Keynote speech by David Lawton, Director of Markets, at the FCA Markets Conference 2013. This is the text of the speech as drafted, which may differ from the delivered version.
Thank you all for joining us today. I hope that you’ll agree that the morning session has seen a very interesting set of discussions around our international agenda. I’m going to use this time to focus more on how the Financial Conduct Authority (FCA) will approach its markets supervision, and hopefully, in the process, pick up on some of the themes you will be hearing about and discussing over the course of the afternoon.
As the FCA we have set out that we will be taking a different approach to the Financial Services Authority. The Government has given us new objectives. Most notably different is our competition objective, and we have a significant new set of powers. There has been a lot of material on the ways we will be a different regulator, in our speeches, and in publications such as the Journey to the FCA and our Risk Outlook. But some people think there has been a bit less said about how markets fit into that new approach.
The change in the legislation was less significant in the sphere of our markets regulation. Our powers were extended modestly - for example, for the exchanges and sponsors we supervise - but the Financial Services Act 2012 (2012 Act) did not give the impetus for a radical change to the way we approach markets supervision.
Nevertheless, our approach to markets cannot remain static. So, while we are not planning a revolution to our markets supervision, it definitely needs to continue to evolve.
The need for evolution is driven by three key factors.
The first is the complexity and dynamism of the markets we regulate. We oversee a substantial part of global markets. Our transaction reporting database receives 12 million transactions a day - that’s roughly 70% of transactions undertaken in Europe; the UK is home to nearly half the global interest rate derivative markets - and over 40% of the FX market. Our equity markets are truly international, representing a fifth of the global total of foreign listings.
A challenge for any supervisor of markets as complex and large as the UK’s, is keeping pace. We are regulating in the context of rapid market-driven change. For example, the trend of market fragmentation continues, there is increased correlation between the physical markets and commodities markets, and in a long-term low interest rate environment, we are also seeing firms revisit business propositions, with new innovative fee structures and bundling across products. Developments in emerging markets are having a growing impact on our own capital markets.
These market changes all bring their own benefits and challenges to market resilience, quality and efficiency. As a regulator of a significant part of those markets, we need to be capable of identifying and assessing the most important risks arising from these developments.
The second catalyst for evolution is the policy agenda that Martin described earlier. Anchored in European initiatives, but also encompassing G20 agreements and broader international policy developments, pretty much every key aspect of capital market legislation and regulation has been a candidate for change over the past few years. For some initiatives, such as EMIR and MAR, we are now moving into the implementation phase. For others, such as MiFID II, the policy negotiations are not yet complete. Market participants are, or will be, subject to a significantly different set of rules, and we have to adapt to that too.
The third catalyst for an evolution in our approach is that we still have not achieved the outcomes that we want to see as a regulator. This is particularly the case in the area of behaviour and conduct. Historically, the FSA had a very robust approach towards market abuse as part of the credible deterrence agenda. But in wholesale markets, broadly, there was an assumption that professional counterparties were sophisticated enough to look after their own interests, and that the FSA would intervene less in conduct issues in the wholesale space than in the retail space.
LIBOR has demonstrated that market confidence can quickly be eroded by poor wholesale conduct, and that the impact of poor conduct, in and outside our regulatory perimeter is far-reaching. While professional counterparties may be capable of looking after their own interests – and we should be prepared to test that – we certainly cannot assume that the cumulative result of caveat emptor adds up to appropriate standards of wholesale conduct. So, we have evolved our approach to incorporate a renewed focus on wholesale conduct. This means an extension of our activity in this area, but that does not mean an extension of our retail approach. We recognise that the wholesale markets are different to the retail markets, and they need to be regulated as wholesale markets. But they do need to be regulated.
And I want to stress that this is an evolution in our approach, we are not starting afresh. You will see an approach that recognises the need to differentiate between different types of markets, but also makes the links more explicitly between market integrity, conduct and consumer protection.
