Competition Policy in Financial Markets

CCP 12th Annual Conference, 8-9 June 2016

The CCP’s 12th Annual Conference on ‘Competition Policy in Financial Markets‘ is fittingly based at OPEN, the premises of the former regional headquarters of Barclays Bank until 2003. The programme for this year’s event boasts a truly multi-disciplinary line-up (with speakers from Law, Economics, Politics and Philosophy) with a strong policy focus to provide a range of different perspectives. The stage is set for some lively debate and discussion over the 2 days.

Our academic organisers, Amelia Fletcher and Andreas Stephan, are looking forward to a compelling couple of days, with insights from a broad spectrum of sectors and disciplines (including the first Philosopher to ever appear at CCP)And with the introductions concluded, we’re all set for the first session of #ccp2016conf, with presentations from members of some of the key financial service regulators in the UK (inc. the Financial Conduct Authority, the Prudential Regulation Authority, and the Payment Systems Regulator).

Session 1: Setting the Scene – View from the Regulators

Mary Starks, Director of Competition at the Financial Conduct Authority, highlighted some of the overarching objectives for making markets work effectively. This includes market integrity, consumer protection and promoting competition in the interests of consumers. Promoting competition is a tough sell post-financial crisis, with serious challenges to trusting the free market more rather than less. Key here is that we know competition is beneficial but not who will get the benefits or when. In the short term promoting competition requires a leap of faith. This is particularly challenging when public policy debates focus on outcomes not output and there is a compelling political narrative for intervention. Ultimately, competition is the best way to find out what consumers want and how to get it to them. That may mean we as regulators do not know necessarily what ‘good’ looks like. This highlights the importance of innovation, entry and exit. This means using a range of tools to understand markets holistically, build detailed knowledge of consumers perspectives and the perspectives of new entrants. In particular, to understand how new financial technology can provide challenger products and services and how regulation needs to adapt to these. This includes a proactive approach to listen to new entrants and provide a ‘sandbox’ for experimenting with new solutions. Importantly, in designing regulation we need to think well beyond the status quo and be open to a wide range of futures. This may require a leap of faith but Mary is optimistic that we will get there.

A full transcript of Mary’s speech is now available on the FCA’s website.

Hannah Nixon, Managing Director of the Payments Systems Regulator (PSR), discusses how the PSR works to ensure that payment systems such as credit and debit cards are secure, reliable, and offer good prices for the services provided. For the PSR ensuring effective competition and innovation in payments systems are key objectives to achieve this goal. Hannah discusses the scope of the regulatory scope and powers of the PSR, in particular with respect to fostering competition to the benefit of consumers. To achieve this, the PSR aims to make a proportionate use of its powers based on evidence. Current key issues in the industry include barriers to entry limiting retail banking competition and slow innovation in payment systems.  To foster retail banking competition, the PSR is working on improving both direct and indirect access to payment systems by improving speed, quality, and cost of direct access to facilitate entry of competitors. Speed of innovation and its effects on service quality is another area of intervention that is tackled, e.g. through the Payments Strategy Forum. Finally, a preliminary market review on the central industry infrastructure has determined that it is not effective, and remedies have been proposed to address problems identified

Session 2: Behavioural Economics and Competition in Financial Markets

Stefan Hunt provided in-depth cases of using “behavioural economics” within the Financial Conduct Authority (FCA) in the UK. The FCA looks to apply the rich literature that has developed over the last fifteen years regarding the implications of “behavioural” understandings of consumer behaviour – that we are all susceptible to biases. This means that consumers make predicable errors in choosing and using financial products which lead to decisions other than thoseof the individuals’ preferences. In particular, these insights have been used to develop competition analysis with field, laboratory and natural experiments. This includes field experiments on insurance redress letters, laboratory experiments looking at point of sale add-ons in insurance and natural experiments around OFT measures on switching and overdraft uses. These are all vital for finding out what works.  In the future, the FCA will be looking bring behavioural understanding into the early stages of policy design and be more ambitious in its recommended interventions.This understanding can mean engaging with thorny ongoing issues such as firm behaviour and switching rates.

