Chapter 9: FCA Principles and outcome-based regulation Flashcards
9.1: FCA Principles for Businesses (PRIN)
NUMBER OF QUESTIONS 7/100
9.1.1: The Principles
The FCA Principles for Business are expressed as 11 ‘general statements’. They outline the regulatory obligations of authorised individuals, firms, and markets. These high-level standards are applicable regardless of whether rules and procedures are in place for a particular situation.
All authorised firms must comply with these, and be ready, willing, and organised to abide by them at all
times. In the event of a conflict between FCA rules and FCA principles, the principles will take precedence.
The Principles, which confirm what a firm must do in 11 separate areas are:
1) Integrity
• conduct its business with integrity
2) Skill, care and diligence
• conduct its business with due skill, care and diligence
3) Management and control
• take reasonable care to organise its affairs responsibly and efficiently, with adequate risk-management systems
4) Financial Prudence
•maintain adequate financial resources
5) Market Conduct
• observe proper standards of market conduct
6) Customers’ interests
• pay due regard to the interests of its customers, and treat them fairly
7) Communications with customers
• pay due regard to the information needs of its clients, and communicate information to them in a way which is clear, fair, and not misleading
8) Conflicts of interest
• manage conflicts of interest fairly, both between itself and its customers, and between a customer and another client
9) Customers: Relationship of trust
• take reasonable care to ensure suitability of its advice and discretionary decisions for any customer who is entitled to rely upon its judgement
10) Clients assets
• arrange adequate protection for clients’ assets when it is responsible for them
11) Relationship with regulators
• deal with its regulators in an open and co-operative way, and disclose to the appropriate regulator anything relating to the firm of which that regulator would reasonably expect notice
You must know these principles for your RO1 exam, and be able to recognise which is Principle 1, 2 etc.
There are likely to be quite a few questions on these principles plus APER which are the principles for approved persons.
The Principles in practise
One way to help remember the principles is to think of what their real-world application is.
EG. principles that tend to come up most in real world:
Principle 1: Integrity
• Think about how an adviser might show integrity.
•One example would be where you are talking to a client who insists on a course of action that goes against your recommendations.
•The PFS guidance on this is to walk away if you don’t believe it is in the best interests of the client.
Principle 2: Skill, care and diligence
• A key point here is ‘competencies’, and having the right people in the right place.
• There is a requirement for a complaints-handler to be competent, but they do not need to have set qualifications.
• They show due skill, care and diligence through their actions, rather than by having qualifications.
Principle 3: Management and control
• This is all about governance.
• A firm could demonstrate this, for example, by having proportionate, risk-based T&C or file-checking processes.
Principle 6: Customers’ interests
• A good example of acting in customers’ interests would be abiding by the six TCF principles.
• Culture should come from the top’ to help ensure good customer outcomes.
Principle 7: Communications with customers
• A key element of this is ensuring communications are appropriately targeted.
•One example would be where a leaflet is left in a vet’s surgery; a UCIS leaflet would probably be inappropriate, but a pet insurance leaflet would definitely be appropriate.
Principle 9: Customers: Relationship of trust
• The industry has seen various ‘mis-selling scandals’ which negatively impact this relationship of trust.
• Good practice examples should be found in client files, where we should be able to see evidence of clear objectives, affordability, attitude to risk, capacity for loss, etc
If a firm knows or suspects that there have been any breaches of these Principles by an individual or the
firm itself, the compliance officer must inform the FCA.
A breach of principles is deemed so serious that it is one of the examples where immediate regulator notification must take place (and big fines are likely to follow!)
The firm must then implement appropriate remedial action to prevent any similar, future breaches of these Principles. Non-compliance with the Principles may also lead to a breach of Threshold Condition 5 (Suitability) and call into question whether the individual, firm, or market remains fit and proper. This is an extremely serious regulatory situation and could lead to the removal of Part 4a permission.
The FCAs Principles for Businesses and Principles for Approved Persons are founded on ethics. One of the definitions of Ethics is determining a moral course of action’. ‘Integrity’ found in Principle 1 is a good example of a’ moral course of action’.
KEYFACT
A breach of the Principles is likely to result in disciplinary action.
This will be taken by the FCA against the authorised firm.
