A three dimensional view of UK financial services – regulation, price and trust

Prior to the Thatcher government’s move to deregulate the industry, UK financial services were characterised by heavy regulation, high prices and confined to a relatively small group of people who were considered specialists. Thus, you could only get a mortgage from an institution that you had been saving with for some time and where you passed an interview with the manager – then you paid the rate of interest that they said. Those wishing to save had two choices; either buy an insurance bond of some description from a salesman where the commissions and investment performance were not visible, or go to a stockbroker who would make investments for you in shares by trading with his friend on the floor of the Stock Exchange called a jobber, and then charge you a fixed, and large, commission. In summary there was a high level of regulation, prices were high but there was also a high degree of trust from the consumers of financial services towards the providers, some of which could be attributed to consumer ignorance, but bank managers and stockbrokers had a high social standing then.

The deregulation of the financial markets began in earnest in the 1980s, most famously with the “Big Bang” of 1986, blowing open the restrictive practices of the UK securities markets and allowing the banks to own and operate securities companies. A boom in house prices and the sale of council houses saw greater demand for mortgages and many more entrants into the mortgage market, which became a low-margin product used to sell a much higher-margin endowment or savings scheme to repay the capital at the end of the term. The unit trust market expanded on the back of this new demand, a bull market was well underway and suddenly everyone wanted product to supply this new demand for long term savings. As the bull market of the 1980s led into the bull market of the 1990s, more and more investment products came out and business models evolved from providing good advice to clients towards delivering sales targets. As the level of regulation declined, competition increased and pricing fell – the performance of the products was good but there was a decline in the level of trust between financial advisers and their clients, as a “product-push” mentality developed.

The post-bubble bear market from 2000 to 2003, saw US interest rates cut to 1% and a new bull market in housing. Financial innovation in securitised and derivative markets dominated by the major banks and a massive increase in financial sector gearing meant that profits from advising clients well became puny compared with the profits that could be generated by the banks from their trading books in these areas. Regulation came to be seen as inimical to innovation and capitalism itself. The bursting of this bubble that has been witnessed over the last 5 years has produced terrible returns for investors and demonstrated that very low levels of regulation, even though combined with relatively low pricing, has come at the cost of a total breakdown in trust between financial institutions and their clients.

What is needed in the next phase of history for the UK financial services sector, is a combination of 1) heavier regulation, particularly over institutions in the investment banking markets and the inherent conflicts of interest they contain; 2) the costs of this regulation  not  falling upon the ultimate purchaser of financial services and 3) new business models that are able to rebuild the trust that needs to exist in the financial services sector between an advisor and his client.

The financial services industry has to get back to a situation where the client is assured that the only interest of his adviser is to give him the best personal, financial advice. To work at its best this means advice needs to be on a fixed fee basis rather than remuneration tied to the purchase of particular products or other services. This may be revolutionary but its time has come.