The Financial Inclusion Centre

The Centre has submitted written evidence to the Work and Pensions Committee Inquiry into the Pensions Freedom and Choice reforms.

We are concerned that the risks associated with freedom and choice have not been fully appreciated. At the time of the launch we warned that the reforms were a regressive policy, rushed and very poorly planned, and badly implemented.

Consumers might welcome the reforms – after all who can be against ‘freedom and choice’. But there is cognitive dissonance evident here. Consumers also want their pensions to be safe and reliable. However, consumers will be exposed to greater uncertainty and risks in the form of market, product, misselling and fraud, and longevity risks. In addition, the reforms are likely to push up the costs of providing financial advice, push up costs of saving for retirement and/ or reduce the value of pensions in retirement.

Savers now have a good value, collective option for accumulating retirement savings in the form of NEST. But, this will now be undermined by the additional costs introduced at the decumulation phase as a result of freedom and choice. Costs are particularly important for the groups of pension savers we focus on – underserved, lower-medium income households.

Sadly, some of our fears have already been borne out particularly with regard to scams. But the real damage will be done in the medium-longer term as the costs of saving for retirement are pushed up and consumers are exposed to greater market uncertainty and longevity risk. It is simple logic that when more costs are extracted from the pensions system this reduces the value of retirement savings meaning households have to save more to compensate.

There were, of course, problems with the old system and annuities rightly came in for some criticism. But, the old system did allow consumers to manage longevity risks. It is not progress to replace a system with some faults with a new system which exposes consumers to greater market, misselling/ scam, and longevity risks and ultimately pushes up the costs of saving for retirement.

Lower-medium income households who can afford to save comparatively low amounts are particularly affected by high costs. They are also disproportionately affected by poor advice and decision making – they cannot absorb the financial losses associated with market and misselling risks in the same way as better off households.

Freedom and choice threatens to reverse the very real progress made through automatic enrolment and NEST. If we think of AE/ NEST filling the pool of retirement savings[1], freedom and choice drains away those savings in the form of consumers drawing down savings and/ or the pensions and investment industry extracting value in the form of high costs.

But, there are interventions we can adopt now to mitigate the risks in the short-medium term. The priority is to ensure consumers have access to objective, impartial financial advice and pension decumulation ‘defaults’ to allow them to identify safer, better value options.

Our submission can be found here: Work and Pensions Commitee Pensions Freedom and Choice-FIC final submission

The Committee’s terms of reference can be found here:

https://www.parliament.uk/business/committees/committees-a-z/commons-select/work-and-pensions-committee/inquiries/parliament-2017/pension-freedoms-17-19/

[1] The filling of the retirement savings pool needs to be speeded up anyway

Last week, Provident Financial, the subprime lender which sells expensive credit to higher risk borrowers was dumped from the FTSE100[1]. The previous week its share price fell by 65% after it issued a second profit warning in three months and scrapped its interim dividend payment to shareholders. The firm, whose main products are costly door-step loans and high cost credit cards, had been one of the stars of the stockmarket in the post financial crisis era. Its share price more than quadrupled from 704.5p in July 2008 to 3,600p in November 2015 – joining the FTSE100 at the end of 2015. But by the beginning of September this year its share price stood at 885p.

Clearly, Provident Financial faces its own specific organisational problems. But, soon after that, the news broke that Buy to View, one of the leading firms in the rent to own sector[2], had been placed in administration[3]. Moreover, the introduction of the price cap on payday loans and much tougher regulation of consumer credit slashed the number and value of payday loans sold to consumers and drove huge numbers of consumer credit firms out of the industry.

This series of events leads us to ask a very fundamental question. The market is ‘amoral’, it will supply products and services to anyone – at a price. This is not a criticism, just a fact of life about how markets operates.  But, the question we should be asking is: can market providers in financial services make decent, sustainable profits fairly from low income or vulnerable consumers?

History suggests that when government and regulators (following campaigns from consumer activists) impose reasonable conditions on the financial services industry with regards to prudential regulation, good governance, fair treatment of consumers and fair charges, the industry struggles to meet the financial needs of lower income or vulnerable consumers. Note that consumer credit isn’t the only market where this is happened. It’s a much wider problem – it just happens to be topical in consumer credit.

When markets shrink, we then hear some in the industry claim that regulation causes or contributes to financial exclusion. This is disingenuous. No wants to see unnecessary financial regulation but it is hard to identify significant pieces of regulation which are actually superfluous. The regulation we have now, in effect, just codifies what society has a right to expect of businesses that are well run and deserve to be trusted. Sadly, the market left to its own devices failed to produce enough of those well run businesses that deserve the confidence and trust of consumers. Regulation exposed the real nature of the commercial relationship between many firms and low income/ vulnerable consumers they were selling to. Indeed, if anything, while we have seen major improvements in the culture in financial services, there is a long way to go. In some areas, more not less regulation is needed.

There is no point ducking this problem. Is it actually possible to promote markets in which commercial providers are able to provide decent financial products and services to low income or vulnerable consumers on terms which also make sense to shareholders/ investors? Changes in labour markets (rise of zero hours contracts jobs etc) and much tougher economic conditions are likely to exacerbate the problem. We see little evidence that mainstream financial services business models (predicated on the lifecycle model of progressive household earnings growth, the debt repayment and asset accumulation) have adapted to this new economic reality.