You will see a more coordinated approach from across the organisation in tackling these risks to our objectives, especially in tackling poor market behaviour and wholesale conduct. We are going to pull together our policy, surveillance and supervision tools, and where necessary our enforcement tools, to build a holistic view of the risks from poor conduct in markets and tackle them in an efficient way. An important driver of our approach is the concept of ‘early intervention’, by which we mean both the need to get on top of issues quickly and also to intervene nearer the root of some problems in wholesale markets before risks and detriment are transmitted to more vulnerable consumers in retail markets.
So how does this look through the filter of our new statutory objectives?
The FCA has three objectives:
- A market integrity objective: to promote and enhance the integrity of the UK financial system.
- A consumer protection objective: to secure an appropriate degree of protection for consumers.
- A competition objective: to promote effective competition in the interests of consumers.
And these three operational objectives support our strategic objective of making relevant markets work well.
Market integrity has always been central to effective markets regulation. We want a marketplace that works for and facilitates a successful UK financial system. To do that we need a market that can facilitate healthy price formation, structured to ensure that liquidity, access and information are sufficient for the needs of participants. We need resilient infrastructure, infrastructure with strong risk management that can deal with extremes in volatility, and with minimal outages. It also means a strong surveillance culture in our markets, and a sense of individual accountability. We expect market participants to act as the first line of defence against market abuse, not relying solely on us to be the market monitors.
In promoting market integrity, we will continue to focus on ensuring that our infrastructure is resilient. The financial crisis has shown us that we do have resilient infrastructure, which can cope with some of the most testing of scenarios. But work could still be done to strengthen operational and counterparty risk. We need to maintain that resilience, staying alert to new and emerging risks which, because of the interconnectedness and dependencies in securities markets, can quickly become systemic risks, such as cyber crime and growing technology dependencies.
Market integrity underpins successful capital markets. In our role as a primary markets regulator, we need to make sure that our rules create a regime where shareholders can exercise their rights and be active investors, and companies support this by making appropriate disclosures. An example here is our recent consultation paper on how we can increase transparency and strengthen minority voices at key points in the company and shareholder dialogue.
Another important part of a successful capital market is the sponsor community, providing expert guidance to premium listed issuers and providing us with the assurance that issuers are able to meet certain obligations. We need to make sure that our sponsor regime is built to maintain expertise in the community so that issuers can appoint sponsors with confidence and that our approval remains an important endorsement of sponsor capability.
As part of our market integrity objective, we have a well-developed and successful approach to addressing market abuse within the perimeter of the Market Abuse Regime. We need to evolve that approach, extending it to recognise that, to tackle market quality, we also need to look at pricing mechanisms and behaviour in markets beyond the market abuse regime. That includes in benchmarks, where we have strengthened the governance arrangements and controls around LIBOR and have been leading the development of the IOSCO principles.
Market integrity means we also need to be aware about where pricing mechanisms bring physical and financial markets together. Commodities warehousing is an example of this, where we have been engaging with the market on ensuring warehouses provide effective and efficient services, and increasing the transparency of financial markets.
Markets regulation is also critically important to the delivery of a strong consumer protection agenda. I should note here that when I say ‘consumer’, the FCA interprets the word in its widest possible sense. The 2012 Act explicitly recognises the wholesale consumer in the definition of consumer.
I’ve mentioned already that part of the evolution of our approach is a renewed focus on wholesale conduct. ‘Wholesale conduct’ is quite simply your framework for managing the way you behave, including in the marketplace. And of course this doesn’t just apply to wholesale firms; a lot of retail firms are also active in these ways.
There isn’t a bright line between wholesale and retail markets. While our approach to wholesale supervision is differentiated from retail supervision, the behaviour in wholesale markets impacts the behaviour we see in retail markets. Wholesale conduct interventions, either through policy or supervision, are often the first step to preventing poor retail conduct. We need to ensure that the benefits of product innovation, increased competition and new technologies flow down to the end-consumer.
