Search This Blog

Thursday, 13 December 2012

Midata Thoughts No. 1

Hard on the heels of the government's recent warning shot, we're now into the working group phase of the voluntary Midata programme.

I'm involved in the working groups on Transmission and Data Protection Regulation & Enforcement. Other members of the Interoperability Board are also looking at Identification; Data Storage; and Onward Data Release to Third Parties. In due course, we will draw those aspects together, with the exact form and format of the output to be decided.

Of course, this is not intended as a 'closed shop' and I have tried to be transparent, via this blog, about my involvement. This has included publishing a summary of my response to the Midata consultation over the summer. In keeping with that, I am now embedding below a presentation of my initial thoughts following discussions on the roles of participants, process flows, the developing co-regulatory environment, risks, controls and challenges. I have also included scenario diagrams covering the three types of scenarios involved.

I welcome any comments, queries or suggestions you may have. I will post further updates in due course.

Monday, 10 December 2012

P2P Finance Policy Summit

Everyone seemed to enjoy the Peer-to-Peer Finance Policy Summit on Friday. Huge thanks to our hosts, panellists and all in attendance for putting so much effort into a great discussion. There will be de-brief at The Finance Innovation Lab tomorrow and a summary of the output from the summit should be available shortly [now here]. In the meantime, I've embedded my presentation below.

A pan-EU version of the Open Letter will be available this week to support a series of other events that are occurring in Europe.

As I mentioned on the day, this event grew out of a session at the Finance Innovation Lab in March on whether disruptive policies can help deliver a sustainable financial system. We thought that financial innovation could be fostered through a series of such forums involving representatives of IT, marketing, finance, operations, legal and so on, as well as platform participants, regulators and policy-makers. Proportionate self-regulation and formal regulation could evolve through this process, as considered necessary. Such 'co-regulation' already has successful parallels in contexts such as broadcasting and advertising, to name but a few, and it will be interesting to see the extent to which such a process develops here.

We may even see some counter-regulation, where offline businesses are required to implement the benefits of successful online business models, as in the case of midata.

Thursday, 29 November 2012

Caution On Payday Loans Cap: It's A Midata Problem

The government is right to resist automatically capping interest rates for short term or 'payday' loans, and to insist on an evidence-based approach to the market which takes account of unintended consequences. Powers to cap rates, prevent endless renewals and aggressive, unsupportive collections activity are important. But it's critical to understand the real problem confronting the payday borrower before leaping to solutions.

Until now, the popularity of short term loans has been positioned in Parliament as a moral problem (rich for MPs!) for which an interest rate cap is the solution. 

But the annualised percentage rate (APR) for short term loans is misleading and unhelpful for borrowers in context. It only enables comparison of one short term loan against another. And it produces such a strange result against longer term loans that borrowers ignore it - especially, as those loans may not be available to short term borrowers anyway.

Typically, a short term loan is applied for when other debts are due, fees are about to be incurred and other consequences are biting or about to bite. The relevant data points include the cost of unauthorised overdrafts, default fees on card accounts, the consequences of missing the rent, failing to pay a phone or energy bill, and so on. Borrowers react to the worst of the known consequences when borrowing, but may not be aware of them all, let alone take them all into account when assessing the best option.

This is a data problem, not an interest rate problem associated with just one of the options available to the borrower.

What would be helpful is a tool that enables comparison of all the options facing a short term borrower in the borrowing context.

Such applications are evolving, and it's important to note that the government is also playing a role to foster that evolution.

The Midata initiative, for instance, is aimed at producing solutions to meet exactly this kind of challenge. It aims to drive the development of simple applications that will access a person's own transaction data (including fees) to enable that person to make better purchasing decisions. Initially, the government is targeting suppliers in markets for energy, mobile phones, current accounts and credit cards. But it has issued a warning to others. 

If only we could get our MPs to focus on proportionate solutions to the root causes of society's problems rather than embarking on populist moral crusades and fiddling their expenses!

Tuesday, 20 November 2012

Warning Shot Fired Over Midata

The government is preparing the way for regulations to enable consumers and small businesses to request all their transaction data related to energy, mobile phones, current accounts and credit cards. If considered necessary, regulations could be in place in 2013, and may target other markets where certain factors point to consumer detriment.

The decision follows a consultation in the summer, and the full  response is here.

The proposals should add momentum to the voluntary Midata programme fostered by the Department for Business Innovation and Skills to help industry and consumer representatives resolve some of the key challenges in the 'core' consumer markets.

The Information Commissioner’s Office would take the lead role in enforcing any regulations, while concurrent enforcement powers could be given to sector-specific regulators.

The 'transaction data' at stake are the records of a consumer’s own purchases or consumption from a supplier - what the consumer bought, where and how much they paid for it - not the supplier's subsequent analysis. The data would have to be released in computer-readable format to enable it to be analysed by the consumer or a service provider of his/her choosing. This would help prevent suppliers gaining an unfair pricing advantage over consumers, for example, and make it easier for consumers to figure out the product right for them.

Factors the government might consider when deciding whether to expand the programme to other sectors include: 
  • the market is not working well for consumers, e.g. consumers find it difficult to make the right choice or their behaviour affects pricing it's difficult to predict that behaviour;
  • there's a one-to-one, long-term relationship between the business and the customer, with a stream of ongoing transactions;
  • consumer engagement is limited, e.g. low levels of switching or competition; and
  • suppliers don't voluntarily provide transaction/consumption data to customers at their request in portable electronic format.
I should add that I am involved in the Midata programme, as a member of the Interoperability Board, and on working groups considering issues related to data transmission and law/regulation.

Tuesday, 13 November 2012

Should The CBI Chief Resign?

Despite purporting to represent 240,000 businesses of all sizes, the Confederation of British Industry (CBI) has long been an apologist for the UK's banks (who account for a substantial proportion of its funding). But in one hilariously poorly judged article in the Times, its director-general has finally eroded all credibility by calling for both a time-bar on PPI compensation claims and protection for UK banks against any successful court proceedings arising from their Libor fixing activities. 

Now you might think it particularly poor judgement to choose the current bank-driven economic scenario as a golden opportunity to demand yet more public assistance for the authors of our doom.  