So, how do we respond to the challenge? Reducing regulation to try to promote financial inclusion is a false economy – it simply transfers the risks and costs back to consumers.

Some are evangelical about the potential of fintech to change the economics of distribution and bring more unserved/ underserved consumers into the market. There may well be some merit in this. But, fintech is just as likely to exacerbate financial exclusion and market discrimination. Fintech costs, it needs to be monetised. For lower income consumers, the cost of paying for new fintech apps may outweigh the benefits created in the form of switching to better value products and so on. The essence of fintech is greater market segmentation and granularity, more individualised or personalised products and services. It becomes even easier to identify profitable/ lower risk consumers and sell to them. Firms can much more efficiently identify and exclude less profitable/ higher risk/ more vulnerable consumers.

If reducing regulation or relying on fintech is not the answer, what is? Clearly, the state and regulators can help by: making markets more efficient and competitive; deploying social policy regulation to protect vulnerable consumers or mandating provision of products and services; supporting the growth of alternative providers and products; or indeed the state meeting financial needs.

Responsible providers who recognise that their firm does not exist just to create profits – and there are many out there – can do more to continue the improvements in culture in financial services and support the development of alternative provision.

Finally, civil society groups and consumers organisations can do more to reform the financial system and develop innovative, alternative financial products. We can do much more to help shape fintech so that it delivers benefits for excluded or vulnerable consumers. We have a duty to do this – we must stop just complaining about what’s wrong and broken or exposing scandals, and do more to make markets work better or develop alternative solutions where markets clearly cannot deliver.

But, if this is to happen, we first of all need an honest, frank debate about the limits of markets and the role of the state and regulators – what might be called a new social contract. Unless and until we do, it is difficult to see that much progress being made.

[1] the index of the leading 100 shares by market value listed on the London Stock Exchange

[2] See Better and Brighter: Responsible Rent to Own Alternatives an FIC report on the detriment caused to consumers in the rent to own sector, https://inclusioncentre.co.uk/our-work/publications/better-and-brighter-responsible-rent-to-own-alternatives

[3] https://www.fca.org.uk/news/news-stories/buy-you-view-enters-administration

As its many champions constantly tell us, the City provides huge benefits to our economy in the form of contribution to GDP, tax take, balance of payments, employment and usage of financial services by UK households. This is undoubtedly true. But, as our latest report, commissioned by the TUC, shows, set against that are the major economic, financial and social costs caused by the City’s activities. (Note we use the ‘City’ as shorthand for the wider financial services sector and financial system.)

To our knowledge, this is the most comprehensive attempt by a civil society organisation to bring together the available evidence on the benefits and costs of the City. It’s not perfect. There is much more work to be done. But we hope the report stimulates new, deeper thinking about the impact of the City on the economy and on the lives of UK citizens. We also hope the report helps policymakers recognise that the City needs reforming if it is to work better for the UK economy and society.

The need for serious financial market reform seems self-evident to us. Brexit provides an additional impetus for that reform. But, reform needs well thought out, robust policies. The dilemma we face is: can we identify policies that tackle the risks and market failures identified in the report without losing the very real benefits the City produces. We don’t have the answer to that dilemma yet. The report sets out a series of questions to guide the development of those policies. We look forward to working with interested stakeholders on developing those policies and campaigning for reform over the coming years.

Report summary

In the report we examined: conduct of business and culture costs; economic and social utility costs; externality costs; and threats to financial stability and economic resilience.

Conduct of business and culture costs:  Our tally for ‘retail’ misselling in the UK is £45bn. UK banks also account for a significant share of the estimated £200bn global conduct costs arising from Libor and foreign exchange market manipulation, money laundering and so on. The litany of misselling has left a legacy of mistrust which undermines consumers’ willingness to use financial markets to save for retirement. This also partly contributed to the buy-to-let boom which has helped pump up property prices beyond the reach of younger generations.

Economic and social utility: We found compelling evidence that a primary function of markets – to allocate resources effectively to productive real economy activities – is not working well. Only a very small share of bank and building society lending still goes to non-financial businesses. The scale of the value extraction (in the form of high costs and underperformance) in the £6trn asset management industry dwarfs the more high profile misselling scandals. Investor short-termism hinders the ability of real economy firms to plan for the future. Much ‘innovation’ in financial services was either about extracting value from clients or designed to deal with risks created by a previous set of ‘innovations’. There has been an illusion of innovation, some might say alchemy, as investors were sold the promise of higher returns at lower risk. Even now, markets are distorted as institutional investors invest huge sums in low yielding, safe bonds (the so-called ‘flight to quality’) and ‘search for yield’ by investing more in property and alchemical financial products. Investment in long term, productive economic activities falls between the gaps.

Externality costs: the sudden shock of the financial crisis resulted in huge costs for the economy and society. But, over-financialisation imposes ongoing costs by contributing to regional and household inequality and harming long term economic productivity. City institutions are not doing enough to mitigate climate change risk. Tax avoidance is a huge drain on public finances.

Financial stability and economic resilience: The financial crisis did so much damage for two reasons – the sheer scale of the UK financial sector and because we didn’t have the right firebreaks to protect the rest of the economic system. We cannot tell how big a risk the City still represents to the economy until it is tested by a new crisis. But, there are growing concerns that risk has been shifted from more visible parts to the ‘shadow’ financial system and major dislocations are evident in financial markets. The UK financial system still does not appear to be diversified enough to guarantee resilience.

