Speech by Andrew Bailey, delivered at the Lord Mayor's City Banquet at Mansion House.
Speaker: Andrew Bailey, Chief Executive
Event: Lord Mayor's City Banquet
Delivered: 24 October 2019
Note: this is the speech as drafted and may differ from the delivered version
- There are strong benefits from free trade and open global financial markets and the FCA will continue to support them
- A biq question for the FCA is how we reconcile risk taking with investor protection. What are the boundaries for this risk taking and when should the regulator intervene, and with what consequences?
- Part of the criticism the FCA faces is justified. We should improve our efficiency – which, is why we want to make a major investment in data analytics to give our staff more effective tools to do the job
As ever, it is a great pleasure to be here at the Annual City Banquet – the one time in the year you can let your hair down with the regulators, so to speak.
I must start by thanking you Lord Mayor for your year of service – you are looking encouragingly fresh and energetic despite several times a day having to explain the logic and coherence of unfolding events in this country.
What to speak about tonight? In case of unforeseen events – surely not – I prepared several speeches, and then I wondered if you really did want to hear another one on the Derivatives Trading Obligation.
So, avoiding that temptation, I want to begin by stepping back to draw out some of the forces shaping the issues we deal with today and particularly how we strike an appropriate balance between risk taking and consumer protection.
And, yes, Brexit is a big part of these contemporary issues. But, it is not the only part by any means. This helps to explain why our work on the Future of Regulation extends beyond the implications of Brexit.
Issues affecting the FCA
I am going to focus on a number of the deeper issues that very much affect us at the FCA.
First, really since the 1980s, we have seen a re-integration of the world economy, and we have seen national financial markets re-integrate with the international or euro markets which had emerged centred in the City. We are still catching up with some of the implications of that re-integration – most obviously in the reform of risk-free interest rates and end of Libor.
There are strong benefits from free trade and open global financial markets. The alternatives produce worse outcomes as history demonstrates.
But, they don’t benefit everyone all of the time. The established prescription is that other policies should be deployed actively to manage those unwelcome effects. In the wake of the global financial crisis there has been a determined response to provide effective regulation in order to preserve and maintain global open markets.
We want to continue to support and encourage open global financial markets – and I mean global not regional. It’s worth remembering what the G20 has said in this respect.
The G20 has called for ‘jurisdictions and regulators to defer to each other when it is justified by the quality of their respective regimes, based on similar outcomes, in a non-discriminatory way, paying due respect to home country regulation regimes’ .
Financial regulatory systems in different countries, prudential and conduct, grow up independently but usually seeking to achieve common goals and outcomes. For prudential regulation there are rather more global standards which provide a common base for regulation, whereas in conduct regulation there is more use of common principles and objectives.
There is then a judgment on whether those regulatory systems deliver sufficiently similar outcomes, and this is the basis for judging so-called equivalence and deferment.
It does not require identical rules, and thus not rule taking by one or other parties.
Let me move on to a second major longer-run development, namely that we have come to accept that economic growth and development is shaped in part at least by institutions (private and public) and how they operate, and by public policies.
They affect, among other things, the price and availability of investment capital, and the rate of innovation and technology transfer. Competition is an important determinant of growth and distributional issues and is more likely to be present in a State that operates an effective legal system and accompanying public policies.
In the 1980s this would have been viewed as a political statement, today I don’t regard it as such at all. Public policy and regulation is a necessary but not sufficient component of growth and effective markets, which is not of course to say that we get it right all of the time.
A third major development has been the growth of the knowledge-based economy, most obviously for finance the importance of Fintech. For a long time we made speeches about the likelihood of innovation and what it might do to financial services, now it is really happening.
But, at least in one important respect, it is not happening exactly as many predicted. The tech economy is no different in terms of its specialisation which is deeply embedded in innovation.
It is more dependent on human capital rather than financial investment (though of course it needs the latter).
There were predictions that this relative dependence on human capital and a skilled workforce would lead to an extremely footloose industry with less geographical concentration and less dependence on co-location because the internet is such an efficient medium of communication – this is a pretty standard prediction of traditional trade theory.
To which, it is reasonable to respond, ‘Have you been to Hoxton recently’.
So far, but let’s not take anything for granted, the knowledge economy has turned out to be more location specific and thus fixed than traditional trade theory predicted.
But, we should be clear that this state of affairs, and the City’s gain here, depends on some important contributory factors.
Going back to my second development, it does depend on effective private and public institutions, an effective legal system that supports clarity of contracts and ownership, a favourable investment market both for investment in private initiatives and for investment in public goods (infrastructure), and yes a supportive regulatory environment.
I hope you don’t mind that at this point I must name check FCA Innovate and our Sandbox and all the initiatives that go with it such as our TechSprints. If you have not been part of one of our Sprints, you have missed regulation but not as you know it.
We should not take the location of our Fintech sector for granted – hubris is never a good thing. But if we understand what supports it and has led to it developing, we stand a better chance of nurturing it.
