Speech on “rethinking investor protection” by Martin Wheatley
Martin Wheatley will be the Chief Executive of the new UK Financial Conduct Authority (the FCA) when it is formed later this year or early in 2013. He will be one of the most powerful regulators in the UK, head of the organisation responsible for the operation of conduct issues across the entire spectrum of financial services. We discuss the purpose and scope of the FCA in this post.
On 2 May 2011 Mr Wheatley gave a speech to the Australian Centre for Financial Studies on “rethinking investor protection”, making general comments about the approach of financial regulators before and after the financial crisis and then focusing on the regulatory challenge of ensuring that financial products are appropriate for those who invest in them. The speech can be accessed here.
Regulation since the crisis: Throwing ideas against the wall to see what sticks
Discussing the general approach of regulators before and after the crisis. Mr Wheatley states:
“Despite a few lone voices, regulators generally failed to appreciate the scale of the crisis that would ensue [as risk built up in the system in 2005-07]…I would categorise the regulatory response in the aftermath of the financial crisis the spaghetti approach – a vivid description of the strategy of throwing ideas against the wall to see what sticks.
Governments and regulators, placed under immense pressure to act, had brought out emergency rules only to be later reversed, creating further problems rather than eliminating them.”
Financial products: Disclosure of information and regulatory intervention
Turning to the debate on ensuring that financial products are appropriate – which will be a key part of the FCA’s remit – Mr Wheatley observes that this debate is “subtle and difficult”:
“Most products are neither inherently good or bad (unless they are fraudulent of course). But they have become very complex where the balance of risk and reward can be opaque – products unsuitable for some may be entirely appropriate for others.”
The speech then discusses the belief that disclosure of information about financial products is all that is required to provide adequate protection to investors; a belief that was widely held by regulators before the financial crisis. Mr Wheatley provides some statistics from a Fidelity Investments survey in Hong Kong (where he is currently CEO of the Securities and Futures Commission):
“A recent survey conducted by Fidelity International shows that 78% of Hong Kong investors think “investor protection” is to provide investors with the appropriate information before making an investment decision – fair enough and rather encouraging.
But in the same survey 59% said they would not read the prospectus and 64% said they would not read fact sheets or product brochure. It’s a bit worrying as a regulator that puts an emphasis on disclosure – if most people don’t read what you disclose.”
Although that was a survey of retail investors, Mr Wheatley observes that the entire range of consumers of financial products, including sophisticated institutional investors, failed (or were unable) to understand the nature and risks of products that they were buying. Discussing the trend towards direct product intervention by regulators (a power that the FCA will have), Mr Wheatley continues:
“Product intervention may take the form of rules placing requirements on products and product features; mandating minimum product standards, and restricting sale of a product to a certain class of consumers…
…Intervention is a fundamentally different approach in the way most regulatory regimes have operated to mitigate risk of financial services.
Regulators may proactively intervene earlier in a product’s life cycle, and exercise greater scrutiny of firms’ product design and product governance. A more proactive, interventionist approach will also require a greater use of judgement.
This is done to complement, not to supersede, the traditional focus on sales and marketing, and the disclosure of information.
But financial markets are primarily about the management and pricing of risk, not its removal. It is therefore imperative that intervention does not make for a zero-failure regime, and that investors are not removed of the responsibility for their own decisions.”
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