The creation of the Financial Conduct Authority in April signalled a significant change in how the UK’s financial services industry is regulated.
We are a new authority and no doubt many of you in this room have watched our actions in the first few months of operation with interest. Yet our principles are directed and informed by the experience of multiple financial events stretching back over the years both domestic and international. You will all know that these events have not always shown the industry in a good light, from LIBOR, to Payment Protection Insurance (PPI) and more recently interest rate hedging products. All of these issues are lessons both for the industry and for us as the regulator.
As a new regulator, we will take forward the lessons of the past and apply them to our new mandate. Some of what we are responsible for hasn’t changed, we still set out to secure an appropriate degree of protection for consumers; to protect and enhance the integrity of the UK financial system, but we now also have a new objective to promote effective competition in the interests of consumers.
Today I’m going to focus mostly on our new competition mandate. This is a new tool for the FCA, and will work alongside our existing tools that you are more familiar with; from supervision to enforcement actions.
I’ll touch briefly on our view of some of the fundamental competition issues we see across financial services and then spend most of my time on some of the concrete steps we are taking to tackle these problems, including the programme of market studies we announced this morning.
The FCA’s approach to competition
I will start with a simple quote from the FCA’s objectives under the Financial Services Act 2012. It says the objective of the FCA is ‘promoting effective competition in the interests of consumers in the markets for regulated financial services’.
There are a few words to highlight.
First, ‘promoting’. That means not just waiting for problems to occur, but being proactive about how we encourage competition, new entry and try to address issues before they become entrenched problems.
Second, ‘in the interests of consumers’.
In short, a powerful driver of good conduct and good outcomes for consumers is effective competition.
Our whole outlook will be shaped by the impact for consumers – both individuals and businesses. It would be fair to say that in the past too much reliance was placed on what many now recognise to be imperfect economic models – that prices, markets and consumers respond efficiently – even predictably – to new information.
The traditional economic model was that decision making was rational, and we could expect especially the more sophisticated customers, given the right information, would make the right decision.
We shouldn’t rush to throw the baby out with the bathwater. There is still a lot of merit in these models. The regulator cannot be everywhere all the time – nor should they want to be. Consumers with the confidence to engage and the right information can punish poor firms and reward good ones.
Classic models of competition analysis will be vital for our work, but we also need to consider new techniques. If we are being really honest with ourselves, when faced with a breakdown of either rationality or price efficiency when our models didn’t seem to work, the most frequent regulatory response was to provide yet more information.
Our goal will be orderly and competitive financial services markets in which firms put their customers at the heart of everything they do and offer them good value products and services.
This doesn’t always mean more rules, more guidance or looking in the rear-view mirror.
What it will mean is using our judgement about the outcomes we think a product will truly achieve for the target consumer; it means considering the root cause of a problem; it means thinking beyond whether the sale was compliant; it means a greater understanding of how consumers ‘buy’.
The challenges in the financial sector for competition
So far, so good, but what are the particular challenges we face to making that a reality in financial services markets? I will mention just a few here.
Probably the biggest single issue is without engaged consumers, firms have all the wrong incentives. Firms that are focussed on customer service and good value products can’t win significant market share from incumbents – even those who treat their customers poorly or like cash cows. This leads to a vicious circle where lack of consumer engagement makes other competition problems worse.
The fact that switching rates are low in many financial products - that you are still more likely to get divorced than switch from the bank which reeled you in with a free railcard at 18 - can sometimes sound like blaming consumers. That, frustrating though this is for the traditionalists amongst us, they are not behaving as a rational economist would like them to.
However, there are good reasons why that might be the case.
For many financial products it is hard for consumers to gain experience. Buy a brand of beans you don’t like at the supermarket and you’ll know not to purchase them again. Buy the wrong pension and you may not know for thirty five years.
There are significant informational asymmetries between providers and consumers. Advice can help bridge that gap in some cases, but it needs to be trusted and good value. The reality is many firms add layers of complexity – impenetrable jargon, pages of terms and conditions, bizarre exclusions in the reams of small print, products launched and withdrawn with often bewildering frequency.
All too often the understandable response of many consumers in the face of such complexity is to rely on rules of thumb, gut instinct or just what their friends or family would do.
There’s also the question of where informed consumers go and can they exercise choice? Competition has to be about more than the ability to choose between a range of suppliers who are all seemingly offering the same thing or behaving as badly as each other or a combination of the two. Switching of any product needs to be as simple as possible and exit penalties have to be justified.
The FCA’s actions
So what are we going to do about competition?
We are starting by taking a look at ourselves. We know that the barriers to entry created by regulation itself can be a reason why some markets aren’t competitive. We have streamlined our authorisations processes for new banks, to encourage new entrants who could shake up retail banking.
When we write new rules, in addition to considering our other objectives, we will also consider how we can promote competition to achieve the good outcomes we want for consumers. Most of our current rules were inherited from the FSA, a regulator without a competition objective – so we are reviewing the Handbook to understand where our rules may have had unintended consequences and adverse effects on competition. Wherever it is possible for us to change rules to make competition work better alongside our standards of consumer protection and market integrity, we will make those changes.