The UK’s system of financial regulation is now well set up for financial stability, conduct of business/ consumer protection and competition regulation (even if it is not used well, it is at least there). But, we lack the institutional policy framework to tackle those structural failures highlighted above. No one in authority seems to be charged with improving the economic and social utility of the City.

Large parts of the financial system are working well and the City does contribute a huge amount to the economy and society. But, set against that, the City may still represent a serious risk to wider economic resilience. Perhaps more importantly for the economy in the long term, the City is just not very good at some of its primary resource allocation and asset management functions.

Reform of the City should be a priority. But this begs the questions: what shape should those reforms take; and can we persuade policymakers that it is possible to reform the financial sector without ‘killing the golden goose’?

To say Brexit complicates matters is an understatement. Brexit will create new risks for the financial sector and for households if regulatory arbitrage occurs. But Brexit also provides the opportunity and possibly the impetus for positive reform of the City.

Overall, the questions raised by this audit can be summed up by asking: what should the City of London look like in a post-Brexit world; what role do we want it play in our economy; and while reform is clearly needed, do we have the credible policies, policy structures and political will to make the necessary reforms happen?

The full report can be found here: Economic and Social audit of the City FINAL

The Centre responded to the FCA’s consultation on proposals for dealing with persistent debt in the credit card market.

We argued that the nature of the problems identified by the FCA’s comprehensive analysis of the credit card market means that any interventions should have three separate but connected objectives:

• To encourage better consumer behaviours and change market norms in the consumer credit market – that is pre-empt and prevent a build-up of persistent debt and encourage borrowers to pay down debt quicker and so save money;
• To protect borrowers from exploitative and unfair practices – that is, the application of very high charges to what is in effect a captive market; and
• To promote a more competitive market – from the consumer perspective.

Interventions will have to address legacy problems and fix the market for the future.

We used those criteria to judge the FCA’s proposals. With this in mind, we were pleased that the FCA has recognised the problem and welcome some of the FCA’s proposals on interventions to help borrowers manage persistent and problem debt.

But, taken in the round, we do not believe that the package of proposals will be effective. In particular, we are very disappointed and perplexed that the FCA has not included potentially the most effective remedy – capping fees and interest rates on credit cards – for consultation. Capping the total cost of credit has been shown to work very effectively in the payday lending market. Capping fees and rates in the credit card market would be a more direct way of meeting the desired objectives of encouraging better behaviours and changing market norms, protecting borrowers, and promoting real competition.

Ruling out a remedy which has been shown to work in similar conditions without even consulting on it, or even explaining the decision, is worrying from a consumer protection perspective. But it also goes against the principles and practices[1] of good regulation.

The FCA already has a duty to make general rules ‘with a view to securing an appropriate degree of protection for borrowers against excessive charges’[2]. Therefore, it would have been well within the FCA’s remit to consult on a total cost of credit cap (including fees and rates). Significant numbers of borrowers in the credit card are still paying effective rates of more than 100% and are experiencing more detriment than payday lending borrowers. A cap on fees and rates in the credit card market would be entirely proportionate and would ensure regulatory consistency.

Behavioural interventions such as those proposed in the CP are very much unproven interventions. Any intervention which requires changes in consumer behaviour involves a great deal of uncertainty. Achieving sufficient behavioural change will be laborious and resource intensive. Whereas, capping rates and fees would have a demonstrable, direct and rapid effect on firm behaviour and, therefore, on the financial wellbeing of borrowers. We urge the FCA to go back to the drawing board and now consult on the introduction of a cap on consumer credit.

Nevertheless, some of the proposed remedies may make some difference in protecting vulnerable consumers in the meantime until better remedies are adopted. For example, ensuring faster repayments of balances is important as is requiring firms to improve their forbearance practices. But these can also be enhanced.

Rather than focus on persistent debt alone, the FCA should be thinking about persistent and/ or problem debt. The FCA’s approach means that a borrower could end up paying more in fees and rates than principal over a one year period and not be caught by these proposals. By any reasonable definition, paying more in fees and rates than principal over a one year period is problem debt. Therefore, we argue that the trigger points for intervention should 12 and 24 months.

Additional measures are needed to change market norms in this market. Therefore, we make two recommendations on this score. The FCA should change the default position on borrowing so that lenders cannot increase credit limits without express request and consent of borrowers. Similarly, the FCA should now actively consider requiring an increase in minimum repayments to a higher default level so that outstanding balances are repaid more quickly – of course, without causing financial difficulties for borrowers involved.

The FCA has determined that its concerns about unsolicited credit limit increases should be dealt with through voluntary industry remedies overseen by the Lending Standards Board (LSB). Of course, we support any interim initiatives to deal with this problem until more effective measures are introduced. But, it is of concern that the FCA does not appear to have committed to making public the compliance data, nor its own assessments of whether the LSB’s monitoring is robust enough. This oversight needs to be rectified. The FCA needs to commit to publishing compliance data plus regular assessments of whether this voluntary initiative is appropriate.