Alasdair Smith from the Competition and Markets Authority (CMA) has spoken on the way that behavioural economics may have important implications for the provisional recommendations of the CMA investigation into the Retail Banking market investigation. Provisional remedies from the Retail Banking market investigation include measures to increase customer engagement and to make better information available to customers.  Provisional remedies include standardised rules for issuing overdraft alerts and ensuring data is available to develop new innovative ways of providing and engaging with financial advice. This aims to meet the challenge particularly relevant to financial services – it is challenging to navigate the complex data on charges and match them to the complex needs of individual consumers. In these provisional remedies, the CMA is aiming to go with the flow – building on activities already ongoing in certain areas. Behavioural economics will play an important role in designing randomised control trials in partnership with the FCA to allow improvements to be tested outside of the time limitations of a CMA investigation. +

Bruce Lyons, Professor of Economics at the University of East Anglia, addressed some robust findings both from literature and in financial markets, which has suggested consumers persistently behave in biased ways. Traditional consumer models assume that consumers are rational, however, there are systematic consumer deviations from ‘rational’ choices in real life. Traditional regulation is based on rational assumption of consumer behaviour while under the frame of behavioural economics, what behavioural regulators should do is less clear.  He says that behavioural economics is particularly relevant to financial markets because financial products contain specific features, which have down side risks, are inherently complex, are purchased infrequently, are dealing with risk and uncertainty and involve effects over time. Behavioural biases affect competition in financial markets because it makes consumers inactive in looking for best services provided by banks and hinders the switching cost from one bank to another from customers. He then introduces some remedies that are relevant with behavioural consumers in financial market. Those remedies are designed aiming at modifying consumer behaviours.  He further points out that regulators should be aware of the behavioural biases in the supply side of the financial market and how regulations influence the supply side response. He addresses the search externalities and rip-off externalities in the supply side, however, he points out that which effects dominates the market is hard to predict. Recent practice in applying behavioural economics in financial market is strong while more academic studies are needed to understand the supply side respond.

Session 3: Competition and Banking Stability

Scott James, Senior Lecturer in Political Economy at KCL, provided an overview of his ongoing research into Financial Industry lobbying – in particular the policy development in three stages of structural reform. In the study presented, there are three hypotheses tested – what difference does the connection between policy actors make, do policy preferences predict collaboration between lobbying actors, and do perceptions of a lobbying actor being a ‘winner’ or ‘loser’ of a policy predict connection to other actors? The findings were that those who are perceived as influential are targeted by other organisations for collaboration, that preferences did not predict collaboration and that those perceived as ‘losers’ were not targeted for collaboration. Interestingly, organisation type was not a predictor for collaboration – instead some trade associations were significant and others not and there were significant differences between banks. In an emerging research agenda these findings can be applied to considerations of how this lobbying impacts policy developments. This includes incorporating a historic view of the interactions between Governments and banks. This provides an important framing to the institutional interactions at different stages of policy development – particularly in that particular actors, such as firms, tend to prefer the less formal structures associated with White papers rather than Parliamentary investigations.

