this thinking into practice – for example, on the problem I mentioned earlier: pension decumulation.

Following the pension reforms, drawdown increased in popularity. But the proportion of drawdown bought without advice jumped from 5% to 30%.

Most people were drawn to the asset they most readily understood and trusted: cash. But in the end, that means lower income in retirement.

We’d tried to head this off. We’d introduced entirely sensible, logical measures to help consumers make the right decision.

And yet, despite the warnings and free guidance, 100,000 people every year were drawing down without getting advice. Many were ending up in investments that would not meet their needs.

So we have gone for something far more radical.

Now firms will need to offer non-advised customers a range of investment solutions that broadly meet their objectives, otherwise known as 'investment pathways'. Pension investments can no longer be defaulted into cash savings, unless the customer actively choses this option.

The key is building interventions around real consumer behaviour.

Our payment protection insurance (PPI) adverts featuring Arnold Schwarzenegger’s animatronic head were loud – some would say weird – but they did the job of grabbing the public’s attention and driving visits to our website[1] to think about their options. So we knew they were working.

The third step concerns working with other agencies. As a consumer, you don’t care whether the problem lies with legislation, regulation, or industry practices – you simply want them all to work in your interests.

So we are increasingly working with Government, fellow regulators like the Information Commissioner’s Office (ICO), and enforcement agencies to think about the right outcomes, rather than each body delivering narrow solutions in respect of their mandates.

In June, we published the first FCA Perimeter Report[2]. As well as detailing where our powers start and end, it sets out how we’re working with others, across the regulatory boundary, to achieve good solutions for consumers.

One example of this is the Government’s pensions cold calling ban, which came into force this January. The ban prohibits all cold-calling in relation to pensions, except in specific cases, such as the recipient of the call having consented to calls.

The ICO is the enforcement body of the ban, but we work closely with them where breaches of the rules by FCA-authorised firms are identified.

And more broadly we want to make sure our work with other agencies is well coordinated and we are responding to the themes coming through the Treasury’s Call for Evidence on regulatory coordination[3].

The fourth step is to look again at our requirements. We have our Principles, our Handbook[4] and a lot of rules. Not to mention, the hundreds of pages of binding technical standards onshored as part of Brexit preparations[5].

We know this affects small business – those lacking compliance departments –  most. While they see the benefits that regulation brings to their firms, many struggle to understand how FCA regulation applies to them.

They find the Handbook difficult to navigate and rely on external compliance advisors to interpret new rules. Often these advisers have a disincentive to make things simple.

We are exploring if there is more we can make of our Principles to be clearer about our expectations.

For example, one of our Principles for Business requires firms to communicate in a way which is fair, clear and not misleading, and pays due regard to the information needs of its clients.

Reading this in 2019, is quite difficult – a mouthful actually. And with our knowledge of behavioural economics, it seems like too low a bar. Its focus is the firm’s processes, rather than the outcome we want to see – consumers understanding their options.

We also have large numbers of rules outlining what should be disclosed to a customer at each stage of the sales process. But even assuming a firm does comply with all these rules, there’s no guarantee the consumer will properly understand the information they’re being given.

So as part of the Principles Review, we will consider things like requiring firms to ensure consumer understanding.

We also hope to simplify and streamline our rulebook through our Handbook Review.

This does not mean a light-touch approach, nor does it imply that market participants will have a free hand. Rules remain important. But hopefully clearer and easier to understand.

The fifth and final step concerns technology and the opportunity it presents to bridge the information asymmetry between customers and providers.

Much of our Handbook is technology neutral, and we have enabled innovation over the last few years.

But our rules feel increasingly analogue in a digital world.

Many practices firms use are simply digitised versions of analogue processes – like PDF statements – rather than truly digital services.

Technology may help us deliver solutions that meet customer needs.

On disclosure, for example, we could improve consumer understanding through a 2-way process using a mobile phone, testing that understanding throughout the sales process.

All of this amounts to a new approach where rules are designed to fit the end-purpose they serve – outcomes-based regulation.

Simply put, our aim is to to be a regulator fit for the age we’re in.

Conclusion

We have the opportunity to re-shape how financial services regulation works in the UK.

The FCA has a key role to play – improving how markets operate, preventing harm from occurring and serving the public interest.

It is only right for us to constantly assess the direction of travel and tailor our approach to ensure we continue to deliver on our objectives.

To achieve this, we need regulation that is agile and doesn’t become outdated as domestic and global markets evolve, resulting in inefficiencies and consumers being unduly exposed to risk and harm.

This requires a bold approach and the full use of tools given to us by Parliament. It also means a focus on simplicity, clarity and real-world effectiveness.

By putting outcomes at the heart of the debate in the coming months we want to ensure financial services markets serve the public interest, now and in the long term.