'Edinburgh reforms come with opportunities and risk'

As headlines go, it reads like good news.

Financial services is stated as one of the UK’s key growth sectors – unsurprising given the UK is the highest net exporter of financial services globally, and the sector contributes about 8 per cent of GDP.

Furthermore, the Edinburgh reforms and retained EU law bill promise to ignite the much promised ‘Brexit bonfire’ of regulation to create an innovative, sustainable, technologically advanced, and competitive marketplace.

But what impact will this have on the market, the financial advice community, and consumers?

Back in 2018, Altus released a white paper entitled "Regulation is eating the world", exploring the explosion of regulation in the aftermath of the banking crisis in 2008.

Not only did we see an increase in the volume of regulation being produced to restore confidence, but we also saw a change in its nature and scope: Mifid II, the US Foreign Account Tax Compliance Act and GDPR all have a multi-geography and multi-domain impact.

Are the Edinburgh reforms good news?

Prophecies at this stage would be subjective and require us to pre-judge what will be removed, and what will stand in its place, but if you cannot predict the future, you can look to the past.

A lesson from the past

Repealing regulation, while appealing, can lead to unintended and unforeseeable consequences.

In 1999, the US repealed the provision of the Banking Act 1933 (Glass-Steagall Act) through the Financial Services Modernization Act 1999 (Gramm-Leach-Bliley Act).

The act brought sweeping deregulation to financial services and marked the end of regulation that addressed the defects in the banking system thought to have caused the depression.

Seventy-five years since the last systemic financial crisis, the banking crisis came along under a decade later.

It is not plausible to explore all aspects of the Edinburgh reforms, given their scope, but the proposed reform of the ring-fencing regime is a good place to focus.

The downside of that agility for advisers, and the rest of the industry, is likely to be greater regulatory volatility.

It seems fair to conclude that the government will implement the recommendation of the independent review of ring-fencing and proprietary trading by changing the scope of the ring-fencing rules to focus on large, complex banks, that would see smaller banks, and those that do not undertake excluded activities above a certain level, be exempt.

The report concluded the regime should be retained as it had made retail banking safer but found it had not increased the resilience of less complex banks. It also limits competition and imposes billion-dollar annual costs on the industry, and ultimately, the consumer.

The utopian pursuit for any regulator is proportionality. A flexible regime that imposes different requirements based on the firm’s business model and the risk it poses to the market.

In that spirit, the potential changes to the ring-fencing regime make sense, but history tells us that well-intended regulatory change, which is prone to biases and misaligned incentives, can lead to negative outcomes for both consumers and wider stakeholders.

This feels particularly relevant with the volume of change proposed under the Edinburgh reforms.

A more agile regime

A key focus of the reforms is to maintain the UK as a competitive and attractive global financial centre.

In researching the Middle East recently, it became clear that their regulatory regime, while not as established as the UK's, is a lot more agile.

These more flexible regulatory regimes present a clear challenge to the UK in remaining competitive in the battle to attract global investment.

As global competition, threats and innovation gather pace, the further empowerment of the Financial Conduct Authority and Prudential Regulation Authority to negate the need for further primary legislation makes sense.

To remain competitive, we need greater agility and flexibility than the time-consuming nature of the parliamentary system, but it again comes with risk of a lack of recourse should things go wrong.

It also relies on the regulators having the capacity and vision to foresee problematic regulatory blockers and act swiftly to resolve them before significant issues arise.

The downside of that agility for advisers, and the rest of the industry, is likely to be greater regulatory volatility.

Working in the field of innovation, it is difficult to ignore the focus of the reforms on technology and innovation.

Despite the potential detractions of Brexit, the UK remains the sixth largest economy and a top destination for financial technology investment.

The UK is second only to the US in pure monetary fintech investment terms, and second only to Singapore in terms of fintech investment per capita and as a percentage of GDP.

If the UK is to retain its position as a competitive global finance centre and respond positively to increasing competition, staying ahead of the curve on the latest technology and innovation is key.

A flexible but well-respected regulatory framework is the foundation of achieving that aim – it should not be a barrier, however well intended.

When you dissect the Edinburgh reforms, it is difficult to foresee the impact on advisers, their clients and the sector as a whole.

I am confident no adviser will be found objecting to a stripping back of the more burdensome and non-value-add activities imposed by regulation. Nor will their clients object to not receiving disclosures they do not want and end up paying for.

If the government and regulators get it right, they have the chance to remove overly burdensome regulations that stifle innovation and customer outcomes, while still retaining a robust, high integrity market that protects the investments that people make in it.

If the government and regulators get it wrong, the danger is that sweeping reforms, and the removal of guardrails, risk once again exposing consumers to some of the worst excesses of the financial services system, and we end up a crisis away from regulation eating its own leftovers.

Jonathan Warren is head of innovation at Altus Consulting