Our full submission can be found here: financial inclusion centre FCA persistent debt CP17-10 condoc final

[1] Openness to ideas, transparency, balance and objectivity, and consultative

[2] See CONC 5A.1.4, FCA Handbook, https://www.handbook.fca.org.uk/handbook/CONC/5A/1.html?date=2016-08-19

The FCA’s asset management market study is one of the regulator’s most important current initiatives. The asset management industry is critically important to millions of UK households who are saving for the future or for retirement. Asset management is also one of the most important primary functions of financial markets – it plays a key role allocating capital to the real economy.

But, as the Financial Inclusion Centre explains in its submission to the Interim Report, the asset management sector and associated financial services (eg investment consultants, investment platforms) is very dysfunctional. The degree of market failure in this sector is striking and damages the financial well-being of investors (and impacts on the real economy, too). Indeed, it is difficult to think of a sector in financial services which is causing quite so much financial harm through the extraction of high costs and poor advice. We need to remember that the more unnecessary costs are extracted from investors funds, the more investors have to then save to make up the difference.

As the FCA’s own analysis of operating margins shows, even with this proliferation of providers, funds and intermediaries the industry is still very profitable compared to other economic sectors. This would not be so bad if all these actors in the market added value by providing investors with better returns on their investments. However, this is not the case as the compelling evidence on the poor performance of high charging active fund managers, and lack of added value provided by financial intermediaries, shows.

Despite compelling evidence, financial advisers and platforms continue to favour high cost active fund managers rather than more efficient, low cost passive funds.

In the pension fund sector, we are now in a ludicrous position where new types of advisers have emerged to advise clients on how to choose fiduciary managers, whose job it is to advise clients on how to choose a fund of funds/ multi-manager fund manager, who in turn chooses underlying fund managers/ funds.

The main issue in this market is not lack of choice or lack of competition per se.  Rather, the ‘elephant in the room’ which must be addressed is that there are simply too many fund management companies, too many funds, and too many layers of intermediaries in the market – which investors end up paying for through high costs or reduced pensions.

Summary of our key recommendations

The primary objective of the FCA’s interventions must be to force through serious efficiency gains in the market, not create the conditions for the market to work. Lowering barriers to entry, encouraging innovation, providing consumers with more information will make little difference – indeed, this would probably just cause even more spurious innovation and proliferation of products. Investors do not need more choice of providers, products or complex strategies. They need better results.

To make the market work, interventions must be aimed at the structural and supply side causes of market failure such as conflicts of interest in the supply chain, the absence of strong governance, product complexity, and behavioural biases amongst intermediaries and so on.

We are encouraged by many of the proposed remedies contained in the FCA’s Interim Report. We would go further in some cases particularly around the issues of who pays for the costs involved in fund management, governance reforms and the responsibilities of intermediaries such as financial advisers, investment consultants and platforms.

The level of market failure is such that interventions are needed urgently to prevent further detriment. We appreciate that the FCA has to consult and weigh up options before acting. But, we would urge the FCA to act as quickly as possible to prevent further harm.

We are also concerned that a referral of the investment consultant market to the CMA (while not a bad idea in principle) could limit the ability of the FCA to act in this market. We need reassurance that any referral would not compromise the FCA’s ability to act.

The key points of our recommendations are:

• We support the introduction of a fiduciary duty for asset managers and financial intermediaries to act in the interests of investors.
• A version of the RU64 rule is needed for the asset management sector requiring all financial intermediaries (advisers, investment consultants, fiduciary managers, platforms and information providers) to justify why they are recommending active funds/ strategies where an equivalent passive fund/ strategy is available.
• Financial intermediaries (institutional and retail) should be required to provide clients with benchmark portfolios to allow them to compare the end-to-end cost of using complex or multi-layered investment strategies (such as fiduciary management, DGFs and funds of funds).
• Further restrictions on the use of past performance data in marketing and promotions are needed along with increased duties of care on all forms of intermediaries to warn investors of how misleading past performance data can be.
• Fund managers and various intermediaries should bear all the ‘production’ costs of fund management and charge clean fees to investors.
• Asset managers and fund governance bodies should ensure that performance bonuses are symmetrical – that is, if the fund manager receives a reward for outperforming a benchmark, there should be an equivalent penalty for underperformance.
• Modules on understanding performance statistics should be included in the training and competence requirements for financial intermediaries (to address the embedded bias towards active fund management despite the evidence to the contrary).
• Major reform is needed to the role and structure of fund governance bodies, with greater independence, enhanced oversight and reporting responsibilities, more explicit duties to promote the interests of investors and manage conflicts of interest (including overseeing the use of reward schemes by fund managers and the use of stock lending).
• In the event of funds underperforming against an approved benchmark, the fund manager should be required to submit a report to the fund governance body explaining why the underperformance has occurred and the remedial action it intends to take. The fund governance body should be required to approve that remedial action plan, and report to investors on success of that remedial plan. Ultimately, the fund governance body should require the fund manager to be replaced or the fund to be closed and merged with another fund.
• Investment consultants and employee benefits consultants should as a matter of urgency be brought within the regulatory perimeter and be subject to full FCA conduct of business rules.
• One of the key market failures is the extent to which financial intermediaries (advisers, investment consultants, platforms and information providers) continue to recommend active funds and retail investors continue to buy active funds. There is a range of reasons for this but we suspect financial media which continues to promote active funds plays an important role. We would urge the FCA to look at the influence of the media.