9.1.2: Principles-based regulation
It would be almost impossible to create a rulebook that covered every situation encountered by every business, firm, or individual. Instead, the FCA focussed their emphasis on encouraging the general types of behaviour required from its regulated individuals, firms, and markets: hence the 11 Principles.
That is what is meant by ‘Principles-based regulation’ (PBR).
The FCA decided PBR was not sufficient and a further regulatory approach known as Intensive Supervision
was born, with the aim of providing outcomes-based regulation.
9.1.3: Outcomes-based regulation (OBR)
This encompasses judging what might happen in the future, rather than acting solely on tangible evidence.
It is another sign of pro-activity from the regulator: where they are trying to make forward-looking judgements.
KEYFACT
A desired characteristic of both the FCA and PRA is to make ‘forward-looking judgements’.
This means that they are aiming to spot risks before they are a reality.
When the FCA was formed, one of its key new characteristics was to be ‘forward-looking’.
The FCA puts the emphasis on supervisors making joined-up assessments of risk. This underpins Intensive
Supervision and the Supervisory Enhancement Programme (SEP). The supervisor’s role is to integrate and analyse any firm-specific risks, which involves analysis of both conduct and prudential information.
One of the FCA’s priorities in supervising individuals, firms, and markets is to ensure consumers are at the
centre of their business. Their aim is to deliver a sustainable programme of supervision with a market-based approach, rather than just concentrating on individual firms. Their role is to tackle risks before they cause harm.
The FCA, as a result, make risk-based judgements about whether the firm’s business model, and how it is run, results in fair treatment for consumers, and that it upholds market integrity and, for the firms that the FCA prudentially regulate, that they are financially sound. Ultimately, senior management are responsible for compliance with the FCA’s outcomes-based regulatory
regime.
The Principles SUMMARY
There are 11 Principles for Business
- Compliance with these, indicates that an individual, firm, or market is deemed ‘fit and proper’
- This is required in order to obtain, and to retain, Part 4a permission
- These are what ‘principles-based regulation is built around
- Current regulatory thinking has moved on to an ‘outcomes-based approach
- This means both the FCA and PRA are looking to spot risks before they become a major issue
- This is part of the characteristic of ‘making forward-looking judgements that both regulators have
9.2: Corporate culture and leadership
What is culture in a regulatory environment?
Culture is defined as the typical, habitual behaviours and mindsets that characterise a particular organisation. The behaviours are the ‘way things get done around here’; they are the way that we act, speak and make decisions, without thinking consciously about it.
Sitting underneath these behaviours are habits and mindsets; the beliefs or values that people feel are
important. The outside world can’t see these mindsets, but they are main determinant of behaviour, from the trading floor to the Board.
How easy is changing culture?
Changing culture is very difficult and takes time, mainly because culture comes from the past.
CEOs, boards, programmes, systems and controls come and go regularly. Mindsets are developed and reinforced over years, even decades, and are passed down from one generation to the next. Indeed, the types of people who are attracted to and thrive in any one culture are those whose have the mindsets best suited to success in that culture.
As a result, culture is remarkably resilient in the face of attempts to change it; it takes focus, consistency and time to effect change.
9.2.1: Key cultural drivers
The regulator view is that there are six key cultural drivers:
• Leadership • Reward • Strategy
• Decision making and challenge • Recruitment and T&C
• Controls
The FCA has stated that, in their view, these drivers are likely to influence the behaviours of management and staff.
The planned-for outcome is that, as a consequence, they have a positive influence on customer outcomes.
The FCA approach is now to draw conclusions about culture from what is observed about an individual, firm, or market.
This can be through a range of different measures.
Examples are:
• how a firm responds to, and deals with, regulatory issues
- feedback from customers in relation to what they are actually experiencing when they buy a product or service from front-line staff
- the manner in which decisions are made or escalated
- …and even the remuneration structures.
9.2.2: Positive and contra indicators
For each of the key cultural drivers, there are both ‘positive’ and ‘contra’ indicators:
Leadership - Senior management must give middle-management direction and monitor this.
Positive indicators
• Fair treatment of customers is central to behaviour
• Senior management advocate this message and apply
adequate controls and monitoring to ensure it happens
Contra Indicators
• Management cannot explain and do not communicate what consumer-protection means
• Staff do not understand what these concepts mean
Strategy - Senior management must allocate time and resource to deliver, even when focused on other priorities.
