FCA has published its "Sector Views", highlighting the information it uses to assess how specific financial sectors and the financial system as a whole are working. It uses the analysis from its sector views when settling its Business Plan for the coming year. This year, it has decided to share the views in advance of publishing the Business Plan.
In this article, Emma Radmore looks at the key messages from the sectors.
FCA has considered, for each of seven sectors:
- A sector overview
- How the sector is changing
- What is driving change
- Consumer perspective and
- Potential harm
It has also considered and identified a number of cross-sector concerns, challenges and themes.
The sectors are:
- Retail banking
- Retail lending
- General insurance and protection
- Pensions savings and retirement income
- Retail investments
- Investment management and
- Wholesale financial markets
There are always common drivers of change, and the key cross-sector themes FCA has examined in the past year (or, at least, to mid-2018) fall within four buckets:
Within the overall category, FCA focuses on:
- Digitalised automation, consumer engagement and firm accountability: it has been well documented that Open Banking and PSD2 have opened the doors to significant activity in digital platforms and initiatives to enable both consumers and business users to manage money real time, using their own bespoke payment patterns and to give consumers better access to comparison platforms, robo-advice, and investment services that automatically trade to a customer's requirements. FCA needs to understand how firms use technology and particularly what assumptions they use to build automatic services and what controls they have in place to mitigate the risks of cyber-crime and misuse of data as well as how they ensure consumers do not get unsuitable services and that the increasing provision of technology-based services does not lead to financial exclusion of vulnerable customers
- Disaggregation of the value chain and the regulatory perimeter: FCA has noted the trend towards regulated firms entering into bespoke partnering arrangements to target specific customer segments for particular services. Additionally, and separately, there is an increase in activity outside the current regulatory perimeter (specifically in ICOs), and thus in areas where there is not regulatory consumer protection framework. It also notes a number of new market entrants which may lead to more complicated accountability and therefore also risks to consumer protection
- Increasing personalised products and services has been helped by technology: FCA notes new business models, facilitated by technology, that lead to more tailored products and services, but cautions over whether these new business models and new market entrant businesses will be sustainable. Again, in this category, FCA is concerned about treatment or potential exclusion of vulnerable customers because of increased use of technology.
More than ever, FCA notes the financial circumstances and needs of each generation will differ from the needs of the previous generation at equivalent ages. An ageing population, slower economic growth and low real wage growth, together with a lower intergenerational progress of wealth accumulation, home ownership and income growth pinpoint the challenge. New freedoms have brought with them also increased responsibilities for consumers taking their own risks could impact trust in some sectors.
It goes without saying that Brexit will impact all sectors, with potentially the most significant impact on the wholesale and investment management sectors and on retail insurance. FCA may find itself supervising firms with a more complex structure than hitherto as firms adapt to whatever Brexit happens.
Finally, FCA needs to react to the external environment, which continues to be challenging, including the low interest rate environment, inflation growing faster than wages, and the resulting pressures on household finances making some consumers increasingly reliant on credit and borrowing.
Retail banking and payments
FCA's key message for the sector is that trust and reliability are central to retail banking services. Key concerns are rooted in the potential for financial crime, the impact of interrupted services or lost/corrupted data and the potential barriers for some customers with the shift to online distribution channels. FCA itself is also still worried about overdraft charging practices – despite recent improvements a minority of consumers pay the majority of fees.
FCA's research shows that over 60% of each of the mortgage and credit card markets are held by the big 6 retail banks. Providers and technology firms are becoming increasingly involved in developing new products and services, while consumers increasingly rely on electronic and contactless payments. The role of intermediaries such as data analytics, foreign exchange services and fraud prevention software providers is also increasing.
FCA concludes that regulation and technology are changing the payments sector, with consumers likely to benefit from new products and improved awareness, although system resilience and security remains a key issue.
Research shows that fewer than a third of consumers have ever switched current accounts, although nearly half have more than one active account, and over half also have a savings account with their main bank. There are indications that reluctance to share personal data outside of a consumer's main bank may slow down open banking – and nearly half of all consumers say nothing would encourage them to share their personal financial data. Interesting, although the branch network continues to decrease in numbers, young customers still use branches, in fact more often than slightly older consumers.
