How the FCA Can Do More to Back Growth

On Christmas Eve, the Prime Minster, Chancellor, and Business Secretary fired out a series of joint letters to Britain’s most powerful regulators, asking them for ideas to support economic growth. The timing of the letter was no doubt meant to convey a message: getting growth is important and urgent.

This should have been obvious already, from Labour’s manifesto, which included a whole chapter on 'kickstarting economic “growth”', and the Chancellor’s Mansion House speech in November, in which she said that attempts to eliminate risk taking had ‘gone too far’. Alongside the speech, in case the regulators’ ears were not pricked up sufficiently, she sent them ‘growth focussed’ letters regarding their remit.

A few weeks later, it was clear that the government thought that its message had not been fully received. Following a meeting with the Competition and Markets Authority (CMA) to discuss its approach to growth, the government fired its chair. No doubt this caused an intake of breath at regulators up and down the land.

In the meantime, the Financial Conduct Authority (FCA) had responded to the government’s festive letter with a list of proposals for growth, alongside a warning that 'more informed risk-taking' would mean 'there will be failures'. Nikhil Rathi, the Chief Executive of the FCA, suggested the government set 'metrics for tolerable failures', a perhaps stereotypical civil servant response.

The interaction between government and regulators is tricky because of the need to balance democratic legitimacy with regulatory independence. Both are important. We live in a democracy, and decision-making should ultimately be accountable to the electorate. On the other hand, according to the doctrine of 'New Public Management' that developed in the 1980s, independent regulators can provide consistency unencumbered by political weather.

The idea of ‘risk metrics’ for regulators may seem a neat way to square the circle of the democratic imperative and regulatory independence. Yet, the government setting ‘risk metrics’ in the abstract is likely to be a bureaucratic process that will not fit with political realities, if it would work at all.  As former FCA Chair Charles Randell has pointed out, this is an extremely difficult debate to have in the abstract.

Better to improve the FCA’s cost benefit analysis process, which is currently flawed, to make sure the risks for individual proposals, and their alternatives, are better understood. An important part of this is an understanding that the risks associated with removing different types of regulation vary greatly. For example, the financial crisis showed the importance of financial stability in regulating credit in the economy. On the other hand, there are some regulatory disclosure obligations that are out of date and not effective, that could be modernised or removed without negative impact.

Most important is for the FCA to develop a compelling articulation of how it thinks it can support growth, taking into account the views of the firms it regulates. The FCA has carried out useful research into the subject, which shows that the relationship between regulation and growth is complicated. It has also identified seven 'drivers' of growth and international competitiveness that it can influence. However, despite having a statutory obligation to issue and consult on guidance on how it supports growth and international competitiveness, the FCA does not appear to have done so. Consulting on this could have helped support a wider discussion about how the FCA could promote growth. Instead, the FCA’s letter to the Prime Minister on growth is a hodgepodge of initiatives, such as removing the £100 contactless limit, the effect of which on growth seems likely to be marginal. 

Too often, we are caught up in the Animal Farm discourse of regulation and growth: less regulation good, more regulation bad (or vice-versa, depending on political positioning). This obscures that the quality of regulation is much more important than its amount. The focus needs to be on how we get smarter regulation rather than a certain amount of it.

While there can be a trade-off between risk and growth, there are also many steps the FCA could take to support growth without increasing risk. There has been too much focus on paraphernalia that is unlikely to move the needle and too little focus on the areas that could make a difference. Not least of these is the operational performance of the FCA. This is an area the FCA should have a lot of control over and could significantly influence growth and likely even more international competitiveness. It may be that it is what the FCA does, not what regulations it makes, that has the most influence on growth and international competitiveness. 

While there have been welcome recent improvements to the FCA’s operational performance, there is scope to go much further. The FCA currently has up to a year to decide on licence applications. Why not make that six months? This is eminently doable and would send a clear message that Britain is open for business without increasing risk.

Another aspect of operational performance is the standard of supervision that it provides. This is important to ensure the FCA intervenes appropriately and proportionally. Top of this list for improving the FCA’s approach to supervision would be to ensure the FCA had more skilled and experienced staff with increased knowledge of the markets they are overseeing. The FCA used to be attractive to experienced people from the private sector due to the FCA ‘deal’ of public service, improved work-life balance and better culture. Since then, pay has stagnated, the private sector has become better for work-life balance, and there have been concerns about the culture at the FCA. At the same time, there have arguably been cultural improvements in the City, ironically partly as a result of regulatory pressures.

These dynamics are affecting not just supervisors but also hiring for important functions for making the FCA efficient, such as IT. Attracting better staff may require increased funding from firms, but more skilled and experienced FCA staff would be widely welcomed by those they regulate. A further question is whether cultural change could be beneficial at the FCA, not to weaken the strength of its interventions but to help ensure its approach to supervision is laser focussed on what really matters. 

One gap in the FCA’s seven 'drivers’ of growth is the lack of reference to productive finance. There is a lively and contested debate about how finance can be used to support productivity, but the FCA seems to be absent from it. This is surely though an area where the FCA (and the PRA) could have the most influence on growth. Similarly, the green economy does not get a mention from the FCA amongst its growth drivers, despite the potential importance of the green economy to growth.

Hopefully, the government’s forthcoming Financial Services Growth and Competitiveness Strategy will take a broader look at how financial services can support growth and how regulators can contribute to that. The government could also help by simplifying the framework of regulatory legislation, which is currently a patchwork quilt of unnecessary complexity.

The government means business on growth. It has been elected with a clear mandate. The FCA should go back to the drawing board and focus on what will really make a difference to growth.

Omar Salem is a financial regulation partner at Fox Williams LLP.