Episode #8: Does the high street have a future?
The Green Room by Deloitte podcast
Once a bustling hub of activity, the high street as we know it is under threat. But is this really the end? Or the beginning? Will technology shape our future high streets in ways we can’t imagine? What does this all mean for retailers? And what about us? Has the way we shop changed for good?
This week, Lizzie and Dara are stepping into the host seats to tackle our latest big question: does the high street have a future? They’re joined by Colin Jeffrey, lead retail consulting partner, and Matt Ward, principal consultant at Market Gravity
Tune in to find out:
• Why Matt wants a robot to do his grocery shopping for him
• How Colin’s house sometimes feels like a recycling depot
• What’s brought on Dara’s online shopping addition
• What 80s pop stars have to do with retail trends.
SM: SM: The final year of the decade, the last year before we get into our century’s very own roaring twenties - and, lest we forget it, fully ten years on since the global financial crisis turned almost everything on its head and changed our lives forever.
Welcome to 2019. It’s a brand new year, with a new set of risks, and let’s hope, new opportunities as well. And the work of central banks and financial regulators will have to respond to it all.
I’m Scott Martin from Deloitte’s Centre for Regulatory Strategy and you’re tuned into Regulated Radio.
I’ve got David Strachan and Andrew Bulley with me here to talk about what we think is at the very top of the financial regulatory agenda going into the new year, what big risks supervisors are looking most closely at, and what might be the most important things for the industry to watch for as 2019 unfolds.
All this in the next twenty minutes or less. It’s a new year, it’s a new episode. And we’re glad you’ve joined us.
This, is Regulated Radio.
(Brief musical play-in)
SM: So, the days of 2018 are now well behind us, and everybody now wants to know what the year ahead has in store.
If you’re watching the markets, the year has gotten off to a bit of a bumpy start. And don’t forget, in 2018, we saw the FTSE 100 drop by some 12.5%, only the largest drop in ten years.
Eurozone equities didn’t fare any better, dropping by an even more jarring 17% in the same period.
If you’re watching the world of politics and policy, then you know 2019 doesn’t exactly promise to be quiet either.
But if you’re thinking how the regulation of the financial sector fits into all this uncertainty, then you’ve come to the right place.
There will be a lot for financial regulators and supervisors to respond to in the year ahead, some new risks and, without a doubt, some old perennials as well.
Now, we’ve got a big show planned, and a lot of ground to cover in it, so let’s jump right in.
As mentioned, I have David Strachan; lead Partner for Deloitte’s Centre for Regulatory Strategy in EMEA, joining me here today to kick things off for us. David, thanks for coming to Regulated Radio.
DS: I’m delighted to be here, Scott.
SM: David, when you think about how far the financial sector has come since the financial crisis – both the industry and its regulators – what stands out to you as the biggest changes you’ve seen over that decade?
DS: Well Scott, the financial crisis certainly cast a long shadow over the work the sector has had to do in the last ten years. That’s clear, but I think we also need to recognise that it is a shadow that has begun to fade a decade on from the events that gave rise to it.
Most of the post-crisis policies addressing the prudential stability of firms have been decided, and banks in particular are now much better capitalised and more liquid than they were before the crisis. That means that, at least when dealing with traditional risks, regulators are more confident today that the sector has done the hard work to be able to weather choppier waters.
Now despite this, a change we’ve seen much more recently is that regulatory attention is becoming increasingly focused on areas such as culture and governance, the challenges of new technology, operational and cyber risks, and the ability of firms to effectively implement post-crisis regulation while still maintaining a functioning and profitable business model.
SM: Are you seeing any sign that the proverbial “regulatory pendulum” is starting to lose momentum or even swing the way of de-regulation?
DS: I think the comparison with a pendulum is misleading, to the extent it suggests that regulation could return to the place it started. This isn’t going to happen. It might return a bit, but not fully. But I agree that the re-regulating phase is coming to an end and there are some early signs among politicians, finance ministries and regulators themselves of what I’d call “implementation fatigue”. That said, regulatory activity is always moving around and responding to new risks where they arise. That’s a big theme in our outlook for 2019 as we see this shift towards areas such as climate risks and cyber. Firms are going to have to be prepared to respond to this shifting focus and the new demands that it will place on them, as well as keeping a watchful eye on continuing implementation and remediation work.
SM: Indeed, and when you talk about new areas of regulatory focus, we’ve identified six big themes relevant across the financial sector that we’re going to talk about today. One of them is a “shift from regulation to supervision” – now, these are two terms that are often used interchangeably – but there’s a clear difference, “regulation” is about making rules and “supervision” is about monitoring how firms comply with them.