The Centre’s full submission can be found here: Financial inclusion centre submission – FCA asset management interim study report

Despite years of regulatory reform, there is a long way to go before we can say UK financial markets work well enough to meet the needs of UK households, the real economy and wider society. The scale of the task can be seen in the Financial Inclusion Centre’s Policy and Risk Outlook which identified nearly 30 priority policy issues and risks that must be tackled to make markets work – see Financial Inclusion Centre policy and risk outlook 2016 final.

To be fair, in 2016 we saw some progress in certain areas which we hope can be built upon. But what can we expect in 2017?

For example, consumers now have a legal right of access to a basic bank account as a result of EU legislation. Moreover, banks introduced fee-free basic bank accounts last year. But there is still work to be done on access to banking services. Banks need to do more to ensure that customers are transferred to the new model basic bank accounts, while regulators must be more transparent on which banks are complying properly with the legal right of access provisions.

At a more fundamental level, we still need to have a frank and open debate about what we expect from banking. Consumer advocates seem to want banks to maintain an extensive branch network, introduce innovative fintech services, and retain the free-if-in-credit current account model. All the while, banks are having to deal with huge legacy redress cases and expensive, creaking IT systems, low financial returns and compete with more agile, newer rivals. Something has to give. We hope 2017 sees that frank and open debate.

The introduction of automatic enrolment (AE) and NEST in pensions has been one of the few genuine public policy successes of recent years. But, much more needs to be done to ensure people are saving enough for retirement. Critically, we need major policy reform to help the millions of people in insecure employment (such as the self-employed and zero-hours contracts workers) save for retirement. Moreover, the pensions ‘freedom and choice’ reforms threaten to reverse progress, exposing consumers to much greater market, longevity, and misselling risks and pushing up the cost of saving for retirement. Consumers will need good value, safer, default retirement options from trustworthy providers.

We have seen encouraging developments in the credit union sector with some innovative credit unions launching more flexible, accessible financial products. But, the community lending sector remains marginal and renewed efforts are needed to scale up the capacity of the sector if it is to meet consumers’ needs for fair, accessible and affordable credit. Moreover, following its success in the payday lending market, the Financial Conduct Authority (FCA) needs to clamp down on unfair overdraft charges and practices in other ‘sub-prime’ sectors such as rent-to-own, and the reselling of  consumer debts.

We have made little progress on building household financial resilience and long term financial security. There is a significant problem with legacy credit card debt and we are seeing noticeable increases in household debt again. Moreover, the household savings ratio has fallen to worrying levels. Clearly, much needs to be done in 2017 to prevent a further deterioration in household finances and to start building financial resilience.

It would churlish to deny that standards of behaviour in retail financial services have improved, driven primarily by tougher conduct of business regulation applied by the FCA. These gains will have to be defended against the deregulation agenda which will gain momentum from Brexit in 2017 (see below).

Similarly, the Bank of England and Prudential Regulation Authority (PRA) have done much to introduce regulation to promote financial stability and improve the prudential regulation of our major financial institutions. Of course, we will not actually know if these reforms are sufficient until faced with another 2007-08 style financial crisis. Let’s hope it doesn’t come to this. But, new risks have emerged driven by investors ‘searching for yield’ in the era of low interest rates (itself a response to the financial crisis). These risks have not been evaluated properly and, as a result, have not been mitigated.

The FCA is also consulting on its ‘mission’. The response to this will guide the FCA’s philosophy and approach over the coming years. This is a big moment for consumer advocates particularly those who represent the interests of vulnerable consumers as the FCA is considering whether it should prioritise vulnerable consumers. But, there are obvious risks, too. The whole debate about the balance of responsibilities between regulators, firms and consumers for protecting consumers has been re-opened. There is a clear risk that the balance will shift back to consumers – again Brexit could provide the extra impetus for deregulation.

While standards of conduct have improved, this has yet to translate into improved consumer confidence and trust. Low levels of consumer confidence and trust remain a serious problem for government, regulators, consumers and, of course, the industry itself. Low levels of confidence undermines consumers’ willingness to engage with financial services which means they are less likely to provide for a pension, save for the future, protect their incomes and contents and so on. The industry has to work harder to persuade consumers to buy financial products which pushes up the cost of distributing products and services. Competition is undermined as consumers are unwilling to shop around and differentiate between good and bad brands, seeing them all as bad as each other. We hope 2017 will see renewed efforts to improve consumer confidence and trust in this critical sector. Maintaining effective regulation will be a pre-requisite.

But, it is not all down to regulation. Our ‘theory of change’ for improving markets is based on the holy trinity of good regulation, good competition, and good corporate governance and business ethics. We hope 2017 will see more effective competition coming into the market. The more far sighted leaders in the financial sector understand what’s at stake if confidence is not restored and maintained, and we hope they will continue their efforts to to improve standards of corporate governance and business ethics.

Overall, it looks like 2017 will be a big year on the consumer protection and conduct of business fronts. Hard won gains are under threat.

But, at least there are gains to be protected on consumer protection and conduct of business fronts. We have seen little progress on the major structural problems which beset the UK financial sector – particularly the sector’s inefficiency, poor economic and social utility and tackling the externalities created by financial market activities.

