How The FCA Could Support Innovation And Diversity In Financial Services

Hats off to the Financial Conduct Authority for hosting and participating in The Finance Innovation Lab's recent workshop on Transforming Finance. It was an excellent, productive discussion and seems likely to help drive helpful change. For the sake of transparency, here are my notes/thoughts (unattributed, on the basis of Chatham House Rules).

The FCA board is interested in how the financial services market can be 'disrupted' in ways that are positive for consumers and small businesses. There is a new awareness of how regulatory uncertainty can be a barrier to entry/growth; and the need to get better at recognising the harm that comes from stifling good initiatives.

Key aspects of beneficial disruption include, innovation, diversity, and competition. There is evidence that competition within markets alone is insufficient, and can actually drive mis-selling (e.g. banks competed to sell PPI). Increasing diversity is also necessary, to enable competition amongst different business models and services in the same market. This requires the FCA to consider how firms outside the regulated markets are delivering better consumer outcomes, as well as firms within the regulated markets.

Greater transparency around fees, incentives and conflicts of interest allows excessive fees to attract competition and/or disintermediation; and the removal/re-alignment of perverse incentives and conflicts of interest.  

FCA could foster innovation with: 

• a 'sandbox' for entrepreneurs/innovators to consider how new models might be impacted by rules - this could include an online method for extracting all the rules in the Handbook that relate to a certain product or activity; 
• pre-authorisation workshops to coach firms through the evolution to authorsiation and obtain feedback on problems and potential improvements; 
• a shortened, small firms registration process that would allow new entrants to operate under certain thresholds before going through the lengthy full authorisation process (as for small payment/e-money institutions);
• a small firms unit made up of staff from each of the FCA's main 'silos' to ensure joined-up focus on innovation and diversity, consistency, fairness and positive discrimination in favour of sensible initiatives.

The regulatory/policy environment needs to be more open and accessible. We need to know which staff are responsible for what. The FCA tends to draft its rules and communicate in its own unique language, rather than in the language of the markets it regulates or even the same terms used in directives/regulations it is supposed to implement. It also needs to 'get out more', and participate in more forums involving firms, trade bodies, policy officials from relevant departments (e.g. Treasury and BIS) and the European Commission. There should be more public roadshows, roundtables etc - perhaps the FCA could host an annual, wider version of the P2P Finance Policy Summit that was run in December 2012? The consultation process should more positively discriminate in favour of those outside the incumbent firms, it should be more socially networked with a more widely telegraphed timetable. In this context it would also be helpful for the FCA to keep a register of who is lobbying it (e.g. as Ministers must disclose). There should be a body to scrutinise what the FCA (and HMT) is consulting on and how the consultation process operates.

The FCA views the market through the lens of products, and types of firms and their activities, rather than from the standpoint of the customer and how the customer can be empowered to achieve their own financial outcome. The customer is seen as victim, whereas the tide of technology and innovation is delivering greater control to the customer (e.g. over personal data - and financial transactions are just another type of data).

The FCA needs to participate in the debate over the best means of credit creation - should we separate banks' role in money creation from their role in actually allocating credit? Should we strip banks of their role in creating money altogether, as covered by Martin Wolf recently. 

How do we distinguish genuine innovation or invention from merely incremental changes to existing models/products? New rules should be tested for their potential impact on diversity, innovation and competition.

The Financial Services Consumer Panel and Smaller Business Practitioner Panel should have specific obligations to consider the above issues, as well as the interests of alternative finance providers and civil society more generally.

Interested in your thoughts!

#RedTape Redline - Mark-up Your Laws!

During any respectable contract negotiation, the party 'holding the pen' produces a mark-up or "redline" of each draft of the contract showing the changes it has accepted so far from the previous version. In fact, it's considered offensive and sneaky not to show those changes. It's as if you're hiding something and don't want to make it easy for the other side to understand the deal they're being asked to sign up to. 

Not so for the people drafting our laws and regulations. No. While they have their own internal mark-up of how a piece of legislation is being amended from time to time, they keep it to themselves and only use it for the purpose of writing up an amending 'statutory instrument' that shows only the change and where it is supposed to be plugged into the original. Nuts, unless of course you're still writing with a goose feather, or you're the one proposing the changes and you want to slow your opponents down by making them reverse-engineer what the changes looks like in context. Or you're one of the legal publishers everyone is forced to pay in order to get an up-to-date version showing all the changes once they are passed, since not even the government's own legal publishing unit has the resources to keep up-to-date with how all our laws have changed.