Where the wholesale and retail markets interact, we need to make sure that consumers have transparency around the risks, rewards and costs so they can make informed and active decisions.
One example of where the wholesale and retail markets intersect is the Listing space. We have recently issued guidance on our expectations that prospectuses must clearly take account of the intended end-investor. Where that end-investor is a retail one, a prospectus has to be ‘easily analysable and comprehensible’, and by that we mean free of excessive technical language and market jargon, and not written in a legal style.
There are some areas where, to achieve better outcomes, we need to be more willing to intervene using our existing supervisory rules where we see a risk to consumers, wholesale or retail. We’ve already announced some key pieces of work looking at risks around the agency role in wholesale conduct; a best execution thematic review, looking at whether firms under MIFID are regularly achieving best execution for their clients. We will be consulting shortly on changes to clarify aspects of the 2006 regime on the use of dealing commissions, and we have said we want to explore what the best longer term approach to this area should be.
These are a couple of examples of how we are going to approach wholesale conduct, targeting areas key to good wholesale conduct, in this case the agency role of a firm, where failure to meet requirements results in direct and unnecessary cost to consumers and undermines trust in the agency relationship.
And when things go wrong, we need to ensure that there are the appropriate safeguards for consumers against wholesale failure. A key example is the client asset regime, which is an important pillar to both market integrity and consumer protection, ensuring that over £100 billion of client money and £10 trillion of client assets are properly safeguarded. This helps to ensure that, where a firm is no longer a going-concern, it can be quickly resolved with minimal disruption to the wider market. The regime offers significant benefits to both retail and wholesale consumers. Keeping this regime fit for purpose is an on-going challenge. We are now looking at responses to the consultation paper we put out in July, which proposed fundamental changes to the regime to improve the speed and accuracy of client asset returns.
Our third FCA objective is to promote competition in the interests of the consumer. This objective will support us in our goal of fair, orderly and transparent markets, providing a competitive market for consumers.
We are working hard to imbed competition skills and knowledge across the FCA and I would note that it is a very interesting time for us to be a given a competition objective in the market space. The competitive landscape for market infrastructure for example has changed significantly over the last decade, driven as much by MIFID as by the commercial environment of new technologies and increased market power of exchange customers. We have seen a proliferation of exchanges and multilateral trading facilities (MTFs), as well as consolidation in the market as entities adjust their business models to this new climate. Historically, we have overall had a very open approach to market entry in the UK, with low barriers of entry for new market participants. Our approach to competition in the market infrastructure has essentially been to welcome it, noting the benefits of increased choice and further innovation.
But our new competition objective will also empower us to look more carefully at what happens after entry, at the way market structures are working, at where market power can be exploited and carry increased cost to market participants, including ultimately ordinary consumers.
We have signalled the importance to our approach of using our competition objective by announcing that we will undertake a wholesale strategy review early next year to assess competition in the wholesale markets. This will be a wide-ranging piece of work and, as part of it, we will be inviting market participants to tell us where they currently encounter issues. We believe this work will be an important step forward in using the competition objective to bring about better outcomes for consumers and market integrity in the wholesale markets.
To conclude, there are a few points I’d like to reiterate:
- Wholesale markets need to be regulated as wholesale markets, but they do need to be regulated.
- We are evolving our approach to market supervision to reflect the changes in the markets we regulate and to renew our focus on wholesale conduct.
- This approach will build on our focus on market integrity, recognising the important link that conduct creates between consumer protection and market integrity. Our competition objective gives us a new lens through which to look at wholesale markets.
- We will deliver this using a more holistic approach, drawing together our data and surveillance capabilities with our supervision and policy tools. We will continue to work heavily on making sure the international agenda delivers more robust financial markets, but that won’t prevent us from robust unilateral action. Benchmarks are a prime example of this – we have led in putting in place a robust regime for LIBOR, taken enforcement action where firm failures undermine the integrity of markets, and are leading in developing global standards.