The Financial Conduct Authority (FCA)'s terms of reference for its wholesale insurance broker market study, published in November 2017, are clear on possible conduct by brokers which the FCA may intervene to regulate. They are much less clear on the dynamics of the market and why intervention should be the favoured route.
In this article, the author, a competition lawyer, examines how a competition authority might approach this market, in particular, by first identifying the relevant markets and market failures that would justify additional regulation.
The nature of the FCA's market studyIn common with a number of other industry regulators, the FCA has a dual function
- First, it is a sector regulator, responsible for authorising businesses to carry out specified activities in the financial services sector and regulating such businesses through detailed rules and principles. The FCA has extensive powers to enforce firms'regulatory obligations, including withdrawal of authorisation and the imposition of financial penalties, and can carry out market studies concerning firms it regulates.
- Secondly, in relation to financial services it is a competition authority, having concurrent jurisdiction with the UK's main competition authority, the Competition and Markets Authority (CMA), to apply EU and UK competition law. This includes the power to carry out a competition market study if it considers that the way in which a market is operating may have effects which are not in the interests of consumers.
In reviewing the activities of wholesale insurance brokers, the FCA has a choice of carrying out a market study under its regulatory or its competition powers. It has chosen the former: why?
The FCA has extensive powers under both regimes. An investigation under the regulatory regime, however, is more closely focused on the need for intervention in markets. The FCA also has more discretion to impose market-wide rules and guidance and to apply remedies to specific firms.
Under the competition regime, remedies are also potentially wide-ranging, but are predicated on a finding that competition between firms is insufficient to resolve any market failure. A competition inquiry also requires a more rigorous and economics-based analysis of markets and how they operate, a task ill-suited to regulators such as the FCA who do not routinely carry out such work (in contrast to the CMA).
Moreover, detailed remedies are likely to require a referral to the CMA for a more intensive competition-based market investigation, which would involve the FCA surrendering jurisdiction over one of "its" markets.
It is, therefore, little surprise that the FCA in this case has chosen the regulatory route, so maintaining its control over developments in the wholesale insurance sector.
What do the terms of reference say about competition in the wholesale insurance market?
While the FCA's market study is not competition-based, it cannot assess impacts on consumers without some investigation of the markets in which firms are providing services.
The terms of reference contain a short overview of the London market, but offer little guidance as to what market or markets the FCA will define, beyond a reference to the possibility of competition differing within different "sub-segments" of the overall sector. The terms of reference focus from the outset on certain stakeholders' "concerns that some brokers possess market power which they may be able to use to restrict competition".
This suggests that the FCA will focus on brokers' conduct rather than examining too closely whether the undoubtedly fierce competition between brokers provides a market solution.
Indeed, in principle, a competition authority such as the CMA would normally address concerns about firms' conduct through a fourstage process:
- What are the markets in which relevant firms operate?
- How competitive are the relevant markets and are any firms dominant?
- Is there a market failure, or can adverse activities be resolved simply by customers exercising choice between competing suppliers to "punish" firms who do not offer a good deal?
- Even if there is such a market failure, would any plausible remedies result in a more competitive outcome or might they have their own unforeseen consequences?
There is little sign that the FCA plans to follow this approach, but it is worth considering how a competition authority acting as such might approach the issues identified in the terms of reference.
Is there a "market failure"?
As noted above, the terms of reference offer few clues as to how the FCA will approach issues of market definition and competitiveness.
The second and third of its topics, however, set out certain problems it has already identified with how wholesaler brokers act in the market, though it is questionable whether they are in fact two distinct topics:
- Under conflicts of interest, the FCA identifies broker facilities, brokers linking placement of business with insurers' purchase of data and other advisory services, tying of reinsurance, and conflicts from broker-connected managing general agents.
- The broker conduct section adds little to these issues, beyond a vague reference to the possibility of tacit coordination between brokers, an issue which, if relevant, would more appropriately form part of an assessment of market competitiveness.
A concern from a competition law viewpoint is that there is a sense the FCA sees its role as protecting competitors, especially smaller brokers and insurers, rather than protecting the process of competition. The terms of reference do not convincingly identify a market failure such that intervention is necessary.
The "do nothing" optionThe lack of rigour — at least at this stage — in assessing market competitiveness suggests that the FCA would have some way to go in a competition-based market study to establish that remedies of any kind are necessary. "Do nothing" is rarely the first choice in a regulatory market study of this scale, however. It is informative to consider two of (the many) competition market cases carried out by the CMA and its predecessors:
- Outdoor advertising : this was a 2011 investigation of the complex market for outdoor advertising (i.e., billboards and digital advertising in public spaces and transport facilities), with many allegations of conflicts of interest and concealment of discounts. Although the market for media buyers (equivalent to brokers) was highly concentrated — essentially just two players — the study concluded that the market was working effectively, with just suggestions of rather obvious negotiating points customers might consider to ensure they got the best deal.
- Groceries : a long series of investigations of the leading supermarket chains eventually resulted in the imposition in 2009 of a Groceries Supply Code of Practice, which is intended to protect small suppliers such as farmers from exploitation by supermarkets exercising their buyer power. It is difficult in this context to see insurance companies as being in similar need of protection.
FCA must understand sector dynamics
The FCA has chosen to conduct this market study under its regulatory rather than competition powers, so it might be thought that a competition analysis is immaterial. Principles of good governance and the promotion of competition demand, however, that any regulatory intervention should be based on a clear understanding of the relevant markets and should take place only where essential.
A "remedies first" approach that protects inefficient operators is ultimately not in the interests of the market or consumers. It is therefore to be hoped that, as the market study develops, the FCA pays close attention to the dynamics of the insurance broker sector.
This article was written for Thomson Reuters Accelus Regulatory Intelligence.