And you might well believe it to be spectacularly naive, irresponsible and even downright absurd to demand protection for the beneficiaries of what is now the largest case of financial mis-selling in British history, at the expense of victims, from the very regulator who is bound to protect them.

But surely then you'd have to consider it to be successfully suicidal to invoke retrospective sovereign immunity for fixing a global interest rate benchmark while domestic criminal investigations are in progress, not to mention civil suits of the kind one or more of your own members might bring.

I can't imagine that even the banks would have the barefaced cheek to ask for any of this privately, let alone in an article in the Times. Still, you never can tell with Britain's institutions.

Finally, however, let's not ignore the CBI chief's bold and cunning suggestion that the banks' £12bn in provisions for PPI compensation might somehow represent spare funds that could, or would otherwise be lent to people and businesses (in other words, not to the low income earners who would have received it in compensation). 

Conflating the accounting for civil penalties with the privilege bestowed on banks by the state to create credit is not just silly in its own right. It also invites attention to the fact emphasised by Richard Werner, that only 10% of the credit created by UK banks in the exercise of that great public privilege is actually directed toward the people and businesses who need it to grow the economy, while the other 90% goes to fuel speculative deals in non-GDP financial assets. So, whatever you might think of opportunistic, ambulance-chasing PPI claims management firms, you might find it utterly contemptuous for anyone to suggest that consumers should forego compensation for being sold phoney insurance when it would barely amount to a rounding-error on such rampant, unchecked public exploitation. 

But maybe this is what the CBI means by "asking for immediate action to smooth the transition to a "new normal" in banking lending [sic]."

Yes, Mr Crudland, I reckon you should get your coat.

Wednesday, 10 October 2012

You Want Another 'Clarion Call' To Regulate Crowd Investing?!

On Monday, Lord Sharkey and Baroness Kramer proposed a 'probing amendment' to the Financial Services Bill to add "The activity of establishing, operating or winding up a crowdfunding scheme" (see here, from column 832). In support of this, Lord Sharkey cited the example of the US JOBS Act and the fact that most new jobs are created by small businesses. He also cited a report by the Association for UK Interactive Entertainment (UKIE). Oddly, however, in declining to support the latest amendment, Lord Sassoon said (at column 835), "there has been no clarion call from industry for more regulation." This appears to arise out of some confusion over the meaning of the term 'crowdfunding', which is being used in some circles to refer to all direct finance platforms, regardless of whether they facilitate donations, lending or investment in debentures and shares.

This is in fact the third amendment that relates to peer-to-peer or direct finance platforms, the first pair of amendments having been debated on 18 July (see columns 325 to 332). All three are really part of the same debate insofar as they share common types of operational risks, regardless of the type of instrument available on the platform. In that earlier debate (at column 330), Lord Sassoon confirmed that "changes being made as part of the Bill under Clause 6 would make it legally possible to bring direct platforms into scope." From the immediate context, he seemed to be only referring to peer-to-peer lending, since that amendment deals with "Rights under any contract under which one person provides another with credit". However, this should also permit regulation of crowd investing in other debt insturments (debentures), leaving open the question of whether equity-based crowd investing can be definitively brought in scope. 

Lord Sassoon said the financial regulatory framework is flexible enough to enable crowd investing, and he says the FSA's note on crowd investing shows that the matter is in hand. But he did add, rather tellingly, that "industry standards and further FSA and FCA guidance may have an important role to play in future." 

That seems an unnecessarily cryptic reference to the Government's recent response to the Red Tape Challenge on challenger businesses, which is why the suggested lack of a 'clarion call' seems rather odd. That Red Tape Challenge indeed yielded a 'clarion call' from industry for proportionate regulation to clear the way for various forms of direct finance. Follow-up submissions produced in consultation with various platforms dealt with both crowd investing and peer-to-peer lending, as did submissions in support of the July amendments in the House of Lords. 

And, as the government's creation of a cross-departmental working group suggests, there is a lot of work yet to be done in response to that call.

Friday, 21 September 2012

Government to Challenge Financial Red Tape

The UK government has announced proposals to clear the path for the growth of peer-to-peer finance platforms (also known as 'crowdfunding'). 

The latest government response to the Red Tape Challenge shows a determination to make it easier to innovate in ways that deliver lower cost, transparent financial services to consumers and small businesses. 

The government is sensitive to concerns that any regulation in this area should be proportionate and not raise barriers to entry or further innovation. As a result, the government wishes to encourage continued self-regulatory efforts by the Peer-to-Peer Finance Association to address common operational risks, and to engage with policy-makers and regulators. 

Critically, the government will also create a cross-departmental working group comprising representatives of all the relevant bodies it considers ought to be engaged in the development of peer-to-peer finance. Specifically, that working group will "monitor the appropriateness of the current regulatory regime for peer-to-peer platforms" and take the lead in engaging with the peer-to-peer finance industry. 

The composition of this working group is testimony to the broad policy implications and opportunities posed by this new form of financial model. The list of members includes the Office of Fair Trading, the Department of Business Innovation and Skills, HM Treasury, the Financial Services Authority and the Cabinet Office. However, it is known that the Department for Culture Media and Sport is also very interested in the potential for peer-to-peer finance to fund the development of the arts and entertainment industry. 

Peer-to-peer industry concerns were also backed by Mark Littlewood, Director-General of the Institute of Economic Affairs, in his response as Sector Champion for this aspect of the Red Tape Challenge. His report offers various additional solutions as an alternative to regulation. However, he does recommend certain exemptions be introduced to the financial regulatory framework to enable 'crowd-investing' for shares in start-up companies. 

Interestingly, Mark Littlewood has also suggested a means of 'future-proofing' regulation. He suggests regulators should be open to engage with new entrants at an early stage of their development to provide them with enough certainty to get started quickly. Officials should support appropriate self-regulation in the early phases, for example, through accreditation with the UK Accreditation Service (who presumably would also need to be similarly approachable and flexible).

Wednesday, 12 September 2012

Response to Midata Consultation

As part of its 'midata' initiative to empower consumers, the department of Business Innovation and Skills has been consulting on a proposal to give the Secretary of State a general power that "might be exercised broadly or in a more targeted way" to compel suppliers to supply transaction data at a consumer’s request. In the interests of transparency, I've summarised below my response to the consultation. As previously explained, I should mention that I've been involved in the midata Interoperability Board from its inception in 2011.

