Opinion

Regulation in the time of COVID: fintech and fraud

Gavin Stewart Gavin Stewart

Financial services regulation is in a state of continual flux as it works to adapt to the accelerating pace of change in the new world. Gavin Stewart has been blogging daily on changing face of regulation.

This week's financial services regulation blogs cover the state of the housing sector, the duty of care to consumers, the different restrictions on fintechs and banks, and the FCA's fight against fraud.

Housing and financial services regulation

Housing is coming back into the spotlight - though I'm unsure it's ever really been away - with renewed focus on the planning system and news that the average asking price for UK homes now exceeds £330,000.

Regulators have always known how intrinsic housing is to the UK economy and consequently to the shape of regulation, but I was still surprised, reading Liam Halligan's recent book, Home Truths, to discover that more than 75% of outstanding UK bank loans are property related.

Rising house prices are superficially attractive to regulators and a combination of factors - from landbanking and Help to Buy to quantitative easing and, more recently, stamp duty holidays - have fed into the endlessly rising market of the last decade, since the financial crisis.

The limits regulators themselves have put on the proportion of 95% loan to value (LTV) mortgages that banks and building societies can have in their portfolios have also played their part. But there are prudential and conduct problems looming.

With the average prices now more than 10 times median income, the vast majority of potential first time buyers are effectively priced out, and this is increasingly skewing the profile of the UK economy, with the COVID-19 recovery likely to accentuate the resulting inequalities.

The Bank of England (BoE) and Prudential Regulation Authority (PRA) will be worrying about this, and about the imminent ending of the stamp duty holiday and when the current bubble will burst.

The Financial Conduct Authority (FCA), meanwhile, will be losing sleep over the impact of ending its own temporary regulations on mortgage holidays, as well as the reliance on credit of those who aren't home-owners.

First thoughts on the consumer duty CP

Flagged in Charles Randell's speech last month, the FCA's consultation paper (CP) on a consumer duty is a departure from its recent thinking. Although it studiously left the door open, from its 2017 mission through to the 2019 discussion paper, the FCA has never sounded enthusiastic about introducing a duty of care, and the process itself (even given the coronavirus situation) has been drawn out.

So, while not a statutory duty, which would have required primary legislation, these proposals do convey a sense that the FCA's view has changed.

With this context in mind, here are a few initial thoughts, which I'll follow up in subsequent posts over the next few weeks:

  • On one level, the pains taken to distinguish between the respective meanings of 'client', 'customer' and 'consumer' are important, but it does speak to these proposals being very much "made in policy" and I'm unsure how practical they are for supervisors.
  • "Treating customers fairly" (TCF) has been a key principle of business since the birth of the Financial Service Authority (FSA) over 20 years ago. More on this next time, but the clarity of the relationship between TCF and the new duty doesn't jump out at me.
  • The FCA has consistently used disclosure and communication to try and bridge the gap in consumer understanding of increasingly complex products and services. These attempts have all failed, but the same approach is still prominent.
  • The proposals themselves are complicated - one overarching principle, three x-cutting rules, four outcomes - when they would ideally simplify the landscape for both firms and supervisors

Back in the 2000s, I worked on several attempts by the FSA to make TCF work. None of them really succeeded, and I've long believed fundamental change is needed in this space. At first reading, however, I'm not confident these proposals will solve the problems.

Fintechs and banks

It's tempting to observe that the FCA's letter to UK fintechs, ordering them to write to their customers explaining that they aren't banks, is long overdue.

Some have apparently been comparing themselves to banks, without pointing out the differences that come from being regulated as e-money issuers rather than as deposit-takers. The regulatory standards for the former are much lower and their customers don't have access to the Financial Services Compensation Scheme (FSCS) when things go wrong, so this isn't a minor issue.

Misunderstandings have been building up in plain sight for several years, inside the regulator as well as out, sometimes aided by an unhelpful blurring of language. The Wirecard scandal is highlighted in the article and, although much smaller than in Germany, Wirecard's UK presence was far from trivial and the impact of its failure, as an e-money issuer, clearly took the FCA by surprise.

Looking ahead, regulators will need to become clearer in their language and more explicit about managing the potential conflicts between their different roles - eg, enabling innovation through the sandbox as against authorising and regulating firms. Many in the FCA would probably welcome this.

They will also need to start levelling the regulatory playing field between e-money issuers and banks. In its own way, this is yet another perimeter issue, this time between different standards of regulation, and will be yet another stretch on FCA resources.

A major overhaul of fees' policy - charging complex smaller firms more - will inevitably be part of any solution.

More thoughts on the consumer duty CP

A key area of the consultation paper is whether the new duty should replace two of its existing principles for business (6 - TCF, and 7 - Information needs) or sit alongside them.

I won't go into the detailed argument here (see paras 3.33ff), but in general terms, the FCA sees the duty as not applying to all firms (unlike the existing principles), and as overlapping with the existing principles not replacing them. It also believes that the detailed language in the handbook that is based on principles 6 and 7, would still support the new, "more-developed" rules.

There is also the question of whether the existing TCF outcomes should be disapplied. These have a long and undistinguished history, going back to 2006, which is neatly summarised by Charles Randell (FCA Chair) in a recent speech.

Complicating the issue, the key problem: that they essentially measure inputs and process not outcomes, was identified at the time, but more-sophisticated metrics were rejected as too difficult/expensive. This dilemma hasn't gone away and will surface again as the FCA looks to measure its four new outcomes.

Some readers will remember that the TCF outcomes originally led to the FCA asking firms to submit relevant board management information (MI) so they could evaluate it against the outcomes. This was a massive exercise that generated forests of paper; it proved predictably inconclusive and eventually was quietly shelved.

To have a realistic chance of success, the FCA will have to find imaginative ways of evaluating the new outcomes, ways that don't default into more paperwork.

Fraud and the perimeter

This recent speech by Mark Steward, FCA Exec Director, Enforcement and Market Oversight, describes what the FCA can and can't do in relation to fraud.

The "can't" is largely the result either of the regulator's powers not being applicable to fraud (eg, the s168 investigative powers in FSMA), or of the scam investments being beyond the regulatory perimeter.

One hope is that, down the line, the Online Safety Bill will remedy some of this. The speech concludes by saying that the FCA "has a substantial role to play here and we are upping our game."

The focus on fraud feels like another example of the impact the Gloster review of London Capital and Finance (LCF) had on the FCA's self-image and its sense of its public persona. However, there is a danger of the FCA overpromising in this space.

For example, having 50 open enforcement cases sounds impressive, but may not be nearly enough to have a meaningful deterrent effect; especially when, as Mark Steward observes, the FCA's powers are limited and less that 1% of police resources are devoted to fraud. In addition, he raises a question as to whether the Online Harms Bill "goes far enough".

Last week, the TSC gave the FCA a hard time for not doing more on Greensill, an essentially unregulated firm, and now the regulator itself (perhaps in response) seems happy to own problems it doesn't have the resources or powers to fix. The LCF review contained some important recommendations for the FCA, but it may be having some unfortunate unintended consequences.

To discuss these issues further, contact Gavin Stewart.