I will be on a panel at 4pm tomorrow as part of AltFi Summit Europe 2016, focused on regulatory matters in the AltFi industry. Ahead of the session, I thought it might be helpful to share some of our thinking here at Growth Street.
Regulators in the spotlight: McDermott, Bailey, Turner
As background, it was suggested to me by one of Growth Street’s advisory board to read this Mansion House given by Tracy McDermott, the acting head of the UK’s Financial Conduct Authority (FCA) titled ‘The rapidity of change’. Ms McDermott uses a rugby analogy – somewhat topical following England’s grand slam victory in the 6 Nations competition yesterday!
McDermott argues that a good regulator should perform three roles:
- Referee on the pitch
- Constantly on the pitch, keeping up with what is going on, respected, fair and consistent.
- Tough where required.
- At the centre of the action without being the centre of attention.
- Requires rules to be set and to be enforced.
- Foul play to be dealt with fairy [sic] and decisively.
- But ultimately the rules will be of little interest or value to the customers of financial services firms if there is no competition between the players in the first place
- Groundsman preparing the pitch
- Create the best environment we can to allow competition to take place
- To have a level playing field which does not advantage one participant over another.
- To set boundaries that are clear, consistent and predictable but, within those, enable firms to innovate and develop new approaches and provide new services.
- Post-match commentator
- Facilitating debate which reflects on, and analyses, past performance.
- Supporting and working with industry and other interested parties to try to find new solutions to old problems.
- Constantly challenging the industry to do better and pushing them to go further and faster in the quest for change.
Within the speech, McDermott also references pertinent topics such as the regulatory ‘pendulum swing’ (and how we need to find a better long term balance to reduce large oscillations) and the role of behavioural economics (a topic championed by her predecessor Martin Wheatley). Since the speech, we now know that her successor will be Andrew Bailey, currently the deputy governor of the Bank of England (and whose signature you can find on the majority of sterling banknotes). Whether he will take a different view or approach remains to be seen.
Additional context to this panel event tomorrow comes in the form of Lord (Adair) Turner’s highly critical comments on the P2P industry. Lord Turner was formerly head of the Financial Services Authority (FSA), before the FSA was split into two as part of the so called ‘twin peaks’ regime, which created the independent FCA, and the Prudential Regulatory Authority (PRA) – a division of the Bank of England.
Where next for AltFi regulation?
While many in the AltFi industry would argue that the industry is already well regulated, and has a history of actively seeking more regulation rather than less, there are a few areas of debate that persist today when taking McDermott’s and Turner’s views into account.
Talking points ahead of tomorrow
The FCA is primarily concerned with conduct risk, and in particular, consumer protection. It can only regulate firms that fall within the scope of regulation, which it referred to as perimeter guidance. For example, some activities, such as commercial finance provided to Limited companies, are currently unregulated – noting that the FCA is running a consultation process to review how financial services to small and medium enterprises (SMEs) could be regulated in the future. It is because of the absence of such regulation that Growth Street, for example, started a campaign arguing for an APR4SMEs – in common with other AltFi platforms, we are actively arguing for more regulation, not less.
Questions of the AltFi industry that we believe are of interest to the FCA (and others):
- Marketing of ‘savings-like’ accounts by platforms to the general public – is it sufficiently clear that capital is at risk? Might this result in tighter, more prescriptive guidance of Financial Promotions?
- Do platforms employ effective controls on client money to avoid corporate malpractice/ fraud?
- Are sufficient ‘living will’ arrangements in place to manage the run-off of borrower facilities should a platform fail catastrophically?
- Is the current regulatory perimeter sufficient, i.e. is the definition of 36H under the Regulated Activities Order (which determines P2P/marketplace lending) suitable?
- Given recent Budget 2016 announcements, when using technology such as auto-bid, does this constitute advice, or as robo-advice, will this be exempt?
Aspects of prudential regulation that are currently outside the scope of regulation
At present the PRA does not have a formal role to regulate AltFi platforms, unlike banks. Two principal areas where the PRA regulate banks that are currently subject to industry self-regulation:
- Provisions – i.e. the capital held to manage credit risk i.e. when borrower defaults are greater than the expected/provisioned losses anticipated by the platform
- Should all models operate provision funds?
- Is there sufficient capital in provision funds? How do platforms compare to the capital structures of retail and business banks?
- How is the capital set aside invested?
- Are provision funds contractually obliged to pay out, or is at trustees’ discretion?
- Liquidity – i.e. the capital held to manage liquidity risk i.e. should market changes restrict the supply of capital for lending
- How much of a risk does the platform / business model present (e.g. diversity of funding mix, interest rate risk, duration mismatch)
- Calls for greater transparency – many large platform are transparent with regards to their borrower portfolios, but should platforms disclose their lender portfolios (and corresponding matches) too to help calculate/understand the liquidity risks?
- Does the platform hold sufficient liquidity reserves to manage the risk, given the business model operated?
Routes from here
Other potential directions that industry, regulators or government might take (including legislative changes already signalled):
- Robo-advice – Will platforms get a free pass given announcements made last week as part of Budget 2016?
- 36H – What changes will be made? Will non-regulated firms fall within the FCA perimeter as a result?
- CIS – Are platforms operating collective investment schemes?
- PRA – Will the PRA regulate the AltFi sector?
- FCA step in – Will the FCA take on PRA duties until such time at the PRA regulates AltFi?
- FSCS – Will platforms be required to join the Financial Services Compensation Scheme?
- Greater transparency – Will platforms offer further transparency in an effort to answer criticisms regarding operational, liquidity and credit risks, in particular?
I look forward to discussing the above questions and others with my fellow panellists at 4pm tomorrow.
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