Introduction: A challenging year
Will 2019 prove to be another challenging year for UK financial services? For those involved in banking, capital markets, asset management and insurance, the upcoming political and regulatory agenda suggests it will be. A year of potential disruption is in store for a sector that is still adjusting to new rules (eg MiFID II, GDPR, PSD2 and other prudential and conduct regulations), rapid technological developments, changing industry practices and evolving client and consumer behaviour.
The number one issue for many, of course, will be Brexit. Undoubtedly, all eyes will be on Westminster for the coming weeks as the Prime Minister attempts to pass her Brexit deal through the House of Commons. While it is widely predicted that Theresa May will fail to convince enough MPs to back her for the first attempt of the meaningful vote, no-one really knows what will come next – so expect markets to react to this uncertainty and disruption with plenty of volatility. The financial services sector is arguably better prepared for Brexit than many other industries, but a no-deal outcome will nevertheless be a profound shock. If no deal transpires, then the immediate disruption could be severe – we would expect to see major international banks enact plans to relocate portions of their operations to other European financial hubs, while UK-focused lenders and asset managers will be focused on the macro-economic impact of a no-deal Brexit.
Brexit is not the only geopolitical issue that the City is focused on. The past week has seen US-China trade relations emerge as key concern for markets, impacting on FTSE share prices. Closer to home, however, the increasingly unstable nature of UK politics has meant that the prospect of a near-future Labour Government led by Jeremy Corbyn is now seen as a genuine possibility. Jeremy Corbyn and his Shadow Chancellor, John McDonnell have been developing a left-wing policy agenda with proposed radical reforms to UK business: including nationalisation, dilution of shareholdings, workers on boards and sweeping trade union powers. The implications for businesses and UK financial services could be significant.
At a more day-to-day level, the regulatory agenda continues to be shaped by policy-makers’ desires to inject greater transparency into markets, facilitate greater competition and choice, minimise risks associated with technology, address a legacy of industry misconduct issues and maintain financial stability. This encompasses a range of industry issues, practices, products and services – including asset management fees, research and advice, payments, P2P lending, blockchain and cryptocurrencies, cybercrime, whistleblowing and senior management accountability.
The following sets out in detail some sector-specific regulatory issues that the industry will be focused on in the coming 12 months. Perhaps the only conclusion to be drawn is that this upcoming year will not be a quiet one for the City.
Regulatory Update: Financial Services Sector Changes
1. Private Wealth Management
• Fund managers are still focused on the implementation of MiFID II, particularly as some of the unintended consequences of become more apparent, particularly with regard to “research unbundling” and the impact it has on relationships between analysts and fund managers
• Under MiFID II, fund managers had to choose between paying for research costs out of their fees or obtaining investors’ consent to a research budget; most chose the former. Nine months’ worth of research has shown the cost of external research more clearly. Depending on market sector, the costs can be 7.5 times higher than if the fund manager absorbs them, e.g., in emerging markets.
• Another consequence of the ban on bundling commission and research has been that fund managers increasingly invest in large cap equities because of the loss of research on smaller ones.
• Another important section of MiFID II is on product governance, which applies to both product providers and advisers. Both have responsibilities for product suitability, disclosure and placement.
• The related packaged retail investment and insurance products (PRIIPs) regulation requires investors to be given a key investor document (KID) before purchase. There is a lot of controversy surrounding the mandatory content of KIDs, particularly past performance figures, which investment trusts are already using. The Association of Investment Companies (AIC) has called for KIDs to be suspended.
• As the implementation of MiFID II and the GDPR passes, the next big regulatory challenge for advisers not affected by Brexit is likely to be the senior managers and certification regime (SMCR), which starts in December 2019. The senior management of all firms need to start thinking now about how to adapt their management structure, including deciding who is responsible for what and how the resulting accountability will be recorded.
2. Asset Management
• Assets managed by UK managers from both overseas and EU investors increased last year. Brexit, and the ability of EU firms to delegate management to UK ones, is the top priority for many UK asset managers with clients in the EU and for UK branches of EU asset managers. Others fear a radical Labour Government more.
• The downward pressure on asset management fees continues. The next step will be the transparency of costs under MiFID II. This is likely to refuel the debate on passive against active investing. The sales of exchange-traded funds (ETFs) and index-tracking products is expected to increase.
