by Andrew Bailey
Lord Mayor, at the end of June it seemed like time to mix things up at the regulators, so here you have Sam and me, from the Prudential Regulation Authority (PRA) and Financial Conduct Authority (FCA) respectively. You see, everything seemed a bit dull at the end of June, after all; we had nothing else to do. I want to congratulate Sam – it is a very well deserved appointment – and I have no doubt that he will sort out the PRA after that guy who came before him. Sam is someone who genuinely understands Solvency II, which brings to mind what Lord Palmerston said about the Schleswig-Holstein Question. And, that is Lord Palmerston the former Foreign Secretary, not the Foreign Office cat speaking. For those of you not versed in European politics in the 1800s (does anyone want to lay claim to that honour), Lord Palmerston said “The Schleswig-Holstein question is so complicated; only three men in Europe have ever understood it. One was Prince Albert, who is dead. The second was a German professor who became mad. I (and I think he was speaking as the Foreign Secretary), am the third and I have forgotten all about it.”
But I do have a word of warning for you Sam. This is the fifth time I have spoken at this event, and you are my fourth partner going back to 2011. I am really hoping this partnership will last longer. We can take comfort that the job of partner is slightly more secure than being England football manager, for the record, five people have managed England for some period in that time. Let me also give my thanks to Tracey McDermott for her work at the FCA and before that the FSA. Tracey has tackled some of the toughest tasks in financial regulation in this country, always with a calm but steel-like determination – unsurprising as she is from the steel producing town of Rotherham. Tracey was a very good colleague and I wish her all the best for what she chooses to do next.
The FCA’s Mission
After four months of my tenure at the FCA, a lot has happened around us. Tonight is a very good opportunity to reflect on that time. I also have to confess Lord Mayor that I feel rather like one of those authors who comes on your show to promote my new book. Today, we have published a document – not a book, don’t worry – on our future Mission at the FCA. I want to say a bit about that tonight, and put it into some wider context. My overwhelming first impression of my new role is of the importance of the public policy objectives that have been entrusted to the FCA. It operates on a very big landscape – a simple indicator of which is that we regulate around 56,000 firms in a wide range of financial services. This underlines just how important financial services are to any modern economy and particularly the UK with its large and sophisticated wholesale markets operating alongside important retail financial activities.
The FCA has a very broad objective given by Parliament, namely to ensure that relevant markets function well. We also have three operational objectives: securing an appropriate degree of protection for consumers; protecting and enhancing the integrity of the UK financial system; and promoting competition in the interests of consumers in the markets we regulate. We translate these objectives into an annual business plan, which I am sure you have all read! But, to my mind, that leaves a great deal to be filled in. Our future Mission starts to do that by setting out our thinking on how we approach our task and the tools we have to achieve it.
There are other reasons why I think it is important to set out our future Mission. The first is out of necessity because of the size of the landscape; we have to make choices about where we go on it, what we examine, and why. We need to explain those choices to further transparency and accountability. Second, we have more tools at our disposal than most other financial conduct regulators in the world. For example, we now have formal competition powers. This makes great sense, and is changing the way we approach our task, but again it is incumbent on us to explain how we choose among our tools when facing a particular task at hand, and how those tools fit together. Our future Mission sets out to do this. The final reason that I would add is that financial conduct regulation is, interestingly, a relatively under populated field in terms of academic and other thinking which can guide our choices. I hope that the work on our future Mission can stimulate some activity to start to fill this gap and thereby reinforce the foundations of our work. The purpose of our publication today is therefore to start a discussion to help to decide the best way for us to apply our statutory objectives in future. This will help us to make many of the fundamental choices that we inevitably face when deciding our priorities and thereby pursuing our objectives. I want to spend some time next setting out some of those fundamental choices, and particularly aspects that are new or rapidly evolving.
Let me start with two examples, one I suspect is better known than the other. They illustrate challenges we face. The first (less well known) concerns the regulation of debt-management companies, something we took over from the Office of Fair Trading in April 2014. Consumers turn to these firms to help them to manage problem debt, and around 400,000 people in the UK currently have debt management plans. However, our review of debt-management firms found evidence of high charges and unfair terms and conditions. As we have gone through the process of authorising these firms, around 100 have opted to leave the market. When they leave, or we decline to authorise them, we have to make sure that customers are not abandoned and that they can get low-cost impartial advice about managing their debts. Our work is changing an industry that has posed a risk to often vulnerable consumers while ensuring a continuity of service. It illustrates a number of challenges we face, some of which I will set out in a moment, and all of which we describe in our future Mission.
