For the compliance experts at Britain's Personal Investment Management and Financial Advice Association, 2020 has been a year unlike any other. Just before 'lockdown' began in March, the trade body's mounting criticism of the UK's financial regulatory set-up reached fever pitch; there has not been a dull moment since.

It has been quite a year! As we, perhaps fondly, remember ‘old normal’ and prepare for ‘normal version two,’ it is worth taking time to remember where our sector has been and try to see where it is going.

As COVID-19 struck the UK in the spring, PIMFA got in early to work with the Financial Conduct Authority, setting up weekly meetings in which it let the regulator know what its firms thought about the operational and compliance-related problems that they were facing. They were especially keen to know how best to collaborate with the regulator during the crisis.

In response, the FCA sent out a ‘Dear CEO’ letter to all firms in which it outlined temporary changes which included the extention of deadlines for their responses to various things, greater flexibility in ways to verify clients' identities, less stringency regarding "best execution" and 10% depreciation notifications and a pause on the implementation of investment pathways. These examples of regulatory forbearance clearly show that our sector and its regulator can deal with each other in a grown-up way and work together well.

The FCA - fit for purpose?

Mere days before HM Government imposed "lockdown" on the population, PIMFA published a paper on the future of supervision entitled FCA Supervision – fit for purpose? This was the product of months of gathering evidence from firms and from the FCA itself. In it, PIMFA identified areas in which the regulator was falling short in its attempts to meet its stated objectives. It was not good at explaining its efforts to assess its own merits as a supervisor, it needed to collect and analyse data more expertly, the better to understand the activities of firms, it needed to improve the way in which it reviewed its own procedures and it needed to prosecute firms for criminal offences swiftly.

In particular, the paper shone a light on the regulator's preference for reviewing its 'handbook' or embarking on a new policy in response to a typical problem instead of trying to work out whether or not the problem has arisen as a result of its inadequate supervision.

The FSCS

When a firm fails, its failure erodes trust in all regulated firms and undermines the confidence of consumers - many of whom are in great need of financial advice and investment services - in the financial sector. Equally, the costs associated with these failures – e.g. the premia that firms pay to the Financial Services Compensation Scheme and their professional indemnity insurance policies – are very high and damage firms' competitiveness and innovation. These high costs also victimise consumers by widening the so-called "advice gap," the void of financial advice created by HM Government in 2012 when it introduced the Retail Distribution Review and stopped customers from being able to choose how to pay for advice. Today, fewer than 10% of consumers in the UK take financial advice; many of the ones who do not are deterred by the cost of it.

Many practitioners are therefore very disappointed at yet another year of increasing levies. Everyone knows that this cannot continue. PIMFA is working closely with HM Government and the regulator to find an effective way forward. Indeed, I gave evidence to the House of Commons’ Work and Pension Select Committee inquiry into pension freedoms and scams on this issue in September. Essentially, we are worried about detriment to consumers. We believe that "the polluter should pay." This is ultimately an issue that the Government can only solve by making holistic changes.

Our latest policy paper is called A rising tide lifts all boats?: A roadmap towards better consumer outcomes and lower levies. It argues that "without a wholesale review of the fundamental drivers of calls on the FSCS, the total compensation bill will continue to rise for all advisers and wealth managers regardless of any review of the levy’s construction."

As a first step towards bringing the FSCS levy back under control, we propose that the fines that the FCA imposes on firms for regulatory failures ought not to be paid to the Exchequer and instead ought to go towards funding the FSCS, with a small proportion going to charity. This should result in more modest annual increases in the FSCS levies and it might even push the levies down.
 
We are also calling for the FCA and FSCS to try harder to recover funds from firms or schemes that have failed and to ensure that they take action in all cases, with the aim of reducing the sums that they levy on firms.

Defined benefits

This year might also have witnessed the end of the FCA’s long battle to get a handle on the defined-benefit (DB) pension transfer market. Having consultated various people and collected data after HM Government introduced "freedom and choice" in pensions and removed the rule that all pensioners must have annuities, the FCA has, I believe, achieved its stated desire and ensured that DB transfers will become less prevalent than now. Contingent charging has been all but banned from the market (except in very specific circumstances) and I expect the FCA to issue formal guidelines for advisors who do continue to advise their customers about DB transfers shortly.

It should be said that this market is improving. The quality of the advice that practitioners give their customers about DB transfers has risen substantially since the FCA’s previous policy statement about improvements for pension transfers. It will be very interesting to see whether or not the more recent changes that the FCA has made in the market will do much to improve the quality of advice.
 
The FCA’s Call for Input into the Consumer Investment Market was a significant event in 2020 but has also given us something to watch for in 2021. It sets out a plan of reform in the consumer investment market that will probably shape the FCA’s efforts for some years ahead.

Broadly speaking, the FCA's work in this area falls into three categories.

• Simpler services and products. The FCA has made efforts in this area but this has largely been confined by the UK's relationship with the European Union and its second Markets in Financial Instruments Directive. When our transitional arrangements with the EU end on 31 December, it seems as though the FCA will want to review this again. PIMFA will be publishing more thoughts on this particular issue early in the New Year.
• Disclosure and exemption protections. The FCA will look at how these protections work. In particular, they will consider issues such as the high net worth investor exemption and whether or not the levels set 20 years ago are still fit for purpose. In particular, it will consider issues such as the high-net-worth investor exemption and whether or not the levels set 20 years ago are still fitting.
• FSCS levies and compensation for consumers. The FCA is looking again at the issue of the FSCS levy. It is not considering a full-scale funding review, but it wants to find out whether more could be done to "make the polluter pay." PIMFA has recently published a paper on the issue of the FSCS levy and it remains an issue of priority for the trade body.