General Comments:

'Midata' scenarios involve consumers' transaction data being returned to them in a way that enables them to use it to improve their purchasing decisions. This reflects an existing, yet evolving commercial trend that is developing positively. Many businesses provide customers with their personal transaction history through ‘my account’ functionality which enables downloads. In addition to price comparison sites, other intermediaries are evolving to help consumers identify where data is stored, as well as to gather, share and analyse it.

It is acknowledged that there are certain operational risks involved in the widespread sharing of such data and various suppliers, intermediaries, officials and consumer representatives are co-operating to address these. One example is the work done by the World Economic Forum ‘tiger-teams’ on “Rethinking Personal Data” (here's my note of the London session). Government is also playing a very helpful role in fostering an environment in which suppliers can evolve best practice in the management of operational risks, as illustrated by the Midata initiative. Official guidance in the area includes the UK Information Commissioner’s guidance on data sharing.

These initiatives are sufficiently flexible and adaptable to support innovation rather than to stifle it. There is no evidence that these approaches are failing to adequately address the operational issues identified.

Regulation, on the other hand, is more rigid and often has unintended consequences that are hard to rectify in a timely fashion, particularly where it is general in nature and not evidence-based. As a general principle, prior to granting powers there should be clarity concerning the basis for their exercise, applicable exemptions, sanctions and other checks and balances.

Risks or undesirable consequences from exercising a power to require certain data to be released electronically could also include:
  • undermining the cooperative approach to addressing operational risks and the evolution of best practice described; 
  • reducing the flexibility and adaptability of risk management measures and stifle innovation; 
  • paralysing development until market participants are clear on the basis for the exercise of powers, applicable exemptions, sanctions and avenues of review or appeal. 

So, while it is worth exploring whether a power of the kind proposed might encourage industry participants to act appropriately, it is difficult to support it in the circumstances described above. Rather, in my view, the government should continue to foster (and participate in) an environment in which best practice can evolve rapidly and flexibly; survey the rate of take-up of appropriate services and the adequacy of operational risk management; and issue guidance where appropriate. This would enable an evidence-based approach to regulation in due course if necessary.

Obligations for Specific Sectors or Data Types?

While all suppliers with consumer or micro-businesses as customers should be encouraged to participate in the 'midata' trend, I would be concerned that a regulatory obligation to provide transaction data to such customers may cause some businesses to withdraw from those markets.

This trend should also naturally pick up useful data that is not currently in digital format. However, I would be concerned that any mandatory obligation that is focused only on data held electronically will discourage businesses who would ‘digitised’ offline data from doing so.

Impact of the Proposed Mandatory Approach

My concern is that the proposed regulatory approach would be too narrow in its focus and effect. The WEF process has established that Midata scenarios require a holistic approach to the various challenges inherent in returning data to customers electronically. The value and utility of personal data is a hugely complex dynamic that varies by:
  • the context or the activity we are engaged in, 
  • which persona we are using at that moment, 
  • the actual data being used or provided, 
  • the permissions given, 
  • the rights that flow from those permissions, and 
  • the various parties involved. 
We need a global set of rules that are flexible enough to address all these variables, with the protection of a person's rights at the centre. Such rules must be capable of being simplified at the customer level, understood in terms of specific rights and obligations at the legal and regulatory level, and ‘coded’ to ensure that computers handle the data consistently with these rules.

The legal aspect of this breaks down into a set of rights and duties from which liability and accountability can flow in a way that does not make it impracticable for any necessary participant in the overall process. Those rights and duties will obviously vary according to whether you are the individual data subject, the provider of a personal data store/service, a business customer relying on data about the individual or acting in a governance role. They must be compatible with public law, yet fill in many gaps where rights and duties are missing or unclear.

By way of example, the current ambition of the WEF is to agree a 'simple' set of common licences or sets of permissions which any individual can nominate to govern the use of their data in a given context (like the creative commons copyright system ). The technological solution is a 'personal data mark-up language' that will enable anyone holding the consumer's data to 'mark-up' items of data in their existing databases to correspond to the permissions they've been given.

Who Should Be Able to Request Data?

Consumers and businesses employing fewer than 10 people ("micro-businesses", most of which are owned and operated by individuals) should be entitled to request a supplier to provide their own transactional data, either to the customer or to a specified third party. Alternatively, a third party who is duly authorised by the customer should be able to seek the customer’s data in electronic format directly from the supplier.

The terms and conditions and other information that are required to be made available to the consumer under applicable law (e.g. Distance Selling Regulations) should be included with the transactional data related to the goods or services covered by those terms and conditions.

Formats and Response Times

The government should not mandate formats, since internet-based technology allows for the development of 'mark-up languages' that allow sharing of data in different formats, as described above. 

Appropriate response times will be contextual. Guidance should encourage standing ‘my account’ functionality accessible by the individual logging-in, rather than a request-and-response model. However, where a request-and-response model is adopted, the response should be ‘prompt’. 

Should Suppliers Be Able to Charge for Releasing 'midata'? 

Suppliers should not be prohibited from charging specifically for releasing transactional data, but be encouraged not to. In effect, however, ‘my account’ functionality is not really ‘free’ in any event since there is a price to the related goods or services. 

It's conceivable that some suppliers might wish to be transparent about the price of goods versus the price of supporting services. In cases where few consumers access their data, it may not be appropriate that all consumers may end up paying for the functionality. However, it is important that any directly applicable charges should be reasonably proportionate to the cost of making the data available, including a reasonable profit margin (e.g. 20%). There are similar regulatory requirements in relation to certain fees in the financial services industry, for example. 

Enforcement and Supervisory Bodies 

It is likely that access to personal transaction data will be included as a right and/or obligation in customer terms and conditions, and customers should be free to enforce these in the same manner as any other provision in that contract, including through the courts or alternative dispute resolution as necessary. 

In the event regulation  is required, any enforement activity in this area could be handled in the context of personal data regulation, general consumer regulation, or regulation related to dealing with consumers in specific sectors.  Accordingly, appropriate enforcement bodies would include those listed below, with the Information Commissioner's Office taking the lead: 
  • Information Commissioner’s Office 
  • Office of Fair Trading 
  • Trading Standards Institute 
  • Citizens Advice 
  • Key sector regulators, e.g.: 
  • Financial Services Authority
  • Ofgem
  • Ofcom
Prior to the advent of regulation, these bodies could participate in fostering an environment in which suppliers, intermediaries, officials and consumer representatives can evolve best practice in the management of those risks.