Households are expected to use financial products and services to build financial resilience and long term financial security. But, much of the industry has not adapted to the new economic and financial reality forged by low returns, technological change, more realistic regulation, changing labour markets, and squeezed household finances. The industry is becoming less relevant for growing numbers of economically vulnerable households. It is difficult to see how we can avoid greater levels of financial exclusion in the longer term unless we develop alternative, more efficient, flexible business models, products and services.

In this new economic and financial reality, the industry will struggle to deliver fair value products for middle-income households, too. In an era of low returns, the priorities for providers and intermediaries such as financial advisers will be to drive down costs, promote long term thinking, and improve the way risk and reward is communicated to consumers.

Financial services isn’t just a pure consumer issue. The financial sector already plays a role in meeting public policy needs such as housing, retirement incomes, long term care, and social security replacement. This role is expected to increase over the years as policymakers attempt to transfer risk and responsibility for meeting these needs to citizens. But, the financial services industry is struggling to provide the flexible, good value, trusted products and services people need.

The housing crisis has been well documented. In parts of the UK, people face a real shortage of decent, affordable homes, and sky-high rents. In comparison to financial consumers, renters have very little consumer protection from exploitative or abusive market practices. The housing crisis can be partly explained by financial market behaviours. Huge amounts of credit were created in the financial markets and then pumped into housing market which, in the absence of sufficient supply, simply had the effect of pushing up prices beyond the reach of many.

But, the financial sector is now shaping up to try to take advantage of the very housing market failure it helped create. Large institutional investors such as pension funds, insurance companies and hedge funds are lobbying for the opportunity to build homes for rent. At a time when the returns on safe assets such as gilts (government bonds) are low, investing in homes for rent is an attractive proposition. But, while this might be good news for institutional investors, it would be bad news for renters and for taxpayers. Renters will end up paying more on rent than if the state had used its financial clout to borrow cheaply to invest in building homes. Taxpayers will suffer too if higher rents result in higher amounts of  housing benefit being paid to support private renters.

Sitting behind retail financial services are the huge wholesale and institutional financial markets and financial infrastructures. These markets and infrastructures are of national economic interest. Despite their importance, wholesale and institutional financial markets receive comparatively little scrutiny from civil society. The economic and social utility of financial markets needs to be challenged. Nor do we have the mechanisms in place to deal with the externality costs created by financial markets.

We have only begun to understand the conduct failures in these critically important markets. Inefficiencies and market failure (such as resource misallocation and poor investment performance which undermines retirement incomes) in these sectors have a greater impact on the economic welfare of households and the real economy than failures in retail financial services.

The range and scale of market failure in the asset management sector still has the power to shock as the evidence in the FCA’s interim report shows. The regulator’s report has deservedly attracted many plaudits from civil society groups. The FCA has proposed some interesting, and potentially effective, remedies to tackle the market failure identified in the report. The scale of market failure means that conventional remedies such as greater transparency and information disclosure (which competition regulators tend to favour) will not work.

Far reaching interventions are needed to tackle the embedded conflicts of interests and structural flaws in the sector. But the asset managers will fight tooth and nail to prevent structural interventions no doubt arguing that serious reform is not advisable given the potential impact of Brexit on the sector. Consumer and civil society groups scored great successes in cleaning up the banking and insurance sectors (think PPI, with-profits, mortgage endowments). They will now need to turn their attention to the asset management sector and maintain pressure on the regulator in 2017 if the necessary reform is to happen.

Behaviour and activities in financial markets continue to create systemic risks and threaten economic resilience. Financial markets have been criticised for misallocating resources on a grand scale, channeling resources to speculative, short term investment opportunities and economically unproductive activities rather than to the most economically productive and socially useful activities. Financial markets can exacerbate regional, intra and inter-generational economic inequality.

Market failure doesn’t just harm consumers, it can harm the interests of firms – for example, high charges on investment funds extract value from consumers’ savings and reduce the amount of investment capital that reaches firms. Market short-termism affects the ability of firms to invest for the long term.

The UK has a very well developed system of regulation for promoting financial stability, prudential regulation, and supervising conduct in financial markets (albeit hitherto mainly focused on retail financial services). But, serious problems and gaps in the regulatory system remain.

The approach to competition followed by UK regulators is flawed. It remains based on demand side interventions in the hope that influencing consumer behaviour will in turn improve corporate behaviour – despite the evidence of history that this has very limited effect. 2017 would be a good time to rethink competition policy in financial services.

More fundamentally, we do not have the institutional regulatory framework to develop and implement policies to improve the economic and social utility of financial markets or deal with the externalities created.  We hope 2017 sees consumer and civil society groups turn their attentions to these critical financial markets.

That is the state of play now. Financial markets and services are not working well for society. On top of this, we now have Brexit to contend with. The shock of Brexit happened in 2016. But, to use a well-worn cliche, the devil will be in the detail and it is 2017 when we will to start to get a sense of the implications for EU-derived legislation.  It all depends on which form of Brexit the UK adopts (or to be precise is forced to adopt by the EU). This could range from ‘Brexit-lite’ to ‘hard-Brexit’.

Hard-Brexit could be potentially very damaging to UK financial consumers and households through the loss of valuable consumer protection measures and the creation of new financial stability risks. Moreover, Brexit risks causing ‘policy blight’ in the Government and regulatory agencies. Senior decision makers will be focusing on Brexit and there may be less time and resource dedicated to dealing with the ongoing market and public policy crises described here.