Regulation of the advice market in 2020-1

Scams have increased in number. People might make more highly risky investments because they want to move money out of cash savings. In April in its Business Plan, the FCA made it a priority to ensure that consumers make effective decisions about investing their savings and not expose themselves to risky or unprofitable investment products.
 
HM Treasury followed this up by consultating interested parties about the risks that arise from misleading, inaccurate or inappropriate financial promotions. Regulatory costs have increased throughout 2020 and the FCA has been trying to find ways to crack down on the root causes of that increase, perhaps by banning the marketing of mini bonds to retail customers. We can expect more of this type of work from the FCA in the year to come.

Towards the end of this year, the FCA "called for input" about the consumer investment market, aiming to make the advice market work better, with an emphasis on promoting simpler products and services that might help investors with "straightforward" needs. It followed this up by evaluating the Retail Distribution Review (RDR) and the Financial Advice Market Review (FAMR) with a view to reform in this area. In 2021 we can therefore expect it to concentrate on problems that inhibit the development of simpler advice models. We can also expect it to pay more attention to the value of advice and ways to improve competition among advisors.

No physical damage, no victim

The Government's Online Harms Bill proposes to impose a measure of regulation on companies that allow users to share or discover user-generated content or to interact with each other online. These are the companies that run social media platforms, file-hosting sites, public discussion fora, messaging services and search engines.

The Bill proposes to set up a dedicated regulator for the purpose. It also seeks to saddle relevant companies with a duty of care towards their users, ordering them to set up systems and controls to keep those users safe online. It stems from public concerns about online safety. It does not, however, propose to ward off financial harm. Why is that?

HM Government, believe it or not, considers fraud to be a “victimless crime” because it hurts nobody physically. It is, however, undeniable that fraud can cause great psychological harm. A person's life can be ruined if he loses his savings to a fraud and he can suffer enormous psychological damage. The exclusion of financial harm from the Bill is therefore going to absolve technological companies from having to check content for fraud-related risks, although they might take some precautions for fear of scandals damaging their reputations.

Despite this, the Government is paying more attention to fraud and allocating more resources to the fight against it. This is welcome.

The IFPR

Meanwhile, the FCA declared this month that it wanted to set up a new Investment Firm Prudential Regime or IFPR [comment period ends 5 February] to keep firms financially resilient throughout the economic cycle.

The idea for the proposal comes from the European Union's Investment Firm Directive and Investment Firm Regulation. The Government wants it to come into force on 1 January 2022.

[Editor's note: Both the directive and the regulation became EU law on 25 December 2019 and must be enshrined in the laws of all EU countries by early 2021, with everybody obeying the main provisions by the end of June 2021, i.e. earlier than the British date.]

The FCA published a discussion paper over the summer and a consultation paper is due in the next few weeks. We do not expect that the calculations in the draft rule will be different from those in the EU instruments, as the UK participated in the creation of those. The rules will contain transitional provisions with timelines applicable to firms in different situations, with a 5-year horizon.

The IFPR is to apply to all MiFID investment firms and is designed to require them to calculate their prudential requirements regularly. Some of the figures that firms need to calculate these requirements go back 15 months, so it is important for them to start capturing the data now.

The new rules will have an additional effect on consolidation in that the IFPR will make the parent company in question responsible for complying with some consolidated prudential rules. Firms will have to think about the ways in which their strategies for growth will affect their prudential duties.

Another point to note is that the IFPR is expected to require firms to take wind-down planning into account.

ESG investing in 2020 and 2021

COVID-19 also taught firms a lesson about Environmental, Social and Governance (ESG) investing in 2020. According to research by the DWS Research Institute, which is part of Deutsche Bank, the initial effect of the crisis on investments seemed bad but ESG-centric fund values did not fall off a cliff because of people rushing to buy traditional stocks instead.
 
In fact, the evidence suggests that investors do care about the obvious benefits of holdings that have good ESG scores. This includes lower operational and reputational risk, better relations between managers and staff and sturdy supply chains. ESG is not simply a bull-market phenomenon. It has now proven that investors can invest in sustainability and gain a return, even in the worst of times.

Social inequality cannot be ignored. Consumers' attitdues have changed and investors have been willing to take risks to fund 'sustainable' investments.
 
In 2021, Joe Biden's US administration will put the Paris Agreement and COP in the driving seat again, backing rules to tackle greenhouse gas emissions and loss of biodiversity. In the UK, HM Government will be issuing green bonds with a view to promoting British green investment and will impose new reporting requirements on investors and issuers. Most will probably show themselves ready to cope with them.

Manifesto update

PIMFA’s top priorities are still the reform of the Financial Services Compensation Scheme (FSCS) levy, action against the rising costs (and shrinking availability) of Professional Indemnity Insurance (PII) for advisors and the future of supervision. In all three areas PIMFA has lobbied the Government and regulators more vigorously. In the coming year it will also concentrate on the effects of Brexit, investments in Environmental Social and Governance issues, digital transformation and other things.

Finally, we have to mention Brexit itself. There has been an element of denial among many British firms regarding preparations for the end of the transition period on 1 January. Nevertheless, the end of the old world provides us with an opportunity to reconsider the practical application of regulation, review the architecture of the FCA's rulebook or 'Handbook' and beseech the authorities to change the rules to take the specifics of the British market into account. We might therefore ask for a review of the rules of MiFID II rules that have caused detrimental and unintended consequences as they apply in the UK, the aim being to create a regulatory system that is cost-effective, does not impose disproportionate cost burdens on financial firms and, above all, works for customers.

Happy New Year!