Under any necessary regulation, the enforcement bodies could be empowered to order disclosure and/or fine suppliers, intermediaries, etc for failing to disclose, security breaches and so on. 

As this trend develops, one could expect to see a decline in data subject access requests under the Data Protection Act 1998, and any related enforcement activity by the ICO. 

I'm interested in your thoughts.

Wednesday, 5 September 2012

FSA Note On Crowd Investing

In response to various comments and queries, I've reviewed the FSA's recent note to consumers on 'crowdfunding'. The FSA's note is actually quite a positive sign, although it's worth clarifying a few aspects discussed below. These relate to terminology and the policy context, the wider audience, opportunities for everyone to diversify, the potential for secondary markets and another means of protecting customer funds.

Here one has to sympathise with the FSA. Alternative finance platforms are springing up all over the country and the FSA no doubt feels obliged to say something helpful about those closest to its remit. Yet it is only empowered to supervise the current regulatory framework, which is ill-suited to the sort of innovation that crowd investing represents. The Treasury, which is responsible for producing the regulation that governs the FSA's remit, has been dragging its heels somewhat on this front. Even the US has beaten us to the punch by cutting a swathe through its byzantine securities legislation to provide a more proportionate regime to support crowd investing.

So in these respects the FSA's note is also helpful in illustrating the need for proportionate regulation that the alternative finance industry has been calling for to enable the responsible growth of non-bank retail financial services. The note is also perhaps a sign that the FSA acknowledges the need to look beyond the regulated markets when considering whether there is adequate innovation and competition within them.

Terminology and The Policy Context

I've previously discussed the various meanings of the term 'crowdfunding' and the policy context here. The FSA's note initially states that "crowdfunding involves a large group of people contributing money to support a business, individual or campaign." But that would encompass a wide array of situations that surely aren't in scope, including ordinary donations to charities, buying shares on a stock exchange and perhaps even retail sales. Accordingly, later in its note the FSA qualifies the statement by adding that crowdfunding investors will usually receive shares in the business or project they contribute to..." pre-purchase goods to be produced or "...receive a reward like a t-shirt or mug". I read this to mean that the FSA is referring to both 'crowd-investing' as well as the original form of 'rewards-based' crowdfunding that I've discussed previously. But that's not to say these activities are necessarily regulated by the FSA - indeed the FSA later points out that "almost all crowdfunds are not authorsed by [it]" - though it can be a complex undertaking to determine what is in or out of scope.

What is perhaps missing, however, is the primary point of distinction between crowd investing and traditional forms of investment. Crowd investing involves a marketplace comprising a crowd of consumers and/or small businesses on both sides, whose direct interaction is faciliated by a neutral platform operator. In other words, members of the crowd are engaging with each other on the same platform, rather than a single financial institution offering its own products to its customers. This phenomenon partly reflects the 'Web 2.0' or 'social media' trend that has also 'democratised' the retail, entertainment and other consumer-facing industries. In the investment context, it most often involves contributing relatively small sums of money you would be prepared to lose, in order to finance the activities of people and businesses whose success might benefit you, your community or society generally, but on terms that could also give you a financial return in that success. Other key differences between various types of crowdfunding models (in the broader sense) and traditional financial services are explained in Annex 1 to this note on regulatory reform.

Wider Audience

The FSA's note is primarily an explanation for consumers acting as investors, rather than an explanatory note to the people or businesses who see crowd investing as a way to raise funds, or to the platform operators who facilitate the interaction between the two. Again, this perhaps misses the point that crowd investing comprises a marketplace with a crowd of consumers and/or small businesses on both the investing side and the receiving side.

But the note does helpfully point out that "for businesses, crowdfunding can be a useful way to gain direct access to investors and finance that more traditional investors, venture capitalist or lenders are not prepared to offer."

That's putting it politely, as you might expect. Aside from the Web 2.0 trend, another reason for the growth in peer-to-peer finance models is that banks, pension funds and other traditional investors whom the FSA does regulate are continuing to conserve capital or offer finance on terms that are unduly onerous, while charging savers and investors high fees and/or failing to offer a decent return. This intransigence suggests that it's down to entrepreneurs and private investors to connect the dots between low returns on savings and the opportunity to fill the SME funding gap of £26bn - £52bn over the next 5 years, or the annual social sector finance gap of £0.9bn - £1.7bn.

Opportunities To Diversify

The FSA says that "crowdfunding could make up part of a diversified portfolio, especially for sophisticated investors." I do not read this to necessarily mean "sophisticated investors" in a regulatory sense (e.g. under the Financial Promotions Order). Even so, this begs the question why only 'sophisticated investors' should enjoy the benefits of the reduced investment risk that goes with maintaining a diversified portfolio beyond "mainstream investment products". People seen as 'ordinary' investors are proportionately suffering much more from a lack of opportunities to diversify than those who are more wealthy or finance professionals (if that's any proxy for 'sophisticated'). ISA and pension rules incentivise the concentration of funds into assets that are providing little return and generate high fees for institutions. Ironically, in rejecting calls by the Breedon Taskforce for broadening the ISA scheme the government highlighted the problem by confirming that 45% of the adult population is herding into the same narrow range of asset classes.

That's not to say that any old asset should necessarily qualify for ISAs and pensions, and I agree that the risks in such investments should be clearly explained to investors, along with the benefits. As I've said repeatedly, simplicity and transparency as to both the benefits and the extent to which you risk losing money are critical to the process of making financial services more consumable, but we need a more facilitative approach to that process. Policy-makers must recognise that crowd investing has its genesis in the trend towards greater transparency and consumer control, not less. Operators are trying to simplify financial services and make them more transparent and accessible to all. Legacy financial regulation is one of very few hurdles in the way of that trend, yet entrepreneurs are responsibly calling for more proportionate regulation rather than some kind of unregulated free-for-all.

Secondary Markets?

Interestingly, the FSA points to the inability to sell many crowd investments as a risk associated with crowd investing (which perhaps misses the point of crowd investing in the first place, as discussed above). Yet, ironically, current regulation renders the development of such secondary markets impracticable. So the fact that the FSA has called this out as a risk suggests that efficient means of secondary trading on crowd investing platforms may be permitted as a benefit to consumers in future.