So, for this, I want to bring in Andrew Bulley, a Partner in Deloitte’s Centre for Regulatory Strategy to say a bit more. Andrew, welcome to the show, it’s good to have you.
AB: Pleasure to be here, Scott.
SM: So, why is it that we’re saying that there will be a shift of emphasis from the regulation of the financial sector to its supervision in 2019?
AB: Well Scott, we see 2019 as being a very different kind of year from 2018 and earlier years in some respects. As you know, 2018 saw a number of major new regulations come into force - MiFID II, PRIIPs, IDD and GDPR – all of which involved hugely resource intensive implementation programmes for firms across the financial sector. Whereas in 2019, leaving Brexit to one side for a moment, for the first time in many years there’s nothing of a similar regulatory scale to be implemented.
So given that, we expect regulators and supervisors to switch their efforts towards assessing how well firms have implemented new requirements introduced in the last few years as part of the wide-ranging reforms to prudential and conduct regulation post the financial crisis. We think the supervisors will be especially keen to examine whether firms are delivering the right regulatory outcomes in the spirit intended rather than just complying with the letter of the law in a technical sense. We expect that this, in turn, will put a further onus on firms to demonstrate that regulations have been suitably embedded. That of course can be very challenging and costly for firms to accomplish, particularly as they continue to face economic headwinds and wider uncertainties in the business and policy environment.
SM: On that point though, economic headwinds and policy uncertainty, one major theme that’s already apparent in the financial sector this year is uncertainty over whether we’re going to see the continued normalisation of interest rates. If normalisation does proceed, do you think supervisors will be concerned about any risks to firms arising from that?
AB:It’s a good question, and a critical one for firms of course. As you know, in the second half of last year, low interest rates and unconventional monetary policy easing appeared to be finally, if slowly, giving way to interest rate normalisation around the world. We saw this in the US, the UK, and the Eurozone. Now, as you noted earlier Scott, equity market falls, declines in most other asset classes and some other less positive economic data have given some central banks pause recently – such that the steady march towards higher rates that we, along with most other commentators, were generally predicting a few months ago, is more of an open question today.
SM: Fair enough, but if interest rates do eventually keep rising, at whatever pace, do you think that will be a good or a bad thing for the sector?
AB: Higher interest rates may be beneficial in net terms to many, though not all, financial firms. Banks in particular may enjoy higher net interest margins; whilst insurers are likely to benefit from rising asset yields. However, it’s not an exclusively good news story for the entire sector. Interest rate normalisation, depending on its scale and pace, may lead to falls in some asset values and rising credit defaults as some borrowers are unable to service loans at higher interest rates. If we see this play out, it may reveal structural weaknesses in individual firms’ business models and risk practices. So in sum, in our view, it is probably still too early to say what the overall effect of these opposing factors will be across individual sectors.
SM: Well, in the face of that kind of uncertainty, is there anything that we can expect financial supervisors to do about it in the year ahead?
AB: A lot of uncertainty indeed, Scott! And bear in mind that interest rate changes are just one aspect of the uncertainty firms will face in 2019. Political uncertainty is rising, whilst technological innovation will almost certainly continue to disrupt and transform the way financial services are delivered. From a supervisory perspective, the supervisors, both conduct and prudential, are going to want to delve deeply into how firms are responding to these trends and risks. One of the principal ways in which they will do so is stress testing firms’ balance sheets against a broader range of adverse scenarios. Remember that stress testing has already been used extensively to satisfy supervisors that firms are now better able to deal with another major financial downturn. But going forward, we think that the scenarios set are increasingly likely to include operational shocks, such as cyber outages, as well as conventional asset valuation and credit default stresses.
SM: That’s very interesting.
David, I wanted to come back to you because, I think, no discussion of uncertainty in the world of financial sector policy in 2019 would be complete without a word on Brexit. Now, we could be here talking about this all day, or at least for the entire show! But, without doing that, what do you think are the most important Brexit-related events for the sector to watch for in 2019?
DS:Yes, Scott, you’re right, Brexit is unavoidably at the top of almost everyone’s agenda, whether for market access reasons, derivative and insurance contract continuity, or indeed the impact of Brexit on the UK economy and businesses. 2019, of course, is the year that Britain will – most probably – end up leaving the EU. There is uncertainty over the final terms of the UK’s withdrawal from the EU and whether any transition period will be agreed and ratified as well as the future relationship between the EU and the UK. We think that this uncertainty will continue right up until the wire of March 29th. Given this, firms have no choice but to continue to prepare for “no deal”, unless they can rely on the UK’s temporary permissions regime. The EU shows little signs of reciprocating, outside the area of Central Counterparty equivalence.
