Stand up for high standards

Stand up for high standards

During the past decade the UK has taken some important and laudable steps to protect the consumer of financial services. Many can take credit for this,including the relatively new regulator, the Financial Services Authority (FSA).

There is now a very real danger that aspects of the EU's Markets in Financial Instruments Directive (MiFID), which comes into effect 1 November 2007, will dilute these hard won gains. Specifically, the lack of any requirement within MiFID for any host regulator to insist on demonstrable and measurable minimum standards of education for customer-facing practitioners and advisers, could undermine a key plank in the consumer protection edifice built up in the UK over the past two decades.

The purpose of MiFID is to open up access to financial markets and foster competition for the benefit of customers right across the European Union. This is a worthy aim. However, in creating an apparent level playing field, those countries such as the UK, The Netherlands, Germany and Italy that have stricter rules on a range of issues, not least on questions of consumer protection, could be seen to be creating barriers to open competition.

Thus, the UK's current insistence on a “licence to practise” for any adviser in the retail market will be seen under MiFID as restricting any European financial practitioner from operating within the UK unless they met the UK's minimum standards of demonstrable and measurable competency.

And yet MiFID recognises that those involved in these activities need to be“authorised” by their host regulator “in order to protect investors and the stability of the financial system”. It goes further. It suggests that there are different levels of protection needed and so it differentiates between the professionals, the practitioners in the wholesale markets, and retail which, for the purpose of the exercise, means “non professional”

So, the FSA is faced with a conundrum, but the UK's financial services sector is presented with a Euro-style paradox: MiFID says it wants to protect the consumer. The FSA has a statutory duty to do so. Many of the FSA's rules and regulations, notwithstanding its “principles-based” approach to regulation, are geared to protect the consumer. Compulsory qualifications,introduced in 1997, are a case in point. Yet the effect of MiFID will be to allow organisations regulated by member states with less consumer protection provision to operate in the UK without laid-down minimum standards of competency which were created to protect the consumer.

The FSA and the UK Treasury have a way forward that will allow it to continue to insist on minimum measurable standards of competency of all those operating in the domestic market. Article 5 in Chapter 11 of MiFID's implementation provisions makes it clear that all firms must “employ personnel with the skills, knowledge and expertise necessary for the discharge of the responsibilities allocated to them”. There is nothing inconsistent here with the qualification and training requirements as applied by the FSA at present.

Moreover, the same implementation provisions also allow member states to impose additional requirements on investment firms where consumer protection is not fully addressed by the directive. The UK has a clear case here in respect of training and competency requirements.

In addition, the UK has the greatest number of providers of investment products in the EU. The distribution system is highly complex and it is a regrettable fact that outside the world's greatest financial centre that is London, the UK's retail clients are relatively unsophisticated. The FSA own recent benchmark research into the dire state of financial literacy in the UK tells its own depressing story.

In 1990, the McDonald report for the now defunct Securities & Investment Board (SIB) argued that consumer protection is needed where complex products are involved and where the consequences of mistakes could be severe and long term. It was also noted at that time that employers had consistently failed to educate their sales forces not only on products, but on needs analysis and the ability to explain matters to consumers.

Some 12 years later, the Sandler Review pointed out that while consumers are not an homogeneous group, they typically find retail savings products confusing and hard to understand. Moreover, there is a low level of trust in the retail savings industry. Similarly, the widespread lack of financial capability showed that even once engaged in the market, consumers have difficulty in discriminating between the products on offer.

So, removal of these minimum demonstrable and measurable education requirements in the retail context might be justified if:

• employers educated their workforce to the same externally benchmarked,objective high standard currently required;

• customers were capable of analysing their own needs relative to the products on offer;

• unsuitable and unnecessarily complex products were not produced;

• wrong products or courses of action were not advised, recommended or sold.

Clearly, nobody believes such utopia is achievable. Experience suggests otherwise. Evidence of the vulnerability of the consumer is there for all to see. Witness the mis-selling scandals around pensions and endowment mortgages in the 1980s and 1990s, followed by recent problems involving split capital trusts and precipice bonds. Just this year, in April, the Royal Liver Assurance was fined £550,000 for mis-selling with-profits savings policies.

In an ideal world, a nation of fully educated financially literate consumers would not need the level of protection it is now provided. That is not going to happen. This is indeed recognised by the FSA. This year it decided, again within the context of MiFID, to do away with the need for a “licence to practise”for “professionals” in the wholesale markets. It went on to say that“at present we don't feel we can extend the concession (sic) to retail businesses as retail customers don't have the same expertise in financial markets as wholesale customers and therefore need more protection”.

There is another important reason, and one that is central to the UK economy,why the FSA and the UK Treasury should demand concessions on this issue. The UK has built a financial sector that is the envy of the world. This reputation has been built exclusively on the extraordinary skills pool that exists among the UK's financial practitioners. This has been built up over time through a mix of high quality education and on-the-job skills.

MiFID's lowest common denominator approach under the dubious guise of open competition threatens to undermine this hard-won international competitive advantage. Why should we give that up? It will not be immediately obvious, but in time it will manifest itself. By then it will be too late.

Gavin ShreeveIFS School of Finance