8 Financial Services Policy Requests - Election Edition

If you've been lumped with the job of writing your party's General Election Manifesto, here are 8 financial policies to simply drag and drop:

1. Remove the need for FCA credit-broking authorisation just to introduce borrowers whose finance arrangements will be 'exempt agreements' anyway - it makes no sense at all;

2. Remove the need for businesses who lend to consumers or small businesses on peer-to-peer lending platforms to be authorised by the FCA - again, it makes no sense, because the platform operator already has the responsibility to ensure the borrower gets the right documentation and so on; an alternative would be to allow such lenders to go through a quick and simple registration process;

3. Remove the requirement for individuals who wish to invest on crowd-investment platforms to certify that they are only investing 10% of their 'net investible portfolio' and to either pass an 'appropriateness test' or are receiving advice - it's a disproportionately complex series of hoops compared to the simplicity of the investment opportunities and the typical amounts at stake;

4. Focus on the issues raised in this submission to the Competition and Markets Authority on competition in retail banking, particularly around encouraging a more diverse range of financial business models;

5. Re-classify P2P loans as a standard pension product, rather than a non-standard product - the administrative burden related to non-standard products is disproportionately high for such a simple instrument as a loan;

6.  Reduce the processing time for EIS/SEIS approvals to 2 to 3 weeks, rather than months - investors won't wait forever;

7.  Reduce the approval time for FCA authorisation for FinTech businesses from 6 months to 6 weeks; alternatively, introduce a 'small firms registration' option with a process for moving to full authorisation over time, so that firms can begin trading within 6 weeks of application, rather than having to spend 3 months fully documenting their business plans, only to then wait 6 to 12 months before being able to trade - others entrepreneurs and investors will stop entering this space;

8. Proportionately regulate invoice discounting to confirm the basis on which multiple ordinary retail investors can fund the discounting of a single invoice - it's a rapidly growing source of SME funding, simple for investors to understand and their money is only at risk for short periods of time.

Optional Annuities Could Mean Working Pensions

Odd that Will Hutton should claim in The Observer, of all places, that making the purchase of pension annuities optional will end in long term social disaster. UK pensions are already a long term social disaster. Hutton himself points out that "400,000 people buy £11bn of annuities every year", yet "the annuity market [has become] overstretched, offering indifferent and often wildly different rates." 

This is because consumers have no choice. There's no competitive pressure at all on the insurance companies or their agents to remove unnecessary middlemen, reduce fees to customers or simplify products. In fact, the Financial Services Consumer Panel recently found that the annuities industry continued to focus on increasing its revenues through product complexity, even when consumers were given the option to shop around. No one in the industry seized the opportunity to make annuities more transparent and better value for the consumer. [Update on 26 March: Legal & General has suggested the market for individual annuities will shrink by 75% - rather endorsing the government decision to make them optional!].

Will Hutton argues that rather than make annuities optional "the response should have been to redesign [the market] and figure out ways it could have offered better rates with smarter investment vehicles". But that seems naive, given the FSCP findings. The industry had that opportunity and declined it. 

It's equally naive to suggest that less demand for annuities will mean losing a valuable opportunity for insurance companies to 'pool the risk' of funding pensions. The industry merely sees risk pooling as a chance to exploit asymmetries of information to line its own pockets. 

The only way for the government to shake up the cosy annuities cartel was to remove the implicit guarantee that everyone would have to buy an annuity. 

Mr Hutton then seeks to set up some kind of moral panic that the 'freedom to buy a Lamborghini' instead of an annuity will result in people simply frittering away their life savings. Not only does this suggest that he'd rather your life savings were placed in the grubby mitts of the annuities industry so they can buy the Lamborghinis, but it also insults the consumers who face the abyss of the annuities market. Their concern clearly arises from the lack of decent returns, not because they're eager to spend the cash on exotic cars.

