Regulation in the time of COVID: pensions and zombies

Gavin Stewart Gavin Stewart

Gavin Stewart has been keeping an eye on the world of financial services regulation during lockdown. We bring this week's posts into digest form.

This week's series of blogs covers the pension freedoms scandal, firms zombified by COVID-19 support measures and predictions as to what regulation will look like in the future.

The pension freedoms​ scandal continues

The Financial Conduct Authority's (FCA) latest pensions' missive is a sign that the saga of pension freedoms, triggered by the 2014 budget and the regulator's too-rapid policy response, is entering a new phase.

The letter was to pensioners who were advised to transfer out of defined benefit (DB) schemes by Independent Financial Advisers (IFAs) who have since gone into liquidation, encouraging them to complain to the compensation scheme (Financial Services Compensation Scheme - FSCS) or the liquidator.

At first sight, the letter looks like the initial stage of a bigger exercise. It also raises questions about the regulator's overall strategy in this area.

The largest mis-selling scandals since the Financial Services Authority (FSA) was formed in 1998 (the pensions' mis-selling that originated in the 1980s, endowment mortgages from the 1990s, and PPI) each lasted more than a decade and were characterised by the regulator initially underestimating the scale of the problem.

In the present case, the problem appears to be more firmly time-bound (2015-18) and the quality of information more robust (235,000 consumers received transfer advice in this period, 69% of these were advised to transfer, but only 48% of transfers the FCA has reviewed were judged suitable). However, there are still several unknowns and some potential pitfalls.

To take a few examples:

  • The reliance being placed on the FSCS to compensate individual consumers is relatively untried and the initial tranche of 2,677 letters seems likely to rise, testing the system
  • Putting the emphasis on consumers to complain has a patchy record, especially when (as here) there is a time limit
  • Other pensions' work will be going elsewhere in the FCA, and in similar situations it's often proved hard to keep the x-organisational coherence and consistency

The risk of unintended consequences, and zombies

With the postponement of yesterday's planned lifting of restrictions and continuing uncertainty about inflation and the path of economic recovery, regulators will be getting nervous about the impact of unwinding both their own temporary regulations and the HM Treasury's (HMT) various support packages, notably: furlough, the uplift to Universal Credit, and the moratorium on tenant evictions.

I posted last week about the risk to regulators of sticking with HMT's timetable, but there is also a worry about what incentives regulation creates once this withdrawal process is complete, currently scheduled for around the end of September.

If we accept the consensus that those who have suffered most financially from the COVID-19 situation were already among the poorest, then the group of consumers who are 'vulnerable' will be considerably larger than pre-crisis and its vulnerability will be deeper.

Given the scope and tone of FCA guidance on vulnerability, firms might then conclude that the regulatory risk of continuing with some customers is simply too great, effectively pushing them towards alternative lenders.

On the flip side, newly vulnerable consumers may decide they can no longer justify the premiums for their existing level of insurance. Both would be unintended consequences of regulation, neither would be welcome.

There will also be nervousness on the PRA side, some around credit quality, but more from the potential 'zombification' of some regulated firms and their customers.

The term, which refers to those kept solvent by the coronavirus-driven extension of quantitative easing and prolonged forbearance, has been with us since the financial crisis. Regulators will be increasingly worried that the nature of our coronavirus recovery will make the problem worse.

Front running the FCA business plan

Yesterday's speech by Nikhil Rathi (FCA's CEO) almost certainly front runs some of the main themes of next month's business plan, and in the process attempts to reframe how the market, the media and parliament view the regulator.

Broadly, the speech covers UK markets post-Brexit, a new approach to authorisations, and the FCA's engagement with international regulatory discussions. Each will bring its own challenges.

In the short run, the markets' agenda is probably the easiest to enact, with the Hill review having set out the major strands and the consultation process is under way.

The issues here are likely to be down the line, in calibrating the balance between becoming more 'open' and 'agile' while maintaining "high regulatory standards", including around governance, transparency, financial crime and due diligence.

By contrast, authorisations is hard from the outset, and will require a reshaping of the FCA model to succeed. Historically, the gateway function has been undervalued compared to policy, enforcement and supervision and, eg, has been the chosen target for successive efficiency drives.

It will also be a long haul, and the numbers mentioned - 1,450 EEA firms, action being taken against 13 - need to be seen in the context of the 60,000 firms the FCA regulates.

However, the biggest challenge is likely to be international engagement, where the FCA, compared to the FSA, broadly downgraded its international efforts in favour of Whitehall engagement.

Perhaps tellingly, the speech focuses quite narrowly, on bilateral arrangements (with Switzerland and Singapore) and on climate change. Engaging effectively across the full spectrum of issues will require a substantial pivot from where the FCA has been.

The TSC's LCF report

Yesterday's TSC report on the scandal surrounding London Capital & Finance (LCF) contained few surprises.

The Andrew Bailey/Elizabeth Gloster row seems to have been put to bed; the perimeter, fraud, and financial promotions are all prominent; the TSC wants more transparency and measurement around the 'transformation' programme; and the FCA receives a slap on the wrist for appointing Megan Butler to run that programme despite her being named in the Gloster report.

More interesting, though still consistent with previous statements, is the recommendation that anti-fraud measures are included in the Online Safety Bill. At this stage it's unlikely the government will budge, but regulation at some point seems inevitable. The potential harm is too great and more scandals will occur and the debate points the way to what looks likely a significant future scope extension for the FCA.

Also worth noting is the TSC's emphasis on the Senior Manager Regime (SMCR), and its insistence that the FCA should hold itself to the same standards it expects of regulated firms.

This recalls the argument in the mid-2000s about whether, on this same basis, the FSA should have an independent risk function, and will be hard for the regulator to resist. The FCA's previous SMCR responsibilities map didn't really reflect the complexity of its matrix model, and this is an area where the transformation programme can bring some welcome clarity and light.

Some perimeter thoughts

In regulation, the perimeter, like death and taxes, will always be with us. Wherever Parliament draws the line, there will be an uptick of activity just beyond it and a greying of the boundary.

Going back to the financial crisis, several financial services groups contained entities that were unregulated, and assets were passed back and forth across the regulatory border. More recently, the LCF report highlighted the 'halo effect', whereby regulated firms conducting legal but unregulated activities exploit the implied safety conferred by regulation.

None of this is dependent on where the perimeter is drawn, so the TSC recommendation that the FCA should be able to ask for a perimeter change solves little by itself.

The call, a couple of years ago, by the departing Head of the FSCS (Mark Neale) for some product kitemarking might help more, but suffers from some of the same drawbacks and would need to be accompanied by a much more aggressive consumer information strategy than currently exists.

The more activist approach to authorisation being pursued by the FCA might also make a difference, but it will be a long haul and sits awkwardly with some of the regulator's rhetoric on innovation.

Two other strands of an effective strategy are likely to be:

1 the use of some regulatory soft power outside the perimeter, eg, the PRA has the power (so far unused, I believe) to ask unregulated entities for information (from the 2010 FS Act) and this could be extended to the FCA

2 more extensive use by both regulators of their group supervision powers

To discuss these issues further, contact Gavin Stewart.