However, we have recently seen moves by some individual Member States to equip themselves with powers to respond to a "no deal" scenario. This reinforces our view that, if push comes to shove, authorities will choose temporary fixes over consumer detriment or financial instability.
And, while Andrew mentioned a few moments ago that there won't be anything like MiFID II or GDPR in 2019, the operational and implementation challenges associated with Brexit pending a Brexit “no deal” scenario are clearly very significant.
SM: Indeed they would be. And, just keeping with the theme of potentially very significant implementation pressures that firms in the financial sector will face next year, I wanted to get your view on LIBOR reform – “LIBOR” being the London Interbank Offered Rate – sometimes described as the most important number in the world – used every day to price a massive amount of financial transactions – it’s also being phased-out, and that phasing-out is now picking up steam. Is this going to be a big challenge for firms in the year ahead?
DS:We certainly think so Scott. 2019 will see pressure to transition away from LIBOR growing, especially for firms in the UK, with greater supervisory scrutiny of whether they are reducing their exposure to LIBOR.
More immediately, however, firms will also need to prepare for a transition away from EONIA and, possibly, EURIBOR. Currently, the transition under the European Benchmarks Regulation allows existing benchmarks to continue to be used up until 1 January 2020. And, at present, EONIA and EURIBOR are not authorised benchmarks for the purposes of the EU Regulation. Also, don’t forget that the replacement rate – the Euro Short-Term Rate – will not “go live” until October this year, so the timelines for transition are very tight.
Now, the European Council and Parliament are currently considering proposals to extend the January 2020 deadline for existing critical benchmarks until December 2021. Should those amendments be approved, EU supervised entities could continue using EONIA and EURIBOR until end-2021, bringing transition timelines (where applicable) in line with LIBOR transition.
SM: And, do you think that this is going to be as challenging a transition as some are making it out to be?
DS: In a word, “yes”. No one should underestimate the impact of IBOR transition in the year ahead. It increasingly looks set to become one of the biggest and most complex transformation programmes many firms will have to undertake. There is little room for complacency today given how significant the volume of work will be.
SM: And very little time left to undertake it. But David, before I bring Andrew back in, I wanted to ask you about one more fast emerging area of regulatory and industry activity, and that is cyber and operational risk. We’ve seen a lot of high-profile events in 2018 where outages at financial firms attracted a lot of attention from customers, the press and even politicians. But it’s probably fair to say that with the growing complexity of cyber risks, we haven’t even seen the half of it yet. What’s your take on this?
DS: As you say, this is very high on firms’ and regulators’ agendas. Firms’ increasing exposure to both IT and cyber risks, as well as a growing awareness of the harm that operational disruptions can cause, will see regulators scale-up their activity in 2019 around what they’ve begun to refer to as “operational resilience”. As part of this push, firms will need to show that they understand their risk exposures and have the capability to deal with any potential disruptions, including those caused by third parties that supply them with critical services.
SM: How does a firm go about demonstrating something like that to a supervisor? An operational failure or a cyber-attack would seem to be quite an idiosyncratic thing that is hard to anticipate until it happens.
DS: One way to do that is to run hypothetical but sufficiently severe tests that can be organised or observed by a supervisor. This is something that we are seeing already in testing for cyber vulnerabilities in the UK and some Eurozone countries. We expect the use of these tests as a supervisory tool to pick up quite rapidly in the Eurozone in 2019 following common standards that the ECB published for them last year. We also expect the G7 to publish international standards on coordinating cross-border cyber risk tests this year as well.
SM: Okay, so we’ll have to watch out for that as it sounds like there’s a lot on the cyber agenda.
Andrew, turning back to you, I wanted to ask about another major trend that I think, like cyber, most people only expect to become more and more important with time, and that’s how the financial sector addresses climate change. What are you seeing there for the year ahead?
AB: That’s right Scott, there’s been a really rapid growth of interest here. Indeed I think it’s fair to say that, when writing the 2018 outlook, we, along with many others, underestimated just how quickly this topic would rise up the regulatory agenda.
