A relatively innocuous article by the FCA’s unusually titled “philosopher of science and economist” Damien Fennell highlighted what has long been a conundrum for financial regulators.
The article refers to “evidence based” policy creation and the impracticality of amassing sufficient information to make the success of any policy decision a formality.
Some form of theory is required to bring together the facts we do know and explain how they all interact with one another. True enough. Too true in fact (an in-joke for philosophers of science).
Given all the time and resources in the world, there will still remain a certain selectivity about the data chosen, methodology used and conclusions drawn. Even with a lab coat on, we damned, dirty humans are unavoidably part of the process with our biases, our opinions and our preconceptions. But if we worried too much about it we would never get anything done.
There is often too much time wasted worrying whether a subject such as economics, investment theory or business management is a science (it rarely is) rather than accepting a scientific “attitude” is a good idea and enough to move on with.
The more significant problem for a market regulator is timing when to intervene.
The preference for any regulator is to prevent major incidents rather than resolve them after the fact. The most recent recession reminds us of the importance of that. However, if you want absolutely unequivocal evidence of a problem presented before acting, the horse has most likely bolted and your evidence is an empty stable.
Former FCA chief executive Martin Wheatley was all bluff when he said in 2012 the new regulator would “shoot first and ask questions later”. A number of its early papers were navel-gazing dissertations on behavioural finance. Interesting theory with very little plot or action.
Nobody is expecting the regulator to act like Dirty Harry, asking a bank executive to describe his attitude to luck while staring down the barrel of a Smith & Wesson .44 Magnum. Acting on a hunch alone can be a huge waste of resource.
So how do you nip a problem in the bud at a point early enough to be effective but late enough to understand it well? Let’s take defined benefit transfers as an example.
- Follow the money. Product manufacturers and, to a lesser extent, advisers are hungry for sales and there is not much new money around. Cash is the largest “asset pool”, to use provider-speak, but hard to shift. DB pensions are sizeable amounts of money already invested which must go into a pension. It is high profile and the public are already motivated to move it. For all the talk of the difficulties of DB transfers, it is far easier than convincing someone to invest cash. Transferred DB monies account for the outperformance of a lot of pension provider sales figures these days.
- Data should show a spike in this activity. An improvement in the format, accuracy and consistency of data will help the FCA over time but pension providers are probably the most reliable source of where transfers come from and who to target. The problem with data is that often it shows a product sale (a Sipp, a repayment mortgage) but not the scenario behind it (a transfer from a DB scheme, a loan to finance a business), which, in hindsight, is often more important. Historic data is often too specific to be reliable for predictive purposes.
- A network of informants, as unsavoury as it sounds, is vital for any regulator to understand the direction markets are heading. The gut-feel of one individual may be unreliable but the gut-feel of a broad cross section of people can paint a clearer picture. It takes more time and effort to build a reliable network of contacts, as any journalist will know. They will help explain where the spike in data comes from.
- Watch and listen. I regularly see FCA delegates at industry events, which are often trying to influence the future direction it takes. Just looking at the agenda items gives a good flavour for it. The latest Market Studies show a genuine interest in understanding the “game within the game” of financial services. Strong, challenging financial journalism is absolutely critical in aiding regulation, even when it might feel uncomfortable.
It is always too early and it is always too late. I think the FCA is heading in the right direction on all these issues but retaining key staff who have developed sector experience and good contacts is vital for success, as the data available is still too patchy to rely on alone.
It is easier to gather around an impact crater and work out what hit us and why after it landed. We have plenty of evidence to look at. Every book explaining reasons for the 2008 financial crash appeared after it happened, although opinions still differ despite all the evidence we have to look at.
I suspect Fennell knows that and perhaps it is with a degree of irony he refers to himself as both a philosopher of science and an economist.
Phil Young is managing director at Threesixty