Protection of Customer Funds

The FSA says you should "find out how your money is protected if the business, project or even the crowdfunding platform collapses - in particular check whether the business has appropriate cash reserves or even insurance supporting if it fails." This is true. While the very nature of 'investment' is that you may lose your money if a company or project you invest in does not succeed, it should also be made clear to you from the outset. But when considering what happens to your uninvested funds if an unregulated crowd investment platform collapses, it's worth mentioning that the platform operator might legitimately choose to hold funds received from customers in trust in a separate bank account, designated as holding customers' funds with the bank's acknowledgement, so that those funds do not form part of the operator's assets and would not be available to the operator's creditors if the operator were to fail. The operator may also make arrangements for the ongoing administration of investments in the event that it ceases to operate.

At the end of its note the FSA adds that "We are also concerned that some firms involved in crowdfunding may be handling client money without our permission or authorisation, and therefore may not have adequate protection in place for investors." However, its important to clarify that 'handling client money' is not a regulated activity in its own right. The FSA's client money rules only apply where the provider is both authorised by the FSA and subject to the FSA's own client money rules. So this does not mean that firms who are legitimately operating outside the FSA's remit (or who are FSA-regulated but not subject to the FSA's client money rules), cannot choose the other ways of protecting their customers' funds described above.

Finally, it's worth clarifying that even FSA-authorised firms may fail to follow the right procedures to protect customer funds, thereby potentially undermine the protective effect of the arrangements (as alleged in the case of Lehman Brothers and MF Global). In January 2011, the FSA also fined Barclays Capital £1.12 million for "failing to protect and segregate on an intra-day basis client money held in sterling money market deposits" over an eight year period.

The point is that even the most intense regulation will not remove investment risk entirely.

Image from Lattice Capital.

Monday, 3 September 2012

Unpacking The Term "Crowdfunding"

The term "crowdfunding" is being used a lot in legal circles these days, but it can mean a number of different things to different people - from many people buying shares in a single company to any form of peer-to-peer financing or donations. So for the sake of clarity I thought I'd explain my own understanding of the different types, as well as the overall policy context.  


In its broadest sense, 'crowdfunding' describes a key impact of Web 2.0 on financial services (as discussed over on Pragmatist, and in print here). It's one aspect of the same trend towards greater consumer control that has swept through retailing, entertainment and so on. The critical point of distinction between the various forms of crowdfunding and 'traditional' forms of finance is that crowdfunding involves a finance marketplace comprising consumers and/or small businesses on both sides, whose direct interaction is facilitated by a neutral platform operator, rather than a single financial institution offering its products to its customers. Other key characteristics are set out in Annex 1 to this note. But when the term 'crowdfunding' is used in this broad sense, one should bear in mind that it actually encompasses a range of very different models, involving very different legal instruments, with very different legal and regulatory outcomes, as discussed below.

'Crowdfunding' first gained currency to describe 'rewards-based' peer-to-peer platforms like ArtistShare and, which were designed to raise money from many people to fund many small budget projects via the internet without infringing US laws that control the offer of 'securities' to the public. On those web sites, eligible people are enabled to post 'pitches' seeking funding for a project (e.g. to start a monthly magazine) in return for a 'reward' of some kind (e.g. a monthly copy of the magazine for a period). There is a range of similar platforms in the UK (e.g., Crowdfunder and those mentioned here).

Independently of rewards-based crowdfunding, peer-to-peer platforms have also emerged in the markets for personal loans and small business loans. This activity was first called 'social lending', then 'person-to-person lending', 'peer-to-peer lending', 'P2P lending' and more recently 'crowd lending'. Examples include Zopa, Ratesetter and Funding Circle in the UK and, say, Comunitae in Spain. The peer-to-peer lending model has also been adapted to enable many people to fund numerous small businesses in developing countries, which is referred to as 'micro-finance' (e.g. Kiva, MyC4). When applied in the domestic not-for-profit or charity sector, the peer-to-peer lending model tends to be referred to as 'social finance' (e.g. Buzzbnk).

However, the term 'crowdfunding' has acquired a more formal regulatory meaning over the past year or so, as a result of the successful campaign in the US to introduce the JOBS Act to allow the crowdfunding model to be used in situations where 'securities' are the reward (Title III of  the JOBS Act is called the Crowdfund Act). This is apt to cause confusion outside the US, because the US Securities Exchange Commission has a broader interpretation of what constitutes a 'security', and narrower exemptions from the scope of its securities laws, than the UK and many other jurisdictions.

Prior to the JOBS Act, the SEC required an individual or small business borrower to comply with the same formal registration requirements for entering into a simple loan contract via a public web site that a major corporation must follow when offering its shares, bonds or debentures to the public. So US-based peer-to-peer lending programmes have had to be registered with the SEC at great expense and require a financial institution to act as an intermediary (e.g. Lending Club, Prosper).

But in the UK and many other jurisdictions such heavyweight requirements are applied to more complex debt instruments (bonds and debentures) and shares ('equities'). As a result, peer-to-peer lending (or 'crowd lending') using simple loan contracts has been established outside the scope of securities or investment regulation in the UK since Zopa launched in 2005 (later joined by Ratesetter and Funding Circle).

However, peer-to-peer models that involve shares and debentures ('crowd investing') have proved a lot more awkward to implement, given that traditional financial regulation is more intense in connection with those instruments. Exemptions have been more liberal than in the US (at least pre-JOBS Act), although fiendishly complex and expensive in time and money to interpret. As a result, there is a growing political consensus that the UK would also benefit from a US-style regulatory overhaul in this area. And it is in the context of this policy debate that use of the term 'crowdfunding' is most at risk of generating confusion between 'crowd investing' and other forms of  'crowdfunding' in the broader sense.

Policy Context

While 'crowd investing' is perhaps most under the regulatory spotlight currently, there are some common issues and operational risks across all types of 'crowdfunding' in the broadest sense (though less so with rewards-based crowdfunding). All types of plaforms involve a similar technological and operational 'architecture of participation'. And they all meet some difficulty under traditional regulation - and the more intense that regulation is, the more complex it is to innovate, launch, operate and grow. Small changes can trigger significant regulatory requirements, increase costs and inhibit marketing. Tax incentives favour products offered by traditional institutions and inhibit the ability of ordinary savers and investors to diversify.

