Financial services

Ten themes for 2021

Gavin Stewart considers ten themes that are likely to impact the future of financial services in the coming year.

Gavin Stewart Head of Strategy Execution, Financial Services Group, Grant Thornton UK LLP

At the start of 2020, there was a clear consensus around the direction for future regulation to progress in. The period of reform triggered by the financial crisis was coming to an end and a new agenda, focused on operational resilience, climate change, digitisation and competition, was taking shape. After Brexit, the UK would move towards becoming a low-regulation financial centre.

Covid-19 has reshaped this landscape, forcing us to think differently about our society and economy. This doesn’t mean, however, that previous assumptions about regulation are redundant, or that long-term trends have suddenly ceased to apply. However, they need to be re-assessed.

Of the previous agenda, digitisation will accelerate and competition will take a back seat, while future regulation around operational resilience and climate change will have been deepened and broadened in scope. Coronavirus seems to be ushering in a period of activist regulation, rendering more distant the prospect of the UK becoming a low regulation centre.

Below are the key themes that UK regulators will focus on over the next five years. Many of these are interdependent and

overlapping. Perhaps the biggest challenge for the regulators and, by extension, firms will be understanding these links and balancing their efforts accordingly.

1. Completing the post-financial crisis reform agenda Although coronavirus has already forced the postponement of many planned regulatory initiatives, with almost certainly more to come, the remaining planks of the reform agenda that emerged in response to the financial crisis seem certain to remain a priority.

UK authorities have repeatedly reiterated that LIBOR replacement will go ahead as planned at the end of 2021. Internationally, Basel IV and the fundamental review of the trading book (FRTB) seem likewise certain to proceed.

However, there will be debates as to whether these reforms should be amended to reflect the impact of coronavirus and the right balance between global and national standard setters.

2. Defining the role of financial services after Brexit The Brexit transition period ended with the predictable last-minute deal containing little on financial services. We are therefore likely to see continuing negotiations over equivalence.

Arguably as important in the long term will be defining the respective roles of parliament, Her Majesty’s Treasury (HMT) and regulators in the post-Brexit world, and HMT has started to consult on this.

This has kickstarted the public debate around whether the UK should be at the front of setting global regulatory standards or become a lowregulation offshore centre – “Singapore-onThames”, as it is often dubbed.

This will play out over the coming years and assume different forms, depending on sector and issue. Bank of England governor Andrew Bailey and CEO of the Prudential Regulatory Authority (PRA) Sam Woods have argued publicly that regulators should retain a high level of discretion over rule making, so we know where the Bank of England and Prudential Regulation Authority (PRA) stands on this.

However, the Financial Conduct Authority (FCA) under Nikhil Rathi is an unknown quantity and the issue could drive a wedge between the UK regulators.

As the volume of consumer data increases, regulators will focus more on what information regulated firms hold, how it is held and how they use it.”

3. Further blurring the line between the PRA and FCA The fight against coronavirus is stressing the UK’s “twin peaks” regulatory framework in unanticipated ways, and highlighting that major financial crises are nearly always both prudential and conduct-based.

This has required regulators to work more closely together than originally intended, and has also forced the FCA to focus for the first time on its supposedly unimportant prudential role.

In the future, the PRA and FCA will continue to work more in tandem, and there should be an enhanced role for the Financial Policy Committee (FPC) as the strategic body in charge during emergencies.

In parallel, the PRA may take on the prudential regulation of the largest asset managers in the same way as it does for the largest investment firms. The sector has become more concentrated since the financial crisis and the coronavirus situation has demonstrated the centrality to the financial system of the largest asset managers.

The debate over whether they should be designated as Global Systemically Important Financial Institutions (G-SIFIs) will also revive.

4. Regulation for vulnerable consumers Coronavirus is increasing the number of vulnerable consumers and, for some, the depth of their vulnerability, and long-term unemployment and lower household incomes seem likely to persist for several years.

The picture is further complicated by the FCA’s temporary regulations, providing mortgage holidays and freezes on consumer credit payments, and influencing the behaviour of both firms and customers. Looking to the future, some form of these temporary regulations may become permanent.

There will also be an extended and painful post mortem on how firms treated vulnerable consumers through the last year that will soak up considerable regulatory and firm resources, including senior management bandwidth.

