David Stevenson looks at how, following the financial crisis, innovation has been stifled and investors led into an ever-narrower range of funds.
When it comes to regulation, we should be careful what we wish for. Following the global financial crisis, everyone and their dog seemed to approve of the idea the markets required closer inspection and supervision.
Markets and key financial agents such as investment banks simply could not be trusted to do ‘the right thing’. That market failure in turn required regulators to intrude into internal processes and management, especially around issues such as risk, treating customers fairly, and professional training.
This form of what is essentially micromanagement borrowed many of the insights of behavioural economics, utilising a smorgasbord of nudges, pushes, and draconian regulations.
Many advisers and fund managers are now in a desperate situation where an ever larger proportion of central overheads are being squandered on internal compliance and regulatory oversight.
Business is booming for compliance consultants, and virtually every start-up I talk to bitterly complains they are forced to spend at least a quarter of any planned budget on keeping the regulators happy.
Take one small example from the world of structured products – investments designed to balance out risks and returns using a structure frequently backed by an investment bank. It is an open secret the UK regulators have a fairly low opinion of this investment niche, especially if they are sold to what it defines as ‘ordinary’ retail investors.
As a consequence, one newish player in the sector recently admitted to me that each issue of an investment product gobbles up weeks in to-ing and fro-ing with internal compliance experts, with all design and marketing spends abandoned in order to pacify their internal regulatory machine.
Regulation and compliance – much of it powered by expensive corporate lawyers and internal compliance people – is now at such an extreme that many in the industry recommend only the most basic of investment products, otherwise they will attract the attention of micromanaging regulators.
That directing of the great ‘retail’ investor herd into increasingly narrow channels dominated by fund managers with huge operations is, in truth, a deliberate and stated aim of the regulators. Officials argue too many products sold to the mass market were too complicated. Investors need proactive protection.
But lurking behind this rhetoric is a more insidious threat, one which makes the plight of spending hundreds of hours arguing with compliance staff seem like small beer.
A distinct undertone is emerging from the regulators that suggests the prized principle of caveat emptor is faulty, ie the buyer beware principle might not be fit for modern day markets.
The thinking is elegant and simple to understand – the poor helpless investor and their financial adviser cannot possibly understand the complexity of modern markets, especially investment banks’ trading and structuring desks, so they need protecting.
Not just after the fact, but by using a precautionary principle which suggests private investors can never understand what has been foisted on them.
As a financial institution, you might have thought your clients agreed to take on a certain level of risk, but the view from on high is that understanding might not be right – no matter that clients sign the paperwork, they still need protecting.
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