Finally, Will suggests that the State is entitled to control how you invest your pension money because it allowed you to avoid paying income tax on your pension contributions in the first place. If you agree with that, then presumably you would say the State is entitled to control how you spend every penny of your income that it has allowed you to keep. This of course places a great deal of trust in the State's financial management capabilities that we know from bitter experience is ill-deserved. As a result, it's more likely that citizens will gain greater control over the allocation of 'their' tax contributions, not less (as I've joked about previously). But regardless of whether it's the State or the taxpayer who is in control, neither party wants the State to be saddled with the consequences of an uncompetitive and opaque annuities market. That would only suit the annuities spivs. Again, the only alternative is to expose the market to competition from all manner of transparent savings and investment opportunities. 

Importantly for economic growth, the freedom to avoid annuities opens up the potential for £11bn a year to be invested directly into the productive economy at better returns in much the same way that the new ISA rules will liberate 'dead money' from low yield bank deposits. Not only could we see some pension capital crowd-invested into long term business and infrastructure projects in a way that won't be interrupted by the need to purchase an annuity, but those in draw-down might also consider some 3 to 5 year loans to creditworthy borrowers as a way to generate some additional monthly income.

A Feast Of Anger And Blame

You have to wonder whether the UK's banking crisis will ever end. After months of wrangling, the regulators have finally decided which UK banks are still short of about £26bn in capital (for now). But yesterday's Parliamentary Banking Standards Commission report points to an endless list of more serious problems that won't be solved by simply leeching yet more billions out of the economy.

The members of the BSC must be highly commended for taking on the long overdue job of trying to bring Britain's banks to heel. Volume 2 of the epic report is an invaluable account of their painful journey, made poignant by the fact that, until quite recently, the members of the Commission actually believed in our rotten financial system. The scale of their disillusionment is almost beyond comprehension. What perhaps started as an investigation into fairly specific allegations of corporate malfeasance resulted in one proud British institution turning on another out of a sense of betrayal. 

So, apart from its entertaining descent into the gory details of British banking, the BSC report represents yet another hammer blow to our faith in society's institutions - this time delivered by one of the ringleaders, namely Parliament itself.

Yet the question remains as to just how far along the 'change curve' we have really travelled. Despite the BSC's list of recommendations, we seem to be merely inching our way through anger and blame, rather than understanding and accepting that the world has truly changed and we need to move on.

While the Commission has voiced great support for alternative finance models and eliminating perverse tax incentives, and the Treasury and FCA have made some proposals to improve the regulatory landscape, the rhetoric from the government continues to put banks at the heart of Britain's economic future, rather than a more open, diverse and innovative financial system.

How much more economic mayhem it will take for society to genuinely 'move on' is anyone's guess.

Shock As Faith Dies: Change Curve Activated

The patient failed to respond.

Faith in our institutions finally died this week after a long illness. Doctors amputated a banker, began a saline drip for 28,000 small businesses, corrected errors in several prescriptions and tried another infusion of cheap money. Parliament even held a debate. But the patient failed to respond.

Reactions were mixed. Some were 'sorry, disappointed and angry', others cried. Some remain in denial.

In other words, nothing has actually changed. But it's a start.

Hopefully, we'll soon have a lot of little things going wrong.

Image from VirtuallyShocking.

What Bank Customers Want And Why They Don't Get It

There's a lot of talk about 'restoring responsibility to banking', and 'returning banking to its sober Quaker roots', 'removing the casino culture', 'getting banks lending again' and so on.

But all these soundbites are focused on the activity of banking.

Nobody, except banks, engages in "banking". We may use a bank's service, but only in the context of a much wider activity, such as buying a house or a birthday present on the way to a party, or getting clothing made in China to sell over here. "Banking" is only what banks think customers are doing, because banks only view the world through the lens of their own products and not customers' activities. Which is why bank products are inherently designed to make money for banks and not to benefit customers (and why they fiddled 'Liebor').

All bank customers want is what the customers of any supplier wants - solutions to their own day-to-day problems rather than those of the supplier.

But if you believe banks are capable of aligning with their customers' activities any time soon - you're flogging a dead horse.

Back in 2009 and again in 2010, there was a lot of discussion about whether the role of social media would ever play a role in consumer finance. Typically, the banks claimed that using Twitter to communicate with customers was a publicity stunt - making the almighty assumption that Twitter is somehow divisible from the vast entanglement of services that make up the social media. They said online peer-to-peer finance platforms wouldn't scale. In 2011 that sort of discussion wasn't repeated. Why? Because even banks realised it was rubbish - just as it proved to be in the markets for retail services, music, entertainment, travel, politics, newspapers, television and so on, where online 'facilitators' have hacked great chunks out of the market shares of once dominant, sleepy, 'traditional' institutions that were not aligned with their customers' day-to-day activities.