The second (better known) example concerns the scandals involving LIBOR and foreign exchange (FX) trading. Conduct regulation is based on regulated activities. But often financial firms carry out other activities which are not directly regulated. LIBOR and FX are examples of this. They are activities carried out by regulated firms, but which fall outside the Regulated Activities Order. Our powers do allow us to reach these unregulated activities, but indirectly, and in a more limited way. For example, we can take them into account when judging the fitness and properness of individuals and in our assessment of whether a firm continues to meet our Threshold Conditions for authorisation.
Moreover, the Senior Managers and Certification Regime allows us to frame and hold to account the broader set of responsibilities of individuals across a firm. This is an important change, and most definitely for the good. But the problems experienced in these areas that lie outside our regulatory boundary have illustrated the challenge of making a more indirect approach to regulation work as effectively as might be needed. For instance, we cannot require redress schemes to be put in place for customers, though we can use our tools to exercise influence over the choices firms make in this respect. Our future Mission sets out to explain the issues we face of this type, and how we seek to deal with them. We have also set out a number of the major questions we face. I thought it might be helpful to describe briefly, as examples, three of these questions and how we have sought to tackle them.
The first question is at the heart of our work, namely “do we protect all consumers to some equal degree all of the time, or do we give more attention to more vulnerable consumers?”
We have an objective to secure an appropriate degree of protection for consumers. We define consumers very broadly, to include users of retail and wholesale markets. The legislation also requires us to take account of the principle that consumers should take responsibility for their actions, while also requiring us to have regard to the differing degrees of experience and expertise that different consumers may have. It is incumbent on us to explain how we put all of this into practice.
But, if we do give more attention to more vulnerable consumers, the question becomes “how do we define vulnerability, bearing in mind that a very large part of the population will be vulnerable at one or more times in their lives?” We set out our thinking on this in the future Mission. To give away the ending, we are more on the side of protecting the vulnerable, but recognise the definitional challenge. I remember a time when this question would lead to a lot of agonising over moral hazard. I think it gets easier when we recognise that vulnerability can create very different financial outcomes for individuals depending on the products they need.
The second question is “what is the role of the regulator in enabling and facilitating change and innovation in the industries it regulates?” It is a parody to say that a regulator’s job is just to say “no”, but like all parodies it wouldn’t exist if it didn’t have a grain of truth. But taking necessary action can lead to a reduction in the supply of services, and thereby competition, which is not consistent with our objectives. This is an issue common to wholesale and retail financial markets. Meanwhile, we also face very rapid technological change, and the need to support that by more flexible and rapid adaption of our rules where that is both possible and sensible. We need to make sure that, through our future Mission, we explain the circumstances in which, and why, we will support and proactively enable innovation. You may be familiar with Project Innovate and our regulatory sandbox. Along with other FCA initiatives these are encouraging and supporting the application of new technology. If imitation around the world really is the sincerest form of flattery, these are successful initiatives. And they are important.
The third question concerns uncertainty. Can uncertainty really go on rising for long periods? We live in an uncertain world, that we know. As a member of the Bank of England Financial Policy Committee, I sometimes find that every quarter we describe the world as more uncertain than ever. I would guess that if there is one thing on which we could agree over the last few months, it is that uncertainty has risen. The last decade has demonstrated, not for the first time, that we live in a world where big economic shocks can, and do, occur, and they can transform accepted norms in financial markets. We have seen this in macroeconomic policy, and we can see the effects in financial services. Just look at the world of pensions. Looking back in time, with the huge benefit of hindsight, it is easy to be struck by the contradiction between the uncertainty of the economic outlook and the precision of projected returns from very long-term financial products. For my generation, just look back at endowment mortgages.
