, Kay review
“Trust” is a current buzzword in the financial sector as the aftershocks of the LIBOR scandal and the HSBC AML case continue to be felt.
Those two cases perhaps diverted attention from the release last week of the final report of the Kay Review into short-termism in UK equity markets, in which, again, that word “trust” was writ large.
Although the reception from the investment community has been quite mixed, the report will have been of interest to anyone working in a compliance function within the asset management sphere. The general view is that the report’s diagnosis is pretty accurate, but opinion is so far divided as to whether its prescription for treating the problem of short-termism goes far enough.
For compliance practitioners, the report’s views on the future regulation of markets were noteworthy. It concluded that the decline of trust and the misalignment of incentives in the equity investment chain are the principal causes of short-termism, and it had a good deal to say on the future role for regulation within the process of restoring that trust to equity markets. It hinted that the approach of the FCA and PRA could be instrumental to this.
One main suggestion is to shift away from prescription and towards principle in the regulation of equity markets; to focus less on issues of market conduct and more on issues of market structure:
“Regulation should focus on the establishment of market structures which provide appropriate incentives, rather than the fruitless attempt to control behaviour in the face of inappropriate commercial incentives. We look forward to a future of less intrusive and more effective regulation, the product of a new emphasis on the incentives market participants face, and to the creation of trust relationships which can give savers and companies confidence that the equity investment chain meets their needs and serves their interests.”
The report therefore fully endorsed the regulatory direction which has been promoted by the FSA post-crisis, namely towards a focus on outcomes and away from a preoccupation with systems, processes and box-ticking.
But while, without doubt, everyone would welcome regulation that is both less intrusive and more effective, the task of achieving this in practice is far from straightforward. Current structures and the proliferation of intermediaries (which, the report observes, have contributed towards short-term market practices) bring with them a range of vested interests, with fees embedded at each link in the investment chain. As Professor Kay suggests, this has resulted in “the rise of an ethos which emphasised transactions and trading over relationships” and “a tendency to view the performance of the market through the eyes of intermediaries” rather than savers. In other words, it’s a potentially self-serving arrangement in which people “who claim to be in the business of providing advice are in fact in the business of making sales”. Restructuring this system will be no mean feat.
So, do the report’s seventeen recommendations do enough to unpick market structures, and to promote the shift away from a transactions and trading culture and towards one built on trust and relationships? Was there anything missing in the report that should have been there? And how should its recommendations be implemented in practice? I’d be keen to hear from any ICA members with an opinion on the Review’s findings and recommendations. As always, feel free to drop me a line at: firstname.lastname@example.org.