Bert Foer, former President of the American Antitrust Institute, summarised the issues and positions taken from the American Antitrust Institute’s transition report for the next Presidential administration on a wide range of competition issues. It looks at issues within industry, mergers, cartels and other collusive conduct, antitrust advocacy, and payment systems in financial markets. Firstly, international cooperation needs to be effective and quick as failures within financial systems are speedy. Dealing with the next financial crisis will require early planning and coordination of competition and regulation. Furthermore, Foer argues the removal of DoJ oversight from banking mergers does not mean that competition does not have a role. The DoJ should apply antitrust tools in future mergers, taking advantage of its legislative powers, and further open-minded analysis of the mergers going beyond standard product and geographic market analysis. Closer attention should be paid to effects from concentration within the market. The fact that only one financial giant has not been involved in regulatory actions or civil suits relating to the manipulation of financial benchmarks raises issues: very few chiefs have been subject to criminal or civil sanctions. However, current attention is on the problem with overlapping ownership issues; a large overlap in stock ownership of the leading firms can lead to an increase in collusive activity. This is a new issue in antitrust. Foer recommends more vigorous and effective investigations with civil and criminal punishment when needed. Furthermore, “too big to fail” creates systemic risks causing danger to stability of financial market and health of general economy. In the US, the requirement is to have “living wills” to provide plans for safeguarding in the event of a crisis. This is still not completely satisfactory; with AAI suggesting that there should be incentives for asset divestiture of company-by-company assets and activities to prevent exploitation of safety net subsidies which creates a competitive advantage. If this doesn’t work, legislation-mandated breakups, functional separation, or ring-fencing would be an appropriate response to this. This should be subject to the precautionary principle, placing the burden on companies and not the regulator to persuade. In relation to payment systems, Boer argues that there is a risk that dominant payment card operators can lead to problems within the global market. This needs attention from enforcers and should scrutinise the “honour all cards” rules. Use of bitcoin and blockchain technology requires attention from enforcers. Access to these technologies by those setting standards could have antitrust concerns. This merits close scrutiny.

Xavier Vives (IESC Business School) asks whether competition in banking is good for society. Vives argues that competition may increase instability in two ways: exacerbating coordination problems and increasing incentives to take risks. Vives bases his conclusions on the context of the crisis between 2007-09. Before the financial crisis, competition policy was taken seriously: regulation, however, was lax. Vives argues that competition was seen as being good for stability gained ground, but competition has a bearing on all perceived failures associated with banking.  However, during the crisis, competition concerns were overridden. There was massive state aid (bailouts), a distortion of competition(cost of capital, quality, market power). Vives argues that this happened due to banks being seen as unique. When banks stop functioning, a modern monetary economy stops. Thus, when placed within this context, Vives reaches the conclusion that competition is not responsible for fragility in banking but that there are trade-offs between competition and stability in several dimensions; for example, that liberalisation without adequate regulation leads to crises. Vives, however, points out that this is an open question. Regulation, therefore, can alleviate the trade-offs but cannot eliminate it. Thus regulation and competition should be coordinated, with tighter prudential requirements where there is strong competition.

Session 4: Hot Topics in Financial Markets 1

Alasdair Brown of the School of Economics at the University of East Anglia discusses how the speed of trading increasingly drives competition in financial markets. Faster traders can use computer algorithms to automatically react to news quicker than their slower competitors, providing them with a competitive advantage. The race for the fastest access to market data might have detrimental welfare effects through a reduction of market liquidity and over-investment in relevant technology.

To tackle the negative effects on market liquidity, the introduction of “speed bumps” has been suggested. These speed bumps remove the informational and competitive advantage of fast traders. While such designs have recently been implemented in several financial exchanges, their effect on liquidity is not yet well known. However, these tools have been implemented in betting markets for several years, which we can study to determine whether speed bumps are an effective means of increasing market liquidity. The results show that that longer speed bumps reduce the amount of speed trading while the effects on market liquidity is mixed. If they only relate to placing orders and not to cancellation as well, speed traders adjust their strategies accordingly to retain their competitive advantage.

