What does this changing world with its new emphasis on data mean for the FCA’s prime concern, consumers? In the third of our articles we examine the final three of our future market dynamics: data as a public and private good, trust and intermediation and finally, the new freedoms and the new risks consumers may face.
Data sharing is capable of bringing wider societal benefits
Access to data is increasingly important in ensuring that financial markets work effectively for consumers. It helps firms supply the services customers need and want, it allows more tailored and innovative services to be developed, and it helps consumers seek out the best firms, and firms seek out the most appropriate consumers.
Here, we focus on the potential positive externalities of data sharing and how we might unlock the wider value of data, while also being mindful of the challenges highlighted in the previous Insight article.
Data can have the characteristics of a public good – it creates benefits for society as a whole and those benefits increase the more data is used and the more widely it is dispersed.
Data has been described as the ‘new oil’, but in one regard it is quite unlike other commodities. Data is not ‘used up’ when it is accessed or exploited. This can mean that, from a common good perspective, it can be efficient to make data available for free at the point of use for appropriate use-cases.
The aggregation and dissemination of data can have diffused social benefits, for example in the use of “track and trace” data to understand and control the Covid-19 pandemic. By allowing our health and location data to be combined with that of other individuals, we help researchers compile a data set that can be used to understand how Covid-19 is transmitted across the population, and to identify which individuals need to self-isolate. The value of this data set is greater than the sum of its parts, and it accrues more widely than to those whom the data is about.
Data sharing can also be a driver of innovation and help new firms to enter markets. New products and applications can in turn create more data, which can be used by other firms, creating a virtuous circle.
However, these very same characteristics pose challenges in the incentives to collect and collate data – if it is available at no charge, then it may be undersupplied by private firms as the value of data is not always fully captured by those who own or create it.
Firms can sometimes capture this value – for example by making it available to innovators seeking to develop services that complement and enhance the value of the services provided by the data owner. But they may also hoard data particularly where there is a strategic advantage to doing so, for example, in preventing firms from creating substitute products or in order to sell exclusive use of it to the highest bidders. This is further complicated with multi-sided platforms, like financial exchanges, where market competition may lead to expensive data and cheap (or even subsidised) activities that generate data. The FCA’s Call for Input on the use of and access to wholesale data starts the conversation on this issue.
Might individuals’ concerns for privacy stand in the way of the benefits from data sharing?
Capturing the full economic and social benefits of data sharing will also require that privacy concernsare overcome.
One challenge here is that privacy also has public good characteristics – a lot of private data in fact contains information about a wider group than the individual. If an individual reveals private information about their self, for example that they have been victim of a spate of burglaries, that may also reveal information about their neighbours: they live in an area targeted by thieves. This could, for example, affect their neighbour’s insurance premiums.
So, while giving up some privacy can have a positive benefit on society by allowing data to be shared and aggregated, it potentially also has a negative externality on certain groups, by undermining the privacy choices of others.
This illustrates the complexity of social issues around data sharing, and that providing consumers with informed consent and protection over how their data may be used, may not be sufficient to solve these problems, particularly where privacy is highly valued or where the public good benefits of wide dissemination are substantial.
The FCA has a key role in ensuring effective data sharing in financial services
While it is not the role the regulator has traditionally played, the FCA is uniquely positioned to regulate the efficient sharing of financially relevant data, and thereby support innovation in financial services. This role is likely to become increasingly important in the future.
In retail finance, the Open Banking initiative – where consumers can easily allow third parties access to their transactions data – is a start. The FCA’s Open Finance initiative might extend it to many other financial products.
Regulators may also seek to help develop a more extensive market for data brokerage. Data brokers aggregate complementary data from a variety of sources to create more valuable data sets, which they then make available to third parties. “Synthetic” datasets are data which share aggregate properties of actual data but that have not been collected from real individuals, so offering comfort on privacy.
Regulatory intervention may also be warranted in certain circumstances to prevent firms from hoarding data with the intent of reducing competition in the market and slowing innovation.
Finally, the FCA may wish to consider leading by example by creating its own data sets – perhaps synthetic ones – which it can then make available to the wider public. The FCA is in a unique position in its ability to request such data, to coordinate its collection, and to package it into usable and privacy-respecting products. This would provide potentially highly valuable assets both for trusted financial services firms seeking to innovate, and for social and economics researchers.
Concerns about data sharing also form part of a wider issue, that of trust. And trust is the cornerstone of our next future market dynamic.
