2013: Levelling The Financial Playing Field

Six years of financial crisis have finally produced some of the legal changes that will expose the cosy world of regulated financial services to innovation and competition. But there is plenty more to do.

During 2013 we've seen consumer credit move to the FCA, the regulation of peer-to-peer lending, and the FCA's proposed rules for how the 'crowd' can lend and invest. And this week the Banking Reform Act implemented the recommendations of the Independent Commission on Banking and key recommendations of the Parliamentary Commission on Banking Standards.

Some may see these changes as a magnificent display in closing the stable door. But I prefer to see it as an opening of the floodgates. 

After all, the European Commission is consulting on its own approach to regulating online financial marketplaces; and the US states are competing with the Securities Exchange Commission on the regulation of crowd-investing.

So 2014 will see a lot of focus on enabling the growth of alternative financial services, at the same time as the banks become even more preoccupied with solving their own problems at their customers expense.

That bodes well for a market that grew 91% in 2013.

But, like I said, there's still a lot of work to do.

 

Failure Is Key To The Success Of Equity CrowdInvesting

An odd article on page 20 of today's FT suggests that the failure of some ventures to raise money somehow puts 'crowdfunding' in doubt, while page 4 cites Nesta research to show that this alternative finance market is growing rapidly. 

What's going on?

Well, traditional financiers have been forced to take crowdfunding seriously now that the FCA is consulting on specific rules to govern certain types (peer-to-peer lending and crowdinvesting in equities and debt securities). Some see this as an opportunity, and want to help these alternative marketplaces grow, while others perceive a threat that must be contained.

Those who feel threatened typically overplay the benefits of 'traditional' investment models, and mistake the strengths of the crowd-based models for weaknesses. 

For instance, venture capitalists often claim that theirs is 'smart money' compared to equity-based crowdinvesting. In fact, one is quoted in today's FT article as saying that VC investment brings "partners, skills and support that will nurture the business through growth over the medium to long term." This is rubbish. Venture capitalists spend most of their time looking for deals, not managing the businesses in which they have invested - and most of those businesses will fail anyway. They are not looking to build a portfolio of steady performers, they are hoping a few stars from their stable will return 20 to 30 times their investment. Board meetings are infrequent events at which VCs study the numbers. The occasional insightful comment may emerge, but these pale to insignificance compared to the 360 degree, 24/7 feedback any business experiences in today's social media world. Ironically, most of the time is actually taken up by management explaining the business to the VC directors - and quite properly so. But any responsible director can fullfil this role, and a business that can raise VC money or other funding is equally likely to attract directors with real subject matter expertise (and/or genuine independence) in any event. VCs don't have a monopoly on introducing good directors.

Related to this is the issue of discretion. Few people may be aware a business is seeking VC investment, but nor could they be expected to care since they are excluded from the process. So the search for venture capital generates zero interest among potential customers or other supporters of the business. Nor is the venture process likely to be very efficient, let alone successful. Start-ups and early stage companies typically approach many VC firms in the hope of getting a commitment from 2 or 3. It's a gruelling 3 to 6 month process involving lengthy, repetitive due diligence sessions that come as a huge distraction from the day-to-day management of the business.

Crowdinvesting, on the other hand, enables the business to engage in a single process that tests the appetite of both investors and customers. Flaws may be visible to the world, but this transparency provides consumer and investor protection while giving the business a chance to adapt on both fronts at an early stage. This may not guarantee long term success any more than traditional venture funding does, but it helps everyone avoid wasting a whole lot of time and money.

It's a process that venture capitalists might grow to like.

UK Government: Gamble All You Like, But Don't Invest

You've got to wonder about priorities at the Department of Culture Media and Sport. They allowed UK bookmakers to harvest £46 billion through betting machines last year - not to mention the bingo and lotteries freely advertised on TV - while computer games companies complained they can't offer shares to fans who crowdfund games development. 

Consider this from today's Telegraph:

• Britons gambled £46 billion on betting terminals last year, an increase of almost 50% in four years.

• Gamblers lose up to £100 every 20 seconds on the fixed odds machines.

• 588,000 under-18s were stopped when they tried to enter a betting shop last year, six times as many as 2009, and 27,000 people were challenged once they had placed a bet.