Positive indicators
• The firm has a clear vision that supports the fair treatment of customers
• This is reflected in decision making
• The firm’s risk appetite reflects customer considerations i.e. the types of business carried out, the types of client advised
Contra Indicators
• A firm’s vision is unclear and contradicts consumer protection
• It does not consider such issues when making key decisions about future direction
• Market integrity is not ‘on its radar
Decision-making and challenge - Policies or procedures must receive enough challenge.
A formal process with this aim needs to be in place.
The environment must be receptive to challenge by
employees or consumers.
Positive indicators
• Decision-making reflects the fair treatment of customers
• The firm uses feedback where appropriate: from a variety of sources, including staff and customers
• There is a balance of interest between shareholders and customers
Contra Indicators
• Decision-making does not consider impact on consumers or markets
• Firms are slow to react to feedback from employees and consumers
• Conflicts are often inappropriately resolved in favour of shareholder and staff members
Controls - Firms must identify, collect, interpret, and use relevant management information (MI) to monitor and
demonstrate TCF.
Positive indicators
• Controls and MI are in place to demonstrate the fair treatment of customers
• They are a key part of the firm’s risk framework
Contra Indicators
Contra Indicators
• Consumer protection or market integrity cannot be evidenced through controls in place
• There is minimal MI
• Mi is not used to improve consumer outcomes or market integrity
Recruitment and TC - Plans that manage performance must include role objectives for the individual and clearly set out the behaviours and actions expected to reflect the firm’s TC strategy
Positive indicators
• The selection of staff is based on TCF
• Training targets the values of the firm
• Performance management is used to drive-up standards, identifying and acting on poor behaviours
Contra Indicators
• There are inadequate arrangements in place for the
recruitment, training and regular competency assessment of staff
• The impact of this on consumer outcomes is not appreciated
• Poor performance is accepted
Reward Firm incentive schemes must not heavily emphasise a target-driven approach, associated with increasing profit and income, reducing
costs or growing the business. The fair treatment
of customers must be a key driver in reward schemes.
Positive indicators
• The firm’s reward and remuneration framework is
transparent
• It also supports TCF
Contra Indicators
• The firm’s reward and remuneration framework
concentrates on sales, volume and profit
• Quality is not a measure
• There is a lack of controls to mitigate the risks that can arise from such an approach
Good practice ↑ Demonstrating a commitment to TCF Implementing strong TCF leadership Maintaining high standards of TCF Listening to and acting on staff feedback
Bad Practise ↓
Failing to identify the meaning of TCF
Inappropriately delegating TCF
Ineffective communication
Producing outcomes inconsistent with the strategy
Failing to identify and deal with TCF risks
Corporate culture and leadership SUMMARY
- There are several key cultural drivers in a firm that affect how things are done
- These include; leadership, strategy, decision-making, controls, recruitment, and reward
- All affect whether clients are treated fairly
- The’ tone at the top’ reflects the way such behaviours cascade down from senior management
- ‘Walking the talk’ translates words into actions
9.3: Main regulatory obligations for an individual
We now turn our focus away from firms and on to approved persons.
No matter how TCF-driven a firm is, the actions of individuals can undermine it.
Therefore, individuals can be held to account for breaching the Statements of Principle for Approved
Persons (APER).
KEYFACT
Remember, an approved person is someone who is carrying out a controlled function.
These are individuals carrying out a significant role within the authorised person (the individual, firm, or market, with direct regulator authorisation).
An approved person must be individually authorised by the regulator. This is carried out through the submission of a ‘CF’ form, of which there are a fair few, due to the fact that there are different types of approved person.
Five categories of approved person:
• Governing functions
Often directors, chief executives, partners. Senior employees basically
• Required functions
Money laundering reporting, CASS rules, submissions to FCA, and compliance to name a few.
• Systems and control functions
Anything to do with systems and controls.
•Significant management functions
Senior management or key roles but non-executive.
•Customer dealing functions
Any role that involves customer interaction.
Regulatory obligations for an individual CONT..
When we looked at the FCA Handbook Block 1 we mentioned ‘APER’
The Code of Practice for Approved Persons helps individuals comply with the Principles by providing examples of adverse behaviours.
