Are Financial Services a ‘Safe Graveyard’?
The industry is being cajoled towards fewer, larger firms. This will have consequences.
To the regulator, the financial services industry looks too chaotic. Yes, there are good firms and products, but there are bad ones too — for which the regulator gets noisily blamed. So, understandably, they want to banish the bad ones.
But the industry has loads of firms and products, which makes it hard to stay on top of. So they’d prefer fewer, larger operators, which allows easier monitoring and control.
Fair summary?
Maybe, maybe not. But it’s why I believe the financial industry is developing in the way it is: Consolidation is encouraged, not discouraged, and the regulatory landscape is becoming hostile to smaller operators (be they advice firms, wealth managers or asset management companies).
Why is this a problem?
To borrow a phrase from Bim Afolami, previous Economic Secretary to the Treasury, muscling out smaller firms risks turning a previously fertile industry into a “safe graveyard”.
For a centralised regulator, it may seem easier to reduce the industry to a handful of giant players then ensure they’re all good. But, from their arm’s-length perspective, knowing what’s ‘good’ and what’s ‘bad’ is all but impossible.
For one, real-life conditions evolve quickly, so what works today can stop working tomorrow, but old practices get cemented in by today’s rules. It’s hard to spot this if you’re not working at the coalface, while fixing it can take forever.
For another, real life is not as uniform as the regulator would like it to be. What’s right for Mr Smith may be wrong for Mrs Jones (or what helps in London might hurt in Llandudno). Scale plays tricks too: Just because something functions well at £1billion doesn’t mean it will at £100billion.
And what happens if today’s received wisdom turns out to be wrong? It was once considered best practice to whip out your appendix — which experts believed useless — at the first sign of a grumble. But they’ve since worked out its job is to flush your gut with crucial bacteria after a serious illness. Oops!
All of these — and more besides — lead to the ‘unintended consequence’: the bête noire of the central planner. It was the unintended consequences of the planned economy that caused the Soviet Union to creak then collapse. If left unchecked, they’ll do the same for us.
Some of them are already here — what are they?
Crushing innovation within the industry is one. Necessity is the mother of invention, but in a market of a few giants and no upstarts, necessity means maintaining the status quo. It’s the small upstarts, like Vanguard in the 1970s, who must innovate to find new, better, cheaper ways of doing things. Otherwise, why would we buy them?
So, by discouraging newer, smaller entrants, we’re cutting ourselves off to the newer, better, cheaper products of the future.
The unintended consequences reach beyond just financial services: Regulatory decisions that impact the wealth management industry impact the stock market, which then filter through to the wider economy.
From where we sit, it’s easy to forget that company shares are more than just a savings product. For companies, particularly smaller, innovative, growing ones, they’re a crucial way of raising money to fund growth (perhaps by hiring more staff, which then creates further societal benefits).
But the market is increasingly failing to fulfil this function, and much of that’s to do with consolidation: When a small, local wealth manager is acquired by a large national firm, its clients are often moved into the larger firm’s model portfolio (for economies of scale).
Smaller wealth managers can buy specialist small-cap funds but, because of size and liquidity constraints, the behemoths can’t. So, upon consolidation, the UK small-cap fund gets replaced by a Fundsmith or a global tracker, channelling more capital away from smaller firms into the large caps that are all the behemoth can hold.
As such, the lower end of the market — our economy’s breeding ground for innovation and disruption — is starved of capital. Witness here the startling valuation gap between super-cheap UK small caps and eye-wateringly expensive US mega caps.
This trend has been exacerbated by the regulatory enthusiasm for the cheapest products, which are usually market trackers (far easier to regulate a market if everyone holds the same product). These too only really work at scale and won’t send their capital to the grass roots of the market.
But in economies as in forests, if the roots are starved of nutrients, eventually the canopy wilts too. And it feels like the UK has been wilting for some time.
These are the external impacts, but there are implications for our customers too.
It’s true that a market of smaller, local operators looks more complex and confusing. But guess what? Real life is complex and confusing. So lots of smaller offerings means we, as individuals, have a shot at finding something to suit our own quirky needs. OK; we may have to look a little harder (and the industry could help more with that), but at least there’s a choice.
Wouldn’t it be nice, for example, if your local railway offered ten different rail services? One that’s cheap, another that’s fast, or one that majors on exceptional service. Or perhaps one with a party vibe while another rolls like a Victorian library? (I’m on that one, by the way).
The geographical limitations of railway tracks make this a fantasy. But geography holds few limits for financial services. Instead, it’s one-size-fits-all regulations that place the biggest constraints between us and a dynamic, diverse, and evolving marketplace for financial products.
Sadly, I fear our current obsession with ‘big is best’ means we’re headed in the wrong direction. But it’s not too late to change track.
This article first appeared in Citywire Magazine.
Disclaimer
These are my own personal opinions for informational and educational purposes only and not financial advice. Nothing here should be treated as a recommendation to invest or take any specific action.
I’m not your financial adviser, and you should do your own research or seek professional advice before making decisions. Any reliance you place on this content is at your own risk, and I accept no liability for any losses incurred.
