Consumer groups focus their work on retail financial services issues and have not played a significant role in the debates about the future reforms of the critical institutional and wholesale financial markets. There is a wide range of issues to cover in these markets. We have selected three issues which we think are particularly important. These are:
- Reforming the asset management/ pension fund industry
- Financial intermediation and the ‘real economy’
- Financial infrastructure, networks, and system resilience
Asset management/ pension fund management
As recent reports from The Financial Inclusion Centre and The European Commission’s Financial Services User Group show, the asset management is not doing its basic job well – that is, providing decent risk adjusted returns at a reasonable cost.
The welfare loss to investors is huge. We estimate that the welfare loss due to underperformance by UK pension funds is at least £112bn over 10 years and could be over £200bn depending on the metric used. The FSUG report shows that underperformance of EU equity funds resulted in a welfare loss of Euro 277bn over 10 years and that the investment fund sector is one of the worst performing consumer sectors in terms of customer satisfaction, confidence and trust.
But the asset management/ private pension fund sector is expected to play an even greater role in consumers’ lives due to pension reforms and transfer of risk from the state/ employers to individual savers. This is not a very sensible move on the part of policymakers given the poor performance of the industry.
Major structural reform is needed before it can be trusted with a greater role especially dealing with the damaging conflicts of interest in the supply chain, high costs and huge oversupply of providers and proliferation of investment products.
Financial intermediation and the real economy
One of the core functions of the wholesale markets and institutional markets is financial intermediation – that is, intermediating savings/ deposits to provide access to credit (short/ long term, secured/ unsecured) for consumers, industry, and government (the bond markets). Inefficient financial intermediation leads to capital being misdirected to less productive economic activities or increased funding or borrowing costs.
Arguably one of the greatest misallocation of resources affecting households happened in the mortgage market. A boom in mortgage lending saw total household debt to disposable income ratio rise from under 100% to 160% over the period late 1990s to 2008. The customer funding gap amongst major UK banks rose from £30bn to £700bn from 2000-2008 creating the need for complex securitised loans and other dangerous financial innovations. There was no corresponding increase in the levels of home ownership. The main effect was to create a housing bubble (average house prices rose from £60k to £180k over the period) and cause a huge intergenerational transfer of wealth from younger generations to older generations. There are very worrying signs that the economy’s overreliance on household debt is re-emerging.
There are concerns that the system of financial intermediation is still not allocating resources to economically useful, real economy activities. In the year to end August 2013, 45% of bank lending went to other banks in the financial system, 38% went to the property sector, while only 3% went to manufacturing. Bank loans outstanding to UK non-financial corporations fell by nearly 30% from Q4 2008 to end 2013.
The dominance of the big players in the wholesale and institutional markets can stifle the emergence of innovative, alternative financial models to meet the long term financing needs of business. Value extraction and short termism in the asset management services not only damages financial welfare of investors and pension funds but also the firms in which capital is invested.
Financial market reform has so far understandably focused on financial stability, prudential regulation, and conduct of business issues. We hope this year the focus now turns to making sure that the wholesale and institutional markets perform this critical financial intermediation function more efficiently in the interests of the real economy.
Financial networks and system resilience
While not an obvious priority for consumer groups and campaigners, the security and resilience of our financial systems is critical. Unless the infrastructure and networks that underpin the banking and financial system are secure and resilient, the financial services industry cannot meet the important consumer outcomes – access, value for money, quality, efficiency etc.
This is increasingly important given the migration from ‘physical’ delivery of services to virtual platforms. Systems and networks are increasingly interconnected. The growth in corporate cybercrime and attacks on financial networks and systems is very worrying and we urge consumer groups and campaigners to give this issue a higher priority in 2015.
 See http://inclusioncentre.co.uk/wordpress29/
 See http://ec.europa.eu/finance/finservices-retail/docs/fsug/papers/1411-asset-management_en.pdf
 See http://ec.europa.eu/consumers/consumer_evidence/consumer_scoreboards/10_edition/index_en.htm
 See http://www.fs-cp.org.uk/publications/pdf/fsa-dp09_03.pdf
 Adair Turner, presentation at Resolution Foundation event
 Financial Stability Board, McKinsey – Economist, p4, Special report on International Banking, May 10th 2014