Effectively they can see ‘what good looks like’ by looking at ‘what bad looks like’.
APER only applies to a person performing a controlled function for which approval had been sought and granted.
KEYFACT
An individual classed as a controlled function is…
individually approved by and registered with the relevant regulator.
9.3.1: Approved Persons Principles
There are seven principles in total that can apply to anyone classed as an approved person.
The first four apply to all approved persons and the final three also apply to Significant Influence Functions’.
These are individuals carrying out an accountable higher management function or any PRA controlled function.
This means that the position they hold allows them to exercise significant influence on the conduct of an authorised firm’s affairs, in relation to their regulated activities.
Significant Influence Functions (SIFs) are sub-divided into categories, including governing functions, which cover directors, non-executive directors, and the chief executive of an authorised person.
FSMA 2000 gives both the FCA and PRA powers and responsibilities over individuals categorised as a controlled function carrying out certain roles within an authorised person.
9.3.1: Approved Persons Principles CONT…
The following is a list of the Principles again, showing which apply to SIFs, with some contra-indicators:
Principles for all approved persons: 1: Integrity • Deliberately misleading customers • Deliberately recommending unsuitable products • Deliberate manipulation of records
2: Skill, care and diligence
• Recommending products without due consideration of the customer’s risk appetite
• Undertaking transactions without consideration of the risks to the firm
3: Market conduct
• Failure to comply with the Code of Market Conduct
4: Open and co-operative
• Failure to report issues that affect the firm
• Failure to supply a regulator with material information
5: Organisation and control
• Failure to take reasonable steps for all areas of the business under control
• Failure to take responsibility or delegate it appropriately
6: Skill, care and diligence in managing
• Failure to inform themselves of the affairs of the business (not keeping themselves up to date)
• Failure to supervise or monitor sufficiently
7: Compliance
• Failure to put in place adequate systems to control risk
• Failure to monitor risks
• Failure to review systems and controls
The code also contains general factors which the FCA feel determine whether an approved person’s conduct
complies with a certain Principle.
9.3.2: The Fit and Proper test
Fit and proper tests for approved persons (FIT) must also be passed. Typically, these are assessed when the individual joins the authorised person and then annually.
There are three key elements which could bring an approved person’s status ‘into doubt’:
Honesty, integrity and reputation
• Any criminal, civil or disciplinary proceeds
Competence and capacity
• Failure to pass exams or tests or demonstrate an inability to fulfil the regulatory requirements of the role
Financial soundness
•Any adverse credit history
For senior managers, a firm must maintain a clear, appropriate and recorded appointment of significant
responsibilities.
A firm must also have appropriate systems and controls, which was mentioned in a previous chapter, plus an effective compliance system, headed up by a director or senior manager.
The FCA may take disciplinary action against anyone who neglects or ignores their regulatory responsibilities. This could result in fines, loss of job or in extreme cases, the permanent removal of approved person status. If a firm believes that a person is no longer fit and proper, then they must inform the FCA immediately.
Remember, an individual must be and remain fit and proper for their function.
9.3.3: Conflicts of interest
Firms often perceive conflicts of interest in too narrow a way, or they assume it solely relates to issues around remuneration.
What is the definition of a conflict of interest?
There are many definitions: a couple of which we have highlighted for you next.
“A situation in which a person is in a position to derive personal benefit from actions or decisions made in their official capacity’.
“A conflict of interest is a situation in which a person or organisation is involved in multiple interests, financial or otherwise, one of which could possibly corrupt the motivation or decision-making of that individual or organisation”
Firms need to ensure that any conflicts do not affect their ability to fulfil their TCF requirements.
What should a firm’s conflicts policy contain?
It should cover off areas including:
- How to mitigate any identified conflicts
- Individuals accountable for identification and managements of conflicts
- Policy and guidance for staff
9.3.4: New Banking and Insurance sector regulator rules
There are two sectors of the market that are subject to some additional new rules:
• The Senior Managers and Certification Regime. This applies to the banking sector.
• The Senior Insurance Managers Regime. This applies to the insurance sector.
Both sets of rules concentrate on increasing individual accountability in the banking and insurance sector.
Senior Managers and Certification Regime
The rules make it easier for firms and regulators to be clear about who is responsible for what.