In terms of consumer harm, this sector is at significant risk of cyber-attacks, which could be made worse by ageing IT systems, and significant use of outsourcing and data transfer. Other identified harms and risks include the risk of financial exclusion with the increased use of technology, lack of incentives for incumbent banks to compete effectively on quality and price to retain business, overdraft charging, treatment of SME customers, misunderstanding by consumers of protections and benefits of different payment services and lack of awareness of relevant regulations.
Estimates suggest there is over £1.5 trillion lending throughout the sector, with current change being driven by the societal factors discussed above. Many consumers have no choice but to borrow, and FCA is concerned this may lead to them getting poor value or unsuitable products and services and may as a result face financial difficulties. FCA has noted that there are some signs that mainstream credit firms may be starting to slow lending in response to regulatory concerns about the growth of consumer credit, with the perceived steady growth in mortgage lending being driven by first time buyers and re-mortgagers. One third of mortgages are now for terms exceeding 30 years and 40% of those who took out a mortgage in 2017 will be over 65 on mortgage maturity – which may impact on their pension savings. Loan to income ratios are also increasing, with over one quarter now at LTI greater than 4 times income. Finally FCA notes the end of the Term Funding Scheme, which could lead to increased costs for firms and potentially consumers.
FCA is concerned that households are less likely to be able to withstand shocks and notes that over-indebted adults admit to poor financial knowledge. It sees a movement towards older home-owners seeking to release equity in their homes. It also notes the benefits in customer communication that technological developments can bring, while cautioning that this may mean inflexibility for non-standard circumstances. It also sees increases in use of outsourcing, which may equally bring improvements in, say, data security while potentially also concentrating the data which makes the potential impact of financial crime higher.
In terms of harm, FCA worries that borrowers may fail to deal with debts before they become unmanageable, and that product design may lead to customers receiving poor value or unsuitable products. Consumers in distress are often not properly supported, including where second-charge lenders delay taking action because of the low level of security they have over their loans. It is specifically also aware that it is hard for customers to assess the many mortgage products on offer, and that as a result they may often not purchase the best value product for them.
General insurance and protection
FCA comments that this is a mature sector, which is now gradually but profoundly being transformed by technology. Its key concerns are over the risks surrounding use and ownership of data, and the consumer behaviours that leave them vulnerable to poor value or unsuitable products. In comparison to the retail banking and lending sectors, this sector uses distributors and face-to-face meetings to a significant extent. Brokers are the main distributors of wholesale and commercial insurance, while retail insurance is often sold in banks or as add ons in retail outlets. There is also significant use of niche distribution channels. FCA also found that most general insurance (with the exception of a few specialist sectors) is sold by insurers who are authorised to write a variety of asset classes, and protection cover is sold mainly by life insurers.
Unsurprisingly, FCA sees increasing calls for cyber insurance, with home contents insurance dropping slightly – which FCA explains by saying more people now rent properties and tenants are less likely to buy cover than homeowners. Apart from in the motor sector, where premiums rose by 9% in 2017, premiums are stable. Consumers are benefiting from the new rules on greater transparency at renewal, and long term customers can save by shopping around. FCA has found desire for greater flexibility that can be provided by pay as you go products. In terms of capital, the size of some natural castastophe exposures has led to more securitisations and firms have been restructuring as larger firms continue to acquire smaller ones. The insurance sector has also already taken significant action in anticipation of Brexit, not least subsidiarising and separating past business.
In terms of consumers, most say they understand insurance but do not find product literature helpful. Over half of younger customers trust price comparison websites to give them the best deal. FCA found there are several possible reasons for people not to buy insurance and that technology continues to create both opportunities and threats. It is concerned about harm that could result from differential pricing – even with the new rules requiring firms to disclose the previous year's premium in renewal notices. It also notes there are situations where it is impractical to compare prices. FCA is also concerned about how quickly and fairly claims are dealt with.