The important point here is that as a conduct regulator the FCA needs to work out how to fulfil its objectives in a world of rising uncertainty. Our future Mission starts to try to tackle this question. The Mission has a second part which is all about how we use our tools, and how we ensure that they are well explained and fit together. We divide our tools into three broad approaches, competition powers, firm supervision and enforcement. Each one of these is considered in the Mission. The main issue for all our tools is one of explanation – what is the tool? And how, and when, do we use it? Competition is a much newer policy toolkit for us, and we are fairly unique around the world in having extensive competition powers. We use our competition powers as appropriate to complement our existing powers under the Financial Services and Markets Act.
For supervision, the challenge is how to look across 56,000 firms and have some touch points for all. Our work in this area is constantly evolving – much like the firms we regulate. More broadly, there is work to be done to develop the model of conduct supervision. I think it starts with the building block of understanding business models and answering the question of where the firm makes its money and how. For enforcement, there is a quite common saying that “x is in enforcement” – to which guilt and punishment will surely follow. We don’t believe it should be seen like this. A referral for investigation is just that, and no more; the beginning of a forensic process of investigation to determine what happened and whether enforcement proceedings should be brought or not. We have set all of this out in the future Mission. I believe the future Mission is a very important start to developing a clear explanation of our purpose. Over the next three months we are looking for as much feedback as possible. Please join in.
The context we operate in
Let me turn finally to putting this into some important context. We need to explain ourselves more than ever because of the scale and speed of outside developments and the prevalence of economic uncertainty. One thing I want to make clear is that the Mission is not about Brexit for the simple reason that the issues we tackle in it are universal whatever the outcome of the Article 50 negotiations.
Let me give a few examples of the profound changes going on around us, drawn mainly from recent work by the IFS. By their early 30s, those born in the early 1980s had average net household wealth of £27,000 per adult – about half the average wealth holding of the 1970s cohort at the same age. Real median income for those aged 25 to 55 grew by just 2% in total between 2004-05 and 2014-15, compared with 26% between 1994-95 and 2004-05. At the age of 30, 40% of those born in the early 1980s were owner-occupiers, compared with 55% of the 1940s and 1970s cohorts, and more than 60% of the 1950s and 1960s cohorts. The 1930s cohort was the last to have a similar homeownership rate. In their early 30s, less than 10% of private sector employees born in the early 1980s were active members of a defined benefit pension scheme, compared with nearly 40% of those born in the 1960s. Add to this a recent estimate that to provide yourself with 70% of your gross income for 25 years of retirement when real interest rates are zero requires setting aside 45% of gross income every year, which is well above most saving rates. Combine these developments with the trend to switch the responsibility for, and the risk of, lifetime retirement savings from the state and employers to individuals and it is easy to see the challenges for public policy.
This includes challenges for us at the FCA since these changes in lifecycle positions have profound effects on long-term savings, pension provision and associated financial products. There is a very important issue here about how, as an operationally independent regulator, the FCA defines and deals with the boundary and interactions with other public policy functions. We have developed our future Mission to help guide us through these complex issues and to explain our decisions and help us to participate in the broader public policy debates that inevitably arise from developments on this scale.
But it is also important to put these issues into proper context. Next year we reach the tenth anniversary of the start of the financial crisis. That’s a pretty sobering thought. More sobering still is that we are still very much living with the consequences, and the evidence I set out on generational shifts starkly illustrates that. The policies that have been enacted over the last ten years were, and remain, a necessary response to a severe crisis. Back in 2007 I well remember that it was initially a mood like the beginning of the First World War of “the war will be over by Christmas”. But that was not the case, anything but.
It is important to have in mind the things that have not happened in that period: we have avoided a serious unemployment crisis; widespread repossession of homes; and likewise widespread business failures on the scale seen in some past recessions. It is an old saying in our world that the best achievements are the things that do not happen for which our policies can take some credit. It is the outcomes of policies that matter ultimately. We should not now start to regret the policies that are in place, but remember the scale of the crisis and what has been avoided. But, now is the time to look forward and take a very close look at how we manage the challenges ahead, which is a separate issue. At the FCA, we are ready to play our part.
Lord Mayor, I’m sure you received some words of advice before taking office. I hope they included “expect the unexpected to happen”. You have been unwavering in your commitment to the office, whatever happened outside. And, for that we owe you great thanks.
The author of this speech, Andrew Bailey is Chief Executive of the FCA.
