Catching the Careless Nudists: The Behavioural Regulators’ Agenda

careless swimmers

By: Dr Roger Miles

“Only when the tide goes out do you discover who’s been swimming naked” – Warren Buffett

Part 1: It’s all going a bit mainstream

Suddenly behavioural regulation is more than just a fashionable theory: it is real, and compliance with its mandate is becoming very expensive. Financial service providers are being fined huge sums, not just for the bad behaviour they have inflicted on customers, but also for actions that they have not taken that have negatively impacted their customers, with regulators prepared to punish sins of omission as well as commission[1]. The first of the self-styled Behavioural Regulators, the UK Financial Conduct Authority, is now a voluble two-year-old, talking up its latest behavioural research to every audience and blazing a trail that other regulators increasingly follow[2].

From the outset, the FCA set an assertive agenda using behavioural analysis to “place consumer interests at the heart of [regulated] business”, and it is willing to both define its own role broadly and work with other watchdogs to get results[3]. Its behavioural weapons of choice include compelling businesses to design out “asymmetric incentives”, such as quick-cash commissions and systemic conflicts of interest; promoting “more functional market structures”; and banning sales practices that “take advantage of consumer bias”.

Other regulators and supervisors around the world continue to expand their overall remit, in both jurisdictional reach and the scope of defined offences, with conduct appearing more and more as a specific focus of attention[4]. As with the new FCA pairing with the competition regulator (CMA), there are other new collaborations, such as the Central Bank of Ireland’s consumer protection review through the Netherlands’ regulator AFM[5].

Meanwhile, the FCA extends its reach to include payday lenders (HCSTCs[6]) and new powers to intervene in person against non-executive directors. The behavioural-economic risks arising from “information asymmetry” continue to excite the FCA’s interest as a natural launching point for enforcement actions against “abusive strategies”—a clear reference to recent scandals involving manipulation of forex market prices and interest-rate benchmarks.

At ground level, the regulator is also starting to use a behavioural approach to call attention to common forms of bias, reminding providers that these affect not just retail consumers but also the bigger beasts on the buy-side: eligible counterparties and professional clients. All are prone to “unrealistically high expectations”[7] resulting from sell-side and buy-side biases. The onus is now on providers, who will be expected to account for how a range of real or perceived biases affects each buyer and to neutralise any inherent biases on both buyer and seller sides—although how this will be achieved is not yet clear.

The shortlist of targeted potential areas for biases reads like a ‘Behavioural Economics 101’ tutorial and includes present-bias, overconfidence, prominent features/complexity, framing and herding. All of this presents a triple challenge for practitioners: they must solve these slippery cognitive problems, explain to the regulator how they have achieved their solution and prove how it works by showing the relative merits of their chosen methods of behavioural risk control.

If that all sounds a bit like some kind of exam—it is. But more than grades are at stake. This is about licences to trade, the livelihoods of you and all your staff, and ultimately market survival.

Regulators in other jurisdictions are not far behind, with proposed extensions of powers into behaviour control after findings of conduct “black holes” among providers in many markets. As other jurisdictions phase in their behavioural agendas, it’s worth noting that the UK regulator has at least helpfully highlighted an important distinction between two discrete elements of behaviour: innate bias (cognitive blind spots we’re all born with) and socially validated “bad behaviours” (notably, mis-selling by over-eager sales teams). We’ll look at more of the detail shortly.


[1] Commerzbank was recently fined over US$1 billion for not having conduct-aware controls in place.

[2] At time of writing, behavioural sections in FCA Business Plan 2015/16 and Occasional Paper 10Message received?: The impact of annual summaries, text alerts and mobile apps on consumer banking behaviour.

[3] From April 2015, the FCA will have “concurrent powers” with the Competition and Markets Authority. Both regulators may then be able to shut down a range of financial and other firms, possibly for undefined behavioural infractions.

[4] Behavioural interventions and initiatives have also been announced by FINRA and the Consumer Finance Protection Bureau (in the US); the MiFIR/MiFID regime (in the EU); SIC and Competition and Consumer Commission (Australia); and the Singapore Monetary Authority. This list is by no means exhaustive.

[5] Netherlands Authority for the Financial Markets (AFM) Peer Review Report on the consumer protection functions of the Central Bank, March 2015.

[6] High-cost short-term credit lenders.

[7] FCA Occasional Paper 9.

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