The role of trust in financial services
Trust is a prerequisite for a well-functioning competitive market. It gives consumers confidence that they will be treated fairly, allowing more mutually beneficial trades to take place.
Trust between financial service providers – for example, that interbank loans will be honoured – is also critical for the liquidity and stability of the financial system.
Trust in financial institutions, and in the services they offer, is provided in a number of ways. It can be provided by the firms themselves through investing in brand and reputation, through intermediaries such as credit reference agencies and auditors, and by regulatory supervision.
The financial crisis dealt a blow to trust in the financial services sector and recovery has been slow, with a series of scandals ranging from illegal price fixing to lax money laundering controls and product mis-selling.
Can new forms of trust emerge?
There are signs of new forms of trust emerging, many of which rely on trust being provided by new intermediaries. These include technological solutions, such as distributed ledger technology (DLT), and blockchain, which provide the possibility of third party verification of transactions.
There has also been a marked growth in platforms whose success depends upon the trust of the firms and consumers using the platform such as Ebay, Uber and AirBnB. The latter’s decision to refund consumers in full for cancelled bookings during the Covid-19 crisis (and offering some compensation to hosts) is an illustration of the delicate balance that platforms need to achieve in order to promote trust on both sides of the platform. And, as already mentioned, there has been more innovative regulation in financial services in the form of open banking, where structures were put in place to allow trusted firms to make use of personal consumer data.
In one vision of how these new technologies of trust evolve, we could witness a move away from competition based on brands and one-stop shopping – which is partly motivated by the trust consumers have in well-known brands to deliver – towards less concentrated market structures that give greater opportunities for smaller and more diverse financial solutions to develop. This has the potential both to increase the intensity of competition and to expand consumer choice.
However, the route to this future is littered with traps. While it is sometimes said that trust has to be earned, the opposite can also be true – consumers are often overly trusting of new firms or products. Trust declines later if or when signs of untrustworthy behaviour emerge.
This exposes consumers to the dangers of putting too much trust in new firms or products only to regret that decision later – a problem particularly acute in those financial products where mistakes can have life-changing consequences. A good example of this is in financial advice – a classic case of what is known as a ‘credence good’ where it can take some time for consumers to ascertain the quality of the advice they have been given.
In this market, firms seek to create trust through brand and reputation, but the risk of market failure remains high. The role of the regulator may be to facilitate new ways of creating trust in financial advice.
Supervising a strong firm culture is at the heart of creating trust
So how should the FCA be prepared to respond to these new models of trust? Where should it focus its efforts to ensure consumers are not left open to traps?
One of the key challenges for the FCA is to ensure that the new intermediaries can themselves be trusted, for example with the providers of blockchain technologies that underpin trust in crypto currencies. An important question is whether these and other intermediaries, including more traditional ones like credit reference agencies, have the correct incentives to highlight mismanagement, illegal practices and other breaches of trust, and to do so in a timely manner.
A positive firm culture is central to the development and sustainability of new trust models and the culture of financial services firms has become a key concern. The FCA has a critical role in ensuring that trust in financial service firms and their products, including the ability to protect personal data, are warranted. This requires effective supervision of firms. But, it also increasingly means ensuring that firms have the right incentives, culture, and social norms, to deliver products which are priced fairly, of the expected quality, and are suitable for the consumer’s needs.
The FCA can also seek to work with industry to promote a more positive culture where firms act in the interest of consumers as they did when requesting lenders to offer payment holidays in the first phase of the Covid-19 pandemic.
Finally, developing effective trust structures requires broad stakeholder buy-in, and in many cases will require co-ordination between regulators.
Where market institutions are trustworthy, a regulator will feel reasonably comfortable with the extension of consumer freedoms and the general reduction of protective oversight in markets. But freedoms involve risks, and we now turn to the changes we must ready ourselves for in this critical trade-off.
Increasing consumer freedoms
New technologies are combining with regulatory changes to give consumers much more freedom and choice in the purchase of financial services.
The pension freedoms introduced in 2015, for example, permits the exercise of new pension choices, while platform and app-based products offer easier and greater choice than ever before.
Freedoms may deliver significant consumer benefits. But the flip side is that consumers are increasingly responsible for their own financial decisions, the opportunities from the unscrupulous to mis-sell have increased, and the consequences of misjudgement and mistakes can be very long-lasting.
The starkest example is pensions, where a shift towards defined contribution pots and greater freedom to access pension savings, mean that consumers are now responsible for complex decisions including how much to save, where to invest, and how the accumulated pension pot is spent, including the form of decumulation. These are often one-off decisions that will affect the consumer for the rest of their life, and the risk of consumers rushing into the wrong decision is greater in a time of crisis.