• Bookmakers made profits of £1.55 billion from the terminals between April 2012 and March 2013.

Meanwhile, even though the FCA has said that ordinary folk will be able to invest to fund the development of a computer game, for example, they must first certify that they will not invest more than 10% of their 'net investible portfolio' and either seek financial advice or satisfy an "appropriateness test". That's because they say investing is risky for consumers... 

Compared to what?!

Image from RoehamptonStudent.com. 

Dirty Data

Westiminster recently feigned shock and horror that the UK's coppers cook the crime figures. But Simon Jenkins says we've known for years that the numbers are meaningless and they should be banned as "they spread confusion and fear".

But 'plod' is not alone in mis-classifying, mis-recording, ignoring or otherwise presenting data in a way that suits himself. We've had many financial trading scandals where banks apparently had no idea of the exposures they faced, either because transactions were concealed or perhaps no one was looking hard enough - the global financial crisis was a function of poor due diligence.

A possible root cause of the problem is that humans are involved too early in the data collection and reporting processes. Rarely are we responding to the 'raw' data, as opposed to figures that have been 'gathered' and 'rolled up' through a series of other people's filters, manipulations and interpretations (which are often taken out of context). It's puzzling why regulators' systems don't receive a feed of the actual trades straight from bank trading desks - or from peer-to-peer lending or crowdfunding platforms - rather than relying on periodic reporting of summary data.

Maybe GCHQ can help...

At any rate, we should focus more on 'clean' mechanisms for capturing and presenting raw data rather than someone else's interpretation of it.

Image from TraceyNolte.
 

Do TV Advertising Rules Limit Economic Growth?

There has been plenty of research into the alleged effect of TV sex and violence on human behaviour, but how does TV adversely impact our economic behaviour? 

This issue was recently highlighted by the FCA's proposed new rules on crowdfunding. Left in isolation, the current restrictions on financial promotions suggest the State would prefer us to play bingo or buy lottery tickets than invest the same small amounts in funding the growth of each other's businesses. 

The FCA is right to point out the risks of investing in start-ups, but it should compare those risks to the risks consumers face when putting their money into other products that are more freely advertised.

We rely on small businesses for over half of all new jobs and a third of private sector turnover. Yet, those small businesses struggle for funding while over half of the UK's adults engage in regulated gambling that is designed to cost consumers far more than they 'win'.

It may be true that over half of business start-ups fail within 3 years, but they still employ at least one person in the meantime. And maybe more of those businesses would survive if we lent them some of our bingo money, or bought their shares with at least some of the money we chuck away on the ponies. Better that the money goes in wages, and the goods and services that small businesses typically buy, rather than simply to line the pockets of the bookies - and you have the chance of getting a decent return on small business loans, or if you happen to invest in the businesses that succeed in the longer term. 

No doubt someone will raise the moral panic about 'good causes' being starved of lottery money if we don't allow the promotion of that form of gambling. But I'm not talking about any ban on advertising lottery or bingo etc., just a relaxation of rules on the promotion of productive financial instruments (though it would be more efficient to simply donate a third of your lottery money directly to good causes on a crowdfunding platform than to wait for it to filter through the books of a lottery operator).

Ads for apparently 'safe' bank savings products are not helpful here, since savings rates are low and banks are not focused on lending to small businesses. We have over £200bn sitting passively in low interest bank deposits, yet banks' savings rates are below the rate of inflation, and banks only lend £1 in very £10 to SMEs. The Financial Services Compensation Scheme might protect your deposit if the bank goes under, but that's another cost that consumers end up paying for, and it won't protect the value of those deposits against inflation. Stocks and shares ISAs and pensions are similarly 'passive' investments in financial assets, rather than productive ones.

The highly restrictive approach to financial promotions has neither prevented financial scandals nor created a sound financial system - two of many reasons why people have resorted to lending directly to each other, or investing directly in each others' projects and businesses. So why not allow these new alternatives to be promoted more openly - at least to the same extent as riskier, non-productive activities like playing bingo or buying lottery tickets?

We need to move away from rules that dictate what we can do with our money, to rules that enable a fully informed choice from amongst all the options. 

At any rate, the State should certainly not create a situation where the money-related messages which the average TV viewer receives do not include investing directly in the productive economy.

Image from RoehamptonStudent.com.