Perhaps there is a silver lining? Perhaps Brexit provides an opportunity for a fundamental rethink of the role of the UK financial sector and how it is regulated so that it serves the interests of society – a chance to take back control of financial markets?

But, we’re not holding out much hope on this. Brexit provides the ideal opportunity for financial sector lobbyists to push hard for deregulation. The chances are that any ‘taking back of control’ will involve an already powerful financial sector having greater control over its own destiny outside the purview of the EU (which has a more social justice, interventionist approach to making markets work).

Understanding what is at stake and hard-wiring consumer rights and financial regulation into UK law pre-Brexit must be a priority for consumer and civil society groups in 2017.

So, it looks like 2017 is shaping up to be another busy year for campaigners in financial services – with Brexit on the horizon, perhaps the most critical year in a long time. As a small, non-profit organisation we have limited resources so would welcome the opportunity to work with other civil society organisations, regulators and progressive firms in the industry to make markets work better.

Just in time for Christmas, last week saw the launch of the Wee Glasgow Loan (www.weeglasgowloan.scot), a new short-term loan product offered by Pollok Credit Union that looks to provide a fair and more affordable alternative for the 100,000 Glaswegians that are thought to be borrowing annually from high cost lenders such as payday loans, door-step lenders, pawn brokers and rent-own-firms.

The Financial Inclusion Centre (FIC) has spent the last few months working with Pollok Credit Union and Glasgow City Council to develop the new online automated platform. By integrating with the credit union’s own membership information and linking directly to credit reference data, it can offer instant loan decisions for applicants and straight through processing of loan disbursement and collection of repayments. For the credit union, this not only helps it meet the growing customer expectations of modern borrowers with 24/7 availability, simple applications and swift decisions and money transfers, but also drives its lending levels and acquisition of new members as well as reducing the costs of loan administration through the automation of much of the process.

With over 1,000 loan applications in the first 7 days, the benefits of the Wee Glasgow Loan has already attracted significant interest across the city. Yet, with an estimated £57 million borrowed from high cost lenders each year in Glasgow, there is still a long long way to go. The Wee Glasgow Loan itself offers applicants the opportunity to borrow up to £400 (and £600 for subsequent loans) and choose to spread the repayments over 1 to 12 months. The interest is charged at just 2% per month or 26.8% APR – making it much more affordable than the costs charged by typical payday lenders and other high cost borrowing channels.

This is the third credit union that the Financial Inclusion Centre has worked with to adopt the automated lending platform originally launched by London Mutual Credit Union (www.cuok.co.uk) and subsequently with Leeds Credit Union (www.handiloan.co.uk). By working in partnership, these credit unions benefit from the economies of scale of sharing the ongoing operating costs for the systems and obtaining lower unit costs on credit searches, transfers and collections. Yet, each credit union can brand and tailor the terms of its individual loan products to match it own requirements as well as adjusting its risk appetite.

Since going live with the online lending platform in February 2012 (to June 2016) – London Mutual Credit Union has approved 23,261 short-term loans with a total value of £6,305,612 with delinquency level of just £109,546 (1.7% of total loans). A 12 month evaluation report of the LMCU payday loan product can be found here:

Can payday loan alternatives be affordable and viable – Summary Report 

Can payday loan alternatives be affordable and viable – Final Report

For more information on the automated lending platform please contact Gareth Evans at Financial Inclusion Centre on gareth.evans@inclusioncentre.org.uk

NEST – Evolving for the future

The Financial Inclusion Centre has responded to the DWP’s call for evidence on the evolution of NEST. We are big supporters of NEST as a good example of how collective provision can introduce real value into complex, failing markets such as pensions where the individual, market-based approach fails to work.

NEST was set up to provide a good value, trusted means of helping consumers accumulate assets for retirement. We strongly support the idea that NEST should also provide a default option for those trying to provide an income in retirement – the decumulation phase. The introduction of the misguided pensions ‘freedom and choice’ reforms will result in consumers being exposed to greater market, longevity, and misselling risks and higher costs/ worse value when trying to generate an income in retirement. It is critical, therefore, that NEST is able to provide a beacon of good value and trust in the decumulation phase of retirement.

The submission can be found here: financial-inclusion-centre-submission-nest-evolving-for-the-future

Regulating defined benefit pension schemes

The Centre also responded to the Work and Pensions Select Committee Inquiry into Defined Benefit Pension Schemes

Resolving the problem with pension scheme deficits requires some tough decisions by employers and regulators. One thing that can be done to address the issue is to reform the regulatory framework for defined benefit pension schemes. We made three main high level recommendations for improving the regulatory framework:

• The prudential regulation of defined benefit schemes should be tightened up;
• Conduct of business regulation as it applies to defined benefit schemes should be toughened up; and
• Linked to the previous point, the ‘architecture’ of pension regulation should be redesigned and clarified so that we have a more explicit ‘twin-peaks’ regulatory architecture.

The submission can be found here: financial-inclusion-centre-submission-work-and-pensions-defined-benefit-pension-schemes

‘Brexit’ could have serious implications for consumer protection and how financial markets are regulated in the UK. How much UK consumer legislation and regulation is affected will depend on which form Brexit takes, which could range from ‘Brexit-lite’ to a ‘hard-Brexit’. Risks would mainly arise if access to the single market in financial services is lost or severely curtailed. Remaining in the single market would require most, if not all, of current EU-derived law to stay in place. Depending on the outcome, we see two key risks emerging.