5. Consumer privacy and data protection As the volume of consumer data that is collected and stored continues to increase, regulators will focus more on what information regulated firms hold, how it is held and how they use it. Unregulated firms and those that are regulated as e-money or payment services providers, rather than under the Financial Services and Markets Act 2000, are likely to play a larger role in this landscape. Regulators will seek new ways to ensure that consumers’ data is properly protected and is not misused, including how to exert influence beyond the conventional regulatory perimeter.

With regulators also focusing more on outsourcing, operational resilience and cyber, the effective entry hurdle for authorisation will become higher.

6. Digitisation of data and decision making Restrictions to combat coronavirus will accelerate digitisation across the industry. Financial services regulators will need to work hard to assess the risks and trade-offs involved and to ensure that these are effectively mitigated and managed.

Understanding the issues raised – for example, by the interface between machine and human decision making and their impact on customers and markets – will stretch regulators in new ways. This will drive fundamental changes in the way they work and how customers interact with regulated firms.

Controlling the risks of what might be an extremely rapid pace of change is an early challenge that the regulators will want to get ahead of, assessing the continuing effectiveness of firms’ systems and control functions in relation to business models and workforces that will alter radically. 7. Regulators re-engineering their own operating models Regulators’ operating models are overdue for fundamental review. The core of the FCA’s is little different from the original FSA model of the early 2000s, and it is now going through a major restructuring.

Meanwhile, the PRA’s model is a semideliberate return to the Bank of England supervision approach of the late 1990s. Neither was designed with the challenges of the 2020s in mind.

The realities of recent events have brought the shape of these challenges into sharper relief and, as a minimum, it is clear that regulators will need to become more digitally enabled and proficient, but also less siloed and hierarchical. They will also need to become more effective at identifying and, more importantly, solving future and long-term problems.

Many of these problems will stretch beyond the regulatory perimeter, as reality regulators now acknowledge, but which their operating models are not geared to tackle. The critical Gloster review of the FCA’s regulation of London Capital and Finance will accelerate these changes.

8. The intermediation role of compliance functions The role of compliance in financial services has grown and evolved significantly since the financial crisis of 2007 to 2009. However, 2020 has called some of this into question and will also accelerate the speed of change.

In particular, the much higher proportions of staff working from home, the impact of digitisation and the greater focus on supply and value chains will drive regulators towards wanting almost real-time access to first-line data and decisions.

This will place the current intermediation role of compliance under considerable pressure, severely compressing or collapsing altogether the time available to review, clean up and generally manage

The current crisis will intensify regulators’ already emerging focus on external treats, such as climate change and cyber security.”

the firm’s compliance and its communication with regulators.

9. The industry’s resilience to major external threats The current crisis will intensify and extend regulators’ already emerging focus on external threats, such as climate change, cyber security and financial crime.

While the regulatory regime has generally responded well to the demands of the coronavirus situation, the crisis has far from run its course. And it has already highlighted areas that current and proposed regulations do not cover adequately or where regulatory thinking needs to develop further.

Likely developments include the broadening and potential deepening of the proposed regime around operational resilience, with the explicit inclusion of provision for future pandemics and long-lasting “events”, as well as cyber attacks, and a greater focus on preventing financial crime.

There also needs to be further thinking on climate change to better capture the increasing probability of climate-related events that are high impact for financial services and the economy more broadly. These might include the steepening frequency of extreme climate phenomena and the indirect effects of droughts, food shortages and geopolitical conflict and instability. 10. Group supervision for financial services One of the major consequences of coronavirus across all sectors will be an increase in M&A activity as the industry continues to consolidate, while also seeking to diversify revenue and risk.

Unfortunately, UK regulation has never settled on a consistently effective approach to the supervision of financial services groups; including both those that are wholly or mostly financial services, and others that are predominantly nonfinancial services but contain a financial services element.

Both the UK’s current twin peaks framework and the FCA’s preference for a predominantly sector-based approach are unsuited to dealing with this.

We should therefore expect a fresh regulatory approach to group supervision – one that includes a rebalancing towards consolidated supervision and, following the Gloster review, a more comprehensive consideration of the risks posed by unregulated activities. ● Author bio

Gavin Stewart is Head of Strategy Execution for the Grant Thornton’s Financial Services Group.