Prof. John Thanassoulis (Warwick Business School) explores the effects of different possible idea of what the moral behaviour is on the outcome of financial service markets and also what regulators can do about ‘bad’ cultures. He says that the financial crisis of 2008-09 released a number of unethical practices; supervisors note that they cannot rely solely upon formal regulation to moderate such behaviour. Behavioural problems (‘Cultural failure’) seems to bean endemic feature in financial markets. He does, however, note that – in the literature– ethics are essentially contested.  He introduces a theoretical model that builds-in ethical problems into economic models that agents not only consider their profit maximization but also ethical dilemmas and are influenced by their senior peers. He explores the adoption of a new social practice by morally aware agents who work in a profit maximising firm. The social practice adoption decision reflects moral considerations, compensation contracts and information derived from external signals. He shows that the socially optimal equilibrium arises when customers are sophisticated. It incorporates cultural, which occurs in the framework when junior agents adopt whatever social practice their senior peers favour. He says that when customers are naïve, the principal may use success bonuses to induce agents to set aside their moral scruples and to adopt socially harmful practices; profits with naïve customers are decreasing in the moral commitment of the agents. He suggests that, a cap on bonus payment in financial market may increase average moral standard.

Session 5: A Legal Perspective on Competition in Financial Markets

Richard Whish (King’s College London) points out that competition law applies to the financial services sector just as it does in any other sector. However, there are sector-specific rules which apply alongside competition law. Whereas competition authorities only apply competition rules, the FCA and the PSR have concurrent power to use both competition and sector-specific rules within their particular sectors.  Thus, Whish argues, there is a complex matrix between these powers and possibilities. Under FSMA2000, the FCA has a duty to conduct its functions in a way that promotes effective competition in the interests of the consumers. Whish states that there is no doubt that competition has a much enhanced position within the FCA: it must promote not simply protect competition. Going forward, Whish states that it will be interesting to see how the FCA uses its tools to tackle specific market issues: will it use its FSMA powers or competition powers? However, there is primacy in regard to the competition rules over FSMA in some cases. In these situations, the starting point is always to ask whether competition rules can be applied. Furthermore, Whish points out that when using FSMA powers, there is a legislative definition of the extent of those powers – in contrast, the Competition Act has no such definition of what is a financial services market. This, Whish suggests, could lead to future litigation over whether the FCA has acted beyond its remit; for example, could the FCA use FSMA to prohibit conduct that infringes Arts 101 or102 TFEU?

David Little from Cleary, Gottlieb, Steen and Hamilton LLP tried to shed light on recent financial sector cases in Europe, by presenting to the audience a map showing the global bank regulatory investigations taking place recently. After ascertaining that the data from banks has been massive in the sense that these financial investigations constitute really good resources, he asked whether we do indeed need more competition enforcement in the financial sector or, alternatively, whether the solution may come from the regulatory enforcement. By proving that independently of the regulatory dimension, the resource cost required is not always proportionate to the expected benefits, his analysis revealed that regulation may sometimes be preferable to antitrust law, especially when regulators have tools more appropriate than those used by Competition Authorities. He concluded his presentation by clarifying that the rate of technological developments and innovations has been higher than ever before in the financial sector and that the regulatory investigations have contributed to the financial literacy education of the population. Therefore, optimism should dominate regarding the financial sector’s future.

UEA Law School’s Andreas Stephan rounded-off the session by considering whether criminal prosecutions are necessary in case of market manipulation and cartel behaviour in the financial sector. He tried to answer to this question by outlining some theoretical arguments, as well as by discussing some benchmark cases in the financial sector, such as LIBOR 6 and LIBOR 5. He then wanted to share with the audience his experience as an expert advisor to the defense in the Galvanised Steel Tanks cartel trial in 2015, where some key themes had arisen, like remoteness of harm and ‘‘jury nullification’’, since most of the time it is difficult for jury to realise why cartels are harmful. Professor Stephan also explained why the USA is better than the UK at prosecuting white collar crimes and he also criticised the mental element of the guilty mind that distinguishes crimes from civil wrongs. He concluded by underlining the trend that exists in the UK towards weaker mens rea or none at all.