I am not the first to complain about this, as I pointed out in 2009 in the context of the Free Legal Web initiative, which you can now see is defunct. Dragged under the waves by the combined weight of institutional inertia, investor scepticism and despair... but I'll leave it to Nick Holmes to tell that story.

And yet, in true Terminator fashion, this won't die. Yesterday, we were treated to a presentation on the new OpenLaws initiative to "make legislation, case law and legal literature more accessible" (please,  take the survey).

It's thought that OpenLaws might benefit from including European law. Certainly it brings European cash, which is smart. But if there's one institution committed to less transparency than the UK Parliament, it's the European Union. You'll see that I've previously considered launching a quest to find the source of European law, but abandoned the idea immediately. Anyone who's tried to keep track of the European Commission amendments to draft directives and regulations as they ooze their way through the European "ordinary legislative procedure" quagmire will understand the true value of the lobbyist. I can't imagine sunlight ever falling on that process.

But I may be wrong. And it could well be that the OpenLaws' social media tools concentrate enough rage against the EU machine that transparency will be introduced. In the meantime, we'll have access to case law, articles, commentary and unofficial redlines of legislative amendments, even if we can't shake the uneasy feeling that only a few officials fully understand what our Parliaments are churning out.

 

Timetable And Forms For Full Authorisation - #ConsumerCredit #P2PLending

The FCA has published the application 'windows' during which various types of consumer credit and P2P lending firms can apply for full authorisation. 

The dates are in Table on page 9. They vary by type of firm and may also vary by region for some types.

The FCA will write to all firms with interim permission by 1 May 2014 to confirm their application period. You should contact the FCA if you have not heard by 15 May 2014. In the meantime, you should register for an online account with the FCA.

In my experience it takes at least 3 months to prepare an application for authorisation, as there is a lot of information to gather and/or summarise at the same time as running a business. The FCA has published an authorisation application checklist, some sample forms and guidance on the supporting documentation required. Note that if you a P2P lending platform or your are offering high cost short term credit (payday loans) or a credit reference service, you will also need to complete a detailed description of your IT controls, which you can download here. There are a few FAQs here. 

Top tip: make your application for authorisation a proper project and start the process of completing all forms and supporting documents on Day One - especially the application form, regulatory business plan and IT controls forms. Complete the forms in parallel, not one after another, as you may be waiting 3 months before each form is complete. I recommend nominating one person to oversee completion of the application documents and a separate person to gather and provide data.

Please note that the FCA has also published the relevant information sheets that must be sent to a consumer with any notice that they are in arrears or default (under section 86A of the Consumer Credit Act 1974). 

EC Support For Crowdfunding

The European Commission today published its communication on crowdfunding, following its consultation in 2013.

The EC proposes to facilitate, rather than regulate - a strategy I wish they would adopt in most areas. Specifically, it plans to:

• establish an Expert Group on crowdfunding to provide advice and expertise to the Commission, particularly on the potential for a "quality label" to build trust with users; and promote transparency, best practices and 'certification';

• raise awareness of crowdfunding, promoting information and training as well as raising standards;

• map national regulatory and self-regulatory developments and hold regulatory workshops to ensure an 'optimal functioning of the internal market', and to assess if EU regulation is necessary;

• issue recommendations via the SME Envoy network;

• consider the possibility of matching public funds with private funds via crowdfunding channels, subject to State aid rules etc;

• support efforts to promote regulatory conver gence of approaches at international level.

There will also be two EU studies - one on how crowdfunding fits in the wider financial ecosystem and which projects use what type of crowdfunding; and another on the potential for crowdfunding to support research and innovation, which will include consider possible tax incentives.

The Commission will report on its progress during 2015.

Could The FCA Do More To Foster Innovation In Financial Services?

Previously I've suggested that two things are choking the flow of money to people and small businesses who need it: broken regulation and perverse incentives. So it's important to give some credit for work on both fronts.

Financial regulation remains overly complex, but at least some reforms have been made to welcome innovation and competition at the retail level. And the recent budget showed the government is keen to ensure that ISAs and pensions encourage people to put their eggs in more than one basket. The FCA has also done some impressive research into insurance add-ons.

