Regulating the retail market: questions for the future

The Malta Financial Services Advisory Council (MFSAC) and the Malta Stock Exchange recently engaged international firm Simmons and Simmons to propose ways to help capital markets in Malta to evolve.

The recommendations will prompt debate on the markets for institutional investors, but MFSA chairman Jesmond Gatt remains convinced that the role of the regulator is also to ensure market integrity and user confidence while protecting retail investors financially who may be challenged to properly assess some of the risks involved.

“The MFSA is there to ensure that consumers of financial products and services are aware of the inverse relationship between risk and growth. Without an element of risk in investments, the possibility of growth is very subdued. Growth for capital markets and investment in the productive industry means embarking on new projects which may fall short of financial return expectations. Institutional and professional investors have the capacity to assess the financial viability of projects being taken by a company through its prospectus, business plan and the required information that had to be made public. But this may not apply to the individual retail investor,” Gatt said.

In Malta, the MFSA is one of several entities that have made financial literacy part of their remit. However, while financial education is having positive results, progress remains slow and the MFSA continues to recommend that retail investors should seek professional advice.

“We are already seeing this happen through pension schemes and UCITs, for example, where people seek help to understand markets and their consequences,” Gatt said.

The popularity of bond markets in Malta reflects this: retail investors often prefer a fixed-income asset. They also shy away from the long-term nature of equities, which may require more than a decade for the full benefits to be reaped.

“Admittedly on a European-wide basis, a 20-year projection is more difficult, so the MFSA needs to understand how to approach this.”

“One of the things we are discussing within Europe is how to leverage assets deposited in banks. During the 2008 crisis, we pushed capital requirements to mitigate balance sheet risks, making banks more risk averse. Given this, banks progressively balanced their portfolio risk and some sectors of the economy started finding it difficult to find the credit required for their activities to develop, especially for SMEs which are the economic bread-basket of Europe. But, as I said earlier, low risk activities generally are also low growth activities, with some economists pointing to this reality as one of the reasons behind the sustained subdued GDP growth which has been the reality of the Europe of the past two decades.”

“Collectively we are now realising that we need to get the traditional financial sector more engaged with more innovative investments. This would also help the retail capital market as banks can be the main link between depositors and those requiring investment,” Gatt said.

This point of view has gained traction within the EU whose recent initiatives – such as the Omnibus package, the Savings and Investments Union and the Capital Markets Union – are trying to recalibrate the capital flows within the economy, putting greater emphasis on access by the retail investors to collective schemes, collective investment products, pension schemes or Individual Savings Accounts, basically wherever people put their liquidity.

“There are many underutilised resources and we need to see how to induce change to depositor behaviour that will deliver investments which have a more positive impact on the economy, creating the context for investments that provide returns to citizens, improving their wellbeing in later years, increasing economic activity that allows the economy to grow, while providing the opportunity for the younger generations to access quality jobs. This will benefit all elements within society, the investors, the industry and their employees”

Pensioners are generally sitting on a substantial savings base and would want to invest in order to improve their standard of living, he said, noting that there were many similar sectors which could benefit.

The MFSA is also pushing for more digitisation of financial products, describing this as “the modern way of thinking which is more aligned with the emerging expectations of an evolving society”.

“Innovation is certainly not the strength of traditional institutions and policy makers. In fact, we continue to encounter more challenges than expected, particularly because traditional operators are not yet convinced that highly innovative technology will reach the required scale and risk mitigation to accrue profitability outcomes through widespread implementation. This notwithstanding, the Authority is looking at tokenisation, for example, as tokenised assets currently listed on a traditional exchange can then be made available to retail savers through DLT technologies.”

“Bear in mind that the European Central Bank and private issuers are now thinking about digital money, mainly CDBC and Stable Coins, which have the ability to move money through payments. Once payments become real time transactions, users will start to expect assets to also move at this speed.”

“The younger generations may not be saving through investments in the traditional capital markets as these may not be aligned with their behaviours and expectations. They have a different approach to the way they access investment advice and how they would like to interact with the capital market – through the use of digital technologies they expect the advice to come from closer to home and the outcome to be more immediate than what the traditional approach proposes. Of course, we regulators must still ensure that the advice is valid and that intermediaries are trustworthy in the context of the semi-borderless society that digitalisation is proposing. This allows for savers to access more developed markets more easily to the domestic one, with more and more people investing in companies listed on USA stock exchanges and European exchanges as these present opportunities and ease of access well beyond those proposed locally.”

One area which has been the focus of regulatory interest for the MFSA is the area of crypto assets and the corresponding markets where these are traded and settled. The MFSA wants to get across the message that investing in crypto assets requires deeper understanding around the rationale of demand and supply in financial markets, thus presenting a specific set of challenges to their users.

“With many crypto holdings, there are no dividends, nor asset growth of the company backing them, so you are only looking at the price differential, a form of speculation which necessarily means that prices fluctuate significantly while having limited drivers of value beyond demand. However, crypto assets are then more aligned with the culture of the younger generation who through digitalisation expect outcomes here and now, thus fuelling their take up which encourages financial rewards.”

Even as the S&S report looks at internationalising markets for institutional investors, Gatt said that the MFSA considers another aspect: digitalisation of traditional assets to tokenised form have the potential to internationalise access to local capital markets to other communities, making it feasible for citizens from the retail markets of other countries to consider local assets. This has the great potential to deliver on the aspiration of a capital markets union at retail level, an objective which Europe has been actively trying to deliver with limited success for the last 20 years. This needs to be enabled by more access to information about the companies to flow across the bloc more freely, as retail investors tend to be more comfortable with local companies that they know and trust.

“Global brand names might be considered by a Maltese investor, but would a European investor consider a Maltese company they had never heard of before?” he asked.

Just as Maltese investors have access to information about a more global market, so too should Maltese companies realise that it is not enough to be exposed to the local market.

“Issuers must realise that they need to get out there… this is the challenge; we think too much in an isolated way,” he said.

One thing is clear: the future requires a different vision and what worked in the past would not necessarily apply in the future.

“Banks used to have a central role in bringing industry and the investors together, with intermediation and risk management fundamental to making this happen. In the future, people might question what value regulated institutions give an intermediary: technology itself may propose better options for intermediation and the management of risk. If consumers do not see the value, they may not be willing to pay for that service. The regulator needs to understand this and be prepared to regulate a financial industry which may not exclusively rely on intermediaries as they exist today.”

“The financial industry is being driven to evolve, and our work is to ensure that the financial industry remains an opportunity to society to continue to deliver the wellbeing to the community, our regulatory work needs also to continue to evolve so that the financial industry can evolve to retain its relevance.”