As a result, the operators of both peer-to-peer lending and crowd investing platforms have been calling for proportionate regulation at the platform-level to enable rapid, responsible development, regardless of the type of instrument available on the platform. This process began when the leading UK peer-to-peer lenders launched the Peer-to-Peer Finance Association in July 2011, proposing a set of Operating Principles to address typical operational risks. They and several crowd investment operators have also participated in various government and private sector forums. The social finance sector has since added its support, with leading charity lawyers Bates Wells & Braithwaite citing the development of these types of platform as a necessary step in the development of social investment (which was also endorsed by the government-funded Community Shares Unit). And a meeting of wide variety of European industry participants took place in June 2012 to discuss the need for EU regulation. 

In the meantime, economic reality has also increased the pressure for clear and proportionate regulation to enable alternative finance. Banks and other traditional investors continue to conserve capital or offer finance on terms that are unduly onerous, while charging savers and investors high fees and/or failing to offer a decent return. There is a dawning recognition that it's down to entrepreneurs and private investors to connect the dots between low returns on savings and the fact that SMEs face a funding gap of £26bn - £52bn over the next 5 years, or that social sector organisations face an annual finance gap of £0.9bn  - £1.7bn

Against this backdrop, there have been numerous UK government reports and recommendations on the need to encourage the creation and development of both peer-to-peer lending and crowd-investing, with the weight of emphasis depending on the focus of the relevant initiative. These include the Cabinet Office's Red Tape Challenge on disruptive business models; NESTA's "Beyond the Banks" report; the Breedon Taskforce report (which the government largely accepted); Andrew Haldane's speech on forging a common financial language; and Lord Young's report to the Prime Minister on the start-up and development of small business. 

However, there has been little concrete action from the UK Treasury, prompting the debate of various amendments to the Financial Services Bill in the House of Lords. In essence, these amendments seek both greater engagement by the authorities in encouraging innovation generally, as well as specific regulation to encourage the growth of peer-to-peer models for a range of different instruments.

By way of comparison, it's interesting to note that the JOBS Act was the product of a US Presidential initiative in January 2011 which received bi-partisan support in the US Congress, and the new law was signed by the President on 5 April 2012.

Image from Lattice Capital.

Friday, 13 July 2012

Of Liebor and Combative Bankers

As sunlight radiates from US investigations into the Liebor saga, the British Bankers' Association looms more clearly out of the gloom. Emails in 2008 between from Tim Geithner, then President of the NY Federal Reserve, and Mervyn King resulted in the Bank of England passing on to the BBA suggested reforms to the way Liebor was fiddled determined. But after a 'consultation process' only two of six reforms were adopted. 

It seems odd that the Bank of England seemed a mere conduit for US reform suggestions, rather than insistent that they be taken up. We know that neither Liebor nor the BBA's Liebor arm were regulated, but clearly the NY Fed expected the Bank of England to be able to do something. Had relations soured to the point that no amount of 'eyebrow-raising' was effective?

It's interesting that Angela Knight was called upon to resign as CEO of the BBA in May 2011, when the banks were finally shamed into compensating customers for PPI mis-selling. Even they spoke of wanting someone less 'stringent' and 'combative'. Similarly, Barclays' ex-Chairman-now-reappointed Marcus Agius recently confessed that he received a stern letter from the FSA Chairman, Lord Turner, complaining that Bobby "Dazzler" Diamond had become "unhelpful" and "aggressive".

That's the same Marcus Agius who chairs the British Bankers' Association, in case you were wondering...

Monday, 9 July 2012

Word Count

Doing the rounds on email last week:
  • Pythagoras' theorem - 24 words.
  • Lord's Prayer - 66 words. 
  • Archimedes' Principle - 67 words. 
  • 10 Commandments - 179 words. 
  • Gettysburg address - 286 words. 
  • US Declaration of Independence - 1,300 words. 
  • US Constitution with all 27 Amendments - 7,818 words. 
  • EU regulations on the sale of cabbage - 26,911 words 

Image from DesignAndBuild.

Tuesday, 3 July 2012

FAQ on Crowdfunding Amendments to the Financial Services Bill

Today, the Financial Services Bill is being discussed in Committee Stage in the House of Lords. Set out below is an explanation I prepared on the amendments to the Financial Services Bill proposed (at 114) as a basis for promoting more effective competition in the interests of consumers and small businesses in the regulated financial markets, including the establishment of a new authorisation regime for direct finance platforms - or 'crowdfunding'. 

Thursday, 21 June 2012

Innovation Meets The Financial Services Bill

Embedded below is a set of amendments to the Financial Services Bill which I've prepared with the help of a colleague, Tony Watts, at the invitation of several Peers to aid in their review of the Bill. The paper builds on a submission to the UK government in January.

The aim is to require the authorities to encourage responsible innovation in retail financial services generally and, as a case in point, to clear the way for the growth of peer-to-peer platforms - transparent, low cost services that are open to all but which don't tie up vast amounts of capital or require a public guarantee.

Specifically, these amendments will:
  1. Generally oblige the financial authorities to look outside the regulated markets when assessing whether there is adequate competition within those markets;  
  2. Remove the uncertainty, cost and delay in launching new peer-to-peer platforms, by creating a clear set of rules by which they must operate, regardless of the type of instruments available (reflecting the carve-out for retail payment services from the historic ‘banking monopoly’); 
  3. Enable the inclusion of peer-to-peer loans and investments within the small range of assets currently available to ordinary people via ISAs.
  4. Enable the same process of evolution towards cost-efficient and transparent financial services that we have already seen in other online retail markets.
The document is still in draft, and comments are welcome.

Saturday, 16 June 2012

Rethinking Personal Data

On Thursday I joined a World Economic Forum 'tiger team' focused on rethinking personal data, a process that aims to build on reports revealing personal data as a new asset class, and meeting the challenges this evolution brings. My thanks to Liz Brandt at Ctrl Shift for inviting me along. Apparently, as one non-legal delegate put it, "there are not enough lawyers at these sorts of events."