But the banks have not been 'Googled'... yet. 

Why not? Comparisons between the rise of facilitators in other retail markets are not apt because there was no regulatory regime that protected high street stores from online competition. There were no tax incentives to persuade consumers it's safer to buy their music on CDs rather than download it. No compensation scheme for advertisers who don't get the return they want on their advertising spend in the newspaper or on TV, leaving online advertisers to fend for themselves. No taxpayer guarantee that allows high street electronics retailers to spend whatever it takes to maintain market share against online marketplaces.

Banks, on the other hand, rejoice in all that protection against innovation and competition.

In these circumstances, it is unrealistic to assume that new business models will thrive without some alteration to the regulatory framework.

Fortunately, change seems to be on its way.

Why The Banks Have Not Been Googled... Yet

In March this year, Andy Haldane, Executive Director of Financial Stability at the Bank of England rather helpfully gave a speech in which he likened peer-to-peer finance platforms to the likes of Google and eBay. But the basis he gave for his comparison overlooked a fundamental difference in the UK's retail markets for financial services compared to those for online search and second-hand sales. Funnily enough, that difference lies in the regulatory and tax framework for which both the Treasury, and to a large extent the Bank of England, are responsible.

Specifically, Andy Haldane said (at pages 14 and 15):

...birth and death rates in banking are lower than among non-financial companies. They are lower even than in other areas of finance. Death rates among US banks have averaged around 0.2% per year over the past 70 years. Among hedge funds, average annual rates of attrition have been closer to 7% per year. Birth rates are similarly low. Remarkably, up until 2010 no new major bank had been set up in the UK for a century...

Commercial peer-to-peer lending, using the web as a conduit, is an emerging business. For example, in the UK companies such as Zopa, Funding Circle and Crowdcube are developing this model. At present, these companies are tiny. But so, a decade and a half ago, was Google. If eBay can solve the lemons problem in the second-hand sales market, it can be done in the market for loans.

With open access to borrower information, held centrally and virtually, there is no reason why end-savers and end-investors cannot connect directly. The banking middle men may in time become the surplus links in the chain. Where music and publishing have led, finance could follow. An information web, linked by a common language, makes that disintermediated model of finance a more realistic possibility.

While it is helpful to find some official recognition of both the lack of innovation and the paucity and size of new entrants to the banking market, the root cause of this scenario does not lie in the lack of a common language or information web (though I've been longing for a semantic solution to price comparison sites for years now).

A clue to the limitations of Andy Haldane's hypothesis lies in his measure of Google's success - its stock market valuation - when a far better measure for current purposes is the scale of Google's advertising revenue. In 2001, Google's total ad revenues were about $67m. By the end of 2011, those revenues had risen to $36.5bn, up 29% on the previous year, and represented 96% of the big G's total revenue.

But here's the killer: Google's advertising revenues exceed the total revenue of the entire US newspaper industry, and are rapidly catching US television ad spend.

How did this happen? Well a clue lies in the fact that Google has 75% of search advertising spend. Google's search feature is second to none and is clearly a far better knowledge filter than the traditional media.

So let's assume, for argument's sake, that Andy is right to suggest that Zopa's platform offers the same kind of utility, convenience and empowerment to savers and borrowers as Google's search function offers to the average internet user. When Google was 7 years old, in 2005, it's ad revenues were about £6bn. Seven years after its launch, Zopa has enabled £200m in loans, and is still growing rapidly, yet this represents about 2% of the UK personal loan market, according to the company.

Is something else at play that would explain the small number of new entrants and their slower rates of growth in the markets dominated by banks?

As previously point out, the critical difference is surely that there is no regulatory regime presenting traditional newspapers as officially sanctioned and somehow 'safe'. No tax incentives to persuade consumers that its better for them in the long term to buy a newspaper instead of searching for stories online. No compensation scheme exclusively for advertisers who don't get what they expect from their newspaper advertising spend, leaving Google advertisers to fend for themselves. No taxpayer guarantee that allows newspapers to spend whatever it takes to maintain market share.