This is a big project and we are just starting out, but together with competition training we are rolling out across the organisation and the recruitment of more staff with competition expertise, we are on a journey which will end with ‘promoting competition in the interests of consumers’ written into the DNA of the organisation alongside consumer protection and market integrity.
We are thinking about how we look at competition issues and any remedies. I mentioned a few moments ago consumers faced with complexity quite sensibly work out their own rules of thumb. Firms have known for years that financial literacy in this country is low. They know that people aren’t very interested in reading small print on their contracts. They know that busy people won’t always shop around for the best ISA rates. This wasn’t labelled ‘behavioural economics’ until recently, and regulators have been behind the pace of firms in thinking about how to apply these insights, but we are spending considerable time on this now.
Of course, as Parliament expects in giving us a competition duty and objective, we are also going to be active in investigating where we see competition issues.
We will be looking into markets where we think ineffective competition is leading to poor outcomes for consumers. We will analyse markets from all angles, seeking to understand the interactions between both demand and supply-side competition weaknesses. At the end of a market study we will use our regulatory powers to make any changes we think would improve the effectiveness of competition or refer issues to the Office of Fair Trading (OFT) and in future the Competition and Markets Authority (CMA).
We already have one study into general insurance add-ons well underway and we are working closely with the OFT on their study into SME banking. Earlier today we announced a programme which will involve three key areas of work over the next 12 months.
Next month we will launch a market study into the cash savings market. Over 80 per cent of all adults in the UK have a savings account and total household savings are worth a trillion pounds. In a low-interest rate environment, it is more important than ever that we make the most out of the money we put away for a rainy day.
We know that consumer inertia in this market leads to low switching rates, which in turn reduces competitive pressure on banks to offer existing customers the best deals. This is why competition in the market has been focussed on so-called ‘teaser rates’ – high returns on your savings for a limited time period only. Firms rely on consumers not switching away once the rates drop. We will explore the hypothesis that this allows incumbents with a large back book to advertise better headline rates than any new player could afford to offer for a sustained period, weakening competitive pressures. We will also explore whether this leads to an inefficient market outcome – firms introduce and withdraw a plethora of savings accounts each year, making it even harder for consumers to compare and choose good value products.
The second area of focus will be retirement products. It is crucial that when consumers make potentially life-changing financial decisions, they are properly informed and there is a range of quality products available to them at a good price. We are concerned that some people may not be getting the best deal when they sell their pension pots for income in retirement.
For instance, inertia leads to many consumers sticking with their current pension provider when buying annuities. This inertia is compounded by the inherent complexity of the decision – factors that need to be taken into account include life expectancy and inflation. Perhaps it isn’t surprising that one third of retirees simply don’t shop around at all when buying their annuity.
This is a one-off decision which can’t be reversed, so there is no chance for consumers to learn from mistakes and this further weakens the ability of the demand side in this market to pressure firms into making competitive offers.
Earlier this year we started some thematic work specifically looking at annuities, which make up about 90% of retirement products – the main alternative is income draw-down. In parallel the OFT has been conducting a study into the Defined Contributions (DC) pensions market. It is too early to say what the findings from either piece of work will be, but this is a market of huge significance to consumers and of great value to the industry. We will be looking closely at the findings of both pieces of work and would expect to say more about the appropriate next steps towards the end of the year.
Finally, we also recognise the importance of effective competition between firms operating in wholesale markets and how this can lead to better quality and cheaper products down the line for retail consumers. By their nature, wholesale markets tend to generate less immediately obvious problems. The transactions on the whole are between businesses rather than more vociferous consumers, but the knock-on effects for ordinary consumers can be huge.
Take asset management for major institutional clients, such as pension funds or insurance companies. This market is worth around four trillion pounds – even small improvements in competition here could lead to enormous savings for these clients and therefore also everyone with a pension or insurance product. Another example is equity underwriting by investment banks. The underwriters face a potential conflict of interest between their issuer clients (who want a high price) and potential investors in new equities and bonds (who want a low price). Since equity underwriting advice tends to be a one-off purchase, issuers also face significant information asymmetries with respect to the investment banks.
From next spring, before we decide whether a full-blown market study is needed, we will conduct a Wholesale Strategic Review, which will help us understand where competition problems may be occurring and if interventions to promote competition could create big benefits for both wholesale and retail consumers of financial services.
To bring us back to where I began, the FCA is a new regulator. Our actions will be aimed at improving customer outcomes. We want firms to do the right thing for their customers, while keeping them and the integrity of the markets they operate in at the heart of everything they do. The new focus on competition will, along with our other objectives, help us get to the root causes of problems.
By fundamentally challenging the shape of the markets we regulate, we want to see firms direct their energies into competing in the interests of their consumers. In turn, if we and they can achieve that goal we will play a key part in restoring trust in financial markets.