Regulating in the public interest
The first lens involves taking a closer look at the strong anchor of our regulation in the public interest, and what that means. My starting point is that regulation is a public good in the sense that the benefits are open to all and can be consumed by all without rivalry for shares of the benefits. Some members of society will benefit more than others, but that should be for a clear public interest reason.
A very good example of this is our approach towards vulnerable consumers. Parliament has given the FCA a statutory objective to protect consumers, but our governing legislation also acknowledges that consumers should take responsibility for their decisions. This avoids the moral hazard that otherwise regulation encourages irresponsible behaviour. But, clearly, some consumers are better able to take responsibility than others. A high-level definition of vulnerability would suggest that it is in the public interest to ensure more protection, and place less reliance on consumer responsibility, for those who are vulnerable. That is what we seek to do.
But more regulation can never be a self-serving agenda for the regulator at any cost. Nor are we seeking to eliminate risk from financial services – that is risk to firms and to consumers. This can at times come across as a harsh message. It is not meant to be so; rather, I see it as a statement of reality.
My starting point is that regulation is a public good in the sense that the benefits are open to all and can be consumed by all without rivalry for shares of the benefits
It is also for these reasons that any proposal we create to extend or alter our rules must be accompanied by a cost benefit analysis that takes into account the acceptability of the balance of costs and benefits for different private interests.
Moreover, advancing the public interest does not mean that we have no interest in corporate health and profitability. Healthy competition depends on firms earning returns on the investment made. And, in fact, our governing legislation already tells us that we should take into account the desirability of sustainable economic growth in the UK.
It is also very important that, almost uniquely among financial regulators, the FCA has a full-blown competition objective, namely to promote competition in the interests of consumers. And this objective is deeply in the DNA of the FCA, rightly so.
Now, I do hear it said in some quarters that the FCA should have a competitiveness objective, that is alongside I assume our competition objective. The quick retort to this point is to recall that, before the financial crisis, the Financial Services Authority (FSA) was required to consider the UK’s competitiveness, and it didn’t end well, for anyone including the FSA. True enough, but I don’t think the issue ends there. The test of any objective for a regulator, as I set out earlier, is that it must meet the public interest. The rising tide lifts all boats approach pre-crisis failed this test. At the FCA, we think that a competition objective with supporting cost benefit analysis supports a competitive and successful financial sector. But, to be very clear, it does not and should not entrench particular business models.
So if we are going to have the competitiveness debate, let’s please have it in a public interest framework that does not entrench the interests of incumbents.
There is one last point I want to make on the issue of public interest. We have a single overarching objective, namely that relevant markets should work well, and three supporting operational objectives: the protection of consumers; the integrity of the financial system; and promoting competition in the interests of consumers. The question sometimes arises of whether having multiple objectives, and ones that strictly do not have a hierarchy, complicates the landscape in such a way that an institution like the FCA is not properly accountable and thus too powerful.On that note, it is also important to remind ourselves that our public interest objectives which are specific to the conduct of financial services, sit within the very broad landscape of all public policy and public interests. And that means there are inevitably boundary issues to be dealt with, for instance with social policy in areas such as benefits, pension, social welfare and housing policy. This is why in every Parliament we can receive a letter from the Chancellor setting out the Government’s broader public policy priorities, and thus we work closely with Government without any compromise to our operational independence. And the same goes for our relationship with the Bank of England and its policy objectives.
It is a reasonable argument that the complexity of public policy objectives has most probably increased, and it has demanded higher levels of transparency and accountability for institutions like the FCA. This transparency and accountability is a good thing.
But it is also a basic feature of life that we have to balance multiple operational objectives which interact, as ours most certainly do. Yes, it demands strong transparency and accountability, but I don’t regard it as a counsel of despair.
Now, in case you hadn’t noticed, this does risk that the FCA turns into a publishing house. I don’t need reminding of this because I read all the material before it goes out. I have to be honest, when I came to the FCA I said I wanted to reduce this and I would still like to do so. Events haven’t helped, most notably Brexit which has required some monster size publications. But the central dilemma is how to manage the important demands of transparency and accountability.
