Chapter 5: UK financial services regulators PART A Flashcards
CHAPTER 5
NUMBER OF QUESTIONS 29/100 = 5A + 5B
5A: The Current UK regulatory landscape
This section covers
- The UK’s financial services regulatory landscape
- FCA – the basics
This part will cover more about the structure of the FCA, greater detail in relation to its objectives. and its main
responsibilities, in terms of scope and powers. - FCA – the divisions
In this section, we will consider each division of the FCA, what their responsibilities are, and how they work to
meet FCA objectives. - Financial stability and prudential regulation
The last section in chapter 5A will look at the drive for financial stability, and then go on to cover the prudential
regulation of firms.
The FCA and PRA are predominantly involved in two types of regulation:
Prudential regulation:
• Fulfilled by the Bank of England over the market infrastructure and payment systems
• Fulfilled by the PRA over significant and systemically important firms, e.g. banks, large companies
• Fulfilled by the FCA over smaller regulated firms and directly-authorised individuals
Conduct regulation:
• Carried out by only the FCA, who monitor all authorised individuals, firms, and markets carrying out regulated activities
5A.1: Financial Services Act
3 new bodies created from this act.
Financial Conduct Authority (FCA)
- Has an overarching strategic objective to ensure that the relevant markets function well?
- Has 3 operational objectives: Consumer protection, Integrity, Competition
- Has 8 regulatory principles
- Has 10 supervision principles
- Uses a 3-pillar supervisory approach
- Has micro-prudential responsibilities i.e. much more involved in day to day activities
Financial Policy
Committee (FPC)
- Responsible for the early identification of risks facing the financial services sector and broader economy
- Aims to reduce and remove systemic risk
- Uses ‘macro-prudential tools’ and ‘micro-prudential tools’ to reduce risk
- Has mainly macro-prudential responsibilities
BANK OF ENGLAND
PRUDENTIAL REGULATION
AUTHORITY
• Has a primary objective of ‘promoting the safety and soundness of the firms it regulates’ which will be
the largest financial firms and markets
• So, those that are systemically important, i.e. if they went bust, the market would be adversely affected
• Also, has a secondary objective of ‘facilitating effective competition’
• Its approach to regulation and supervision has 3 characteristics (same for the FCA later):
- Judgement-based
To assess strength, policyholder protection and compliance with key conditions.
- Forward-looking
Looking at current and potential future risks. Remember, this was the biggest criticism of the old
FSA, so the new regulators must be different.
- Focused
Looking at firms that present the highest risks. Again, has micro-prudential responsibilities
5A.1.1: Financial Policy Committee (FPC)
Run by the Bank of England, the FPC has mainly ‘macro-prudential’ responsibilities. It is set up to identify businesses that are in financial trouble and limit their impact on the resilience of the financial system as a whole.
3 macro-prudential tools:
• Counter-cyclical capital buffers
It is when banks put aside greater capital reserves in
times of financial plenty, with the aim of compensating for times when profits are poor.
There are minimum percentages set by the FPC.
• Variable risk weights
A company’s capital reserves are required to be higher or lower,
depending on the types of risks they are exposed to.
• Leverage limits
These limit the use of higher-risk financial tools, such as derivatives. Leverage is simply debt. Higher levels of debt increase volatility and are the antithesis of financial stability, so must be carefully
controlled.
The FPC must respond to any guidance and recommendations but is not
bound to accept them.
It must draft a Financial Stability Report twice-yearly and publish minutes of meetings within 6 weeks of
their occurrence.
5A.1.2: The Prudential Regulation Authority (PRA)
Core purpose of “protecting and enhancing the stability of the UK financial system” by introducing threshold conditions for firms to meet.
The PRA has micro prudential responsibilities. Its objectives are broken down into three:
Primary objective
• To promote the safety and soundness of larger companies, so look after their prudence.
• Specifically, it is the top 1,700 systemically important firms/markets, such as banks and building
societies.
Secondary objective
• To facilitate competition (subject to meeting the primary objective).
• This objective was introduced as part of the Financial Service (Banking Reform) Act 2013.
