You may quite reasonably think that a title of ‘The future of financial conduct regulation’ is overly dramatic in an environment where we have quite enough drama in the world of public policy thank you very much. Or, you may think that it is typical of a regulator to over promise and under deliver. We shall see, but it is a reasonable ask that I should start by explaining why this subject and why now?
Let me go back to 2017 when we published the FCA Mission statement, which continues to be the centrepiece, the glue, that holds together our approach to the large landscape of activity that the FCA covers to meet its statutory objectives. It shapes our culture too, for example we have re-done our statement of values in the light of The Mission. What we did with The Mission was to set out a much-needed framework to explain and interpret why we regulate conduct across the markets for finance. At the heart of it was a very simple point – but simple is I believe a source of strength – that we always and only regulate in the public interest, and we must always and only do just that.
We have therefore set out to explain how we interpret the public interest in the light of the objectives given to us in statute by Parliament. And, we also recognise that while those objectives are timeless, or should be, how we put them into practice will change with time as the world around us changes. The public interest is therefore our anchor, and it needs to be a strong one.
I was careful a moment ago to say that our objectives should be timeless, which implies an element of doubt. That’s right, because the record of history indicates that broad attitudes towards public interest regulation have changed in what can appear to be long waves. Those changes can be large and destabilising for both the regulator and the regulated. Prior to the financial crisis, the light touch era reflected a view that a greater emphasis on the private interests of firms, their owners and managers would benefit all and thus the public interest. I tend to call this the ‘rising tide lifts all boats’ view of our world. But it didn’t turn out that way – there were very clear losers, and the scale of that problem has emerged over a long period of time.
The consequence has been a decade of re-regulation, reversing the long swing. And, this has not been the invention of self-interested regulators alone, far from it. There are very strong public forces pushing for stronger protection in society. If you spend a day or two with my inbox, you will see that writ large.
This can easily result in regulators being cast as the villains of one side of the argument or the other. Indeed, I am always conscious of the need to avoid to resort to the comfort that, if my inbox suggests that I am the villain of both sides, I must be broadly okay. Let me therefore have a go at setting out how I view our stance in this debate on the role of regulation in a big picture sense.
As a regulator, I support economic growth and want to encourage and enable it to happen. I support a strong and successful financial services industry and I want to enable that outcome. And I support successful open financial markets, with free trade that points away from tying markets to locations, and markets that are global not narrowly regional. But, the big but, all of this needs to be done on a basis that is fair and sustainable, and fair to all groups in society reflecting the different capacities and vulnerabilities that exist in any society including our own. The public interest demands that we combine success with fairness and sustainability. Now, let’s be realistic: no one really ever disagrees with that statement, but people can interpret it very differently, and that’s where the regulator comes in.
Let me finish this very lengthy opening with a concrete statement of why now to put the future of financial conduct regulation on the table. First, most proximately, today the FCA has published a response to our Discussion Paper on the case for introducing a duty of care on authorised firms. This is another part of our follow-up to The Mission. I will say more about it towards the end of my remarks. Second, I have got this far without mentioning the B-word, but no further. Brexit does inevitably raise important issues for the future of regulation. Today I want to go back to some first principles to start to lay out a framework to think about questions of what comes next.
In going back to first principles as a framework for considering the future, I am going to use four lenses to look at the approach to conduct regulation.
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.
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.
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.
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.
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.
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.
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. So, what follows only scratches the surface in the interest of getting the debate to progress.
It is easy to draw a simple distinction and note that the UK’s legal approach is rooted in common law and developed more through case law, while the EU system has deeper roots in the continental legal tradition of codification and greater use of statute rather than regulatory rules. On this basis, the UK approach (I am deliberately ducking the English versus Scottish legal tradition here, simply noting that Scottish law is more of a hybrid of the two traditions) is based more on the experience of cases, evolving in response to changing conditions and conceptions of the public interest.
It is thus more inductive rather than being deductive in the sense of drawing from a single vision of a legal system. But to be clear, I don’t see this observation as inconsistent with Parliamentary sovereignty – it’s about how that system is put into practice.
And in the world of public or administrative law – of which our world is part – the task is to apply standards of reasonableness and fairness through the use of discretion which respects the values and attitudes of the time. I am all too aware that views on what is fair and reasonable can differ.
But there are very sensible challenges to this view of an underlying difference of legal approach which assert that EU law for instance is more of a hybrid of the two traditions, a mix of reason and experience. And, clearly since the 1970s the UK approach has become more hybrid as the EU space has expanded.