In essence, we are moving from a world where data about each of us is compiled into large national databases by corporations and governments (since they are the only ones with the vast resources required to do it); to a world where personal data is highly distributed and grows with every interaction with or about each of us, so that no one can keep up with it, let alone store it in a single place. 

It's therefore important to understand that a "personal data store" is not envisaged as your own personal database of all personal information about you. "Store" is not used here in the sense of 'storage' but in the retail sense of controlling what is offered or sold (which is also not exactly appropriate but does the job for now). So a 'personal data store' is really just a set of rules that determine whether and how data about you can be used - wherever that data sits. It's another type of 'personal information management service'.

The WEF process involves first 'unpacking' the big notions of 'identity', 'privacy' and the imagined benefits to be gained from sharing personal data. These concepts are too static, theoretical - and too emotive - to use as the basis for establishing detailed rules for the responsible use of personal data. The significance and value of personal data can't be captured in a single dollar amount or 'yes'/'no' answer to whether it can be used. Instead, the value and utility of personal data is a hugely complex dynamic that varies by: 
  • the context or the activity we are engaged in, 
  • which persona we are using at that moment, 
  • the actual data being used or provided, 
  • the permissions given, 
  • the rights that flow from those permissions, and 
  • the various parties involved.
So in order to ensure that our transactions and other day-to-day activities are as frictionless and seamless as possible, we need a global set of rules that are flexible enough to address all these variables, with the protection of a person's rights at the centre. And those rules must be readable at various levels by humans, lawyers (legislature, courts, regulators, governance panels) and machines (computers, microchips).  

A previous tiger team session identified business, legal and technology as the three primary stakeholders or perspectives in agreeing such a set of rules. The business rules must first be established clearly at the outset, then vetted from a legal and governance standpoint, then coded in such a way that everyone can be confident machines will handle the data in accordance with the rules.

The current ambition is to agree a 'simple' set of common licences or sets of permissions which any individual can nominate to govern the use of their data in a given context (like the creative commons copyright system). The technological solution is a 'personal data mark-up language' that will enable anyone holding the consumer's data to 'mark-up' items of data in their existing databases to correspond to the permissions they've been given.

The legal aspect of this breaks down into a set of rights and duties from which liability and accountability can flow in a way that doesn't represent a deal-breaker for anyone in the overall process. Those rights and duties will obviously vary according to whether you are the individual data subject, the provider of a personal data store/service, a business customer relying on data about the individual or acting in a governance role. They must be compatible with public law, yet fill in many gaps where rights and duties are missing or unclear.

An earlier tiger team had proposed a useful set of rights and duties from the standpoint of the data subject. So we focused on the rights and duties of the service provider operating the personal data store on that data subject's behalf. We also made a start on the rights and duties for the governance role. The full write-up is due in the next few weeks, but some of the key issues we covered were: 
  • the need for transparency as to whether the provider of a personal data store is acting as a full agent in the fiduciary sense or as a lesser form of agent or broker; 
  • the need to ensure co-operation in the timeliness, accuracy, integrity and authenticity of the personal data accessible via the service; and
  • security protocols for data access and sharing. 
From a governance standpoint, it seemed critical to have both the public and private sector represented on the governance panel - just as they were both represented in the tiger team process itself - to ensure not only that the public laws are obeyed at a minimum, but that official guidance can support the additional contractual standards that are agreed to 'fill in the gaps'.

The most immediate next steps would be to flesh out the governance aspects and to address the rights and duties of businesses relying on the data. Having allocated all the necessary rights and duties amongst each of the participants should make the final step of determining the liability and accountability for each of the participants a far less combative process than I've seen in other forums ;-)

Overall, I'm very optimistic that a cohesive global framework for the responsible use of personal data is achievable. Specifically, it was very encouraging to witness how much easier it is to address the overall personal data challenge when you commit to 'unpacking' the big notions of identity, privacy and public benefit, as described above. It was also a huge relief to hear that it is considered feasible by those who've introduced data standards previously to implement a personal data mark-up language to link the flow of personal data to a set of permissions and rules. I'm also hoping this can help achieve dynamic, momentary user identification that minimises the need for large, vulnerable repositories of personal identity material.

Of course, political and commercial acceptance and 'take-up' are where all this rubber hits the road. But the fact the discussions are taking place globally via the WEF is clearly very helpful. 

Monday, 11 June 2012

Why Flog A Dead Bank?

I'm currently drafting some amendments to the Financial Services Bill designed to encourage the growth of non-bank, alternative financial services. However, I've declined the opportunity to help with banking reform.

Now don't get me wrong. I've been very public in pointing out that retail banks are failing to enable the cost efficient flow of surplus funds from ordinary savers and investors to creditworthy people and businesses who need finance. But that's not to say I wish to spend any time discussing the reform of retail banking.

I prefer encouraging the growth of alternative financial services to flogging a dead horse. 

Banks have proved themselves to be too capital intensive and too expensive to manage and operate for them to be worthy repositories of consumers' surplus cash. They also have a proud history of being fined. Indeed, recent analysis by the Financial Times has demonstrated (lest you were in any doubt) that banks exist primarily to solve their own remuneration challenges at the expense of their customers and shareholders. 

That's why I prefer encouraging the growth of alternative financial services.

Banks might have a role to play in the infrastructure of future retail financial services. Providing segregated account services for peer-to-peer finance platforms, for instance, or enabling retail payments.  But that shouldn't mean banks get to treat the money in those accounts as part of their own assets, any more than peer-to-peer finance platforms or payment instutions can. Such funds should remain safeguarded even in the banks' hands, especially when the consumers and small businesses involved in those scenarios are not intentionally investing their money with a bank in the first place. But that's not so much a matter of banking reform, as ensuring banks play according to the same rules as everyone else in the growing array of markets for non-banking services.

Image from Worth1000.

Monday, 28 May 2012

Sailing The Wide EC?

Loyal readers will know that I usually picture the European Commission cooking breakfast.

But recently I've begun to conceive of the EC as lashed to the wheel of the good ship Eurozone amidst a howling gale and mountainous seas, courageously holding course for the mystical land known by some as the Single Market. I fancy that their struggle against all odds reveals something of the pioneering spirit that perhaps one might grudgingly admire, if only as an enthusiastic collector of red tape.

Anyhow, last week saw the publication of the EC's consumer agenda and a report on consumer policy.