3. Retail Banking
• Open banking (under which a customer can arrange for their accounts to be available to other financial advisers) has not gained much traction, perhaps because of the fear of hacking or simply consumer inertia. However, it could be a slow burner, with the increasing number of app-based services pushing consolidation of a person’s overall finances and know your customer (KYC) information into one accessible place.
• A milestone has been passed recently, with card payments exceeding cash payments in the UK (card payments accounted for 75% of all UK retail sales – an extraordinary figure). Some countries, such as China and Sweden, are well advanced in this trend.
• The Bank of England (BoE) is planning to issue guidance on climate change for banks. It is likely to focus on physical risks, including extreme weather events, such as flooding, and on transition risks from changes in Government policy and from technology, eg, lending to coal mines and coal-fired power plants.
• The peer-to-peer (P2P) lending sector is concerned by the FCA’s proposals to limit the marketing of P2P opportunities to sophisticated retail individuals (there are already restrictions on crowdfunding) because of the risks of loss that the individual may not have understood.
• Blockchain continues to be explored by both banks and customers. More than 75 banks are studying whether they can reduce costs by using it to meet the challenge of fintech payments firms. Accessing payment information using blockchain enables problems between correspondent banks to be resolved more quickly.
4. Financial Planning
• The FSCS have proposed that pension transfer advisers should pay higher levies than other types of adviser because of the higher risk of claims and their potential high value. There is currently no such distinction in categories of advisers (such claims account for more than a third of compensation). The FCA is asking advisers to report in their retail mediation activities returns on the high-risk activities they undertake.
• Independent advisers now account for 96% of those who advise on equity release plans (the FCA rules require that either the provider or an independent adviser should do this). This compares with a recent survey of individuals, which found that 81% did not want to take advice.
• A speaker at the CISI’s Financial Planning Conference warned advisers to reduce their charges to 1%. They pointed out that investors would see the full cost of disclosure from January 2019, and that some would realise that it is impossible to generate enough income if fees and charges were 2% or 3%.
• Retail insurance brokers are concerned that they may be bypassed under rumoured plans by Amazon and Google to put their subscribers in direct contact with insurance providers.
5. Capital Markets
• The BoE is putting pressure on banks and insurers to switch from using the London Interbank Offered Rate (LIBOR), in transactions such as interest rate swaps, to using the newly reformed Sterling Overnight Interbank Average Rate (SONIA) benchmark. The Prudential Regulation Authority (PRA) has sent a letter to larger banks asking them to confirm that their boards have considered the risks involved in the transition to the new benchmark. The implicit threat is that, if banks persist in using LIBOR, they may face higher prudential requirements.
• The change in payment for research under MiFID II has contributed to a reduction in brokerage house profits (for example, Cenkos’s income from research and commission was down 12%).
General Regulatory Changes
1. Corporate Governance
• Whistleblowing has claimed another high profile ‘scalp’. Swiss asset management firm GAM has said that the well-known fund manager Tim Haywood was suspended as a result of breaching internal procedures and fund rules (shades of earlier scandals) brought to light by a whistleblow.
• The FCA has warned firms against technology failures. Andrew Bailey identified two types of risk – straightforward breaches because of a lack of operational resilience and “greater complexity of operational platforms and frameworks which can lead to disruption for consumers when things go wrong”.
• Through the Money Advice Service (MAS), the UK Government is testing the use of robots on social media, which will encourage people to save more.
• The global movement to regulate social media platforms is gathering speed, eg, through forcing them to take legal responsibility for material posted on their platforms. The UK Government will publish a white paper next year; other governments are addressing individual social harms.
3. The FCA
o There is greater use of the FCA’s relatively new competition powers, particularly in promoting good consumer outcomes and reducing costs to consumers. There is also a new Director of Competition at the FCA, Sheldon Mills, who was at the Competition and Markets Authority (CMA). Early studies of platforms and asset management show the direction of travel, but the timing of these may be held back by the FCA’s current focus on Brexit.
o There has also been much talk about phoenixing – where the individuals behind a failed firm apply for authorisation for a new firm. The classic case is Beaufort Securities which recently failed; the people behind it were previously involved in another firm that had severe regulatory problems. It also applies to advisers. The FCA is planning to use fintech approaches to identify suspicious individuals, eg, those who use a different date of birth or even a different name.
4. The FSC
So The Financial Services Compensation Scheme (FSCS) has calculated the levy on private wealth management firms from the failure of private wealth manager Beaufort Securities, at £50 million, or possibly less. It plans to cover this from its annual levy rather than by a one-off supplementary levy.