The FCA's sector views

IN-DEPTH ANALYSIS

The FCA published its annual Sector Views on 18 February 2020.

The Sector Views report analyses the way in which the financial markets are changing, and the impact of these changes on consumers and market effectiveness.

It also sets out the FCA's perspective on how each financial sector is performing based on the data available in mid-2019, and helps the FCA to keep its priorities under review and focus its resources effectively for business planning.

The findings of Sector Views will feed into the FCA's 2020/21 business plan and its decision making around its three operational objectives:

protecting consumer
protecting and enhancing market integrity, and
promoting effective competition.

Drivers of change

Overview

The FCA's chapter on the drivers of change includes sections on economic, social, technological and international drivers of change. We set out a selection of the FCA's key views and observations in its chapter below.

Economic

In its section on economic drivers of change, the FCA draws attention to GDP, monetary policy, financial markets, and the labour market and household finances.

The FCA describes UK GDP growth as relatively volatile in 2019 in the context of Brexit-related uncertainty. Along with wider geopolitical tensions and slowing GDP growth rates in certain regions, the FCA emphasises that this may continue to reduce business confidence and affect spending. It also observes that low interest rates by historic standards drive a continued search for yield, encouraging movement towards riskier products. Although the low-interest environment can make it cheaper to access funding, it may be difficult for some firms to develop sustainable long-term strategies.

The FCA also explains that UK households are increasingly directly exposed to financial market conditions as a result of auto-enrolment in pensions and investment in retail products such as stocks and shares ISAs. The investment rate on longer-term instruments has declined since the financial crisis, further incentivising investors to search for yield. In this context, the FCA is concerned that some households and firms may be underestimating potential future volatility.

In addition, the FCA notes that UK households' debt to income ratio remains high relative to historic levels, with the result that certain consumers may be vulnerable to economic shocks and be taking on debts that could become unaffordable. Firms are urged to be aware of consumers who are likely to become vulnerable and treat them appropriately.

Social

In its section on social drivers of change, the FCA considers intergenerational differences and climate change.

The FCA is concerned that intergenerational differences could have negative impacts, and is interested in the effect of young people's limited earnings growth for their saving priorities, irregular earning patterns and the gig economy.

Fewer young people own property due to the growing gap between average incomes and house prices, and measures introduced to address this could lead to a higher debt burden for longer. Those born between 1966 and 1980 have to meet the cost of supporting aging parents with long life expectancies while raising their own children, and have not benefited from auto-enrolment or defined pension benefits in the way that the generations on either side have. Those born between 1946 and 1965 may require more varied products to help them to manage their resources over a longer time horizon.

The FCA also observes that the momentum behind climate change and sustainable finance policy has been accelerating. Recent developments include:

the Government's Green Finance Strategy
the Treasury's introduction of a taskforce (which includes the FCA) to coordinate the approach to climate-related initiatives, and
the Bank of England's plan to conduct stress testing in 2021 to assess the UK financial system's resilience to the risks of climate change.

These developments may affect consumer and firm decisions in the market.

Technology

In its section on technological drivers of change, the FCA confirms that technology could increase efficiency and improve access to products, but could also create harm for consumers. Key drivers of change it identifies include open banking and open finance, big data, AI and data use, fintech, and new technologies and ways of interacting.

The FCA explains that open banking and open finance, despite still being at an early stage of implementation, aim to transform the way that customers engage with their finances. In its view, they may increase fairness in pricing by allowing third-party providers to reach out to 'overpaying' customers with better deals. However, older people who are less likely to use digital tools may be disadvantaged, and open banking also introduces certain challenges for data security and sharing.

In the FCA's view, big data and AI may affect pricing decisions by increasing access to data and insight, but this could lead to concerns about unethical data use, particularly for insurance and credit products and in cases of unfair pricing and/or the exclusion of certain customers from the market. In this context, fair pricing will be particularly important to maintain trust in the market and to prevent discrimination against certain customers. Key issues are likely to include how firms use data, who they share it with, and on what basis.

The FCA mentions that global investment by retail banks in fintechs more than doubled in 2018. The growth of fintech is reshaping the customer experience, but also creates new challenges for the FCA, including:

growing participation from financial services entrants (and the resulting complexity of issues around accountability and liability)
the adequacy of protections for consumers, and
gaps in consumer awareness around whether regulatory protections apply to fintech products.

The FCA also notes that cyber incidents are increasing, with firms reporting a 7% increase in technology outages from 2018 – 2019. Firms are also increasingly relying on third-party service providers, including for critical services. New technologies and ways of interacting may increase firms' vulnerability to cybercrime, fraud and technology outages, but can conversely create improvement in these areas.

In particular, the pace of innovation raises questions about the adequacy of new firms' controls to safeguard client funds and prevent the use of their systems for financial crime. The FCA is also concerned about social media advertising of, and easy access to, high risk investments or credit products.

EU withdrawal and international context

The first chapter also sets out the FCA's view on the UK's withdrawal from the EU.

The transition period that is due to run until 31 December 2020 should provide continuity for firms and funds, as they will continue to benefit from passporting throughout 2020. This means that cross-border products and services can continue to be provided throughout this period, and consumer rights and protections from EU law will also continue to apply.

After the transition period, the political declaration accompanying the Withdrawal Agreement sets out the UK and EU's agreement to cooperate on regulatory and supervisory matters, and both have committed to seek to conclude equivalence assessments by the end of June 2020.

The FCA expects significant changes under any agreement between the EU and UK regarding their future relationship. In particular, the FCA expects that "passporting" in its current form – the mechanism which currently allows EEA authorised firms to conduct business across the EEA based on their home authorisation – will end. Any new regime will depend on what is ultimately agreed between the UK and EU. On this basis, the FCA urges firms to ensure they are prepared for a variety of scenarios, including cases where their activities are not covered by a future regime.

Brexit will also impact the FCA's responsibilities. While changes to the regulatory framework in the EU will continue to affect financial services in the UK, the UK will no longer be directly involved in the EU decision-making process. The FCA aims to help ensure that the UK continues to influence global regulatory developments, enable market access and maintain an effective relationship with counterparts across the EU.