Insurer-specific objective
• To secure an appropriate degree of protection for those who are, or may become, policyholders
• This includes protecting the reasonable expectations of with-profit policyholders with regard to surplus distributions.
KEY FACT
An easy way to remember the overarching aim of the PRA is to consider its title.
‘Prudence’ in financial terms means: Watching the pennies.
PRA CONT…
PRA’s approach to regulation and supervision has three characteristics:
• Judgement-based
They will use their judgement to determine whether financial firms are ‘safe and sound and insurers are providing sufficient protection for policyholders.
• Forward looking
The PRA will not just assess larger firms against current risks but possible future ones too. The old FSA regulation structure was heavily criticised for being reactive rather than proactive back in 2009.
• Focused
A focused approach will be used concentrating on the issues and firms that pose the greatest threat to the stability of the UK financial system.
PRA uses 2 tools to meet its objectives: Regulation - Set standards for companies to meet Supervision - Assess risks that firms pose and take action where necassary
KEY FACT
The PRA approach does not seek to operate a ‘zero-failure’ regime where no large organisation fails.
It will, instead, attempt to minimise the impact of any firm that fails, rather than take
extreme measures to prevent it from failing.
It is not accountable to parliament
5A.1.3: Financial Conduct Authority
The FCA was set up by the Financial Services Act 2012, and took up its statutory powers from the 15 April 2013, known as N2 day. The old FSA became the new FCA, with different objectives. It is funded through levies on the financial services industry.
It is the sole conduct regulator. It also shares prudential responsibilities for some firms with the PRA.
Financial Services Act Summary
- The FPC has macro-prudential responsibilities
- It is responsible for reducing or removing systemic risk
- The PRC replaced the PRA board, and aims to provide a simpler, more coherent governance structure
- The PRA has micro-prudential responsibilities
- It has three objectives: safety and soundness, competition, and greater protection for insurance company policyholders
- The FCA also has micro-prudential responsibilities
- It is the sole conduct regulator, but also covers prudence for smaller firms and directly-authorised individuals
5A.2 FCA - The basics
5A.2.1: Objectives and Principles
The FCA is an independent body. It reports annually into parliament, and more regularly to the Treasury.
Three FCA Operational Objectives
- To secure an appropriate degree of protection for consumers
- To protect and enhance the integrity of the UK financial system
- To promote effective competition in consumer interests
I.E. Protection,Integrity, Competition (PIC)
Consumer Protection:
To make sure that consumers are protected and treated fairly, the FCA monitor which individuals, firms, and markets can enter the financial markets, making sure that they meet set standards before they receive ‘Part 4a’ permission. They are then supervised in how they work.
Part 4a permission is required to carry out regulated activities, otherwise this is a criminal offence.
The FCA can act to stop those that are not meeting these standards from carrying out regulated activities.
The FCA’s greatest responsibility is to retail clients; so ‘Mr, Mrs and Ms Average’.
Integrity
Like the PRA, the FCA will be subject to FPC recommendations, and there should be a continuous flow of information between all the regulatory bodies, both UK and European.
KEY FACT
The aim of the FCA is
To support and empower a healthy and successful financial system, where firms can thrive, and consumers can place their trust in transparent and open markets.
Competition
Competitive markets are hugely important to the FCA. Firms must offer quality products, better value, prices should be linked to costs, and they should promote innovation.
The FCA view is that, when competition works well, consumers are empowered as well as informed.
This helps generate better outcomes for consumers, which is another key regulatory requirement.
KEY FACTS
How do CMA activities impact on the role of the FCA?
The CMA can investigate how FCA rules are affecting market competition and get them changed if they are non-competitive.
The FCA operational objectives are backed by a series of regulatory principles.
They guide both the creation and pursuit of these three objectives.
FCA - The basics Cont..
The FCA has, as previously mentioned, eight regulatory principles:
The FCA aims to follow these principles when carrying out its various functions.
Efficiency & economy
• Use its resources in the most efficient way and offer value for money.
• At any point, the Treasury can commission value for money reviews to check this.
