Investors must be wise to the risks of deregulation

The share prices of car finance providers such as Lloyds Bank and Close Brothers were rewarded with a big boost this week following the Supreme Court’s ruling on commission payments, sparing them from a worst-case compensation scenario.

The redress scheme planned by the Financial Conduct Authority (FCA) could still run to billions of pounds, but it will not be a repeat of the payment protection insurance scandal, which had fattened up that industry for years before eventually costing it around £50bn. 

In this case, while the tale has ended less badly than it could have done, there was a real risk that the attempt to put things right for car owners would harm the economy, and a government intervention was expected should the Supreme Court have ruled in favour of the claimants. The case has caused turmoil for shareholders, too. In anticipation of huge compensation costs, Close Brothers scrapped its dividend and sold its wealth management division. 

What the car finance saga tells us is that even in a highly regulated environment, events and scandals can happen that end up costing shareholders. Numerous crises can attest to that, from those on a global scale to local issues such as cladding and leasehold scandals.

Resolving the issue of faulty cladding in the wake of the Grenfell fire has proved a toxic issue for housebuilders, with more than £1bn wiped off listed housebuilders’ values at one point. Taylor Wimpey confirmed in its half-year report that its cladding liabilities are now likely to be in the region of £435mn, leaving it nursing a loss of £92mn for the half year. 

Long before carelessness on cladding had become an issue, housebuilders had the bright idea of selling houses on a leasehold basis with onerous ground rent clauses. These “fleecehold” terms were so appalling that many homeowners were unable to sell their properties. The Competition and Markets Authority intervened and legislation has been created to end leasehold abuses. 

Clearly investors cannot take it for granted that companies are safe from episodes of poor judgment, whether of their own making or the parties they deal with, despite the oversight of regulators and mountains of legislation. Worryingly, regulations are increasingly seen by western politicians as the chain that is holding back growth. 

US President Donald Trump entered office promising an agenda of deregulation designed to unleash growth by allowing companies to become more innovative, reduce their compliance costs and make it easier for new entrants to make inroads. The UK government is also using deregulation to drive growth. Deputy prime minister Angela Rayner is ripping up planning rules to kick-start a building boom, and Chancellor Rachel Reeves has stated her intention to do the same with financial services despite a cool reception from the Bank of England. Governor Andrew Bailey agrees that a degree of reform is needed, but has rejected the chancellor’s claim that regulations are a boot on the throat of industry. In the end, the changes may not be as radical as Reeves would like but it is likely that it will become easier for households to borrow larger amounts – something that has been more difficult since the financial crisis. 

Loosening the rules, and cutting the number of regulators, could encourage greater risk taking by banks (regulation of smaller banks in the US was watered down in 2018, just a few years before the collapse of Silicon Valley Bank in 2023) but would almost certainly be positive for growth. Hence, many in the City support the plans to loosen financial regulations. “We’re a decade and a half on from the financial crash. Banks are holding too much capital and some of the rules could do with a gradual relaxing. The EU and the US are rolling back restrictions and the UK will have to follow,” says Alex Crooke, manager of Bankers Investment Trust, who expects the sector to enjoy stronger loan growth (currently at around 2 per cent) with earnings and dividends rising as a result.   

But there is always the risk that unwatched, and encouraged to be innovative, companies will make costly mistakes and misuse their freedoms.  

Investors have already lost some of the protections that shielded them from trouble. Pension funds are now expected to support the government’s infrastructure programme regardless of the merits of these investments. And amendments to London listing rules that came into effect a year ago mean new listings and companies raising fresh funding are not required to disclose the same level of information as previously. Companies can now raise cash as quickly and easily as anywhere else, but the onus is on shareholders to satisfy themselves that these PLCs uphold high standards.

Growth is badly needed, and if an easing of regulations can foster this and inject real momentum into the economy, then steps in this direction should be taken. But investors must stay alert to the new risks this brings for them.

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Rosie Carr

Editor