The changing purpose of regulation
Let me move on to the second lens through which to view the future of regulation, namely a more philosophical view of the purpose of regulation, and how in an important respect it is changing. In philosophy, there is a view of regulation which is namely that rules are prescriptive statements that forbid, require or permit some action or outcome, and that one of these three must be present in any rule. So, three verbs: forbid, require, permit.
When I look particularly at our competition objective, and it has been fascinating for me coming to this as a somewhat old dog trying to learn a new trick, I think there is a fourth verb. This is namely to enable change to happen consistent with our public policy objectives. An important impetus for this change has been behavioural economics and the insights from psychology. Certainly, in my recent experience it quite profoundly changes the nature of the regulatory debate. And, it changes the set of remedies that we can apply. It leads to important debates for instance on the limits of informational tools and remedies.
But it must still remain grounded in public policy objectives and the discipline of public goods. Thus, to give the obvious example of fintech, we are neutral as to technologies and types of firms, and we are therefore not in the business of picking winners.
I think this fourth verb – using regulation to enable change consistent with our public policy objectives – is an important development, and one that has clear potential to further re-shape the nature of regulation. But, and here I’m afraid I have to do a bit of party pooping, innovation has to be consistent with our public interest objectives – there is no free pass to ignore these objectives.
Sometimes innovation will be so consistent, and sometimes it will need some guiding to get there. And, some businesses will succeed and some won’t, which is in the nature of competition and innovation.
Brexit and the importance of a transition period
The third lens through which to view financial conduct regulation is very relevant to what might be the consequences of Brexit. I say that carefully because as usual I must emphasise that the FCA takes no position on the substance of Brexit itself. We have always been of the view that a period of transition is important to avoid the cliff edge risks of a no deal outcome. The extension of Article 50 is welcome in this regard but we will need to continue to prepare for a full range of scenarios.
During this period, we will continue to be an active member of ESMA and work closely with our EU27 counterparts on legislation that is in development. Wherever we end up, our markets will remain closely linked and our close cooperation with our EU counterparts in order to meet our objectives will continue after exit.
Our regulatory landscape can be viewed as comprising two spaces, an EU and a non-EU one. By this I mean that in one space the rules have been made in order to be consistent with EU law and regulation, and in the other they are the product of domestic UK actions. Strictly, the non-EU space has been the residual of the total space not occupied by the EU space as EU law has had primacy. The EU space has grown over time as a share of the total, though the domestic space has seen important developments such as bank ring-fencing and the Senior Managers and Certification Regime (SMCR).
Another important respect in which the EU space has changed over the years is the move from a system which sets minimum standards of regulation across the EU (the world of minimum harmonised directives) to one where the EU space has been filled with standards that are both minimum and maximum (the world of maximum harmonised regulations and directives). Views on maximum harmonisation in my experience can be mixed – it is more intrusive at the national level but I also hear the argument that it can act as a constraint on so-called national gold-plating of EU rules. It has played a role in ensuring a level playing field across the EU market and facilitating supervisory cooperation between EU regulators through bodies such as ESMA.
I think there are at least two important questions to answer on EU and UK regulation in the context of a future post-Brexit. First, are the EU and UK approaches to regulation notably different, and what does this imply for the future? And second, what sort of equivalence arrangements should we want and expect? These are obviously big questions. [...]
What does that mean for the future? Left to our own devices, I think the UK regulatory system would evolve somewhat differently. It would I think take on board practical experience more rapidly, and it would be based more on principles that emerge from experience in public policy and somewhat less on detailed rules that can tend to become overly set in stone. [...]
Therefore, as the European Commission have themselves started with their ‘call for evidence’ work, we would continue to look to improve onshored EU legislation on a ‘same outcome, lower burden’ basis.
In a post-Brexit world what will actually happen? That will depend on where the process of equivalence leads. I am going to make a few broad points. First, I think the point on the differences of the common law approach strengthens the need for outcomes-based equivalence rather than a rules-based approach – in other words, the outputs of regulation not the inputs. Now that should not be controversial because it is how equivalence works between the EU and the other countries, so why change approach?
