Opinion

Regulation in the time of COVID: beyond London

Gavin Stewart Gavin Stewart

The country may be locked down, but regulation isn't. Gavin Stewart continues his series chronicling financial services regulation in lockdown.

This week's regulation round-up includes the housing market, post-pandemic reform and regulation outside of the capital.

Housing market risks

Together with pensions, housing is where UK household wealth has become increasingly concentrated. From the secondary banking crisis of the early 1970s, through the Lawson boom of 1988 and the secondary banking crisis that followed; to the great financial crisis of 2007-2010, it has also been where the biggest regulatory crises tend to originate.

Since the financial crisis, the mortgage market has been relatively dormant from a regulatory perspective, but we're about to enter a period of greater uncertainty, and both UK regulators and the Financial Policy Committee (FPC) will be in glass-half-empty mode.

The government's new mortgage guarantee scheme, launched today, echoes the 2013 Help-to-Buy scheme. This was generally viewed by regulators as a risk, due to its impact on house prices, but the guardrails put on mortgage portfolios after the financial crisis meant that any negative impact was dampened. And banks' exclusion of new-build properties from the scheme indicates the result will be little different this time.

The situation now, however, is more fluid and difficult to manage, with lockdown being progressively lifted and vaccination rolled out, and with the stamp duty holiday still in place until August and the furlough scheme until September.

Much depends on the smoothness of the UK's exit from the COVID-19 situation, and how effectively the recovering economy replaces the extensive state support that has been available. Given the history, regulators will be holding their breath on housing for a while yet.

LCF and Connaught: the end of the story?

Yesterday, the Financial Conduct Authority (FCA) set out its approaches to assessing complaints in respect of both London Capital & Finance (LCF) and Connaught. The two approaches differ.

1 For LCF, there will be some ex gratia payments and access to taxpayer funds, for those not eligible to claim on the Financial Services Compensation Scheme (FSCS)

2 For Connaught, an apology is considered sufficient. Others will dissect the respective approaches (eg. the former is described as "broad", the latter not) and their appearance on the same day will invite comparison

Both statements are obviously trying to draw a line, but the history of such attempts is mixed at best.

Connaught investors have already demonstrated their perseverance. And they may not be satisfied with the FCA saying it has reconsidered their complaints in light of the Parker report, but not giving any details of why an apology is the right answer.

With LCF, much will depend on how clear the line is between those investors given incorrect information in direct communications with the FCA and others.

Stepping back, I'm not sure consumers will pick up the distinction between the two cases, while the government's decision to cap its offer of compensation at 80% of the initial investment may also be challenged.

For LCF, comparisons have been made with Equitable Life, the collapse of which also triggered the use of public funds for compensation. Equitable was a different situation - a major institution whose failure was played out through the courts and in a glare of publicity - but there were, I think, nine different reports into its demise. They spanned a decade and the Financial Services Authority (FSA) always struggled to escape its shadow.

The ringfencing dilemma

This seems to be the season for evaluating post-financial crisis reforms.

On 1 April, the Financial Stability Board (FSB) published its evaluation of the too-big-to-fail reforms (TBTF), and we now have the start of the UK's review of ringfencing.

In regard to the latter, Sir Keith Skeoch, chair of the review, here sets out a balanced summary of the likely issues. The TBTF verdict was a conditional tick and the ringfencing review might well reach an equivalent conclusion, so it's worth taking a step back and understanding what we're really talking about.

Both sets of reforms were essentially about giving governments more options about whether to save failing banks:

  • TBTF was aimed at making the manner of failure more bite-sized and better ordered, with bail-in etc to spread the load
  • ringfencing looked to split the riskier 'casino' banking from the 'real economy' retail side, with the implication government is more likely to help the latter

In both cases, however, politicians still have a choice to make and, as the FSB report notes, they still tend to step in rather than back.

Meanwhile, many of the underlying risks haven't gone away, and the recent Archegos collapse is a reminder that risk management checks can still be overwhelmed by risk-taking culture, as well as of the waterbed effect of some of the reforms, pushing risk into unregulated territory.

This story is still unfolding and regulators will be worried that Archegos - a supposedly "small" family office - is indicative of a wider problem. TBTF and ringfencing might well be successful in their own terms, but it would be naïve to imagine they won't need adapting to face off to 'new' variants of risk.

The BoE outside London

News that the Bank of England (BoE) will establish a hub in Leeds, effectively replacing its cash distribution centre (which is shutting) is significant news, but the detail will matter more.

Much will be made of the bank expanding beyond its London footprint, but more significant in this context is its traditionally centralised decision-making, and whether the Old Lady's new north-of-England presence will have a material influence on bank policy.

Recently, the bank has made much of its agent network, but until at least the early 1990s, it also used to have physical branches in regional centres, such as Leeds. Bristol was another, and it will be interesting to see if the Leeds initiative is followed by other hubs.

Before lockdown, the bank was quite forward-thinking in its flexible working and doubtless this will continue, which should mean it can develop the Leeds hub into a thriving centre.

A great deal of Bank decision-making is concentrated in the governor's office, however, and while authority has become more-widely distributed since the creation of the Prudential Regulation Authority (PRA), it remains highly centralised compared to many other organisations (including the FCA).

The Bank is talking about moving "senior officials", but unless at least one executive director is based in Leeds, the hub's influence on Threadneedle Street will be limited.

The FCA outside London

Despite the bank's decision to create a new Leeds 'hub', it's the FCA that faces the more-pressing challenge to broaden its footprint across the UK. Whereas the Bank already has its agent network and the PRA's regulatory responsibilities are prudential and confined to 2,000 banks, other deposit takers and insurers, the FCA covers about 60,000 firms and has no agent intelligence to fall back on.

The FSA took a serious look at establishing a branch network in the mid-2000s, but decided against it, partly on cost grounds. At the time it regulated around 26,000 firms, but this more than doubled in 2014 when consumer credit was added to the (new) FCA's responsibilities and the option of branches was again considered, but not taken.

As a result, while the firms it regulates are far more geographically dispersed and locally focused than is the case with the PRA, the FCA's only presence outside London remains its Edinburgh branch.

None of this is easy, and consumer credit creates a series of major challenges for the FCA, including to its risk-based approach and its systems and processes, many of which were touched on by the LCF report.

Now, however, in the current political climate and with the FCA embarked on a 'transformation' and determined to improve its use of data, it's hard to imagine the conduct regulator won't end up with a significant branch network covering not only the English regions, but also the devolved nations.

To discuss these issues further, contact Gavin Stewart.