Banks, on the other hand, rejoice in all that protection, even though we know they are failing to fulfill their fundamental obligation to move money efficiently from those who have it to the people and businesses who deserve to use it.

Some of the peer-to-peer platforms have formed the Peer-to-Peer Finance Association and campaigned for a level playing field, so far to no avail. But given all the official protection from innovation and competition, it is unrealistic to assume that new financial platforms will thrive as they should without some alteration to the regulatory and tax framework to enable more rapid market entry and strong, responsible growth.

Image from Silverback.

We Need A Lot More Little Things To Go Wrong

As Nietzsche said (I always wanted to begin a post that way), "That which does not kill us only makes us stronger."  Or as my first boss was fond of saying, "We only learn when things go wrong."

Both are right. But implicit in both sayings is survival and survivability. 

Survival of the fittest, building strength through adversity - this is how species evolve. It's what makes Kipling's poem "If" so stirring. It's the difference between all those 'best practice' presentations at corporate off-sites (let's be honest, they're about rescued screw-ups) and the whirring of shredders at Arthur Andersen. It's what turns complaints into fixes, features and products instead of fines.

Yet all the research suggests it's impossible to 'pick winners'. In fact almost all significant events in our history are Black Swans - surprise events that have a huge impact and which we rationalise by hindsight. We have no real idea which ventures will succeed and which will not until the facts and figures emerge. And even then we don't know how sustained that success will be. Indeed, sometimes we don't even know what success looks like, expecially with not-for-profit projects or organisations (including government departments - and the European Commission). In his book "Adapt" (a veritable bible on the importance of survivable failure) Tim Harford explains the need for built-in feedback to distinguish success from failure in such contexts. 

But, hey, the Euro had built-in entry criteria, and they were ignored because the politicians refused to countenance failure as an option.

And there you have it. Above all, as Harford emphasises, the critical thing is to accept the risk of failure, but to ensure that such failure is survivable.

Our political and economic leaders don't grasp this any more today than their forbears did when negotiating the Maastricht Treaty. Because they see it as their job to protect 'the system'. But by continuing to back the same institutions, the same systems, and essentially replicating and deepening the same old regulatory regime, they're merely resisting the tide of evolution. Rather than cutting their losses, they're busy hurling the big dice again, and again, and again like so many casino junkies.

It's impossible to mix too many metaphors in a situation like this. So here's another: if Necessity really is the mother of Invention, then we have to get her to a fertility clinic.

We need more trials and more errors of the survivable variety. In other words, we need a hell of a lot more little things to go wrong before the big things start going right.

Maybe we should make it our leaders' job to promote innovation instead of protecting the system?

Big Media: Inside The Propaganda Machine

You know something's hokey when the Financial Times, a leading paywall operator, devotes a whole page to the war on content sharing 'online piracy battle' just days after the big set back for SOPA/PIPA. Here's the lead article, snuggled between two stories from the 'front line' ("Parameters shift in online piracy battle" and "Upload websites bar file sharing"):

"Digital revenues set to offset CD fall"

It's then you realise you're inside the propaganda machine for the Big Media faithful:

"Keep sluggin' it out, people! 

Less content sharin' means more money for us!"

Think about that.

Because these are the same institutions who were leeching public money out of New Labour in 2009 for help with copyright enforcement, with tales of 'losing £1bn in music sales in the next 5 years'. Whereas only 3 years later, the FT reports they have this to say:

[Rob Wells, of Universal Music] "Some of those big global subscription players are only playing on a small playing field... As they mature, they are more likely to be bundled with internet service provider or operator subscriptions which is where we start to see real anti-trust investigations scale. The future is looking extremely bright."

"We are going from headwind to tailwind," said Edgar Berger, chief executive at Sony Music International. "There is no question the music industry is going to be in great shape shortly, it will become a growing business again. The internet is a blessing for the music industry."

Big Media is not in the business of solving consumer problems. It's a cabal of institutions out to solve their own problem of how to return to rampant profitability at the captive consumer's expense. And they won't give up trying to stop you sharing content 'til your MP3 player looks like this: