12
Examination of witnesses
Richard Davies and Charles McManus.
Q190 The Chair: Welcome to the second session of the committee, Richard Davies from Allica Bank and Charles McManus from ClearBank. Would either of you like to make any opening comments?
Richard Davies: First of all, thanks for the invite today. It is great to speak to the inquiry. Perhaps in contrast to Sir Howard, I have more of a perspective on smaller banks to offer you. I have been the first CEO for OakNorth Bank; I was then the COO for Revolut; and I am currently the CEO of Allica. They are the three fastest-growing banks or fintechs in UK history.
Just briefly on Allica, we are exclusively focused on what we call established SME businesses. These are typically businesses with five to 250 employees, which make up about a third of the UK economy. We provide a full service offering for those customers, which we believe passionately is really important to UK productivity and growth as a segment. Too often that segment can be an afterthought in policy-making from both Government and regulators, as it falls between the retail segment and the wholesale segment.
There are a couple of key points that I would like to make to the inquiry today. First, there is a need for increased regulatory resource and focus on ensuring that the UK has successful scale-up challengers. Secondly, I want to double down on that point about the need for a focus on key aspects of the economy, such as SMEs.
I know the inquiry is focused on competitiveness and growth as a secondary objective, but there is also a longer-standing secondary objective around competition. I see them as very intertwined, and the PRA also recognises this. If you have competitive markets in SME or consumer, for example, that will drive better value, better productivity and ultimately growth. I see competition, competitiveness and growth as being very intertwined.
Charles McManus: To introduce myself, I am the co-founder and CEO of ClearBank. ClearBank is the UK’s first new clearing bank in 250 years. I personally have 30 years’ experience, not the 40 of Sir Howard, in global investment banking, wealth management and retail banking.
I have held a number of executive and board roles throughout my career. I have been regulated throughout the world throughout my career. I have worked for Royal Bank of Scotland Ulster Bank and the Royal Bank of Canada’s investment bank, and I started my career at Hambros, the merchant bank. I have been regulated throughout that period, but all of the organisations that I have worked for have been regulated by numerous regulators around the world.
More recently, I have just taken up the role as co-chair of the Unicorn Council, which is an Innovate Finance initiative to drive further growth for the UK’s fastest-growing firms, of which both ClearBank and Allica are examples.
I will just give you a very brief history in relation to ClearBank, which is relevant to the committee. We founded ClearBank in 2015. It was a fintech with a full banking licence. It had the latest cloud-native technology, with a mission to transform the UK’s payments and clearing infrastructure. We now provide payments clearing to over 240 financial institutions and our end customers represent well over a million consumers and SMEs in the UK market. We have nearly 800 employees and a balance sheet that is now over £10 billion, which is all held pound for pound at the Bank of England. We do not do any lending of any kind.
We became profitable last year and in September we received our European banking licence and launched ClearBank Europe in the Netherlands, which is the beginning of our international global journey. ClearBank plays a critical role in the fintech ecosystem. We serve some of the fastest-growing and most innovative fintechs in the UK, not just Allica Bank, but OakNorth, Tide, Chip, Wealthify and Coinbase, to name just a few. We also provide payment services to a third of all the new banks established in the UK since 2013, of which there have been 36, and we work with over 40 credit unions, which provide banking services to often underserved communities.
Turning briefly to the fintech sector as a whole, for the past decade it has thrived in the UK. This has been driven by technology advances, new business models enabled by payments regulation and some forward thinking by the Bank of England. Indeed, if you were to add up today all the valuations of all the fintechs in the UK, we would represent 25% of the FTSE 100.
More recently, though, we have seen a shift in relation to the regulatory environment, which this committee has heard a lot about in relation to risk, becoming less focused on enabling successful firms to grow. Our regulators, in our opinion, need to get better and faster at offering tailored support for those high-growth firms, just like ClearBank and some of the others I have mentioned already. How do we take those firms from good to great, growing from successful scale-ups to international global brands? We do not want less regulation or weaker regulation. We want world-leading smarter regulation: fast, effective and with timely execution.
To deliver this, we believe that firms seeking scale-up would be happy to pay more. We come back to some of Sir Howard’s comments previously in relation to compensation for regulators. There is no doubt that growth firms potentially would pay more for an enhanced service. This support could mirror the structure of the regulatory start-up units. It could be a sandbox for scale-ups, if you like. It would be focused on addressing policy barriers such as disproportionate capital requirements and supervision barriers such as long lead times in relation to product authorisations. These require experienced supervisory relationships.
Additionally, we would welcome—it sounds odd in relation to the previous witness—the Bank of England’s resolution function and the PSR also being subject to the secondary objective. As you have seen in relation to authorised push payment fraud rulemaking or the setting of certain capital requirements, these bodies do not, in our mind, consider enough about competitiveness and growth. This has a significant impact on the fintech sector.
This committee’s inquiry is a welcome opportunity to consider what more regulators and the UK fintech sector can achieve together to secure the UK’s strong position globally and ensure we contribute to its growth and competitiveness going forward.
The Chair: Thank you very much for that. Perhaps I could just begin by saying that we are grateful for your written evidence and for these statements, which in general terms are a complaint that the regulators are not very good at hand-holding when firms are trying to move forward and that the compliance costs are onerous. These are general points. Can you give us specific examples, not necessarily now but perhaps in writing, of things that might change and some data on the costs of compliance and the difficulties that arise from the regime for both of you?
One question struck me for ClearBank. You secured a banking licence from the Dutch financial services regulator recently. How was your experience working with the Dutch regulator compared with UK regulators? Is there anything that the FCA or the PRA could learn from the Dutch regulators?
Charles McManus: It is a very good question. It has been an interesting experience as a UK bank seeking a banking licence in Europe post Brexit, of which we were one of the first. We, the Dutch National Bank and the ECB are also quite proud of the fact that we were the fastest new approval for a Netherlands banking licence. It still took 15 months and we felt it was too long, but it was still the fastest in relation to getting an approval.
To answer your question, the primary objective of all the regulators is in relation to financial stability. Having gone through a similar exercise in relation to the UK banking licence, we are up to 2,500 pages in relation to an application. In terms of safety and soundness, financial stability, consumer protection, governance, risk appetite and all the other aspects for a new bank, the process is very similar in relation to the PRA and FCA and indeed the DNB and ECB.
There is one big difference, which is a point that we wanted to make. Without getting too technical, you will appreciate that after awarding a banking licence in the UK there is a period known as mobilisation, in which a bank operates with restrictions on deposit-taking, et cetera. In the ECB, there is no such equivalent. Once you have your licence, you are able to then service your customers, of course under proper supervision but with no caps in relation to the licensing. In the UK, there is a 12 to 15-month period of mobilisation. After doing all the work and going through the process, the supervisors and regulators are then happy that you can do business, whereas the UK is more conservative in relation to the first 12 to 15 months of operation.
The Chair: By “conservative” you mean “restrictive”.
Charles McManus: Yes.
Q191 Lord Vaux of Harrowden: I would like to understand a bit more about any aspects of the regulatory system that we have here that you have found particularly difficult in terms of getting established and that are potentially acting as a brake to expansion. We talked in the previous session about the cliff edge of MREL, for example, but are there any areas particularly that you want to bring to our attention where you think we are not doing it properly or well?
Richard Davies: First of all, we have to give real credit to both the Government and the regulators for changes just over a decade ago to improve the authorisation regime for new banks. As Charles mentioned, there have been 36 new banks in that last decade; there were very few before that. There has been a real change there. That has been very positive. OakNorth was one of the first banks to be authorised post the change in rules. That is where I was at the time.
Echoing what Charles said in his opening remarks, the gap that we see is that there has been this very good focus on starting a new bank—our stats on that compare pretty well to most countries—but, as the firm gets larger, there can be a bit of a void between the start-up units that exist in the PRA and FCA and the resource that is applied to the major banks.
Probably the most common consensus issue that I hear among the fintech community is this lack of focus of resource and policy around scale-up firms. Those firms clearly are ones that should be the real champions of tomorrow, if they can cross that void and become major firms. I would echo what Charles says. This is something that could have a dedicated unit around it at both regulators, similar to the start-up unit. We and most firms would be happy to pay a levy towards that.
We would echo Sir Howard’s point that there is a real need for high-quality regulatory resource. We are not generally asking for lots less regulation. We are asking for very good resource at the regulator that can work for us in a very timely fashion when we are fast-growing firms.
Lord Vaux of Harrowden: This is a resource and ability situation at the regulator rather than particular regulations that are holding you back.
Richard Davies: Perhaps I will build on that. If we can get that resource in place with sufficient focus, that will help a lot of areas. It will help with policy issues, such as some of the things that we may come on to around the possible barriers to growth for scale-up firms. It is not that there are no policy issues, but there is so much policy work to be done at the regulators that they need more resource to be put in to focus on these aspects. I have sympathy that they have a finite capacity, particularly post Brexit and given the Basel international rules, where they have a lot of work to do.
If you talk about some possible areas to look at, when I looked at the PRA’s first report on its wider secondary objectives published in July, what struck me was that it is quite noticeable that small and medium-sized banks, in their data, have on average 4% higher equity-capital ratios than the major banks in the UK. In the US, that is not the case. It is interesting that the output of the whole framework is creating higher equity-capital ratios at the smaller banks. It would be good to have a study as to why that is. Is it a good thing? Does it create barriers to growth as firms try to scale?
There are clearly also points such as MREL and operational continuity resolution. There is a range of aspects that kick in at £10 billion or £15 billion or 40,000 transactional accounts that are very relevant to this as well, which can lead a lot of firms to not want to get beyond a certain size. That cannot be good for the economy, if those firms are succeeding up to that point.
Charles McManus: Can I just add to that the ClearBank experience of trying to get a banking licence and become a member of the payment schemes at the same time to be a clearing bank? We had 26 different regulatory stakeholder authorities. Our first achievement was to get them all in a room. Remember that this was before Pay.UK. We were a member of Faster Payments, CHAPS, BACS, et cetera, before the changes with CHAPS going into the Bank of England and Pay.UK.
We collected all of those in Canary Wharf in one room for the first time. I was asked what the purpose of the meeting was, and we talked about what we were trying to do to establish ClearBank. It was the CEO of CHAPS who said, “We now get it. We need to turn this into a monthly steering committee to help you execute it”. Without that moment, I am not sure we would have got through the red tape and the regulation because you cannot become a member of a payment scheme if you do not have a banking licence. We were doing the two at the same time.
A lot has changed since then. We get back to Sir Howard’s debate: “Are you going to change and amalgamate?” That is unlikely, but we all work in a practical world of change. In particular for our business, the PSR’s authorised push payment rulemaking has really crystallised the issue of whether it should be consolidated with the FCA. We need to get to much better consolidation and effectiveness of risk types across regulators. From our perspective, authorised push payments would have been different if the PSR had considered growth and competitiveness and competition much more strictly as an objective, hence our recommendation.
The MREL debate is really fundamental. We are at £10 billion. We are a clearing bank; we do not have any lending; we have all our cash at the Bank of England. It is operational risk. There is no credit risk. Getting technical for a moment, the pillar 2B capital that we have to hold starts off in the rules—this is for the wind-up of a new bank—as six months’ of expenses. On a stress-testing basis, the cost of winding down ClearBank, without the taxpayer or anyone else paying a penny, would be significantly lower. The rules do not allow that. You have to be a bank for two or three years and you have to go through an approval. We are still waiting to move from expenses to a stress test; we are now five years in. That capital could have been used to expand the business further, to service our customers and do all the normal things you have heard in relation to it.
Going back to bank resolution in relation to MREL, there are reasons why the limits are the way that they are. I personally agree with Sir Howard that the US is far too high, but ours are far too low. In relation to Europe being at €100 billion, the new consultation is between £20 billion and £30 billion. For scale-up firms that understand the risks of their firms and are managing those properly within all the rules, Basel III and the rest, there should be more discretion. Whether that is a sliding scale or there is some smoothing, as Sir Howard mentioned, those things would make a massive difference to scale-up banks.
Richard Davies: If I may expand on that, the US point is relevant because there clearly were a few failures in the US in the last year and a half. MREL is not particularly relevant to that. The US was not applying quite a range of different requirements to quite sizeable firms. Silicon Valley Bank was nearly $200 billion of assets. Even smaller banks in the UK have international requirements such as liquidity risk management ratios and interest rate risk management. It was those issues that were fundamentally at the heart of why Silicon Valley Bank failed, as opposed to capital.
We are in full agreement with those being enforced on us as a smaller UK bank and we do not find those onerous. Frankly, they are part of running a bank responsibly, in our view. The debate often gets confused between MREL thresholds and some of the wider non-applicability of risk management that has been seen in the past in the US.
Q192 Baroness Noakes: From the comments you have made, I think you are largely talking about your interactions with the PRA. Could you say whether the FCA causes particular problems for the fintech sector as well? I suspect it applies to Mr Davies rather than Mr McManus, who is probably not troubled by the FCA.
Charles McManus: I am afraid I wish that was the case. “Trouble” may not be the word, but there is still a lot of interaction.
Richard Davies: We interact with both regulators. I have to say that the supervisory teams for both have good relationships with us. For us, the majority of our products are not regulated by the FCA because most SME lending is not regulated in specific terms. We do not do things like consumer mortgages or consumer credit, which are regulated, but, for example, financial crime, operational risk complaints and so on are very much under the FCA’s auspices. Our deposit products are also under their auspices.
Clearly, the Consumer Duty has been the major thing that has come into force. Sir Howard gave his views on the degree to which that came from Parliament as opposed to being regulatory-driven. We welcome that. We think it is sensible to think about delivering good customer outcomes. That feels like a good objective for financial services firms.
The point can be, “What is a good customer outcome?” The more clarity that there can be around that, the better. I would probably echo some of what Sir Howard said about the fact that various different bodies, in the absence of that clarity, have been making up different variations of a good outcome. We have the FOS, the FCA, the courts and so on. We would probably welcome more clarity around that because that uncertainty can be a deterrent to investors in fintech.
Baroness Noakes: That probably applies to the whole financial sector, but, particularly for the fintech sector, are there aspects of your interactions with the FCA that cause problems for you as a fintech?
Richard Davies: For us as a firm, no. Speaking to the wider founders in the fintech community, as myself and Charles both do, the firms that are with the FCA but are not banks are in a much wider pool of firms. Often they do not have any named supervisory teams with the FCA. It is all pooled. That can lead to difficulties in getting clarification and so on.
This goes back to some of the point we were making about the PRA. For the firms that have got beyond start-up and are trying to scale up, a dedicated unit to support that would be good. The same applies probably more to the FCA because it supervises such a wide range of firms and therefore its approach is one of pooled supervision for most firms.
Charles McManus: I will make three quick points. Naturally enough in relation to clearing and payments settlement, financial crime and AML are at the top of our list. For all of our regulated financial institutions, we are doing all of that checking as well as our customers.
We have a lot of very positive interaction with the National Crime Agency and the FCA on thematic reviews in relation to certain sectors and them reviewing us in relation to those controls. You heard before about SARs, suspicious activity reports. We do a lot of that. Indeed, with authorised push payment fraud data there is some data sharing between all of us to eliminate bad actors and fraud—if only we could do that more comprehensively. We have a lot of interaction with the FCA and with our customers on financial crime, et cetera.
The second aspect is in relation to innovation. I made the point about authorisations and, when you go and do new things, the speed with which you then get approvals. This committee has heard a lot about that. Whether you want to get an e-money licence or, in the new world, register with the FCA in relation to digital assets or digital clearing, it all takes far too long and it is one size fits all. Again, the fintech community would pay for speed and higher quality, so that we can grow, innovate and bring new products to the marketplace. That is not necessarily about more risk-taking but being innovative within the regulatory rules to serve our customers better and grow the marketplace.
The last example, again, is about risk classification across regulators. The moment that the PSR moved forward in relation to authorised push payments, they entered the fin crime arena. You then have an FCA/PSR issue of, “Who is in charge? Hold on. We have one set of fincrime reports now for APP in relation to the PSR and one set of data for the FCA”, hence you get to Sir Howard’s recommendation. Why can we not just put the two together and deal with fincrime with one regulator? It makes absolute sense. If the PSR is going to continue to exist, it needs to look much more at cost-benefit analysis, competition and all of those things.
The final aspect in relation to that comes back to know-how and quality of supervision. Why did the PSR have 17 consultation papers on authorised push payment fraud? Where is the know-how to bring forward something with focus groups, with fintechs involved and all the rest, to have two or three consultation papers and then to get something nailed? I am sorry to be so explicit.
The Chair: We like explicit.
Charles McManus: We want clarity. We want know-how. We want expertise. Going back to the question before, secondments may not be the answer. Having high-quality regulators with proper relationships, such that you can pay regulators properly and they are able to execute faster, is how we get growth in the fintech community.
Q193 Lord Lilley: I am still bewildered at what the regulators are doing. You are not a split revenue bank or whatever it is called. You do not borrow short and lend long, as most banks do. I used to think that was the definition of a bank. I am not denying that you are a bank, but you are not doing that. All the problems that arise from borrowing short and lending long do not apply to you. What is it that they are regulating? They could just have a list for a new bank and say, “We want to know all about your senior management, their criminal records and everything. We want to know…” There is a list of things; the speed is how quickly you fill it in. How can it take 18 months? I am just bewildered.
Charles McManus: To be fair, I am a risk manager. I have been in banking all my life. I lived through the Barings crisis. Our compliance department at the Royal Bank of Canada found the so-called NatWest Three. That case went to the regulators and they were extradited to the US. I have seen quite a lot in my career in terms of conduct, bad behaviours and essentially wrong risk-taking.
Lord Lilley: Before you start, you cannot even be doing that. How can they regulate you?
Charles McManus: I am sorry. I am taking a long time to answer your question. There is, in relation to the governance, the board of the bank. There is operational risk that, on the face of it, may seem quite trivial but is not. Payments go wrong; clearing goes wrong; people do not pay money; there are disputes. It is all of that.
In terms of a bank, fair enough; you have to go through the process. They are not then tailoring, ie being proportionate, to the risk type. This is exactly what we are talking about in relation to MREL. In fact, we do not fit very well. It is great that there are new banking business models, but the PRA does not know where to put us in its structure to regulate us.
The Chair: Lord Kestenbaum?
Lord Kestenbaum: My question has been answered.
Q194 Lord Grabiner: Both your businesses, as I understand it, have an interest in digital assets. That is right, is it not? That includes cryptocurrency. I am just thinking about bitcoin. My understanding is that this is not currently regulated by anybody. I do not know how much business you do in that. Perhaps you could just give us a little explanation. To what extent, if at all, is your business model impacted by the presence or absence of regulation?
The short point is about whether you think it should be regulated. There are enormous fluctuations in that market, and consumers out there, especially the great unwashed, might find it a very attractive investment, only to discover that it is an exceedingly dangerous enterprise, which is, as I say, unregulated. I do not know what your views are about that.
Charles McManus: I am pleased you have asked the question because it leads to innovation and growth on the right product set. Let me first clarify that ClearBank takes no crypto risk of any kind. In relation to digital asset exchanges—the likes of Coinbase, Kraken and BCB—getting technical for a moment, we do the banking, the payments and the fiat on/off ramp rails. That is the technical answer. We have no exposure to any crypto assets of any kind.
If you want to make a payment to one of those platforms, for example, the £10 will go through us to Coinbase. When they have sold their bitcoin, the £10 is then paid by us. We service those businesses in relation to purely the payments and clearing aspect. We have no risk in relation to their underlying assets, but we have the reputational risk and all of that.
The second part of your question, though, is about innovation and growth. You will have seen the struggles with the new payment architecture and modernising the UK’s payment schemes, such as Faster Payments and the rest, and the difficulty of getting change there. The world is moving very fast. Digital clearing is nothing to do with crypto but about using the technology of blockchains and smart contracts for more efficient clearing. That is something on which we are working with the Bank of England, the FCA and the PRA.
Again, going back to the earlier point, we are having to work with numerous regulatory bodies. We do not fit any of the rule types. The FCA may be looking at stablecoins in relation to retail or central bank digital currency, and there are other rules for the systemic banks in relation to issuing stablecoins. We sit right in the middle. We want to do wholesale digital clearing to remove cost friction and improve real time, not take risks in relation to crypto assets. It is incredibly difficult.
I am going to mix the two for a moment, but, as tokenisation and digitalisation take hold, we have a real opportunity to lead in that innovation. Whatever you may think about digital assets, the numbers are getting larger and larger. If you take all the stablecoin valuations in the world, this summer it was valued at $650 billion. That is expected to get to $2.2 trillion by 2028.
In a safe way, London needs to play its part in providing safe digital clearing for those assets. Although it is not a government agenda, we are very keen for the FCA, the PRA and the Bank of England to come forward with proposals in relation to this quickly. Otherwise, we will get left behind.
Lord Grabiner: They are taking their time, are they not? This has been going on for some time.
Charles McManus: Yes, it is not about central digital currencies for retail. This is about more efficient wholesale digital clearing. It is about moving money faster and safer. Richard, I do not know whether you have any comments.
Richard Davies: We do not do any crypto assets either. I believe there is an FCA crypto asset regulatory regime in place, but I am not a specialist on that, given we do not do it at Allica.
Q195 Baroness Bowles of Berkhamsted: Very quickly, I wanted to ask you a little more about the 4% extra capital requirement that small banks seem to have. Is that entirely down to the absence of being able to use internal models, stress tests and so on? Is some of it justified because you have higher fixed costs? Are there time periods before you can move over to something more tailored? We should also bear in mind that you have the mobilisation phase as well. Is there a good case for that period to be shortened?
Richard Davies: On mobilisation, that is for a brand new bank. The ratios that I saw reported in the PRA’s report are for all small and medium-sized banks. Those figures will be dominated by banks that are not in that mobilisation phase.
The truth is that I do not know. It surprised me that the equity-capital ratios were, on average, four percentage points higher for small and medium-sized banks than larger banks. It struck me as quite a thing. There should be a study into why that is the case when it is not the case in the US. I am not sure it has to be the case because the requirements that Allica has are more in line with the major bank equity-capital ratios that were outlined in that report. It just struck me as something that was not particularly commented on in the report but is highly relevant to competition.
Baroness Bowles of Berkhamsted: I had always understood that it was just the absence of being able to use internal models.
Richard Davies: The way the ratio was reported was as equity capital divided by risk-weighted assets. Internal models actually reduce the risk-weighted assets. So it has not been driven by that. I do not know. There was not much detail given behind it. It just struck me as quite a thing when that is not necessarily the case in other countries.
Q196 Lord Hollick: You talked about the frustration you have with the slow pace of approving new products and the multiplicity of various consultations. You have also said that you are prepared to pay more for better service. Have you put these points to the chair or the CEO of the FCA and what was their response?
Charles McManus: Janine, the CEO of Innovate Finance, has presented to you. There is a short answer and a long answer.
Lord Hollick: Could you keep it to the short answer?
Charles McManus: The short answer is yes. Yes, we have. We are very happy to share. Innovate Finance has come up with a whole series of recommendations in relation to all of that. We are really keen.
Lord Hollick: Do they share your enthusiasm?
Charles McManus: The CEO of the FCA’s response very much was that they are looking at it and understand. They had considered a fast track in which firms potentially pay more, but they were concerned that it would be discriminatory to others that could not afford to pay. We understand all those protections and concerns, but we need change. That is the part that I cannot assure you on, but the FCA is sure there will be.
Richard Davies: My perspective would be not to do it as a “pay for a fast-track visa” type of scheme. We should define what a scale-up firm is and have a levy on those firms that fund extra regulatory resource that covers the gamut of policy and specialist supervisory activities. I know many firms would be happy to pay that. That would give the regulators the resource to focus on this area.
Q197 Lord Sharkey: I am conscious of the time. Perhaps I can ask this question and ask for a written answer rather than a verbal one. The PSR has a secondary objective, of course, which is to promote innovation. To what extent has the PSR been successful in promoting innovation? What else could it do to fulfil its secondary objective?
Charles McManus: We would be happy to submit a written response to you, but it has not been successful.
Lord Sharkey: That in itself is a response.
The Chair: Thank you very much indeed for your evidence and for the written evidence that you have given us. As I said at the beginning of the first session, if you want to submit further evidence, we would be very grateful to have it. The small, innovative fintech businesses are the big businesses of the future, and it is a very important issue with which the committee are very concerned. We are grateful to you for taking the time to come today.