The other side of the picture
So far so good you can conclude. The road has been bumpy to say the least, but we are moving ahead with real positive outcomes. Let me now describe the other side of the picture, the things we need to focus on because not every development is positive in every respect, something I can assure you we see clearly at the FCA.
We have seen the emergence of a stronger identification of winners and losers, and the distributional effects, of open markets, free trade, international competition and technological progress. Added to that, the Global Financial Crisis fuelled a breakdown of trust in institutions, including in regulators, something we are still dealing with.
At the heart of this breakdown is a belief that the system is no longer fair.
Another part of this response, not limited to the world of financial services but nonetheless very much present here, has been a growing impatience with the responsiveness both in terms of substance and promptness of timing (for instance, frustration with the processes of public law).
This has led to growing demands for stronger and faster intervention by public authorities like the FCA. Added to this list is the big question of how we reconcile risk taking with investor protection in a world that has changed in important respects.
We can point to very big achievements at the FCA in recent years – our work on high cost credit in its various forms being a well known example.
But part of the criticism we face is justified. We should improve our efficiency – which, again turning to the FCA, is why we want to make a major investment in data analytics to give our staff more effective tools to do the job.
We must also be prepared to challenge the perimeter of our regulation. And we need to be prepared to take on the important issues that come out of the distributional effects.
To give you important an example from the current work of the FCA: access to financial services – we seek not to mandate how access is done, but if as a firm you want to change access, then I think you should demonstrate that the alternative meets an acceptable standard across all groups of society.
Let me describe two large and contemporary issues that illustrate why these things are not straightforward. The first is the scope or perimeter of FCA regulation, what we call the perimeter. The second is the balance between risk taking and consumer protection.
As a colleague of mine likes to say, our perimeter looks rather like the coast of Norway, the full length is around 38 times longer than a straight line drawn round the edge, and the full length would circle the planet two and a half times. It’s complicated.
This year we published the first of what we intend to be annual reports on the perimeter. The reason for doing so is that many of the toughest issues we face have in common that they involve activity at or over the other side of the perimeter. We will in future reports respond to the request of the Treasury Select Committee to make clear our views on how the perimeter needs to change.
The FCA’s role is to make clear its view on the perimeter based on its direct experience as regulator; it is, of course for the Government and Parliament to decide what to do about the statutory definition of the perimeter.
Let me give one example concerning an issue that is controversial for the FCA, the past conduct by banks towards small firms. In our report on the RBS Global Restructuring Group we made an important point which to be honest was not picked up by many commentators.
We stated that activity outside our regulatory perimeter is governed by the institution of contract law only and not by contract law plus our rules and principles. The effect is that there was no overarching principle of good conduct or a rule to that effect.
It doesn’t mean regulation is always good, but it shows what role it can play and what happens when it is not present in the institutional approach. And it shows the need to be clear about the scope of the regulatory perimeter and the consequences of its positioning.
The second issue I want to highlight concerns the balance of risk taking and consumer protection and where as regulator we should intervene. This is a perennial issue for a financial regulator, not least because markets continuously evolve and develop. But I want to set out briefly why I think the issue has become more acute.
Over the last decade we have seen a major shift in risk taking away from banks towards non-banks. This is part of a story in which the public has taken more direct exposure to asset values. Developments in pensions and long-term savings have also led in this direction.
What are the boundaries for this risk taking and when should the regulator intervene, and with what consequences? This is much debated, rightly so given the changes that have occurred.
It is important not to generalise here. Amongst the perceived problems there are so-called investments that are fraudulent, ones that are genuine but missold to the particular investor, others that look misjudged at the time of purchase if not missold, and others that were reasonable at the time of purchase but turn out to be poor value.
We see all of these. The regulatory actions are different. For some we have used product bans as well as enforcement, elsewhere we have limited retail investment as a share of an investor’s net financial assets, for others we have or are proposing rule changes, and in some cases we propose no action because no action is the right approach.
But, and contrary to the implication of some commentary on what the FCA should do that I read, we want to foster an environment in which risk taking occurs. Part of our role is to facilitate investment in the economy to support jobs and the livelihoods of people in this country. Innovation and start-ups are an important part of that activity.
We cannot therefore hold to a standard where people do not lose money and where the value of assets does not decline. Investing is inherently risky.
But, the public needs to receive clear meaningful disclosure on the risks they are taking and should expect markets that work well. We want to see more transparency in the risks of non-bank investment so that investors get useful information.
That’s why I have argued that there needs to be reform in the UCITS (Undertakings for the Collective Investment in Transferable Securities) framework. And there are circumstances in which we impose limits on investment or outright bans.
Lord Mayor, over the last decade or so we have seen big changes to our financial system. No doubt, there is more to come. In my view, there are good reasons for those changes. But we have to come to terms with them.
At the FCA we are very alive to the challenge of balancing suitable investor protection and supporting the economy. We will always seek to act to strike this balance and in doing so we may rarely appear popular, but it is a balance that has to be struck.