Fostering a culture of compliance, an alignment of regulation and incentives, through best interests standards.

Whether he realises it or not, Bill Rice has unwittingly argued for the introduction of best interests standards as a solution to the regulatory burden.

I wanted to make a further comment on a topic that spins nicely off Bill Rice’s Keynote speech, that applies to everyone who opposes the introduction of a best interests standard. 

“It is important to securities regulators that intermediaries are as effective as possible and, in that regard, that they be as skilled and experienced as possible, and are motivated by incentives to do as good a job as possible.”

That topic is compliance and the benefits of encouraging a culture of compliance.  At the moment the focus is on balancing the opposites of advice based service requirements and transaction based remuneration.   Compliance and incentives are in conflict and the hammer and the nail will always be needed to keep the two together. 

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Best interest standards…not a recent movement

As per Bill Rice’s recent keynote speech (to the IIROC – CLS Compliance Conference 2013), there is a mistaken assumption that the global movement towards best interest standards has occurred as a result of the most recent financial crisis, and that because Canada emerged relatively unscathed (although I would argue that Canada’s consumer debt dynamics would suggest otherwise) that best interest standards are an ill conceived knee jerk reaction to problems which do not exist in the Canada.

In point of fact, regulation in the UK has been focussed on issues of best interest standards for a much longer period of time. 

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The essential role of securities regulation…

Recognising and protecting the implied contract, to act in one’s best interests, between consumers of financial services and advisors should lead to more market efficient outcomes, should better maintain the integrity of the market place and raise the confidence of consumers in the advice they receive and the markets and securities in which they invest.

I wanted to address a central theme in Bill Rice’s recent address. This theme is the apparent regulatory focus on intermediaries (noted throughout his speech) to the exclusion of consumers.  

The following is taken from “The Essential Role of Securities Regulation, Duke Law Journal February 2006”.

“Any serious examination of the role and function of securities regulation must sidestep the widespread, yet misguided, belief that securities regulation aims at protecting the common investor….…The law of securities regulation may be divided into three broad categories: disclosure duties, restrictions on fraud and manipulation, and restrictions on insider trading.

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Euphemism: regulators still clinging to the past, still unwilling to face the fundamental problem?

Quite frankly I am gobsmacked, but at the same time eternally grateful to the many gifts this communication will provide the public debate on best interest standards.  I of course refer again to the Keynote Address by Bill Rice, Chair Alberta Securities Commission, on December 3, 2013 to the IIROC – CLS Compliance Conference 2013.

In this address he made a number of points that I think are worth pointing out and rebutting:

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Financial intermediation…

Just doing some research on financial intermediation and came across this interesting paper:

Finance vs. Wal-Mart: Why are Financial Services so Expensive? Thomas Philippon, New York University

“The finance industry of 1900 was just as able as the finance industry of 2000 to produce bonds and stocks, and it was certainly doing it more cheaply. But the recent levels of trading activities are at least three times larger than at any time in previous history. Trading costs have decreased (Hasbrouck (2009)), but the costs of active fund management are large. French (2008) estimates that investors spend 0.67% of asset value trying (in vain, by definition) to beat the market.

In the absence of evidence that increased trading led to either better prices or better risk sharing, we would have to conclude that the finance industry’s share of GDP is about 2 percentage points higher than it needs to be and this would represent an annual misallocation of resources of about $280 billions for the U.S. alone.”

And also:

Has the U.S. Finance Industry Become Less Efficient? On the Theory and Measurement of Financial Intermediation Thomas Philippon May 2012

Keynote Address by Bill Rice, Chair Alberta Securities Commission -December 3, 2013

I am just going through this key note address.   I will be blogging about this in greater depth, but I thought it would be useful to note some interesting statistics and one key observation:

Use of the word advisor/adviser – 0 times

Use of the word salesperson – 5 times

Use of the word intermediaries – 7 times.

It seems to me that the heart of the matter, as far as this key note address is concerned, is the differing view over the roles of advisors and the representation of that role.   Bill Rice views the role as one of salesperson and intermediary.   If the role was clearly one of pure intermediation, then I would agree with him, but it is not. 

This speech betrays an alarming level of ignorance, within the corridors of our country’s regulators, as to what is happening in the financial services industry.