Speech by Martin Wheatley, Chief Executive of the FCA, at the ICI Global Trading and Market Structure Conference. This is the text of the speech as drafted, which may differ from the delivered version.
2013 has been another eventful year for the financial community. So I thought it would be useful today to take a step back and offer some broad reflections on what it means in terms of where we are as we approach year-end.
I also want to look ahead – to 2014 and what is likely to be an important period of consolidation. Less ‘exciting’ maybe than previous years – but also a platform to bed in regulatory change and move things forward.
A key issue here is the fact that much of the reform process is now behind us. In the EU and the US, the majority of the rules breathing life into the G20 principles have already been scripted and delivered.
In the UK, an entirely new regulatory structure took flight in April – governed by new principles and strengthened by new powers.
So to a large extent the financial world moved on significantly in 2013 – meaning the next 12 months are unlikely to involve long discussion about whether something should be done. But should be increasingly focused on transitioning towards next steps. The delivery of standards that will allow us to begin to turn the page on a very difficult chapter in financial history.
There are two key challenges for us to consider today within this context. First, the overwhelming importance of achieving cultural transition in 2014. In other words, publicly demonstrating that there is clear blue water between the past and future.
Moving away from the Gordon Gekko-era, if you like, of financiers hurling adding machines across offices and ripping their own shirts off their backs, to a more mature age where investor interests are front and centre of firm business models in the global markets.
Second, the perhaps drier, but equally important issue of technical transition. Making sure we get the nuts and bolts of international regulatory reform right – MiFID, EMIR and the like – so markets remain deep and liquid.
A word on both priorities today – starting with the important question of culture and accountability. So, how do we get firms to do the right thing, whether the regulator is watching or not? How do we get senior management – not just in banks but players in the global markets as well – to be accountable for doing the right thing.
The traditional regulatory mechanism for dealing with cultural weakness has always been to enhance the rules. To close loopholes in the law as and when they appear. To require more disclosure or compliance with specific processes.
The problem with this approach is twofold. First: it is, ‘static’. So it is closing stable doors after horses have bolted. Second – and perhaps counterintuitively – we know it can encourage the behaviour it seeks to stamp out.
As an example, if we trace back to around 2005 to 2008, the breeding ground for many of the conduct cases we’re dealing with today – like PPI and benchmark manipulation – we find them occurring in a period that saw Financial Services Authority (FSA) guidance expand by some 27%. In other words, growing the rulebook did not prevent cultural weakness.
Which is why, in his excellent book Ethicability, Roger Steare argues for a more sophisticated interpretation of integrity in business – one that is not simply defined by the ethics of obedience – so what is legally right or wrong – but actually looks towards the ethics of care and the ethics of reason.
Steare makes the very good point that: ‘At their worst, rules, laws, regulations and red tape have a tendency to multiply because they remove our responsibility for deciding what’s right’.
His major criticism, the fact that governments over the years have responded to scandal with rules and regulations, without considering that it was ‘the obedience culture’ that often failed in the first place.
The FCA’s solution to Steare’s challenge has been to use a broader array of judgement-based tools and techniques – including competition, behavioural economics and more sophisticated modelling – to get under the bonnet of the financial services industry and make sure consumers – across the markets – are treated more fairly.
As part of this work, we’re also being more probing on sources of revenue – so, how does a firm make its money? As well as looking at how the firm business model delivers against the expectations of consumers.
In the context of today’s discussions, perhaps the best example of this change in regulatory approach – and a fair benchmark of what to expect in 2014 and beyond – has been the FCA announcements around asset management over the last few months.
At the centre of this debate are key points of principle and culture. So, are asset managers acting as agents for clients by putting their best interests first? Or is there more we can do – collectively – to restore the trust link with investors?
Clearly UK asset managers command significant respect across the global markets. Hence the reason they attract so much inward investment.
But as other markets cleanse their own operations – as we’re seeing in Singapore, Hong Kong, the US, Australia and so on – it becomes increasingly important to do the same domestically. In other words, this is not something for the UK to fear. It is something for us to lead.
So as we move forward, the FCA will be working with industry to find solutions to key asset management issues, including evidence of poor transparency. Evidence of a lack of accountability in spending commissions charged to customers. As well as question marks over conflicts of interest and firms pushing the definition of research.
By and large, these problems are cultural and our solutions need to reflect this fact, which is why the FCA approach has been to launch an open conversation with the sector to find viable, long-term answers that don’t affect the competitiveness of the UK market.
There are several important questions we are considering within this debate:
First, are fund managers scrutinising spending to ensure they are acting in the best interests of their clients. A case in point is research spend. Does it provide good long-run value for clients? If funding for research is linked to the trading volume that generates dealing commission, what is the incentive for the fund manager not to spend it – irrespective of value added?
Second, how can we support investors to enable them to better understand what they are paying for, and whether their investment managers are getting value for money? Particularly when dealing commission is used to purchase bundled services, offered by sell-side brokers, which combine costs for execution, research and a variety of other services into one figure.
Third, does the current system of corporate access, which is often linked to bundled brokerage services, compel asset managers to dig into their pockets more than they should, possibly at the expense of their clients’ best interests and effective competition for research, in order to curry favour with brokers?
And – as an aside – does the use of dealing commission allow fair competition for providers of independent research against the bundled brokerage model?
I should say this list is not exhaustive. Nor do we imagine they are simple problems to tackle but if you’re looking for a useful bellwether of FCA direction, this is it: so, a more probing analysis of culture and ethics versus rules. A more assertive focus on wider markets as opposed to picking off individual firms one by one. A greater inclination to step in early, rather than wait for problems to scale up and become less manageable.