Firstly, the financial sector already argues disingenuously that the current system of financial regulation stifles innovation and competition. Industry lobbyists will capitalise on the opportunity provided by Brexit to lobby for deregulation and a weakening in consumer protection in financial services.

Secondly, if access to EU markets end up being reduced, the City of London will seek to offset this by attracting additional business from other international financial markets. On the face of it, this could be beneficial for the UK economy. But, the economic and social costs of the 2007/08 financial crisis provided a painful reminder of the risks associated with an over-reliance on financial services. The UK financial sector is already one of the biggest in the world and if the UK’s exposure to international financial markets is increased, this could further threaten the stability of the UK financial system and resilience of the wider economy.

There are big choices to be made and well-resourced financial services industry lobbies are already actively trying to influence the course of Brexit. It is important that consumer groups and civil society understand the potential consequences of Brexit.

With this in mind, The Financial Inclusion Centre is providing seminars for consumer groups, civil society organisations, and other stakeholders including journalists looking for a deeper understanding of Brexit implications.

The seminars  cover the framework of EU legislation, the UK’s current approach to implementing EU legislation and, critically, what the implications of various Brexit scenarios might be for  UK financial consumers and financial market regulation.

The one day seminars are led by Mick McAteer, one of the UK’s best known consumer advocates with 20 years experience representing UK financial consumers at UK and EU level, and John Crosthwait, previously a senior lawyer with one the leading law firms in the City and a specialist in  financial services law and regulation.

Seminars can be organised for individual organisations or provided on a group basis.

The seminar programme can be found here: financial-inclusion-centre-brexit-seminars

For further information including on costs please contact mick.mcateer@inclusioncentre.org.uk.

The Financial Inclusion Centre today publishes its Policy and Risk Outlook which identifies nearly 30 major policy issues and risks which need to be addressed if financial markets are to work for society.

The resilience, efficiency and conduct of the UK financial services industry is critical to the economic well-being of UK households, the ‘real economy’, current and future generations.

Retail financial services has historically been the focus of consumer group and media scrutiny. A litany of financial misselling scandals (now costing £50bn according to the latest tally) has left a legacy of mistrust and low levels of confidence in the industry. On the face of it, there have been improvements in the conduct of firms in retail financial services. But serious concerns remain about the dominant culture. All this is bad enough in its own right but a wider cause for concern given how much consumers are expected to rely on retail financial services in the future.

Households are expected to use financial products and services to build financial resilience and long term financial security. But, much of the industry has not adapted to the new economic and financial reality forged by low returns, technological change, more realistic regulation, changing labour markets, and squeezed household finances. The industry is becoming less relevant for growing numbers of economically vulnerable households.

Financial services isn’t just a pure consumer issue. Financial services already play a significant role in meeting public policy needs such as housing, retirement incomes, long term care, and social security replacement. This role is expected to increase over the years as policymakers attempt to transfer risk and responsibility for meeting these needs to citizens. But, the financial services industry isn’t ‘fit-for-purpose’ to provide the products and services people need.

Sitting behind retail financial services are the huge wholesale and institutional financial markets and financial infrastructures. These markets and infrastructures are of national economic interest.

We have only begun to understand the conduct failures in these critically important markets. Our analysis suggests that inefficiencies and market failure in these sectors (such as resource misallocation and poor investment performance which undermines retirement incomes) have a greater impact on the economic welfare of households and the real economy than retail financial services. Despite their importance, wholesale and institutional financial markets receive comparatively little scrutiny from civil society.

Behaviour and activities in financial markets continue to create systemic risks and threaten economic resilience. Financial markets can exacerbate regional, intra and inter-generational economic inequality.

Market failure doesn’t just harm consumers, it can harm the interests of firms – for example, high charges on investment funds extract value from consumers’ savings and reduce the amount of investment capital that reaches firms. Market short-termism affects the ability of firms to invest for the long term.

That is the state of play now. Financial markets and services are not working well for society. There is much to be done to remedy existing failures. But, more challenges lie ahead. The environment in which financial services operates is being reshaped by a range of powerful external forces creating a range of risks and challenges for the industry and its customers.

It is important that consumer groups, civil society, policymakers, regulators and, of course, the industry itself understand the current and emerging risks and policy issues. To identify the major risks and policy issues we used a two stage process:

• We analysed the forces shaping the environment for the financial services industry ie. socio-economic, demographic, technological, commercial, and political factors; and
• Applied four tests to assess how well financial services will respond to these challenges and identify which sectors and activities create the greatest risks for consumers and the real economy.

From this process, nearly 30 risks and issues emerged. To provide some structure, we have grouped these into the following areas:

• Retail financial services including financial inclusion.
• Wholesale/ institutional markets, and financial infrastructures.
• Major areas of public policy in which financial services has a role.
• How regulatory and public policy is developed.

Much more work now needs to be done to develop the robust policies to address the risks and issues identified here. As a small, non-profit organisation we have limited resources so would welcome the opportunity to work with other civil society organisations, regulators and progressive firms in the industry to make markets work better.

The Policy and Risk Outlook can be found here: Financial Inclusion Centre policy and risk outlook 2016 final