However, for this momentum to be maintained, financial regulation must become even more welcoming of innovation and competition - and much simpler and transparent for everyone to understand. So here are seven suggestions:

1. Tailored rulebooks: By the FCA's own admission, about 10% of the rules spread throughout its giant, ever-expanding 'Handbook' are relevant to each regulated activity. But the FCA does not gather the relevant rules into 'tailored' rulebooks, as the FSA used to do. That means everyone must waste time and resources wading through the 90% of rules that don't apply to their given activity. But it's worth noting that the FCA still maintains the helpful “Approach” documents that explain its separate regimes for e-money and payment services. Why not adopt this same 'approach' in other areas?
2. Registered small firms option: The FCA authorisation process involves 6 to 9 months' work in advance of filing, at an estimated cost of £150,000 per firm (see note 10 from this Treasury/Cabinet Office workshop). It then takes another 3 to 12 months to become authorised, depending on the permission required. This makes funding the launch of a new financial service very expensive compared to an unregulated service, and the slow time to market increases the risk of failure (ironically). A 'registered small firms' option already exists in relation to e-money and payment services, and would reduce the cost and delay of market entry for firms preparing for full authorisation. It should be brought in more broadly.
3. Client-money banking platform: Many authorised firms are obliged to 'safeguard' their clients' money by keeping it separate from their own funds in 'segregated' bank accounts. UK banks can be particularly slow and uncooperative in opening these accounts, which delays time to market. This, along with the recent financial and IT problems amongst UK banks, suggests it might be wise to 'ring fence' segregated accounts on a separate platform, possibly under the supervision of the new Payments Regulator.
4. Small Investor Option: Any web designer will tell you that the more 'clicks' you put in the way of a consumer, the less likely it is the consumer will go through a process. So 'dialogue boxes' that require people to certify things or take tests to invest in bonds or shares will also deter them. That's a barrier to the adoption of new 'crowd-investment' services, which many people might prefer to try out with small amounts. In fact it's far easier to gamble on lotteries and bingo than it is to invest. So allowing people to be invited to invest up to, say, £250 in debt securities or shares per project on authorised crowd-investment platforms with a clear, fair and not misleading description of the risks, but without any form of certification, advice or appropriateness test would seem appropriate (see the French proposals for crowd-investment).
5. Platform-level regulation: current financial regulation operates on the basis of different types of activity related to certain types of legal instrument, regardless of the customer experience. However, the online 'marketplace' model is now being applied to many different types of financial service, enabling people to transact directly with each other in relation to payments, savings, loans and investments, for example. Insurance and other services will likely follow down this path. This offers the chance to removing doubt and duplication by regulating common operational risks with a single set of rules at the platform level, with relatively few extra rules for different types of instruments or different types of activity being financed.
6. FCA 'Sandbox': coupled with the registered small firms option, the FCA could maintain a more dynamic focus on innovation and competition if it offered a dedicated space or channel for evaluating new services - both inside and outside the regulated sphere - which would also help it decide whether to flex its rules to suit.
7. Seek solutions from outside the existing market: the FCA should not assume that every innovation is designed to circumvent the existing regime to the detriment of customers. There are plenty of entrepreneurs who have spotted opportunities created by poor banking and are trying to increase transparency and reduce costs. So where the FCA is aware of existing consumer detriment or other market problems, it could present these to the market in open 'innovation workshops' - similar to those fostered by the Treasury/Cabinet Office - and/or release them into its 'sandbox'.

Your thoughts?

At Last: ISAs Go To Work!

Readers of this blog will be familiar with my rants on ISAs. So you can imagine my delight that the Chancellor has finally announced an the extension of the scheme:

"To further increase the choice that ISA savers have about how they invest, ISA eligibility will be extended to peer-to-peer loans, and all restrictions around the maturity dates of securities held within ISAs will be removed. The government will also explore extending the ISA regime to include debt securities offered by crowdfunding platforms."

In addition, from 1 July 2014 ISAs will be reformed into a simpler product, the ‘New ISA’ (NISA), with an overall limit of £15,000 per year. You will be able to hold cash tax-free within your Stocks and Shares NISA (if your provider allows it). And you'll be able to ask NISA providers to switch your money between cash-NISAs and Stocks and Shares NISAs.

As explained here, these changes offer a huge boost to the real economy, because savers will be able to lend their 'dead' savings directly to each other and to small firms to help fill the funding gap left by the banks. At the same time, savers will improve the value of their investments, not only by diversifying into a new asset class, but also one that provides a decent return.

Hats off to the government and the Treasury for putting in the work to turn this situation around.

FCA's Response And Final Rules On Crowdfunding

The FCA today published its response to its recent 'crowdfunding consultation'. 

In essence, the paper merely justifies why the FCA has refused to alter its earlier proposal. Accordingly, all the previous criticisms still apply... [sighs].

This won't be terribly welcome news, but at least crowd-investment platforms now know they can market to a restricted area of the 'crowd', if not everyone.

And, following Friday's release of the consumer credit rules that also apply to 'P2P agreements', peer-to-peer lending platforms now have the two rulebooks they need to begin preparing for the first wave of regulation in 25 days' time, followed by full regulation from 1 October.