I will though make one practical observation, which may have considerable implications for future choices. If you look around the world, you find that wholesale financial markets are more commonly found in countries with common law systems. I don’t think this is an accident or random act. Wholesale markets work better in systems that base their rules and principles more on experience.
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.
Let me give one example, something that is the subject of the day at the moment in our world of Brexit preparations, the so-called trading obligation rule in EU law. The problem with this debate from my perspective is that I simply fail to understand why we need such a rule when there is a well-established principle that firms must obtain best execution for their clients.
In such a world, through applying a trading obligation and limiting options for best execution, we harm a regulatory objective we are seeking to achieve. Furthermore, in a world where one jurisdiction applies a trading obligation, it may force others to do the same and drive fragmentation in markets.
Taking the lessons of experience, I think it’s safe to say that there are things we would have done differently with EU rules if we had developed them unilaterally, but where we compromised to ensure a level playing field across the EU and through cooperating closely with our counterparts. But where we have generally not differed is in our agreement on the objectives we want to achieve, which will not change with Brexit.
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 central principle of equivalence is that both sides are free to determine unilaterally whether the other side’s approach is equivalent to theirs. Yes, but, taken to an extreme this eliminates any scope for common understanding and goes against some of the significant achievements recently such as the common approach to derivatives clearing and trading between the EU and US that was agreed in 2016 and 2017.
To work effectively, it surely needs a common agreement on ‘rules of the game’ setting out the substance and factors and the procedure for reaching unilateral judgments, and there should be a mechanism also for dealing with disagreements or issues such as withdrawal of equivalence on either side. The substance is the outcomes which are shaped by the objectives that matter in the public interest – consumer protection, market integrity, financial stability, competition and these should be set out clearly. So, it is not about whether we each approve of the other’s rules but whether they achieve the common substantive outcomes.
Moreover, a conclusion that the other party does not meet these objectives must be open to reasonable challenge and therefore with appropriate warning, and any resulting implementation must also be consistent with those objectives. Clearly, the issue of equivalence and the differences in approaches to regulation and legal systems is a big one, and deserves extensive debate.
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.
But they have to be grounded in something which is more than a means of delivery as rules are. That grounding needs to be in clear principles. With this in mind, principles are the fourth lens through which to view the future of financial conduct regulation.
As I mentioned earlier, today we have published a response to our Discussion Paper on the case for introducing a duty of care on authorised firms.
The backdrop to this is that some parties have expressed concern to us that our regulatory framework, including our Principles for Businesses, may not be sufficient or applied effectively enough to prevent harm to consumers. Hence the suggestion of a duty of care to reduce that harm. Others believe that our existing set of principles and rules are sufficient and they, in effect, impose the same requirement on firms as a duty of care would. They also point to the SMCR as an important new tool which should be given time to prove its worth.
The volume of feedback we received on the Discussion Paper reflects the strongly held views on both sides. Today, we have published a summary of those responses and set out our initial thoughts and conclusions.
Neither argument is invalid, nor should either be dismissed as self-serving. But they do point to two different worldviews. And, as the frequent arbiter of these debates, we have to find a balance between them.
For one side, a duty of care would trigger a fundamental change within firms, moving them to ask, ‘is this right’, rather than, ‘is this within the rules’? It would create clarity for consumers about what they can expect and/or demand of firms, and articulate a single, overarching concept of care, which would help rebuild consumer trust. And it would create clarity for us at the FCA, by acting as a general ‘backstop’ against which we can take action in cases of new and emerging harms that may not be captured by the existing approach.
For the other side, a duty of care would be difficult to apply to the wide variety of firm-consumer relationships in financial services, not to mention the challenge of developing a wide body of legal precedent in sufficient time. They also point to the loss of regulatory agility and adaptability if the courts take a larger role, the risk of duplication and confusion of existing obligations, the challenges of litigation for consumers and the potential stifling of innovation and access.
Alternatives to the duty of care were put forward – such as a reset of our principles, which, it was posited, would clarify the duty of firms towards consumers and prevent harm more effectively without adding legal complexity. Respondents also challenged us to apply the concept of fairness more vigorously, by acting where we see misconduct that breaches a principle, even if not a rule (this could be seen as the ‘spirit and letter’ approach).
Other respondents told us that real change to consumer outcomes can only come from a fundamental cultural shift within firms – of a kind that cannot be driven by external forces, such as regulatory intervention or a legislative duty – even if we have an important role to play in driving and sustaining that cultural shift.
So where does the FCA stand in all this?
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.
The canvas on which we work is big, and at times daunting. But, more than ever, it requires our attention.
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.
This is the future of financial conduct regulation that we are striving for. And I look forward to working with you to achieve it.
Note: This is the speech as drafted and may differ from the delivered version.