Mark Hoban is a former Financial Secretary to the Treasury and Employment Minister, and is MP for Fareham.
Technology is developing sophisticated networks that are connecting people, machines and data. In the language of TechCity, this is called hyperconnectivity – and we see examples of it in fields such as social media and Big Data. Hyperconnectivity is transforming politics and the way we govern, and it is a disruptive force in business, too. It shakes up markets and improves consumer outcomes through better choices and lower costs.
I like the idea of people regaining control over their lives through disintermediation. Knowledge should be widely dispersed so that people can make their own minds up rather than defer to experts, and new businesses can enter markets where the incumbents have had it too easy for too long. In financial services, it is reshaping how we save, invest, bank, and borrow. Hyperconnectivity is driving economic change and I believe it is an asset in a market economy.
Let me give three examples of how hyperconnectivity is changing financial services.
There is nothing new about investing in start-ups or lending money to a business or a person. Bank loans and business angels are not new. But hyperconnectivity has opened up these markets by enabling P2P lending and crowd sourcing by using technology to create a network of borrowers and lenders and of investors and investees – circumventing the intermediary role previously played by banks and asset managers. Financing decisions are no longer the exclusive preserve of bankers and major investors but are given to anyone prepared to lend or invest money in a business.
Hyperconnectivity transforms the way we access information to help us manage our finances. For example, it underpins comparison websites: transforming the economics of motor insurance and giving consumers a better deal. But we can take this one stage further by harnessing the wisdom of crowds: Etoro is a share trading facility where a trading platform is linked to a social media site that enables users to follow, analyse, evaluate and copy the investment strategies of other users. We think of the cult of superstar fund manager as inhabiting the world of big, institutional funds, but a successful trader on Etoro can be followed for a fraction of the cost of Neil Woodford.
My third example is Bitcoin, which is only feasible because of hyperconnectivity. Bitcoins are mined harnessing the power of computers. They are validated not by the signature of the Chief Cashier of the Bank of England on a bank note but by other Bitcoin users. Bitcoins are as much a child of technology as a political statement by libertarians wanting to create competing currencies free from the control of central bank and finance ministries. Whilst governments, central banks and regulators have scratched their heads about how to shoehorn Bitcoin into a regulatory framework, Bitcoin has developed and expanded.
The challenge for regulators, businesses and politicians is: how do we react to the social and regulatory changes that this disruption presents? How do we facilitate innovation by removing barriers without dismantling fundamental consumer protections? How do we distinguish between vested interests using spurious arguments to defend the status quo, but accept legitimate concerns about risk?
So how should regulators tackle these challenges? I believe they should embrace hyperconnectivity: it can promote their objectives. Hyperconnectivity can help the Financial Conduct Authority (FCA) deliver against its objectives of market integrity, competition and consumer outcomes. By creating new business models, hyperconnectivtity can increase competition. When hyperconnectivity enables the aggregation of the prices of shares traded across a number of exchanges and trading venues, this transparency strengthens market integrity.
Publishing data on bank stress tests would enable every banking analyst to number crunch their own scenarios and apply a layer of market discipline to bank balance sheets augmenting the work of the ECB and the Bank of England. But regulation is double edged. Incumbents can use regulation to protect their position – just look at the number of cases across Europe where taxi drivers are using regulation to withstand the threat of Uber.
Disruptive business models don’t always fit neatly into existing regulatory boxes, and Bitcoin is an example of this. But let me give another example. When I was at the Treasury, we had a number of discussions about the regulation of P2P lending. I took the view that heavy-handed regulation would have crippled a new business model that challenged incumbents. My preference was for P2P lending to be unregulated. If lenders understood the risk they were taking by making a loan, why should the business be regulated? This approach to regulation facilitates new entrants. It helped people find credit at a time when the banking sector had been damaged in the financial crisis and gave people a new home for their savings, so long as they understood the risk they faced.
The regulator should, therefore, create an environment that promotes innovation, not stifles it. It is right that the FCA has set up Project Innovate to help businesses that are developing new ways of meeting our financial needs to navigate their way through the regulatory process. When scrutinising new business models the regulator should not ask if this harms incumbents, but: does it give better outcomes for the users?
Hyperconnectivity brings together data that would previously only have been accessible by experts. It is about disintermediation and democratisation, as we make huge chunks of data available so that we can make our own decisions. But we know from behavioural economics that data overload can lead to paralysis. Choice architecture enables you to structure data to help consumers make better choices. We see it in action on comparison websites. But how do you decide from hundreds of motor insurance policies the half a dozen you want a consumer to choose from? Whose interests are being promoted by ranking credit cards or car insurance? Is it a sponsored selection, is there a commission bias, or is it simply value for money?
As we saw in the Financial Services Consumer Panel’s work on annuities, some websites failed consumers. The pane; found that some websites did not disclose how they earned commission and whether they gave of all or only some annuities in the market. Using hyperconnectivity to aggregate data across banks, insurers and credit card companies is a good thing, and we should facilitate this development whilst ensuring that its presentation to consumers is within a regulatory framework that is based on competition, transparency and integrity.
Hyperconnectivity has the power to transform the delivery of existing services. It is disappointing that, in the aftermath of RDR, we haven’t seen greater progress being made in digitising the process of providing regulated advice. Complicated algorithms gathering together millions of pieces of data are used on a daily basis, yet none appear to be sufficiently sophisticated to be used to provide regulated advice. I think part of the problem here is a rule book that is predicated on a particular model of delivering advice and doesn’t accommodate digital services. We shackle innovation if regulation fails to keep pace with new technology. This problem is exacerbated because so much of our financial services regulations can only be amended through a clunky European process, which tends to favour incumbents and not challengers.
Hyperconnectivity presents new opportunities and challenges for society, consumers, business and regulators – creating new business models, giving consumers and driving better outcomes through the use of data. In financial services, regulators need to adopt three principles: hyperconnectivity is an asset to regulators in their work; regulators should be on the side of consumers and challengers in regulating hyperconnected financial services; and be nimble in the face of change – otherwise hyperconnectivity will leave them, alongside businesses that fail to adapt, behind.
This article is based on a speech given yesterday by the author to Barclay’s Digital 2014 Conference.