When the Financial Conduct Authority (FCA) launched its Mission earlier this year, it promised to publish a series of documents that would explain its approach to regulation in more detail. (See our blog on the FCA Mission and Business Plan.) The FCA published its draft future approach to consumers document last month (see our blog on vulnerable consumers in this context) and has in the last few days published two further draft approach documents on competition and authorisation.
The FCA has said it will publish a further three approach documents by the end of Q1 next year. The table below summarises the latest state of play:
Approach documents already published
Approach documents to be published
Approach to competition
Approach to supervision
Approach to authorisation
Approach to enforcement
Future approach to consumers
Approach to market integrity
Together, these documents are intended to provide greater transparency as to how the FCA regulates markets and makes decisions.
In this note, we focus on the draft approaches to competition and authorisation. The documents are well aligned, as the FCA sees reducing the regulatory barriers to entry as vital to promoting effective competition. Furthermore, as it itself highlights, the FCA is one of the very few financial regulators in the world with a core objective to promote competition. These powers are still relatively new and the draft approach to competition is, therefore, a useful reference point for firms in providing a comprehensive overview of the FCA’s priorities, powers, objectives, and decision making in this area.
Importantly, the FCA makes clear that it has a duty to promote effective competition in the interests of consumers and will accordingly consider competition issues across all of its work. This underlines the breadth of the FCA’s competition remit. Nevertheless, the document also emphasises that competition work is less likely to be prioritised if “changes are already likely to address competition concerns in the near future” or “another organisation can better address specific competition issues”.
Below, we outline areas where we think the FCA documents offer further insights or developed thinking on themes previously set out in its Mission statement and Business Plan.
Approach to Competition
The FCA emphasises that its objective is to promote competition in the interests of consumers, not for its own sake. This is important, as it signals that FCA is likely to continue its recent activist stance in using competition powers as a vehicle for meeting its consumer objectives.
The FCA notes that its primary role is not to regulate prices or profitability directly: there may be times, however, when it intervenes directly to protect consumers, such as on product standards or, more rarely, on price. The FCA may, for example, intervene on a specific aspect of price such as an exit fee or surcharge. Intervention on overall pricing will, however, be relatively rare and will typically be in response to “acute concerns” about the lack of competitive pressure. An example cited is the FCA’s intervention on default pension scheme charges under auto-enrolment.
When the FCA intervenes on price, it considers firms’ costs and what they need to charge to make a “reasonable” return, but it does not define what it considers to be reasonable. We would expect, therefore, that the FCA would assess this on a case by case basis via peer or sector comparisons. The FCA makes clear that its role is not to regulate the returns a firm makes. However, it will often look at pricing and profitability as important evidence in its market studies to help it understand “market dynamics”.
In certain circumstances, the European Commission may take a competition case involving financial services in the UK which means the FCA cannot exercise its competition powers for that case. The European Commission would consult the FCA before this happens. The FCA states that it expects this to change when the UK leaves the EU, however. (See page 10 of the draft approach to competition.)
Potential Harm to Consumers
In identifying potential harm, the FCA makes clear that a range of market characteristics can indicate weak competition. Specifically, the FCA draws attention to the following market trends and characteristics as potential areas of concern:-
- Concentration – a firm with significant market power may be able to exploit its customers or exclude rivals. Highly concentrated markets can also make it easier for firms to coordinate their actions.
- Barriers to entry and growth – in markets where challengers cannot enter and grow, established firms tend to be less responsive to customers, less efficient and less innovative.
- Integrated supply chain – vertical integration can sometimes create conflicts of interest or allow firms to exclude rivals and so avoid competitive pressure.
- Barriers to switching – these can include exit fees, unwieldy or time consuming processes and can prevent or deter consumers from taking their business elsewhere.
- Price discrimination – in markets where firms broadly charge the same price to all customers, switching by a minority of informed and engaged consumers can drive price down and quality up for everyone. However, where firms can discriminate on price, only those consumers who switch may get the benefits, possibly at the expense of those who are less active or engaged.
- Lack of access to information – where information is hard to find or understand and compare, it can be difficult for consumers to understand and compare products. This can directly harm consumers as well as reduce competitive pressures on firms.
- Sustained excessive profitability – when a firm or a group of firms compete successfully, the FCA might expect their profitability to be high, while less successful firms will make less money. It deems this as part of the competitive process. However, the FCA is likely to be concerned where an entire industry is making high returns for sustained periods of time, because this may indicate weak competitive pressure.
- Complexity – complex products can make consumers feel that financial decisions are “beyond them” and so follow the “path of least resistance” rather than make active choices. Consumers may be more likely to end up with products poorly suited to their needs or to be overcharged.
Prioritising FCA Competition Work
The FCA notes that it is likely to prioritise market studies where market characteristics indicate low levels of competitive pressure; where the market size or type of customer indicates harm on a significant scale or severity; or where vulnerable customers may be at particular risk. The report notes that there is a balance to be struck between reducing barriers to entry to promote competition, and ensuring consumer protection and financial stability is maintained. Crowdfunding and peer-to-peer lending are cited as examples where the FCA has stepped in to ensure consumer protection and financial stability.
Approach to Authorisation
The draft approach to authorisation mainly reiterates themes in earlier FCA publications whilst drawing important links to culture and governance, as well as competition. Key points are:-
- The FCA highlights the ways in which it intends to use permissions and authorisation as a “forward-looking” tool in order to prevent harm from occurring.
- In considering an authorisation application, the FCA will look at behavioural factors that are likely to drive the governance and culture of the new firm and create the risk of a culture that could lead to consumer harm. “These include a firm’s purpose, its leadership, its approach to rewarding and managing people and its governance arrangements.”
- The FCA recognises that regulation could be a barrier to competition by deterring firms from entering the UK market. To mitigate this risk, the FCA commits to a “tailored approach”. This includes additional support at the pre-authorisation stage or authorising with restriction to allow firms to test business models and products in a controlled environment. Furthermore, the FCA recognises that some innovative firms and start-ups may find it difficult to meet some of its standards, such as having appropriate financial resources. In response, the FCA may decide to authorise “subject to” a restriction, limitation or requirement that the firm must meet from the point of authorisation. Its Regulatory Sandbox, New Bank Start-up Unit and Advice Unit are examples of its work in mitigating potential authorisation barriers to competition.
The FCA consultation closes on 12 March 2018.
Implications for Firms
The FCA’s draft approach documents are intended as important reference points for firms, to help build greater understanding of the regulator’s decision making processes and objectives. We would encourage firms to engage with these documents and respond to the questions set out. We recommend that firms pay close attention to the FCA’s thinking around price intervention, and market characteristics that may indicate weak competition, in order to anticipate areas in which the FCA might challenge individual product lines or overall business models or undertake future investigation. Firms should also note the FCA’s comments around sustained excessive profitability – which it defines as a situation where an entire industry is making high returns for sustained periods of time – as a potential area of challenge.
On the authorisations side, when engaging with the FCA in the authorisations area, the approach document provides a basis for clients to open up a dialogue with the FCA where they consider there are regulatory barriers to entry for innovative services or products that they think need to be addressed.