Pensions savings and retirement income
FCA views this sector as split into accumulation and decumulation supported by advice and service sub-sectors. It splits consumers into the categories of workplace consumers and individual consumers. It sees continuing increase in membership growth within workplace pensions and, more generally, a sharp rise in defined benefit to defined contribution transfers. The largest providers have looked to update products to reflect the new pensions freedoms, and the size of non-workplace pension sales almost doubled from the previous year.
Clearly the ageing population presents a challenge in this sector, and FCA has found consumers are on the one hand facing a future of needing to take greater responsibility for managing their financial risks, yet struggle to engage with their pensions. There are many further challenges to the sector caused by a variety of factors, but FCA is hopeful that technology can be helpful with costs and GDPR with consumer protection.
The clear potentials for harm are that consumers will not have enough saved and, for various reasons, are not maximising their savings. FCA's recent survey that found less than half of DB transfer recommendations suitable and which led to many firms exiting the advice market for such transfers is not helpful to consumers. There are numerous concerns stemming from poor value and outdated products.
FCA notes this sector has seen steady growth in consumer numbers and assets invested, though a range of channels, although the client base tends to be older. It notes that the older, wealthier customers tend to use wealth managers while the financial advice and guidance market caters for the mass market.
Again, FCA notes transformation in the sector driven by a variety of factors, including changes in regulation, the low interest rate environment, new fee structures, complex client needs and easier-to-access platforms, with technological developments also helping consumer understanding so they can make more suitable investments. Yet UK adults do not widely hold retail investments – often because they do not trust financial advisers but do not know enough to take out an investment without consulting one.
FCA sees the key risks as being potentially unsuitable products, particularly in the retirement income sector and with the advent of high risk cryptoasset products. It notes the myriad regulatory changes implemented recently, with more to come, which should generally better protect consumers, and also encourages online services that can aid consumer understanding. FCA also sees that investment platforms are generally working well, but it is not happy with how firms are risk labelling their model portfolios.
FCA notes the growth in both total assets under management and the proportion of passively managed assets (a quarter of all assets are now passively managed). It remains predominantly a sector for institutional investors who account for 80% AUM.
This part of FCA's report includes investment consultants, insurers, pension funds and other institutional investors within the sector, but note it addressed distribution of asset management services to individual consumers falls within the retail investments sector, while pensions and retirement solutions are within the pensions chapter. FCA sees changes being driven by a range of factors, including pressure on responsible investing and the impact of regulatory change. The key challenges the sector faces come from pricing and quality of services and threats to the stability and resilience of the UK financial markets. FCA specifically notes the risks of technological failure and disruption and the potential harm that could be caused if one or more of the relatively few firms that many asset managers outsource to were to fail. It also sees risks if funds invest increasingly in illquid, or less liquid, assets.
Wholesale financial markets
The final sector FCA addresses is a wide-ranging sector which spans multiple activities and asset classes. FCA notes the substantial changes the sector is undergoing largely through regulatory changes. It sees seven themes that could cause harm in the sector: financial crime, market abuse, stability and resilience, conflicts of interest, market effectiveness, market power and information asymmetries. FCA provides a useful diagram showing how the sector divides between corporate banking, primary markets, ancillary and third party services, secondary markets and post-trade services, provided to corporates, investment managers and retail investors – and some regulated by FCA and some by other regulators (and some not at all). While firms adapt to regulatory change, wholesale firms are increasing their use of third-party service providers. This sector is possibly the most at risk from technology-enabled financial crime. These constant risks apart, FCA sees most other risks to this sector as reducing with increased or updated regulation.
Diverse as the sectors FCA identifies are, a number of themes clearly come through. This article has not focused on the risks associated with Brexit, which are a given and (at the time of writing) still not possible to predict with any accuracy. The risks to market integrity and stability caused by increasing use of technology by criminals are not new, but with ever-more financial services activity being based on, and increasingly reliant on, technology, the drivers to protect customers and the financial system are stronger than ever. While customer and consumer behaviour is driven by market forces, firms are grappling with sets of new regulatory requirements and the need to address perceived conduct risks – not least those of mis-selling and poor presentation of information.
This article originally appeared in Compliance Monitor.