Opinion

Regulation in the time of COVID: crypto and coronavirus

Gavin Stewart Gavin Stewart

With lockdown extended for another month, at least, we continue our series on the state of FS regulation during the COVID-19 situation. Gavin Stewart provides the updates.

This week's series of blogs covers the regulator's ongoing steps to tackle financial services (FS) regulation during lockdown, the future of crypto currency regulation and the question of culture.

Basel, crypto and beyond

Last week's consultation by the Basel Committee on Banking Supervision (BCBS), on the prudential treatment of cryptoassets, was an important moment, both in what it means for crypto and in the evolution of financial regulation more broadly. Most commentary has, rightly, focused on the first of these, so I'll try to draw out what I think it might mean in terms of the bigger picture.

Firstly, it's worth reminding ourselves that Basel has 45 members (eg, often the central bank and the prudential regulator) from 28 jurisdictions, and includes China, India and other major developing economies. So in financial services terms its coverage is good.

It's also led by central banks rather than finance ministries, unlike the Financial Stability Board (FSB), which has a similar (G20 only, so slightly narrower) membership. Because of this, during the Trump years, when multilateral bodies were out of favour, the BCBS started to re-emerge as a way of sidestepping the politics and getting things done.

For the past decade, Basel predominantly focused on post-financial crisis reforms, but recently (with this consultation and the April consultations on climate risk) it has been looking ahead rather than behind. I doubt any of this is linked directly, but Basel does appear to be emerging as a body where (to take the obvious example) China and the US can work together.

As well as climate and crypto, operational resilience is an area where the BCBS is likely to get involved and, as the old boundaries between banks and other sectors blur, its influence might broaden.

Watch this space...

Should HMT and the FCA remain in COVID-19 lockstep?

Yesterday's announcement of a well-trailed four-week delay, until 19 July, in the lifting of remaining lockdown restrictions starts to crystallise the question (always present in the background) of whether the Financial Conduct Authority (FCA) should start to diverge from the lockstep relationship with HM Treasury (HMT) it has adopted since the start of the pandemic.

Until now, the gradual unwinding of the FCA's temporary regulations on credit and mortgage payments, like HMT's own temporary measures (eg, furlough, stamp duty holidays, the moratorium on evictions) essentially began after these last lockdown restrictions were lifted.

Now, however, this is no longer the case and the resulting gap poses more problems for the FCA than it does for HMT, which has signalled it sees no reason to change its timescales. This is because HMT is focused on UK GDP as a whole, which is growing very strongly, whereas regulators are more concerned with individuals and households, large numbers of whom are now at greater risk.

FCA supervisors were always likely to have difficulty making consistent judgements about firms' treatment of 'vulnerable' customers during and after COVID-19, and the delay will make this harder again.

The challenge for the FCA, bearing in mind the potential for future COVID-19 variants, is whether it can find a supervision strategy on vulnerable customers that can be applied consistently across what is likely to be a bumpy recovery.

Regulation, red tape and risk

Yesterday's report by the task force for innovation, growth and regulatory reform, led by Iain Duncan Smith MP, contains a raft of recommendations around FS and other regulation. It's the biggest manifestation so far of the "bonfire of red tape" rhetoric that preceded Brexit.

The headline recommendations for FS cover pensions, venture capital, a common-law approach, fintech, and proportionality around disclosure. Others, such as its proposal to replace GDPR with a "more proportionate" framework, would also have a big impact on FS.

It will be worth following how much influence the report has on the future regulatory framework (FRF) for UK regulation. But today, I'll take a step back and touch on a couple of the trends that have led us to the present position.

Firstly, the decreasing UK political appetite for consumers to be subjected to risk, particularly in financial services. Fuelled by the financial crisis, this runs through, for example, HMT's 2011 decision to exempt FS from the 2011 'one-in, two-out' approach (resurrected here), SMCR (which emerged from a parliamentary commission), and the extending definition of vulnerability/duty of care.

Second, the increasing quest for consistency, which has led to regulators (largely at firms' behest) writing rules of ever-greater granularity, often at the same time as they are advocating greater reliance on principles and outcomes. And, while the EU is at the 'detail' end of the spectrum, this is a global trend and is unlikely to go away anytime soon, not least with digitised rulebooks coming over the horizon.

In both instances, the gap between rhetoric and reality reflects tensions at the heart of most regulatory debates. Without regulation, is there too much risk to consumers, markets and the system? With regulation, should the risk diminish or just move elsewhere? How important is a level playing field? Do the right actors pay the cost and is it worth it?

The next step is probably to see how HMT responds to the report in practice.

COVID-19, culture and compliance

The interaction between firms' approach to bringing staff back to the office is emerging as a fascinating indicator of culture, and regulators - PRA as much as FCA - will be paying close attention.

It's less clear what conclusions they can reliably draw, and the relationship between firm culture and compliance is best seen as a series of complex feedback loops, rather than as a simpler matter of linear causality (ie, poor culture leads to poor compliance).

Some of the fog relates to measurement and is explored in a recent Bank of England research paper, which highlights issues around self-reporting and instead uses unobtrusive metrics, while admitting these still have limitations. But the complexity goes beyond measurement.

For example, regulators and others tend to set great store by ' the tone from the top', but at best, this falls into the 'necessary, but not sufficient box', especially for larger firms. And, beyond the obvious outliers, poor culture has a habit of being much easier to spot after a major conduct issue has occurred than it was before.

Neither is firm culture as homogenous as most commentary seems to assume. The FCA itself has half a dozen different internal cultures, dependent on predominant professional background, nature of work, direct line management, etc, and the larger regulated firms could have many more.

Culture can have several contradictory strands with unpredictable results. Let's say the CEO says (and does) all the right things, but it's known they are under pressure from shareholders and the board to improve return on equity, with the resulting targets applied differently across the business...

Culture will always be important to regulators, but its relationship with compliance will seldom be simple or transparent.

Crypto and communication

Consumers' lack of awareness of what regulation means (and doesn't mean) is a longstanding problem, so we shouldn't be surprised that the FCA's latest research found that less than 10% of potential crypto investors are aware of FCA warnings of the risks involved.

Back in 2002, when only around 15% of people had heard of the FSA, there was lively debate within the regulator about whether its website should be used as a consumer education tool. I suspect this will be somewhat higher today, but there must still be a big question whether the website can be used in this way.

The growing retail appetite for crypto is also bound up with other narratives:

  • JP Morgan's purchase of crowdfunded Nutmeg
  • How much consumer protection, post Hill Review (SPACs, etc) and Gamestop, should be given to retail equity investors
  • Low understanding of the limited coverage provided by the Financial Services Compensation Scheme (FSCS)

The common element across these is retail consumers' search for a higher return in a low-interest-rate environment, a phenomenon regulators have wrestled with for at least a decade.

Part of the answer used to be articulating the regulatory perimeter more clearly, but the 'halo effect' of regulation highlighted by the LCF report and regulators' increasing appetite to look beyond the perimeter for risks to their objectives mean this approach is no longer credible.

Even assuming crypto becomes regulated at some point in the future, regulators are likely to struggle with calibrating their approach and, just as important, with communicating its message to retail consumers.

To discuss these issues further, contact Gavin Stewart.