Proportionality
• Any FCA burden or restriction takes into account the benefits expected as a result
• It will take costs to firms and consumers into account as well.
Sustainable growth
• To ensure effective regulation still retains a desire for medium to long-
term sustainable growth in the UK economy.
Responsibility of consumers
• Consumers should take responsibility for their decisions.
• It is not a ‘one-way responsibility street’ with all the fault lying with advisers, firms, and markets (though it may, at times, seem that way!)
Responsibility of senior
management
• To comply with the regulatory framework.
• To lead by example and set the ‘tone at the top’.
• Senior management have huge responsibilities here.
Recognition of business differences
• To exercise the regulator functions, whilst also recognising that individuals, firms, and markets work in a variety of ways, with different
objectives.
Openness and
disclosure
• The FCA will publish information about regulated activities with a view to improving consumer knowledge of financial matters.
Transparency
• The FCA aims to be transparent in its role, and accessible to regulated individuals, firms, markets and to the general public.
The overall objectives of these regulatory principles are to:
• Provide political and public accountability
(The FCA annual report outlines progress to Parliament)
• Govern the way the FCA carries out its functions
• Assist in providing legal accountability (If the FCA fails here, this can result in court action)
UK Regulatory Authorities Objectives Summary
FCA
Overarching objective:
Ensure that the relevant markets work well
Operational objectives:
• Secure an appropriate degree of consumer Protection
• Protect & enhance integrity of UK financial system
• Promote effective competition in consumer interests
Regulatory principles:
• Efficiency & economy: Use its resources efficiently, and offer value for money
• Proportionality: The monitoring of firms should be in proportion to their size
• Sustainable growth: To keep a desire for medium to long-term sustainable growth in the UK economy
• Responsibility of consumers: Consumers should take responsibility for their decisions
• Responsibility of senior management: To comply with the regulatory framework
• Recognition of business differences: To exercise the functions of a regulator whilst recognising that businesses work in a variety of ways, with different objectives
• Openness and disclosure: Publishing information about regulated activities
• Transparency: In its role, and to be accessible to regulated individuals, firms, markets, and the general public
Bank of England
Promote and maintain a stable and efficient monetary and financial framework
Manage stability by influencing and achieving government inflation targets
PRA
Primary objective:
• Promote safety & soundness of firms, to achieve a stable financial system and appropriate protection for policyholders
Secondary objective:
• Facilitate effective competition
Insurer-specific objective:
• Secure appropriate degree of protection for those who are, or may become, policyholders
• Secure reasonable surplus distribution for with-profit policyholders
FPC
Primary objective:
• Identify, monitor and take action, to reduce and remove systemic risks, protecting and enhancing resilience of the UK financial system
Secondary objective:
• Support government economic policy to promote growth and employment
PRC
To deliver a simpler and more coherent governance structure within the PRA
HM Treasury
• Formulate/put into effect financial and economic policy
• Raise sustainable growth rates to create economic and employment opportunities to achieve rising prosperity
5A.2.2: Scope and powers
KEY FACT
Any individual, firm, or market wishing to carry out regulated activities must apply for Part 4a permission (a licence to trade). Otherwise, they are guilty of a criminal offence
The scope of the FCA covers three main powers:
Authorisation
•Granting, varying and cancelling authorisations as necessary.
Supervision
•Devising rules for conduct of business, co-operating with other regulatory bodies.
Enforcement
•Policing the industry and imposing penalties as necessary - both civil and criminal.
5A.2.3: New FCA powers
As a result of the Financial Services Act 2012, the FCA was granted wider, more far-reaching powers.
These new powers include:
- Banning inappropriate retail products for up to twelve months
- Insisting on the withdrawal of misleading financial promotions (adverts)
- Publication of any enforcement action (sanctions against individuals, firms, and markets)
- Market intelligence gathering and research; through a new Policy, Risk and Research Division
- A new whistleblowing team, allowing individuals to report their suspicions confidentially if they think a firm or individual is involved in wrong-doing within an area that the FCA regulate
A Policy, Risk and Research division exists within the FCA which acts as its ‘radar’. This, as it sounds in its title, is to help the FCA be forward-looking.