Firms can undermine the benefits of freedom of choice
In liberalised markets where freedom of choice is available, firms will compete to cater to a wide variety of needs and will also sometimes work to generate previously unsuspected demands. This typically leads to greater product diversity and choice for consumers.
But consumer freedoms, technological developments and market liberalisation are also likely to increase the risk that firms deploy tactics to undermine the benefits of these freedoms.
Greater product choice could result in greater price dispersion and firms supplying what can be a baffling array of apparently similar products. This makes it difficult for consumers to make good choices and putting more emphasis on consumers to search for the product that is most appropriate for their needs at the best available price.
The difficulties consumers have in making good choices can be exacerbated where firms adopt “sludge” tactics designed to nudge consumers into purchasing poor value or inappropriate products – for example by giving greater prominence to higher margin products. These risks are greater where consumers can be guided to products at the touch of a button.
Some consumers may not fully appreciate the choices available to them, and sometimes they may not realise they have a choice to make.
Pensions provide a clear example. Evidence from the FCA’s Retirement Outcomes Review found that many consumers “took the path of least resistance” with 94% of consumers who accessed their pension pots without advice choosing a drawdown product from their existing provider (the default option), compared to only 35% of advised consumers.
Where incumbent firms have this type of point-of-sale advantage it can be difficult for consumers to enjoy the full benefits of competition and in the worst cases it can lead incumbents to abuse their positions of dominance.
The risk of mis-selling and outright scams is also likely to become greater the more consumers have choices to make that can be influenced by firms’ selling techniques, which may increasingly exploit behavioural biases.
The Covid-19 pandemic, which has put many households in severe financial distress, is likely to provide greater opportunities for scamming and other forms of mis-selling.
There are a number of market solutions that might develop to help consumers to make better decisions. Investment in brand is one route. Intermediaries may emerge who develop a business in aiding decision-making, as price comparison websites (PCWs) have started to do. Some PCWs could become full-blown advisers, assisting consumers on the suitability of different products, perhaps using “Roboadvice” services.
The FCA has in the past found, however, that consumers are often loath to pay for advice – notably in Defined Benefit to Defined Contribution transfers – which obviously raises serious incentive questions in the case of intermediaries who offer advice or quasi-advice “free” to consumers.
Regulation to balance freedoms with paternalism
The increased scope of individual responsibility raises the prospect of consumer harm – and anger – because of poor choices, whether precipitated by bad firm conduct or not. In some cases, such as pensions, there may be a substantial financial impact from making the wrong choice at a time when individuals may be at their most vulnerable.
In a market where consumers face greater choice and freedom, but also greater risk, how should regulation strike a balance between enabling consumers to take advantage of these freedoms and ensuring they do not use those freedoms to make choices they will later regret? What level of paternalism will be appropriate to ensure consumers are suitably protected in the outcomes they experience but suitably free in the choices they make?
On the one hand, there could be market solutions to improving the quality of consumer choice – for example better ways to offer advice, and incentives to build a reputation for offering good products. But we do not expect the market alone will solve all problems of consumers making ineffective choices. In some cases, solutions could continue to involve reductions in personal freedoms.
There is likely to be an important role here for behavioural science. The FCA may need to think more about the ‘safest’ default options, or provide clear pathways for consumers to take depending on their attitudes to risk.
Some of the challenges associated with paternalistic approaches will include questions of fairness, especially where the protection of one group of consumers comes at the expense of an imposition on another. The FCA will need to continue to develop its thinking on fairness to fit new cases.
The obvious example of this would be if the new freedoms and risks begin to show certain demographic groups as being markedly more vulnerable to the risk and less likely to benefit from the freedoms. The FCA already has a focus on vulnerable consumers, but new freedoms and risks may require ever more vigilance and will pose questions about how far regulation deepens or widens its interventions on what some may regard as societal issues.
Regulation for the future
This draws our series of articles on the seven Future Market Dynamics to an end. As we set out at the beginning of the first article, these articles are not intended as predictions, especially given the uncertainty we face right now in midst of the Covid-19 pandemic. Nor are they rigid prescriptions for action.
But we believe these are the trends that will shape the future and they provide a vital context and framework for thinking about how regulation will have to adapt its approach and consider how best to use its tools and deciding what role it has to play in tackling some of the challenges that go beyond financial services.
Whatever actually happens, the FCA and the industry need to be prepared and to have an approach that is ready to rise to these myriad challenges and opportunities.