It’s not an original observation, but the FCA is at heart a publishing house.
Work on annual set-pieces like the FCA business plan (currently in its 2017/2018 run) begins months before publication, with Associates across all parts of the FCA writing summaries of their work, and sending it up the line for review. The strategists and macro-economists submit big chunks. The whole thing is then proofed for plain English, and typeset in-house.
This piecemeal approach, overseen by the former management consultants, lawyers and economists who make up a significant proportion of the FCA’s staff, may explain why this year, the FCA has embraced two positions on the role of financial technology. It’s beneficial when applied to real-time or almost real-time compliance. It’s disadvantageous when the firms with the most data use it to exclude bad insurance/lending risks.
Happily, speculation about the future state of current trends remains just that. Enforcd found it more helpful to head straight for the Appendix, and see what the FCA will actually work on. There, we found a distinction being made between FCA reviews, and FCA thematic reviews. The latter are undertaken to investigate “current or emerging risk regarding an issue or product across a number of firms in a sector or market”. We’re still not sure about the former.
The FCA has dropped the ball on investment over the past few years. Arch Cru (Greek shipping, forestry, 20% interest loans to mid-sized European firms), Harlequin Property (off-plan Caribbean villa developments), Stirling Mortimer (traded right to buy off plan units in Turkish and Moroccan holiday developments) and Brandeaux (an investor in UK student accommodation) all collapsed on its watch. In almost all cases, assets were alternative and illiquid, promised returns were triple the return on cash, and in the case of Stirling Mortimer, investors were reassured by bank guarantees, without being informed that developers of the underlying properties were responsible for obtaining these. Not surprising then that the FCA is continuing to review suitability of advice across retail investment, wealth management, and complex products.
The remaining thematic work is across long-standing FCA concerns: mortgage forbearance, interest-only mortgages, treatment of with-profits customers. These are long-dated UK problems. At what point should people be booted out of their homes, to preserve any equity accrued from being eaten up by fees and interest? Will the tranche of interest-only mortgages coming due in 2020 spark an unanticipated property market rout? With-profits have been an FSA/ FCA concern for well over a decade. Turbulent investment markets, a shift from annual to terminal bonuses, charges to inherited estates transferred to closed life book consolidators (zombie funds), and high exit penalties all mean that millions won’t get the returns they were promised.
More prosaically, the FCA has remembered that credit cards are still sold by shop staff in shops (consumer credit point of sale thematic review). The last time they looked in this area, they reviewed the sale of payment protection insurance alongside point of sales credit (the latter being overseen by the Office of Fair Trading). They’ve added a motor finance review too (part of a broader loose credit theme). And they’re taking their first long look at the debt management sector.
All in all then, a plan of work focused on delivering greater protection for the greatest number of consumers. And they’re taking a look at the robo-advice/ auto-advice sector. This sparked quite the discussion between expert complaint handlers the other day. Just who is responsible for an algorithm gone wrong?
On this last, the FCA is concerned that a small number of providers, or just the same data scientists moving between firms, could lead to the industry being unable to make sensible underwriting (loan and insurance) decisions regarding non-standard customers (FCA business plan 2017/18, page 29). Similar decision making algorithms in investment management could lead to herding behaviours in the market. Reasonably, the FCA is concerned about senior management and control functions: “Firms have a responsibility to ensure they have the appropriate skills and knowledge to service and maintain algorithms”.
They’ve clearly been reading Frey and Osborne on “The Future of Employment: How Susceptible Are Jobs to Computerisation?”[i]. That paper concludes that most insurance jobs will be automated out of existence (underwriters, claims managers and adjusters, brokers). Financial analysts probably won’t be.
Interestingly, they’ve entirely omitted systemic risks arising from changes to IFRS/ US GAAP (international financial reporting standards/ generally accepted accounting principles). The last time these caused an upset was in 2008, when a bunch of bank-owned special purpose vehicles (SPVs) were found to have been loaded down with risky mortgage backed securities which their promoters couldn’t sell. The link? Assets held in off-shore SPVs could be deemed off balance sheet, and so capital neutral.
Enforcd doesn’t have a specific accounting example in mind. But US high frequency traders are currently lobbying the US Securities and Exchanges Commission to alter the Order Protection Rule (within Regulation: National Market System). Their proposed changes would make it easier to cherry pick profitable trades (described as picking off stale quotes[ii]). The new US President is deemed sympathetic to the needs of the financial services industry. He appointed Vincent Viola, founder of high frequency trading firm Virtu Financial to his cabinet. At 23/04/2017,the pdf containing the 12 year old rule was not available on the SEC’s website[iii].
The FCA does a fine job of summarising macro-economic trends. It’s not necessarily alive to global regulatory arbitrage opportunities in the world’s major jurisdictions. As a parting shot, both Arch Cru and Stirling Mortimer chose Guernsey to incorporate their Channel Island Stock Exchange listed closed end protected cells.