KEY FACT
A word of warning: Don’t always choose the most severe FCA penalty in R01 exam questions. Look at the offence and analyse the wording of the question stem.
5A.2.4: Overall accountability
The FCA is accountable to HM Treasury for the way it carries out its duties. It has four ‘panels designed to feedback to the regulator the views of practitioners, consumers, small businesses, and the markets. The regulator listens to these views but does not have to act on them.
Each panel has its own remit:
• Financial Services Practitioners Panel (FSPP): the views and concerns of the industry as a whole.
• Financial Services Consumer Panel (FSCP): the interests of consumers.
• Small Business Practitioner Panel (SBPP): the interests of small businesses.
• Markets Practitioner Panel (MCP): the markets and investment exchanges.
KEY FACT
Who is responsible for the FCA?
The Treasury
FCA Basics Summary
In Summary
• The FCA has one strategic objective and three operational objectives
• It carries out its day to day activities guided by eight regulatory principles
• All FCA activities are to achieve its objectives
• Retail clients receive the greatest FCA protection
• The FCA sends an annual report to Parliament
• The FCA is the responsibility of the Treasury, as this is the body ultimately responsible for the UK financial services industry
• The FCA uses four panels to try and have ‘forward looking’ judgements
• These include a practitioner, markets, smaller business and consumer panel
• The FCA was given several new powers to make it a stronger regulator
These include:
-being able to ban products for up to twelve months
- asking for inappropriate financial promotions to be withdrawn
- publishing enforcement action taken
- better market research, intelligence-gathering, and a new whistle-blowing service
5A.3: FCA Divisions
The structure below, whilst simplistic, covers off the three main activities that the FCA is involved in.
The three main FCA areas of responsibility are:
Authorisation, Supervision and Enforcement
NOTE: Authorisation and supervision divisions have subsequently been merged and then split into two supervision departments
5A.3.1: Authorisation
Authorisation is viewed as the FCA’s first defence against poor practices and consumer outcomes.
5A.3.1.1: Granting new authorisation
The FCA looks at a variety of areas when considering new authorisations.
These include:
- The proposed business model
- The culture of the organisation
- Their proposed product governance
- Their end to end advice processes
- Their systems and controls aimed at financial crime prevention
KEY FACT
There are strict rules in place for how quickly applications must be turned around by the FCA:
• Up to 6 months for complete applications from individuals, firms, and markets
• Up to twelve months for incomplete applications
5A3.1.2: Scope of Authorisation division’s activities
Authorisation includes matters such as: ‘Granting, varying and cancelling authorisations as necessary’.
It’s important to be aware that there are two main types of authorisation:
Granting Part 4a permission
Approval of individuals
Granting approval to certain individuals relates to roles within an authorised person known as a ‘controlled
function’. These are individuals carrying out a role of significant importance, and who, as such, need to be
individually approved and registered by the FCA/PRA.
Remember an ‘approved person’ and a controlled function are the same thing.
The terms relate to where an individual works within the authorised person, and carries out a role of ‘influence’. An approved person is someone who has been approved to carry out a controlled function within the business. Any one person may be approved to carry out more than one controlled function.
A public record is kept of both authorised and prohibited persons.
KEY FACT
• Authorisation could mean granting Part 4a permission to an individual, firm, or market, who then become what is known as the authorised person.
• Or it could mean approving an individual that will be carrying out a ‘controlled function’ within the authorised person.
5A.3.2: Supervision
Supervision is the term used by the FCA to describe its day-to-day regulatory relationship with authorised
individuals, firms, and markets. This relationship is built around a ‘risk-based approach.
KEY FACT
The FCA assesses the risk of a firm after looking at:
The sector it operates in, the volume of transactions, the product types, the type of customers typically interacted with, and the likelihood and impact of the customer suffering a financial disadvantage should they not be treated correctly.
5A.3.2.1: Categorisation
Larger firms and markets can expect more frequent interaction with the FCA than smaller ones and individuals.
