It's been a challenging year for financial services regulation. Gavin Stewart has been documenting the ups and downs, and in this round-up summarises his daily updates for the week.
Last year, I began writing daily blogs about the impact of the current circumstances on financial regulation. Other issues - notably Brexit and digitisation - have featured as well, but the recent situation remains the dominant driver of regulation as we enter 2021.
Here's a round-up of this week's insights into financial services regulation.
I've written before about the low proportion of Financial Conduct Authority (FCA) enforcement cases being concluded, and two announcements last week shone light on the reasons behind this and the resulting consequences. The start of criminal proceedings for fraud and insider dealing against two brothers - Mohammed and Suhail Zina - is an example of how the profile of FCA cases has changed, while the statement on the Woodford investigation shows how the resulting delays can have a damaging knock on effect on the regulator's broader activity and reputation.
Since the Financial Services Authority's (FSA) early years, when its enforcement function had quite an aggressive approach, it has evolved through different phases: from a position of "not an enforcement-led regulator" (c.2003) to "credible deterrence" (c.2008), which has increasingly meant taking criminal (as opposed to civil) cases, and against individuals as well as firms. However, individuals don't tend to settle as early as firms, if at all, and the regulator's high level of risk aversion, have together meant that the time taken to complete cases has lengthened. The decision, in 2017, to open larger numbers of cases (in the mistaken hope many of them could be closed early) has compounded the problem. The model is creaking.
So, coming back to last week's announcements, we can safely assume that both these cases have already consumed large amounts of FCA resource and senior management time, almost certainly to the delay of other cases, with more to come. And the Woodford case in particular has a high profile, with the FCA's rushed statement last Tuesday indicative of its perceived importance. That this statement didn't satisfy either the Treasury Select Committee (TSC) or external critics, and is a further sign that the FCA's enforcement model may need some serious reform.
Brexit and the Future Regulatory Framework
Post-Brexit, EU regulation has been 'onshored' by the UK, adopted into domestic law until they are reviewed and either reformed or updated. The first major review is of Solvency II, and the Association of British Insurers (ABI) has laid out its stall for a significant reduction in capital buffers, which it believes could be used to significantly boost UK GDP. No great surprise that the Prudential Regulator Authority (PRA)/Bank of England view is more cautious on this and that, as in this speech by Anna Sweeney, approaches the subject from a different perspective.
Although the consultation on the Future Regulatory Framework (FRF) has only just closed, the Solvency II review can be seen as a dry run for how it might work in practice. Specifically, it shines a light on the interplay between regulator and HMT, and on the precision with which the government and Parliament will set out the "key public policy issues" for regulators to consider. As an example of the complications ahead, the PRA sees the Government's three objectives for the Solvency II review - broadly around international competitiveness, safety & soundness, and long-term investment - as "consistent and mutually supportive". But there are obvious tensions, and trade-offs will be needed.
Turning briefly to the PRA/Bank's overall thinking is, it's worth taking a closer look at Andrew Bailey's Mansion House speech, specifically where he gives three examples of where the UK might want to amend EU rules. None is an obvious bonfire of regulation and one of them - the consultation on not including software assets in bank capital - would mean UK rules become significantly tougher than the EU's. So far, the Bank has trodden a careful path on Brexit but this will only get harder given the disparity of expectations.
The FCA and unemployment
The future path of unemployment remains unclear, dependent on not only the duration of the crisis but the extent of state support, and the exact profile of what increasingly looks like a K-shaped recovery. This presents a tangle of dilemmas for regulators, which the FCA again tried to cut through yesterday with its latest guidance on "fair treatment of vulnerable consumers". This comes in the wake of a slew of disturbing reports on poverty and inequality, most recently the National Institute of Economic and Social Research 's (NIESR) on the regional distribution of destitution as a result of the current circumstances and the FCA's own Financial Lives survey, which found 53% of adults "displaying a characteristic of vulnerability". Given these numbers, it's still unclear how practical the FCA's guidance is, either for supervisors or firms.
As an illustration of the uncertain complexity of this emerging picture, it's worth noting that the unemployment figures don't include the 4.4 million furloughed workers, many in the 18-24 age group. Best estimates of true unemployment, once furlough unwinds, seem to be in the 7-8% range, which would take unemployment well above 3 million, likely for a sustained period, in a way it hasn't been since the 1980s. This will be new territory for regulators and, for example, there is relatively little regulation around the financial services most used by the young - much more around investments, where customers tend to be older - so fair treatment is harder to assess.
It's also curious that the regulator's focus remains so exclusively on retail consumers, with little attention seemingly paid to small businesses, business interruption (BI) insurance excepted. Historically, this has been a blind spot - interest rate swaps would have been tackled earlier if they had been a retail product. The overall picture is obscured by Government-backed Bounce Back Loans (BBL), and firms will be more sensitive since the Royal Bank of Scotland global restructuring group (GRG) scandal, but there are still many pitfalls for the FCA to avoid.
With the media full of leaks, predictions and assessments of what's likely to be in next week's Budget, regulators will be holding their breath that it won't contain any surprises comparable to pension 'freedoms' in 2014. That reform triggered the FCA, which responded enthusiastically, into a year of too rapid policy formulation for which it is still paying the price.
At the same time, they will be trying to take a longer view of the Budget's impact, in the context of both the current circumstances and the longer term course of the economy. They will be wary of, and probably dismayed by, talk of the economy as a 'coiled spring', just as they would have been of last summer's predictions of a sharp V-shaped recovery. Sharp movements in the economy, even off the back of a crisis, are invariably bad news for markets and consumers in the long term, and regulators worry about both the initial rush and the over-corrections that inevitably seem to follow. Both consumers and firms have a history of misjudging risk in such situations - the dotcom bubble and what followed is one of the best examples of this, contributing to the financial crisis a few years later.
Hopefully the Chancellor's plans for the furlough scheme, stamp duty holiday and the other elements of state support, as well as his future path towards paying for them, will be sufficiently clear and reliable for regulators to build their own credible exit strategies. This should in turn push the FCA and PRA into longer term planning themselves.
FCA new leadership
Yesterday, the FCA announced a swathe of new senior appointments at executive director level, all with impressive backgrounds. They will help form an almost entirely new executive committee (ExCo), and when they arrive; by my reckoning, only one executive director will have been in post for more than a year, with another in a different role. So this is a new start, but while it's probably the most extreme changeover the regulator has seen, others run it close. Although the rate of change was slower, the FSA saw a major turnover at (ExCo) level and just below in 2003/04, and the FCA the same in 2014/15. And almost without exception, the new arrivals of previous eras came with similarly impressive CVs.
Of course, none of these ExCo 'revolutions' have taken place from a position of strength, and the respective shadows of Equitable Life and the Davies Report hung over the earlier changes as London Capital & Finance's (LCF) does now. Over the years, the FSA and FCA's remit has also changed - e.g. the PRA now does prudential regulation for 'systemic' firms, while the FCA regulates more than 4x the number of firms the FSA did in 2004 - but it's evident from the Gloster review of LCF that the job hasn't become any easier.
It's not self-evident, therefore, that calibre of leadership has been the biggest issue in the FSA and FCA's struggles over the years. And while most of them have been largely deck chair-moving, various different structures have also been tried, some more than once. So a successful 'transformation' of the FCA is likely to have to go deeper and tackle the nature of the way regulation works. Nikhil Rathi and Charles Randell (chair) are due to give evidence on LCF to the TSC on Monday, so we should find out more then about how they see the problem and how they aim to solve it.