At the other end of the regulatory spectrum in terms of moving things forward is the linked priority of achieving technical transition. So, tightening up legal requirements and rules, as is happening across Europe and the US at the moment.
Most notable here, the increasing number of European conduct dossiers emerging (like the Insurance Mediation Directive, Packaged Retail Investment Products, the Mortgage Credit Directive and so on) as well as the market dossiers with conduct elements (MiFID and EMIR).
Let me start with MiFID, which is, as we all know, on the verge of moving out of the negotiating chambers of Brussels into the full glare of public scrutiny as a completed piece of legislation.
Even allowing for the fact that the date of application is still two to three years away, this is clearly a critical period. Most would agree there is still a significant amount of work to be done. Both in terms of implementing these measures, and clarifying the application of the legislation before it takes effect.
To support progress, it will be crucial for firms and organisations like ICI to engage positively with ESMA to help get MiFID into the right place.
There is also a challenge for the FCA to support this transition, which is why we’re setting up our own implementation project: a key part of which will be engaging with firms to help them meet the new obligations and to respond to queries.
As I’m sure has been discussed this morning, the revised legislation will place a cap on the total amount of certain types of dark equity trading in the EU. Clearly, investors need to have confidence in the price formation process on EU financial markets, and we recognise the concerns that have led various jurisdictions to introduce restrictions on dark trading.
Time will tell whether the level of the cap in MiFID is the right one, but it’s clear ESMA will need to track carefully what happens when the cap takes effect – and be willing to provide robust advice to the Commission and Parliament if it damages Europe’s equity markets.
The revised MiFID will also contain new provisions explicitly regulating automated trading. As such, automated trading will continue to be a significant focus for regulators, in relation to both firms and venue operators, as we look to make sure the financial system remains strong.
This afternoon there is a session on market data and a consolidated tape. I think there are two key aspects for us to bear in mind in relation to those discussions: first. the process of consolidation itself, and second. the data being consolidated.
In the last two years there has been a significant focus on the first of these as arguments have pingponged back and forth over whether there should be a single, or multiple providers.
The legislators now seem certain to back multiple providers. But this regime cannot be made to work by legislation alone, this can only provide a broad framework. It will require a significant effort on behalf of all interested parties to ensure the system delivers.
Less attention has been paid to the inputs to the consolidated tape but a key issue here in relation to data is that there is insufficient clarity about who reports – and there are too few checks on the quality of the data being reported. The revised legislation offers the opportunity to make improvements on this by rolling out the approved publication arrangements regime across the EU, and reducing the instances of double reporting.
G20 and EMIR
Finally, a few words on the general reshaping of the international derivatives market, most of which is already well in train.
Clearly, this final delivery stage includes some key issues for the derivatives industry – namely the cross-border application of derivatives rules, preparing for EMIR requirements and resolving issues around benchmarks.
The cross-border issue raises the fundamental question of whether regulators should operate independently on global issues so that they can intervene quickly in the national interest, or whether they should find international solutions to international challenges.
The clear risk of the former, as I’ve argued before, is that it brings in a patchwork quilt of national and regional rules, which run the risk of becoming unworkable.
It could create space for overlaps and underlaps in regulation, with all the question marks that brings with it: opportunities for regulatory arbitrage; less protection for end-users; lower margins for firms that operate by the book and the possibility that any one transaction or participant could easily be subject to multiple different regulatory regimes.
Our colleagues in the Commodity Futures Trading Commission (CFTC) along with the European Commission have made significant strides over the last year to resolve these issues and we are committed to the Path Forward agreement. Yes, it remains a roadmap. Yes, there are significant points of detail to work through. But I think most would accept it does represent real progress.
Having said that, there are some urgent points that still need to be worked through, including detail relating to trading venues – particularly trading venues in the EU and US – used by firms in both territories as major conduits for transatlantic derivatives trading. The FCA, along with the EU, is pushing hard for this approach to be based on mutual recognition.
The second, related, area to mention is around the broader recognition of equivalence between different international regimes.
Clearly, it makes good sense for regulators to accept compliance with foreign rules for cross-border trades, so there’s a general sense of relief, I think, to see the additional commitments in the Path Forward paper for broader substitute compliance.
A different set of challenges in so far as they’re already rapidly moving towards full implementation, are the EMIR requirements.
ESMA have already authorised the first trade repositories under EMIR and, as of the 12 February, all derivatives trades (both exchange traded and over the counter) falling under the jurisdiction of EMIR will have to be reported to one of ESMA’s recognised trade repositories.
We have started to review firms’ compliance with EMIR in terms of the business conduct regulations already in place, and will also be checking firms’ preparations for the February start date in the coming weeks.
It bears repeating that firms should be making sure the relevant data is available internally, as well as arranging direct access to a trade repository or delegated reporting facilities. I’d also encourage firms to get a legal entity identifier as soon as possible. As I understand it, this is a relatively quick and straightforward process. But vital to the overall success of reporting to trade repositories.
Now, some of this regulatory detail may sound rather arid and technical but it is important. Ultimately the big reforms succeed, or fail, on matters of small detail, not grand principle. So the custodianship of this final leap from paper to practice is an area we all have a stake in...
And it’s why the successful execution of cultural and technical reform should hold equal weight as we look ahead to 2014.
There is an acceptance I think that both challenges are extremely complex to achieve. Albeit it in very different ways.
So, it will be vital for organisations like ICI Global to continue to engage positively in the debate around both as we move into 2014 – a year of consolidation I hope – and also, incidentally, the Chinese Year of the Horse, which, if you’re looking for a sign, is meant to be lucky financially. (It is also reported to be a year of poor health – so take from that what you will).
To end, let me thank you for all your support in 2013. And wish you a very successful and happy new year.