But that is not always what I hear. The argument is sometimes made for a form of proportionality in which the UK is held to a higher standard, because it has large financial markets and they are close by.
But if this argument has substance – and the IMF have in the past described the UK’s financial system as a global public good – it should argue for strong outcomes not a switch to rules. And, wherever possible, those outcomes should flow from global standards, which should always be the best test of equivalence. Our financial markets are global not regional. [...]
The things I think we can all agree on are: a common commitment to outcomes based approaches; an expectation that the UK and the EU will be able to find each other equivalent on day 1 by virtue of having the same legislation and well established supervisory approaches; and that as our rulebooks evolve we will both want to ensure predictability around issues such as assessment processes or withdrawal of equivalence in a similar way to, but I hope even deeper, the way that the EU has worked with the US and more recently Singapore.
I want to finish this section on the issue of the outcomes-based approach, which I believe should be the approach taken for equivalence. We need to be careful here because I would submit that the record to date indicates that all of us are good at talking the language of outcomes but practising the world of rules. The latter are superficially easier – firms often say to me ‘just tell us precisely what you want’. It’s a short step to box ticking. Outcomes can be harder to judge, they can have strengths and weaknesses. But they do allow us to describe in some detail what we are trying to achieve and what difference we want it to make – the harm that we are seeking to remove.
And this focus on outcomes should make it easier to hold the FCA to account for its actions and inactions, and whether we really have served the public interest. In short, I think we need to reflect on what it really means to have an outcomes-based regulatory system.
I see rules as a means to deliver outcomes, and it is important not to focus too much on rules as the beginning and end of the process of regulation. Outcomes matter at the end of the day.
Having clear principles
It is clear there is a strong desire to see us strengthen our principles and use them to much more real effect. I have sympathy with this. History has shown a tendency to talk principles but write rules, amongst the regulator and regulated alike. But principles are not debating points, they are the bedrock of our regulation, and there is a good case for enhancing their standing and practical impact.
This would also help us to ensure that the scope of regulation can adapt to the changing environment in which we operate. Let me give one important, current example.
There is, rightly in my view, a growing debate about physical access to key banking services, whether that is branches or ATMs. This is against a context of declining bank branch use and concerns around the commitment to a distribution of free-to-use ATMs. There are two important and at times competing principles at work here: physical access to key banking services, and innovation which improves the overall provision and quality of services. The question is how to strike a sensible balance. The answer will not be found in a rule, at least not to start with, and I question whether it would end there either.
We intend, as part of considering the future of regulation, to undertake further work to examine the role of principles, and we will consider the most efficient and proportionate options for achieving the substance of a duty of care. We will continue to engage broadly on this. [...]
Conclusion
[...]Brexit will clearly be a defining factor. I do think that, left to our own devices, the UK, with its common law system and large, global financial markets, would construct financial conduct regulation in a rather different way. To be clear, that is not a comment on the level of regulation, but rather the approach and the means, and, to be very clear, it does not involve taking a position on Brexit.
I have emphasised the roles of outcomes, principles and rules. They are different and should not be confused, and they each have a role to play. Yes, I would put more emphasis on principles and outcomes, and recognise that rules are a means to deliver them, but not the only one. An organisation that prioritises being within the rules over doing the right thing, will not stand up to scrutiny for long. My aim is to see that mentality deeply embedded in the culture of firms. As the duty of care debate shows, there are strongly held views on consumer harm, and its incidence. The post-Brexit system cannot and should not seek to deny or ignore them.
Equally, we need a financial system that earns sustainable and acceptable returns and does so transparently. And, we need to encourage fair and sustainable risk taking. In these circumstances, there should be a debate about the future of regulation.
But, beyond that debate, it bears repeating that there’s a lot of common ground. We all want strong, open markets. We want our financial services to succeed. And we want sustainable growth as well as the innovation and progress that benefits the consumers we’re here to serve. [...]
Full speech
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