Session 6: Hot Topics in Financial Markets 2

Lee Callaghan from Aviva opened the last session of the conference by providing a brief overview of how big data is used by general insurers, in particular Aviva, and by addressing the main challenges the firm faces when dealing with it. He presented to the audience the MyAviva site, which is a single login that enables Aviva’s current customers to view their policies in one place. He then referred to Aviva’s Home Checker service, where they ‘‘squash’’ a great variety of information into a single site, such as information about flooding, subsidence, crime, schools, broadband, etc. Mr Callaghan then referred to some key recent events that have to deal with Big Data, like the Big Data dilemma that House of Commons faced on the 10th February 2016 and the report that House of Lords prepared and which concerns besides the consumers’ protection and competition. After this, he dealt with the regulatory focus so far, mentioning that CMA has not explicitly proposed any procedural next steps and that there is no indication of whether they will proceed to further studies or not. European cases and comments made in the context of the EU were also outlined in order to show the tendencies governing in Europe regarding Big Data. Mr Callaghan finished his talk with the following conclusion: ‘‘analysing big data, that is the secret to living happily ever after.’’

Maarten Pieter Schinkel of the Faculty of Economics & Business at the University of Amsterdam, discusses state-aided price coordination in Dutch mortgage banking. Compared to other European countries, the Netherlands’ average mortgage rate is significantly higher since the financial crisis of 2008/2009,and mortgage prices show signs of being driven up by tacit collusion. The Netherlands’ competition authority concluded that such potential tacit collusion, while temporarily may have been present, has ceased to exist.  Yet, Maarten Pieter shows the opposite. One reason for the tacit collusion is the increase in concentration in the Dutch mortgage market. Further, most of the dominant banks in the market received state aid during the financial crisis. The European Commission imposed conditions for the state aid, including a price leadership ban forbidding the use of the money to undercut banks not received state aid. As a consequence, four of the five leading banks had restricted options to change prices.  Both theoretical and econometric results show that the price leadership ban has removed the incentive of the large state-aid receiving banks to undercut price leaders. As a result, the state-aid receiving banks were effectively following the prices set by the largest bank Rabobank, which did not receive state aid

Session 7: Panel Discussion – Competition, Ethics & Culture

Panelists: Alison Cottrell (Banking Standards Board), Brad Hooker (Uni. of Reading), Steve Smith (Lloyds Banking Group), Mary Starks (Financial Conduct Authority). Chair: Amelia Fletcher (CCP)

Our final session encompassed a panel discussion, where members attempted to answer the inherently difficult question: ‘How is competition in financial services markets helped or hindered by a heightened focus on ethics and culture?’. Unsurprisingly, the discussion entailed a number of wide-ranging issues, which proved a testament to the need for further research in this area. A key theme to arise from the discussions concerned the role of a firm’s ‘reputation’ in facilitating good culture in financial markets. ‘Reputation competition’ may be enhanced by competitiveness within markets and it is generally assumed that culture and ethics play an important role in developing and maintaining reputation. However, the effectiveness of ‘reputation’ in this context is contested, and it is unclear whether this can be addressed with intervention. Indeed, a notable counter-argument is that efforts to regulate in pursuit of ‘good’ culture in financial markets may actually create a hindrance for competition in these markets. So with competition, on the one hand, and the regulation of ethics, on the other, can the two complement one-another or does the relevant authority have to choose one or the other when making interventions? Clearly, this remains an ongoing debate. In terms of interventions, the heterogeneity of firms is a significant point of consideration. Indeed, even though intervention may only be directed at a handful of ‘unethical’ firms, these measures will have an impact on all firms within the market. As such, it will be more difficult for firms with a ‘good’ culture to maintain their good reputations: herein lies the complex perceptions that consumers/regulators have of (i) an untrusted firm in a trusted market, and (ii) a trusted firm in an untrusted market. Because of this, trustworthy firms may ultimately struggle to maintain the trust of consumers. In terms of the significance of researching the role of competition, ethics and culture in financial services, there was a clear consensus that, although notable scandals exist in other markets, scandal in financial markets will ultimately have a most severe impact on consumers. As such, it is worthy of special consideration and additional research ventures in the future.

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