Who do these rules apply to? The rules apply to: • Banks and Building Societies • Credit unions • Investment and foreign banks operating in the UK
What are the key features of these rules?
These rules can be categorised into five areas:
- A senior managers regime
- A certification regime
- Additional conduct rules
- Remuneration
- Whistleblowing
They include details such as:
Senior Managers Regime
• Each must have a Statement of Responsibilities
•Setting out areas of personal responsibility
•There must be a Firm Responsibilities Map bringing these together
Certification Regime
• Applies to material risk takers
• This is any person subject to the Dual Regulated Firms Remuneration Code
•Plus anyone whose poses a risk of significant harm to a firm or its customers
Conduct Rules
New high level rules applicable to most staff
•Staff must be aware of these new rules
•and how they apply to them in their role
New Banking and Insurance sector regulator rules CONT…
The regulators are planning to extend this Regime to all FSMA authorised firms from 2018.
So, what rules apply to the insurance sector?
Senior Insurance Managers Regime
These rules came into effect on 7th March 2016.
The rules on the Approved Persons Regime for Insurers take into account:
• Requirements in ‘Solvency II’ on firms’ governance, and fitness and propriety of key individuals within them
• Provisions in the Financial Services (Banking Reform) Act 2013 that apply to insurers
• Changes that the PRA are making to their approval regime for these firms
The rules apply to: • Insurers and reinsurers • Lloyds of London • Managing agents • Approved persons working within these firms
What are the key features of these rules?
These rules can be categorised into five areas which include, amongst others, governance maps, scope of responsibilities and new conduct rules
Again, regulators are planning to extend this new Regime to all FSMA authorised firms as early as from 2018.
They include elements such as:
Governance maps
• One for each entity
• Setting out the management structure and allocation of responsibilities
Scope of responsibilities
• Applies to PRA senior insurance management functions (SIMFs) and FCA significant influence functions (SIFs)
Conduct Rules
• New high level rules for all approved persons
Main regulatory obligations for an individual Summary
- There are an additional 7 Principles for any individual carrying out a controlled function
- Four of these Principles apply across the board
- A further three apply as well to anyone carrying out a significant influence function such as senior managers (classed as a SIF)
- An approved person must be, and must remain, fit and proper
- This must be checked by the authorised person at least annually
- The responsibility for identifying and managing conflict risks lies with senior management
- Such risks must not affect a firm’s ability to Treat Customers Fairly
- Additional rules for both the banking and insurance sectors were introduced in 2016
Chapter 9: FCA Principles and outcome-based regulation SUMMARY
In this chapter, we have looked at the following areas:
FCA Principles of Business
• There are 11 Principles that apply
• In the event of a conflict between FCA rules and FCA principles, then it is the Principles that win
• This is due to the fact that it is not possible to draft rules to cover every situation or scenario
Principles Based Regulation (PBR)
• The FCA focuses on the Principles set out in the FSMA 2000
• Failure to apply the Principles alone can be enough reason for the FCA to take enforcement action
Outcomes Based Regulation
• Added after the recent financial crisis
• More forward-looking than PBR and involves making judgements on what might happen in the future, rather than what has happened
Corporate Culture and Leadership
• 6 cultural drivers are listed, with examples of good practice
• Leadership sets the tone for the culture of an organisation
• TCF is cited as a key variable
The Statements of Principle for Approved Persons
• 7 listed Principles
• The first 4 are for all categories of Approved Person
• The final 3 for apply in addition to the first 4, to those with significant influence functions (SIFS)
Code of Practice for Approved Persons
• Provides examples of when the Principles may be judged as having been missed
Fit and Proper Test for Approved Persons
• Must maintain honesty, integrity and reputation, competence and capability, and financial soundness to be classified as fit and proper
• The FCA must be informed of any individual that a firm assesses as not being fit and proper
Conflicts of interest
• A formal policy must be in place
• The policy must be controlled by a board member or
member of the senior management team
The Senior Managers and Certification Regime
• Regulator rules affecting the banking sector
• Putting in place rules that increase individual accountability
• And improve professional standards and culture within this sector
The Senior Insurance Managers Regime
• Regulator rules affecting the insurance sector
• Putting in place rules that increase individual accountability
• Aiming to improve governance of these firms
• And the fitness of key function holders within them
