Jeff Salway: New City watchdog has much to do to restore confidence

CRAIG Levein surely allowed himself a wry smile last Friday when his successor as manager of the Scotland football team saw his side deservedly beaten at home by Wales.

Levein, so heavily criticised while at the helm, will be only too aware that the fortunes of the team with Gordon Strachan, pictured, in the hotseat will help shape how history judges him. Carry on like this and redemption will be a step closer.

The same may one day be said of the Financial Services Authority (FSA), the outgoing City regulator. From Monday its role will be shared by the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA). The FCA, responsible for conduct and markets, will be the new City watchdog and its successes and failures may help change our perception of its predecessor.

The FSA will be remembered for many things, some negative or downright catastrophic.

Let’s look again at its basic remit – to maintain confidence in the UK financial system; to protect and enhance the stability of that system; to protect consumers; and to reduce financial crime. So how did it do? The highlights include presiding over a banking crisis that its “light touch” approach to regulation helped cause; allowing the mortgage market to spiral out of control; failing to heed the sub-prime warnings signs and falling asleep at the wheel as Northern Rock edged towards the precipice.

The demise of HBOS and the green light given to Royal Bank’s disastrous purchase of ABN Amro certainly won’t look any better with further hindsight.

It’ll also be defined by the Libor scandal, another episode in which it failed to act despite clear evidence of malpractice. The same goes for payment protection insurance (PPI) mis-selling. It was warned time and again of a mis-selling scandal that became the most expensive of them all, but did nothing about it until it the damage had been done. Even now it is struggling to make the banks treat customers fairly in their handling of complaints and payouts.

Then there’s the Equitable Life shambles, the Arch Cru and Keydata debacles, mis-sold precipice bonds, endowment mis-selling, interest rate swaps mis-selling… the list goes on.

There are a few plusses too. One may yet be the retail distribution review (RDR), the reforms that came into force in January banning commission payments from investment providers to advisers selling their products, among other measures. It’s been a shambolic process and early evidence suggests that the worst fears – even more people left without access to advice – will be realised.

The RDR has the potential to help restore trust in financial services if it raises the quality of advice and improves the public perception of its value. It may also prove disastrous, though the reality is more nuanced.

The new regulator promises a tougher, more interventionist approach. Only time will tell, much as it will give us a better idea of the legacy of the FSA. There’s huge room for improvement but as Craig Levein may claim of the Scotland job, it’s a lot harder than it looks.

The outgoing regulator leaves the FCA with more than a few challenges on its hands, some of which are highlighted in a “risk outlook” document published this week.

Among the risks flagged up was that posed to savers by the paucity of inflation-beating returns available on cash accounts. It’s now more than four years since the base rate hit 0.5 per cent and with inflation creeping up again, it’s clear that many people who would otherwise prefer to avoid share-based investments are having to think again.

By eating into savings returns, inflation strengthens the argument for equities, which, if the basic principles are observed – most notably diversification – can be a very effective hedge against rising prices.

But where there’s a threat there’s an opportunity – for investment firms, that is. Billions of pounds has flowed into products promoted as offering a safe alternative to cash, when in reality they’re far riskier than their marketing suggests. The FCA rightly identifies structured products and absolute return funds as an example of funds pitched towards risk-averse savers looking for more income.

Very few absolute return funds have delivered on their promise of growth regardless of market conditions. They are also poorly categorised. Composition of the funds can vary widely, making true comparison almost impossible.

The Investment Management Association’s attempt to “clarify the nature” of the funds extended to renaming the sector as “targeted absolute return”. Does that really help manage investor expectations and understanding? It doesn’t make a difference.

Investors will continue piling into the funds, including risk- averse investors unwittingly putting their cash into vehicles that use complex hedging strategies. The FCA recognises the risk; if it is going to be an improvement on its predecessor the difference will be in how it acts.