Regulation? No, it’s dangerous mumbo-jumbo
EFFECTIVE regulation is key to a consumerfriendly financial services industry. But rule-making for the mere sake of it can prove horribly damaging, both to providers and product buyers. No one benefits, not even the regulator long term if its actions crush the industry it oversees.
You could argue that regulatory overload is not as lethal as ineffectiveness, which the Financial Services Authority got off to a tee in the run-up to the 2008 financial crisis. Yet it is stifling, drives up costs (which we all ultimately pay for through higher product charges) and may have unintended consequences. Rather than protect, it can result in widespread consumer detriment.
Sadly, this is where we now are as a result of new regulations dreamt up – and implemented – by an unholy alliance of bureaucrats: the Financial Conduct Authority (son of the Financial Services Authority), the European Securities and Markets Authority and the European Commission.
The rules defy logic and are resulting in investors being provided with misleading information. As one longstanding investment professional (usually a mild individual) told me last week, they represent ‘by far the worst piece of financial regulation ever in Europe – and the Financial Conduct Authority is complicit’. Strong words indeed. It is a subject I touched upon briefly earlier this month, but it is worth returning to.
To give this ‘worst piece’ of legislation its full title (wait for it, you could not make it up), it is called the ‘packaged retail and insurance-based investment products’ regulation.
As part of this, every investment trust company must make available to new and existing investors a ‘key information document’. This explains the investment risks involved on a scale of one to seven, with seven indicating ‘higher risk’. It also spells out the charges and how the product works.
All fairly good so far. But it is the information about likely investment returns where the wheels suddenly fall off. It is nothing other than mumbo-jumbo and dangerously misleading.
Individual trusts must provide likely returns – after costs – on a £10,000 investment after one, three and five years and for four different investment scenarios: stress, unfavourable, moderate and favourable. How these numbers are calculated is heavily prescriptive. Fine in theory.
But the failing is that these figures are primarily based on the returns a trust has delivered in the past five years – contradicting the long-held mantra that past performance is no guarantee of future returns. Given the last five years have been good for stock market investors, the scenarios being painted are overoptimistic – taking no account of the fact that many investment experts believe equities worldwide are due a correction.
Take the key information document that The Baillie Gifford Japan Trust has to put before investors. Under its unfavourable scenario, investors are being told that a £10,000 investment made now could be worth £18,508 after five years – an average annual return of just over 13 per cent. Unfavourable? Pull the other one.
If market conditions are ‘favourable’, £10,000 might become £64,401, an average annual return of 45.1 per cent.
I reckon I have more chance of becoming a Lotto millionaire than either of these scenarios panning out. It is as if the figures have been plucked out of the sky.
Thankfully, key figures in the investment world – including my mild friend – agree. A refreshing response given that some trusts could conceivably use the exaggerated favourable outcomes as powerful marketing weapons – ‘How you can turn £10,000 into £64,000 in just five years: buy Baillie Gifford Japan’.
Ian Sayers, numero uno at the Association of Investment Companies, is a longstanding critic while academic John Kay – an independent director of investment trust Scottish Mortgage – recently recommended that all key information documents should be burnt, not read (I find it difficult to disagree with him).
The Financial Conduct Authority is already backtracking. Last week, it said trusts could provide supporting ‘explanatory’ notes if they felt the need to put the ludicrous figures produced under the performance scenarios into context. One small step for personkind. The next is for the regulator to put up its hands, admit it has fouled up, rip up the ridiculous scenarios and start all over again.
The rules defy logic and are resulting in investors being given misleading information