Guest viewpoint: Tracy Blackwell, Pension Insurance Corporation
The financial services industry underpins the UK’s economy: it provides mortgages, pensions, payment services, insurance, start-up capital, finance for infrastructure including housing, the ecosystem that allows investors to finance growth and so much more. Through the finance system, many, many millions of transactions are conducted every day.
And yet, over 10 years after the Great Financial Crisis, the industry is one of the least trusted in the country. In fact, in many people’s view, the best way to describe financial services is ‘corrupt’, which is a disaster for everyone who wants policymakers to consider and implement the reforms needed to ensure that the wealth generated by economic growth is distributed more equally across society.
The Purpose of Finance project aims to address issues of trust and reform. We are discovering that there are structural reasons driving unwelcome behaviours and preventing finance from becoming a more efficient and benevolent servant of society and helping us achieve a more inclusive capitalism.
Many of these structural imbalances can be addressed by refocusing the purposes of the industry. Using purpose as a lens allows us to take a fresh look at many market characteristics and developments that are currently taken for granted. For example, market incentives, investment philosophy, investor outlook, the concept of risk and the nature of regulation. Starting by asking why products, services, departments and even organisations exist, instead of the default of ‘how’ they do what they do, could allow us to democratise wealth creation. This may seem radical, but many would argue that this reassessment could not be more necessary in today’s political and economic climate, characterised by a society that is deeply divided into the ‘haves’ and ‘have nots’ and where mistrust is the default setting.
The lack of trust manifests itself with layer upon layer of regulation, designed in the hope of building a ‘zero failure’ system, at least in the eyes of the customer. This comes with a cost. McKinsey estimates that regulatory reporting for UK banks costs the industry £2bn–4.5bn (€2.2bn–4.9bn) a year in run costs and risk change costs alone1.
“It is incumbent on us to find a solution to the privatisation of wealth accumulation”
There have been numerous crises in the financial services industry, each of which have resulted in new controls designed to avoid such calamities from reoccurring. Yet, experience suggests that this does not work. According to Jihad Dagher, a senior economist at the International Monetary Fund, there is consistent evidence of pro-cyclical regulatory policies by governments in the aftermath of financial crises2. Dagher’s observation that post-crisis regulations do not always survive the following boom, allude to a regulatory whack-a-mole when it comes to trying to control the industry. This cannot result in the financial services sector becoming a more efficient and benevolent servant of society.
Over the last three years, the Purpose of Finance project has proven to be a channel through which parties can safely debate, discuss and analyse some of the established and emerging trends within finance.
The first of these is the proliferation of short-termism within the markets. As we all grapple to address long-term disruptions such as artificial intelligence, to more profound challenges such as climate change, we can no longer afford to be short-sighted in our approach to the finance system. Modern practices such as high-frequency trading, activist investors calling for ever larger profits in shorter time frames, and the predatory nature of leveraged buyouts, which often turn successful companies into debt management vehicles, makes the system increasingly vulnerable. Even seemingly mundane requirements such as quarterly reporting can become obstacles to the industry’s capacity to serve a more common good.
One area where the impact of short-termism should be of concern is in the changing role of stock exchanges. Throughout history, these have been accessible marketplaces, for the buying and selling of stocks and shares on one hand and for capital raising and funding of company expansion on the other. This dual function has allowed stock exchanges to be the most powerful tool ever created to share the profits of wealth creation across society. They allow everyone, as savers and investors, to benefit from the innovations and entrepreneurialism to which they have contributed.
Our most recent paper, written by William Wright, managing director of the think-tank New Financial, describes the paradox of stock exchanges. They are more successful than ever, but fewer companies are choosing to be listed on them. The number of companies listed on exchanges in the UK and US has halved over the past 25 years. The pressure on listed companies to focus on short-term returns (for example, through share buybacks) has led to falling levels of investment and productivity, leading directly to falling real wages and economic inequality. This is far from a benign issue. With the advent of auto-enrolment, 10 million people are effectively becoming investors for the first time. But with fewer companies to invest in it is difficult to see how these new investors will be able to achieve the returns necessary to maintain a comfortable retirement.
If we want to reinvigorate capitalism and replace trust in the industry, it is incumbent on us to find a solution to the privatisation of wealth accumulation. If this trend continues, only the wealthy will be able to access growth companies, via private equity, precipitating a future pensions and savings crisis. The consequence of much of this is increased social inequality and a widening of the wealth divide. With the rise of populism on one side and a re-energised left on the other, it is vital that the rewards of capitalism are spread more evenly within society, helping alleviate poverty and giving people an increasing stake in the system.
1 Future of Finance; ‘Review on the Outlook for the UK financial System: What it Means for the Bank of England’, June 2019
2 Jihad Dagher: Regulatory Cycles, Revisiting the Political Economy of Financial Crises, IMF working paper, January 2018
Tracy Blackwell is the CEO of Pension Insurance Corporation in the UK