Global, EU and national regulators are all in the process of defining their expectations for climate change risk management. Central banks and regulators will increasingly focus on the financial risks that arise from climate change and the transition to a low carbon economy. Consequently, they will expect boards to be proactive in identifying and managing these risks. At the same time there is growing investor pressure on firms to take action.
So in a nutshell, Scott: we see this trend as one where regulators will seek to take climate change beyond the world of Corporate Social Responsibility and disclosure and make it an issue that sits squarely within the remit of the Chief Risk Officer and, ultimately, the board.
SM: And pivoting quickly, another important issue that I’d like to discuss while we still have time on the show is that of “value for money”. We’ve seen this as a prominent issue before, especially in the UK, but why do we expect it to be so important this year?
AB: Well, in recent years we’ve seen conduct regulators put increasing emphasis on the bad economic outcomes that poor value products and services can have on consumers, particularly those who are in a vulnerable situation. As you say, Scott, this is familiar territory to those subject to FCA regulation here in the UK, where the FCA is being increasingly activist in intervening where it finds what it calls harm to consumers. But what we expect to see in parallel this year is an increasing interest on the part of supervisors beyond the UK on value for money in financial services.
Now, in terms of concrete supervisory action, we think this interest will translate into a sharp focus on firms’ fees and charges across customer groups, including whether any unfair cross-subsidies are going on, as well as on the transparency and comparability of products. In short, supervisors are going to apply much higher expectations to firms around how they apply clear and fair charging structures to their customers.
SM: All right, but Andrew, zooming back out to a macro view of the stability of the sector, we know that regulators don’t regulate in a vacuum. Their primary responsibility is to safeguard the stability and functioning of the financial system, and that, of course, requires them to tread very carefully sometimes when there’s reason to suspect that the system might be vulnerable.
Some commentators have begun the year predicting that we might be in for another economic downturn in 2019, particularly in light of the equity market trouble we’ve already discussed. Do you think there’s cause for concern?
AB: Well, it’s a fair point to make, Scott. We have seen a significant build-up in debt around the world. It now stands at around $247 trillion dollars. That is significantly higher than its pre-crisis peak. Regulators and central banks face an on-going question as to how far this represents a systemic vulnerability.
But it’s also about more than that. Low rates have contributed to a sustained search for yield; and that, not surprisingly, has led many lenders and investors to move down the credit quality curve. Additionally, higher capital requirements for banks have paved the way for a rise in non-bank lending. As a result, exposure to credit markets now extends to a much wider variety of firms, well beyond the banking sector.
I’ll add that the leveraged loan and real estate markets are likely to be vulnerable to higher interest rates if -or to the extent - that we do see them. And the consumer credit expansion of recent years, and the resulting higher levels of personal indebtedness, may have left many consumers vulnerable to interest rate rises, especially after such a prolonged period of low rates - one frankly that is without precedent.
SM: And David, what’s your take on this? How does this fit into the regulatory agenda for 2019?
DS: Well Scott, as you and Andrew have noted, some commentators consider that the global economy has reached its “late cycle” phase. And historically, downturns or recessions have occurred at least once each decade, suggesting that such an event may be overdue. This is most evident in asset valuations, which on some measures still appear stretched even after recent market corrections, but also for other reasons. In the EU, non-performing loans continue to act as a major risk to some banks’ resilience and profitability, while globally, increasing trade protectionism and political uncertainty also weigh heavily on the minds of many in the industry. Brexit, of course, continues to be a major political and regulatory uncertainty as well.
Against this background, we expect regulators across sectors to remain highly vigilant to the risks of economic downturn and shocks. As we were saying earlier, part of this will mean that regulators will be keenly attentive to firms’ resilience and potential vulnerabilities, recognising that during a period of unprecedentedly low interest rates some business models have grown up in relatively benign conditions and have yet to be tested in a sustained downturn.
SM: All right, David, Andrew, thanks so much for coming on Regulated Radio to share your thoughts today.
And there you have it – 2019 – a new year – and a new set of priorities for financial institutions and their regulators. Whether it’s handling Brexit, developing green finance, dealing with cyber risk, or even the threat of another economic downturn, you can be sure that we’ll all have our hands full in the months ahead.
But that’s why we do what we do – that’s why we bring you Regulated Radio – to give you a short briefing on what you most need to know about the top issues.
If you’re interested in hearing more about the Centre for Regulatory Strategy’s Outlook for 2019, you can download our full report with our expectations for the year ahead on Deloitte.co.uk/RegOutlook.
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It’s definitely the right way to kick things off this year.
But that’s all for now. Thanks so much for joining us, and you’ll hear from us again soon!