Watchdog to Protect 'Irrational' Investors

Investors cannot be counted on to make rational choices so regulators need to “step into their footprints” and limit or ban the sale of potentially harmful products, the head of the UK’s new consumer protection watchdog said on Tuesday.

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In his first big interview since starting work last autumn, Martin Wheatley told the Financial Times that the 2008 financial crisis had fundamentally reshaped regulators’ assumptions about the people they protected.

“You have to assume that you don’t have rational consumers. Faced with complex decisions or too much information, they default ... They hide behind credit rating agencies or behind the promises that are given to them by the salesperson,” said Mr Wheatley, a key figure in the government’s effort to revamp financial regulation.

Under the government’s plan to break up the Financial Services Authority, the FCA, headed by Mr Wheatley, will spin out as an independent agency early next year and be granted enhanced powers to police markets and protect investors. It intends to be far more interventionist in an effort to head off the mis-selling scandals that have dogged the financial sector in recent years.

The new approach rests on research in behavioural economics that shows investors often make decisions contrary to their own interests because of their aversion to losses or unwillingness to ditch a losing strategy. It represents a profound shift in regulatory stance.

Rather than simply ensuring that consumers are provided with complete and accurate information, the FCA will be monitoring firms to make sure that the right kinds of products get sold to the right kinds of people.

“This much more interventionist style in many respects [means] stepping into the footprints of the investors,” he said

The recent 6 billion pounds payment protection insurance fiasco might have been prevented if the FSA had had the power to tell banks to stop offering the highly profitable but frequently mis-sold product, Mr Wheatley said. But he added such bans would be “relatively rare ... Interventions should be the last tool you grab when all others have failed.”

Instead, FCA supervisors would push firms to improve the way they designed and sold products to insure that the products themselves had merit and that they ended up in the hands of the customers for whom they were designed.

For example close monitoring might have prevented the recent problems at HSBC, which was fined 10.5 million pounds for selling complex investment products with five-year time horizons to customers who were too ill and elderly to benefit from them.

This activist approach is taking shape at a time when the risk of mis-selling and poor consumer choices is running especially high. With interest rates at historic lows, many investors searching for higher yields are turning to complex, poorly understood products. Banks and brokers, meanwhile, are under heavy pressure to find new sources of revenue.

“Those two things don’t meet in a happy place ... The profitability to the firm appears to be a bigger concern than the suitability to the customer,” Mr Wheatley said.