Originally, to provide structure, firms were categorised’, with C1 being larger banks and C4 being smaller
As part of the FCA’s ‘new strategy’, the C1-C4 categories were replaced with two categories, fixed portfolio
firms and flexible portfolio firms.
Fixed portfolio firms
- Smaller population of the total firms regulated by the FCA
- Generally, the largest and highest-risk firms
- Named supervisor within the FCA, who pro-actively supervises the firms, using a continuous assessment approach
- Supervised to ‘Pillar 1
Flexible portfolio firms
- Most firms
- The firms that do not carry significant risks to the stability of the UK
- Contact-centre, rather than individual supervisor, as first point of contact
- Pro-actively supervised via market-based thematic work
- Lighter-touch regulations
- Could move to fixed portfolio if they grow big or become more risky
- Supervised to ‘Pillars 2 and 3
This means that…
• the old C1, and possibly some C2, firms and markets are now known as fixed portfolio.
• the old C3 and C4 firms, and individuals, are now known as flexible portfolio.
5A.3.2.2: Three pillar supervision model
Supervision is based around three activity pillars, which
draw on FCA ongoing analysis of each industry sector, and the risks within them. ‘Issues and Products work’, and the FCA response to specific events, feed in to their ‘Proactive work with individuals, firms, and markets with Part 4a permission.
The three-pillar supervision approach will encompass:
Pillar 1: Proactive firm/group supervision
Applied to fixed portfolio firms, Proactive supervision
• Assesses conduct risk
• Asks the question: “Are the interests of customers and market integrity at the heart of how this firm is run?”
• Looks at TCF, and the firm’s culture and business model
• Uses a forward-looking, judgement-based approach
• Looks to address issues that could damage consumers
and markets
Pillar 2: Event-driven, reactive supervision
Applied to flexible portfolio firms, Event-driven
- Supervision in response to issues that are emerging or have already occurred
- Devotes FCA resources to situations and firms of the highest risk first
- Events such as a spike in complaints is an example of what will drive this pillar
- Allows, and is facilitated by, flexible allocation of FCA supervisory staff
Pillar 3: Thematic approach - Issues and products supervision
Applied to flexible portfolio firms, Proactive thematic reviews
- The FCA will review any product-related issues that may be possible drivers of poor consumer and market outcomes as they take place
- A thematic review looks at risks and issues to analyse current events. It also investigates potential drivers of poor customer outcomes, which is a key FCA concern
KEY FACT
Authorised individuals, firms, and markets are now either fixed or flexible portfolio.
• Fixed portfolio are supervised to Pillar 1.
• Flexible portfolio to Pillars 2 and 3.
5A.5.3.3: FCA ten supervision principles
These FCA principles are designed to form the basis of all supervisory interaction with all authorised persons,
regardless of their categorisation.
• Fair outcomes for consumers and markets
These two considerations run through all FCA activities including their assessment of issues.
• Being forward-looking and pre-emptive
Trying to predict and limit risks to consumers and markets before they happen. So being forward-looking…(now, where is that crystal ball?)
• Focused on big issues and problem causes
Concentrating FCA efforts and resources on big risks to their objectives.
• Having a judgment-based approach
To ensure the right consumer and market outcomes are achieved.
• Ensuring firms act in the right spirit
This means not simply complying with conduct rules, but considering the real impact of any unfavourable actions.
• Examining business models and a firm’s culture
In relation to how businesses make their profits, as this can be the underlying reason behind many risks to consumers and markets.
• Individual accountability emphasis
Ensuring senior management fully understand that they are responsible and accountable for their actions.
• Being robust when things go wrong
In terms of ensuring risks are fixed, consumers are protected and, if appropriate, compensated, and poor behaviours are addressed.
• Communicating openly
To ensure a greater regulator understanding of issues faced by the financial services industry, firms and consumers.
• Having a joined-up approach
Working with other regulators both in the UK and Europe to ensure a consistent regulatory message.
KEY FACT
The PRA has its own Proactive Intervention Framework. This involves five categories from low, moderate viability and imminent risk, through to firm wind-up.
This should ensure that the PRA identify and respond to emerging risks as early as possible.
