Protecting irrational investors

The new Financial Conduct Authority (FCA), which is replacing the Financial Services Authority (FSA), plans to use its powers to protect “irrational” investors by banning certain products from sale.

Speaking in the Financial Times, new FCA managing director Martin Wheatley explained that the global financial crisis had changed the view taken by the regulator of investors.

As a result of this new view, which draws lessons from behavioural economics, the FCA will take a more interventionist approach than that previously taken by the FSA.

Some investors will be unhappy with the description of them used by Wheatley.

He said to the FT that investors, when faced with complex decisions or too much information, will often hide behind credit ratings agencies or the promises that are given to them by the salesperson.

By taking a more interventionist approach, the new regulator could help to protect some investors from those financial products that involve the greatest risks.

We have recently seen the FSA flex its own interventionist muscles, with a warning over the suitability of life settlement funds for retail investors.

Had this approach been practiced earlier, it is possible that the FSA could have banned the sale of other toxic investment schemes, including Arch cru.

There is a risk that the FCA banning unsuitable products will result in their tacit approval of the products they have not chosen to ban. This will not be the case.

The FSA has not historically been a product regulator and we do not expect the FCA to take up this role either. There is a big difference between banning toxic financial products and giving approval to all financial products in the marketplace.

Whether a more interventionist approach from the FCA works to benefit investors in the long-term is still to be seen.

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