Happy reading.

Sunday, 27 May 2012

Abandon Hope All Ye Who Enter The Financial Services Bill

The new financial regime is unsinkable
As a desperate alternative to the Eurovision Song Contest, last night I combed the latest version of the Financial Services Bill for a glimmer of evidence that the Government understands the extreme difficulty of innovating responsibly in a retail financial world dominated by a byzantine regulatory regime

Alas there's nothing much in the Bill except two new supervisory deckchairs from which the authorities can watch our major financial institutions power us inexorably into the icy depths. 

To be fair, the word "innovation" does appear once in this homage to complexity. But it is used in a way that could only be intended to evoke the maximum possible relief amongst those terrified of it. The financial authorities need only promote effective competition and innovation within the markets for regulated financial services. God forbid there should be a process for developing proportionate regulation of emerging business models, or that the authorities should provide guidance to those intent on delivering better outcomes for consumers than established firms or existing services. Here is the leading, bleeding, cutting edge of our giant financial regulatory regime:
"1E The competition objective

(1) The competition objective is: promoting effective competition in the interests of consumers in the markets for—
(a) regulated financial services, or
(b) services provided by a recognised investment exchange in carrying on regulated activities in respect of which it is by virtue of section 285(2) exempt from the general prohibition.

(2) The matters to which the FCA may have regard in considering the effectiveness of competition in the market for any services mentioned in subsection (1) include—
(a) the needs of different consumers who use or may use those services, including their need for information that enables them to make informed choices,
(b) the ease with which consumers who obtain those services can change the person from whom they obtain them,
(c) the ease with which new entrants can enter the market, and
(d) how far competition is encouraging innovation."

Saturday, 26 May 2012

Cardholders Don't Seem All That MIFfed... Yet.

At long last we have a judgment in the MasterCard interchange case. And if the strength of MasterCard and the UK banks' resistance is anything to go by, you might've thought the impact will be profound. But does the decision really threaten the reign of credit and debit cards as the dominant retail payment method in the UK?

In essence, the multilateral interchange fee (MIF) is a share of every credit or debit card transaction that is retained by the bank that issues the card. As previously explained, we all end up paying for MIF, because it's passed through in the charge to retailers for the ability to accept card payments (see here for how card acquiring works generally). 

The saga of complaint, denial and escalation over MIF seems even worse than the Great PPI Robbery, which definitely ended badly for the banks. The first complaints about the anti-competitive nature of MIF were made to the European Commission by trade bodies representing retailers in 1992 and 1997 respectively. To escape allegations that the banks had a common interest in maintaining the MIF, MasterCard's member banks went so far as to agree to float MasterCard Inc. as a separate company on the New York Stock Exchange in 2006. This did not convince the Commission. On 19 December 2007, it outlawed MIF. In response, MasterCard (tellingly 'supported' by former member banks as "interveners" in the proceedings) applied to the European Court of Justice to overturn that decision on 1 March 2008. It has taken over four years to get a judgment dismissing their application. Only a limited appeal on points of law is possible.

The Commission had decided in 2007 that the MIF set a floor below which merchant service fees would not fall, and so restricted price competition to the detriment of retailers. It considered that the absence of a MIF would also reveal any bilateral interchange fees agreed between specific issuers and acquirers, making the acquirers' service obviously more expensive, and exposing them to competition. The Commission rejected the idea that MIF paid for various 'efficiencies' that justified its anti-competitive effect. It also considered that the issuing banks had tried to justify the MIF by including costs that are also inherent in other forms of payment, such as the costs of maintaining a current account...

The Court has now agreed with the Commission. Both believe that MasterCard and the card issuers make so much money out of their payment card businesses that the loss of the MIF won't significantly impact the scale of their activities, or their ability to drive cardholder demand. In particular, the Commission found that "issuing banks generated 90% of their revenues with income from cardholders (mainly [interest]) and only 10% from interchange fees." Debit card payments also drive cost savings for the banks by reducing the number of more expensive cash and cheque transactions they needed to handle. And a significant reduction in MIF in Australia did not have any of the effect the banks claimed an outright ban would have here. In fact, the Court found that to determine the level of MIF for credit and charge cards, MasterCard tries: 
" answer the question: “How high could [MIFs] go before we would start having either serious acceptance problems, where merchants would say: we don’t want this product anymore, or by merchants trying to discourage the use of the card either by surcharging or discounting for cash”’.
From the nature of this equation, the removal of MIF should mean lower costs to merchants, who can use these savings to invest in increased selection, to improve customer experience, to expand - or to simply survive in the current downturn. Those merchants who merely take the lower overhead as profit are clearly in a good position, and I guess there's a chance they may one day face their own competition investigation, but that's an entirely separate issue as I've pointed out before.

That's good news for consumers generally. But what of the impact in the market for new payment methods amongst cardholders themselves? What will prevent card issuers from reducing the value of loyalty schemes or otherwise charging cardholders more in interest and/or fees to make up for lost MIF income?

Interestingly, MasterCard and the banks said that removing MIF would mean "a move towards alternative products or services." But the Commission believes that consumers' strong preference for card payments means the pressure of other payment methods has been too weak to make any difference to the level of MIF (and therefore card issuing and acceptance). As mentioned, removing MIF should actually make card payments cheaper for merchants, so make them less inclined to explore alternatives. In those circumstances, a cardholder rebellion would seem difficult to achieve.

So while the ability to "extract rents" via the MIF has been curtailed, the dominance of cards as a payment method may be sustained. Indeed, card issuers may believe the strong consumer preference noted by the Commission allows them to compensate for the loss of MIF by raising interest rates and charges for cards. That would avoid the need to dip into interest income for the marketing budget to keep stoking demand in the midst of a downturn, pressure to repair bank balance sheets and Basel III capital constraints that attach higher risk-weightings to consumer lending. Such increases could happen soon. The Commission originally gave MasterCard 6 months to remove MIF and this timeline may be insisted upon. But card issuers might well try to raise interest rates and/or direct charges in advance of that date, pointing to the cost of systems changes to remove MIF as instructed.

Ironically, it would seem that we cardholders only have ourselves to blame for such a scenario.

It remains to be seen how high interest and charges on card payments will need to go before we'll rebel.

Image from GAO report on interchange.