Opinion

Regulation in the time of COVID: unlikely bedfellows

Gavin Stewart Gavin Stewart

While we've all been locked down at home, financial services regulation is continuing to move at pace. Gavin Stewart has been summarising regulatory updates on a daily basis.

Since lockdown began, I've been writing daily blogs on the impact of COVID-19, Brexit and digitisation on the financial services industry. In the second of this series, I've compiled this week's updates into a digest form.

Unlikely bedfellows

The Hill review of Listing and an increase in the threshold for contactless payments to £100 both featured in last week's Budget. At first sight they have little in common, but both imply a loosening of  financial services regulation and an assumption that the remaining protections are sufficient, or can be effectively strengthened.

As the links show, the Financial Conduct Authority (FCA) has welcomed and accepted both, implicitly with the Hill review - "we will act quickly" - and explicitly on contactless payments. Elsewhere, the Hill review seems to have been broadly welcomed, although some are warning against the "watering down" of shareholder protections.

The contactless payments' increase, meanwhile, comes after a public consultation by the FCA, but has still elicited push back from Which? among others.

In the first case, relying on fewer protections likely entails each of them carrying greater weight. In the second, it's worth noting that industry voices almost always dominate consultation responses by number and, in the interests of successful long-term reform, the FCA will hopefully have given appropriate weight to the consumer voices that did respond.

Both reforms also, in different ways, increase the risk of financial crime. Opening up the Listing regime as suggested, inherently adds to the importance of ensuring appropriately strong governance, due diligence and transparency regulations; the increased threshold for contactless payments logically increases the attractiveness of card theft.

In both cases, the FCA will need to decide what priority to give the resulting risk.

Clean markets and GameStop

Mark Steward, the FCA's Executive Director of Enforcement and Market Oversight, recently gave a wide-ranging speech on activity across his patch over the last year. It covers a lot of territory but, for today, I want to focus on just a couple of areas - cleanliness of markets and his comments on market monitoring post GameStop .

'Measuring' and reporting on market cleanliness has long been a dilemma for the regulator, and I well remember discussions a decade ago about whether the Financial Services Authority (FSA) should highlight in the Annual Report a year-on-year improvement in the measure of the day.

The metrics themselves have moved on, but the arguments against highlighting still seem to hold true:

  • the metric is imperfect
  • a one year improvement isn't a trend
  • we haven't defined what 'good' looks like

As a decade ago, Mark Steward made no great declaration of success in this territory, probably rightly.

He also made some comparative comments on the UK's market monitoring in relation to the GameStop phenomena.

Briefly, he argued that short selling was less aggressive and more transparent in the UK, and that there had been an increase in retail trading accounts, but that many remain unused.

Despite this, I would be surprised if the FCA wasn't looking in some detail at what happened in the US, and at the evidence being given to the congressional and parliament inquiries there and in the EU, respectively.

At some stage, this story is likely to have greater relevance for UK regulators.

FCA exits temporary regulations

It's been obvious from the start that the FCA would need a carefully calibrated exit strategy from the temporary COVID-19 regulations around mortgage and consumer credit payments that it introduced last April.

I've written often about the absence of such a strategy and the danger of tying the regulations so closely to the government's furlough scheme. This was best illustrated at the end of October, when the last-minute extension of furlough was swiftly followed by the rushed extension of the temporary regulations.

After last week's Budget, it seemed likely the FCA would extend the regulations again, but the regulator, in its latest guidance update, has instead decided this is the right time to start unwinding the temporary measures.

The key sentence in their update is "we recognise that repossessions can be difficult and stressful, but delaying repossession can lead to poor customer outcomes as a result of increased balances and equity erosion."

This, of course, has always been the case, and so the question for the next period will be whether the FCA has got the timing right.

As the guidance makes clear, there are still a lot of tests firms will have to satisfy before repossession, and lenders should be confident they can justify and evidence their decisions after the event.

Largely because they tend to crystallise in the long term, it's easy to underestimate the risks of forbearance - even for regulators. And repossession will sometimes be the right answer for the consumer.

The original regulations were probably too broadly drawn, making the exit all the harder, but it's good that the FCA has started that journey.

The parable of interest rate swaps

The story of interest rate hedging products (IRHP) could serve as a cautionary parable for the pitfalls of conduct regulation, and John Swift QC is now due to deliver his report on how the FCA dealt with this problem in the summer, some nine years after its intervention and almost a year after it was originally due.

Some of IRHP's continuing impact can be seen in the regulator's enthusiastic pursuit of the Business Interruption (BI) insurance case, but it's still not clear (eg, in the recent vulnerability guidance) that the FCA pays sufficient attention to small businesses as consumers. There are likely to be some lessons still to learn.

Before it intervened in 2012, the regulator had understood for a while that, on some level, IHRP was a problem, but it took some time for it to be prioritised.

This may have been due to its being partly a perimeter issue (that one again!), or that the core product wasn't really the problem. Rather, it was the interest rate environment and customer base into which a complex product was sold.

Linked to this, the FSA largely viewed small businesses in the same way as individual retail consumers, and thought they needed less protection than was the case. In some shape or form, all these issues are still with us. When the FCA did decide to act, it did so on the back of relatively small samples of cases, the great majority of which had major deficiencies.

The advantage of this was that the regulator could move fast. 'Fleet of foot' was the phrase of the moment, close to the current FCA Chair's term "agile" at the Treasury Select Committee (TSC) to characterise what he wanted to see in a future FCA.

The downside was that it lacked the breadth of evidence to understand the real size and shape of the problem. Moving fast can often be the best way to fix things, but not always.

Are we heading for another Big Bang?

Following on from the Kalifa review of fintech and the Hill review of Listing, HM Treasury (HMT) is now kicking off its own review of MiFID II, the omnibus EU markets' directive that has been on-shored into UK legislation as we exited the Brexit transition period. Taken together, they constitute a wave of change that some may see as equivalent in impact to the City's Big Bang in 1986.

On the face of it, the MiFID II review is designed to strip out the regulations that the UK didn't want included in the first place. But once the box is opened, it's possible the debate may become much wider, and loosening MiFID's core elements would carry risks to the UK's reputation.

In this respect, HMT's aim to "reduce burdens for firms whilst maintaining high standards of regulation” should sound some alarm bells. It's not an impossible ambition, but the rhetoric is a lot easier than the reality.

In a similar vein, "competitiveness" was removed from the regulators' remit after the financial crisis, due to the inherent tension with financial stability, but Hill and others are suggesting it be reinstated.

Another obvious set of questions surrounds the place of retail investors in London's markets. What access should they have? How much protection? Is it a level playing field?

In the age of special purpose acquisition companies (SPACs) and GameStop, measures such as lifting the cap on private trading in "dark pools" and weakening transparency regulations risk a backlash. The effect of Big Bang 1986 is still debated, and there are increasing signs we may be approaching a similar leap in the dark.

To discuss these issues further, contact Gavin Stewart.