The Model Office Blog

Captain Scarlet and the Future of Regulation

[fa icon="calendar"] Jul 5, 2024 10:45:51 AM / by Chris Davies

We were fortunate to present to The Investment Network last week on the future of regulation, covering key themes retail financial advice firms need to factor into their governance, risk and compliance (GRC) activities, against a thematic backdrop of sci-fi films. 

Starting on a positive note and taking a ‘Back to the Future’ approach, we think the industry and financial planning profession is in a good place. The FCA’s outcomes focused regulation has been with us since their Responsibilities of Product Providers and Distributors (RPPD) report back in 2012. Outcomes-based regulation can be applied more easily to technological change and market developments than detailed and prescriptive rules. This means consumers are better protected from new and emerging harms. Firms can also innovate to find new ways of serving their customers without prescriptive requirements designed for a different situation getting in the way. 

The issue we have is decision making, bias, psychological noise (internal/external factors effecting decision making) and, a bit like Luke Skywalker and Darth Vader, using ‘the force’ or ‘subjective reasoning’ to interpret a principals based FCA handbook. The good news is outcomes focused regulation provides an agile framework that firms can use to build their businesses compliantly, as long as they ensure they apply tech and are data led, and emply data analytics that can evidence products and services are supporting client good outcomes on an on-going basis.

The key issue here is, a outcomes focused regulatory approach moves firms away from checklist/tick box activities into a holistic approach where quantitative and qualitative data should be measured, monitored, managed and improved where necessary on a longitudinal (not just a cross sectional i.e. short term) basis.

The key issues the FCA have been grappling with over the years, can be summed up in their ‘Blakes 7’ suitability papers; FG11/5 Assessing suitability, FG12/6 Replacement business TR16/1 Research and Due Diligence, Assessing Suitability ’17, FG21/1 Consumer Vulnerability, FG 21/3 Assessing pension transfers and FG24/1 Retirement Income Advice Review. Here the FSA and FCA showcase they are grappling with similar compliance challenges and risks across:

  • Inconsistent information and risk profiling
  • Poor evidence for advice
  • Poor governance and controls
  • Low evidence for ability to monitor and assess on-going client needs.

We also see that firms can suffer from over confidence bias and just like Captain Scarlett are indestructible when it comes to regulatory scrutiny. Yet, recent research by Linklaters shows that whilst individual and business FCA enforcement penalties are up, the values are down. This then points to a focus on smaller, medium sized businesses straying within the FCA enforcement crosshairs. The FCA now have significant intervention powers across, skilled persons reviews, market disclosures, listing suspensions, insolvency powers, on notice letters and are making headway with the controversial ‘polluter pays’ and name and shame directives.

The key strategy to remember here is firms need to be prepared for a regulatory visit, in whatever shape or form. Given the FCA recent feedback on information and data requests and how firms struggled to pull together requested data in a meaningful format, advice firms need to ensure they are data driven, employ RegTech that can deliver compliance data at the touch of a button.

When it comes to unintended consequences of regulation, Blade Runner springs to mind where the synthetic humans ‘replicants’ rebel against their creators and have to be hunted down. Like the replicants, bad actors have played a significant part in creating damage to trust in financial advice which amongst other issues has created an advice gap. Indeed, added to this The Lang Cat’s recent Advice Gap report points to this increasing due to firms off-boarding clients due to Consumer Duty obligations. We would argue a tech and regulatory data driven firm could manage much business cost and regulatory risk and retain the vast majority of these clients and continue to serve their needs.

The fact that the FCA are persistent in their strategy to deliver streamlined advice to the 12M people who have investments sitting in cash (some £250BN apparently) and the new Labour government manifesto promises high innovation within financial services, means that they will eventually crack this nut, particularly as they are now clarifying the boundary, applying behavioural science in targeted advice and people like you along with the prospects of AI driven tools and the right products that can enable cost effective service delivery.

We also have the unintended risk for the Consumer Duty driving the next PPI-style compensation challenge. For example, the FCA information request for firms to deliver data for on-going advice suitability reviews means those firms who are still paper and filing cabinet dependent will struggle to deliver evidence of compliance and those consolidators who have hoovered up such firms’ margins are also now at risk. We only have to look at certain organisations share prices when the FCA published this request to see the potentially damaging effects this could have.

This may also lead to product manufacturers pulling certain products and not developing others, but the Consumer Duty should lead to innovation and promote more client-centric services and products over time where firms with the aid of data analytics can evidence, they support on-going good client outcomes.

With all this in mind, The FCA can be viewed as the Star Trek crew, a data led, altruistic team who apply these ideals to resolve difficult dilemmas. We now have the FCA’s AI update which focuses on how they will look to regulate AI tech and firms who deploy it via existing regulations such as SM&CR, Threshold Conditions, Systems and Controls. They will also develop AI to horizon scan and predict potential regulatory risks and bad actors (screen scraping, market surveillance, synthetic data applications to fight financial crime).

The FCA have already been advancing their data led regulatory approach through their sandbox that has seen some 300 tech firms splash in the regulatory sands and running leadership events such as Tech know, TechSprints trialling tech solutions to meet challenges such as mental health / vulnerability and digital regulatory reporting.

Indeed now they have their innovation team who apply regulatory horizon scanning, looking to the future for the industry and regulations across new tech such as Web 3.0 prompting decentralisation of ownership data away from BigTech, RegTech that can integration seamlessly and meet key risks such as AML, KYC, ESG, Disclosure, Regulatory reporting and blockchain and tokenisation which through smart contracts can potentially replace platforms linking the financial universe through compliant synthetic data lakes an digital wallets, producing compliant access to private markets (worth over £100BN over the next 10 years) and investment in space projects (worth over £400BN) and which meets the appetite for investors looking for more ways for increasing long term returns.

If all this sounds somewhat fantastical, just thing just two years ago, no one had heard of generative AI and the benefits this is now providing, which will be accelerated even more, when Apple Intelligence hits our smartphones later this year.

The FCA want to make the UK “the best place to do business in the world”. They believe that retail advice firms need to be tech savvy and data led, this means firms need to take the fourth industrial revolution seriously, apply AI, streamlined Tech stacks along with skilled professionals, across client engagement, business processes and compliance activities to ensure they remain agile, flexible and relevant in a tech driven world. Only then does the financial services industry stand a chance to go boldly and build a tech driven eco-system to empower and evidence ongoing client-good outcomes.   

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Topics: Financial regulation, client engagement, regtech, Risk management, practice management, FCA, advice, compliance, consumer duty, open-source, closed-source

Chris Davies

Written by Chris Davies

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