Supervision Summary
• The FCA is made up of several different areas or divisions
• Authorisation is the FCA’s first defence against poor practices and consumer outcomes. It has two main roles:
1. granting Part 4a permission to individuals, firms, and markets wishing to carry out regulated activities known as an authorised person
2. approving individuals who carry out a greater role within an authorised person known as controlled functions/approved persons
• Supervision is involved in the day to day relationship with individuals, firms, and markets carrying out regulated activities
• There is now a fixed and flexible portfolio approach to supervision
• The PRA has five categories that affect their level of supervision - known as the Proactive
Intervention Framework
Summary of the maximum prison terms in relation to different offences covered so far:
Money laundering- 2 years
Failure to report suspicions- 5 years
Making misleading statements, misleading conduct, or insider dealing-7 years
Proceeds of Crime Act 2002 offences- 14 years
5A.3.3: Enforcement
5A.3.3.1: The process
Any breach of FCA rules will result in an investigation being opened by FCA enforcement division.
The FSMA also provides the FCA powers to take action against insider-dealing, via the Criminal Justice Act.
Anyone carrying out regulated activities without permission to do so (Part 4a permission) will be
investigated by the FCA. This is viewed as a breach of general prohibition.
There is a set process by which any offences are investigated:
Enforcement officers open an investigation then,
Evidence is gathered leading to recommendations then,
The Regulatory Decisions Committee (RDC) decide on appropriate sanctions
5A.3.3.2: Civil and criminal courts enforcement
What is a civil offence?
Civil law deals with disputes between private parties, or negligent acts that cause harm. Examples include:
• Continuing to use misleading financial promotions (adverts)
• Making misleading statements
• Breaches of certain FCA rules
What is a criminal offence?
A crime is a deliberate or reckless act that causes harm to another person or another person’s property, and it is also a crime to neglect a duty to protect others from harm. Examples include:
• Insider-dealing, market manipulation, and money laundering
• Any form of financial crime
• Carrying out regulated activities without being authorised or exempt
KEY FACT
Why would the FCA go for civil rather than criminal proceedings?
There is a lower burden of proof on civil proceedings.
Less paperwork will be required and the investigation will take less time.
Enforcement Summary
• Enforcement are responsible for opening an investigation into FCA rule breaches
• A Notice of Appointment of Investigation must be issued to the individual, firm, or market under investigation
• Unless the investigation is in relation to a possible offence such as insider dealing
• There are both civil and criminal offences
• A civil offence is where there is a dispute between two private parties or harm is caused to others
• A criminal offence is a deliberate or reckless act that harms another person or their property (assets)
• Sanctions are decided by the Regulatory Decision Committee (RDC) – they decide whether an offence
has been committed, the type and from there the relevant sanctions
• These include varying/cancelling Part 4a permission, unlimited fines, statements on conduct or prison sentences
• Compliance may be dealt with internally or by bringing in external expertise
• The responsibility for compliance however cannot be contracted out
5A.3.5.2 Prudential Regulation
The factors that should be considered would probably include:
• A provider’s financial reserves (prudence)
• How risky it is perceived to be (credit-rating)
• The services it provides to its customers
• The strength of its product proposition
KEYFACT
The PRA prudentially regulate the top 1,700 systemically important firms and markets.
The FCA are responsible for the prudence of everyone else.
Individuals, firms, and markets must have sufficient capital reserves to:
• meet all liabilities as they fall due be able to keep trading on a day to day basis
• have some form of financial buffer for expansion and development
Individuals, but more importantly firms and markets, must have systems in place to monitor the adequacy of
their capital reserves. These include:
• A documented process to identify and deal with such risks
• At least annual stress-testing of reserves (using ‘worst case scenario’ applications)
• Annual reporting of capital reserves to the appropriate regulator
• Openness and transparency in the availability of this financial data to the public
KEYFACT
What is Free Asset Ratio (FAR)?
The financial strength of a life office or insurance company.
What are ‘ratings’?
These are the credit ratings given to financial institutions by agencies such as Moody’s and Standard and Poors.
They are designed to show the financial strength of an
institution but can also be applied to governments, funds
and other areas.
