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Does nanny know best?

The new regulator wants to protect 'irrational' consumers by removing 'bad' products from sale.
December 21, 2012

A worrying picture is emerging of a nanny state approach to investment regulation that will curtail the freedoms of many self-directed investors.

Next year the regulation of financial services will change, with the new Financial Conduct Authority (FCA) replacing the Financial Services Authority's (FSA) consumer protection beat. Rejecting the UK regulator's prior approach, which emphasised disclosure and buyer responsibility, the new FCA chief, Martin Wheatley, has announced the FCA will seek to protect "irrational investors" from their own worst impulses by keeping potentially problematic products out of their hands. The new FCA will have new powers to restrict the marketing of products at risk from misselling to certain groups of customers, or remove or change unsuitable product features. It will even be able to put in place instant product bans, without consultation, for up to a year.

Critics have said this regulation strategy looks more like product approval by another name, while many in the industry are worried about the introduction of what they term 'nanny state' financial services regulation.

But as Mr Wheatley has already taken full charge of investor protection and markets regulation at the FSA, the new approach is already with us. Earlier this year the FSA published proposals to ban the promotion of unregulated collective investment schemes (Ucis) to private investors. There is a risk that the new rules could restrict access to venture capital trusts (VCTs) and enterprise investment schemes (EIS), to the detriment of those markets for existing investors.

On the Ucis consultation, the regulator says: "Our proposals may limit choice for some consumers but not all innovation or choice is in the interests of retail customers. We are making the judgement that the benefits of improving customer outcomes for most retail investors outweigh the costs to the minority for whom they may be suitable."

This 'boots-first' approach to investor protection springs partly from Mr Wheatley's own bitter experience as Hong Kong's chief securities regulator. In that post he was personally targeted by some of the 31,000 investors who lost money in structured products linked to the failed Lehman Brothers investment bank.

In an interview with the Financial Times in January 2012, Mr Wheatley said that the 2008 financial crisis has led to the regulator changing its assumptions about how best to protect investors. He said: "You have to assume that you do not have rational consumers. Faced with complex decisions or too much information, they default."

The body of evidence from behavioural finance backs up the irrational consumers point. But the problem is that the Retail Distribution Review, under which all financial products are to be sold come January 2013, is predicated on an intelligent consumer able to make rational decisions about what they should and shouldn’t pay for - in other words able to select whether to go direct to product providers or pay for independent financial advice. So we already have opposing philosophies behind a regulatory strategy which quite simply doesn't add up.

While Mr Wheatley has said that he believes use of product ban powers will be rare - the FCA has said it will only ban products outright in "the most serious of circumstances" - he also said: "When we start to hear of problems with a product we will go in much earlier than in the past."

If the FCA decides a product is suitable for a certain category of customer, it will be interesting to see whether they will take any responsibility if that product then becomes a disaster.

Another issue is that Mr Wheatley has the same staff transferring over from the FSA. These employees have already been accused of failure in relation to several 'bad product' scandals: most notably Keydata - Britain's biggest personal investment scandal in decades - which left tens of thousands of pensioners without an income after the FSA fast-tracked the business into administration in 2009. So the FCA is clearly not able to provide a fool proof vetting system.

 

 

The Investors Chronicle's view is that rather than worrying about protecting irrational consumers, the FCA should be talking about an education agenda. It should be educating people to make rational choices. The more people are protected from 'complex' decisions and products, the more reliant they become on the system to protect them.

Charles McKinnon, chief investment officer at Thurleigh Investment Management, is not a fan of the new approach to regulation. He says: "Are we going to have someone standing in the entrance to McDonalds weighing you and telling you what to buy? Or shut down gambling because consumers lose money and casinos make money? Let's start with some really sensible things. I don't think it is smart to pretend to understand savers' needs. Prohibition never works. However, taxation works - really well. It works for cigarettes. Why not tax products to stop people buying them?"

Other critics also point out that there is a difference between bad products and misselling of good products. Payment protection insurance was not in itself a bad product - it was just sold to the wrong people.

In October 2012, Ian Sayers, director general of the Association of Investment Companies, said: "The major cause of the consumer problems identified by the FSA has been sales to retail investors where advisers were inappropriately incentivised by commission or did not understand the products they were selling. This should be tackled by embedding the distribution reforms envisaged by the Retail Distribution Review. This will achieve the FSA's objectives while guarding against any false sense of security which could be created by arbitrary restrictions."

It is that false sense of security, which some commentators view as the greatest danger that the FCA's tactics may pose to consumers. In banning bad products, they run the risk of consumers abandoning the principle of caveat emptor (let the buyer beware), instead making them feel secure that they are buying 'good' products, even if they too are unsuitable.