PRA RULEBOOK AND FCA HANDBOOK OF RULES AND GUIDANCE Flashcards
FINANCIAL POLICY COMMITTEE (FPC)
Part of the Bank of England and responsible for macroprudential regulation, or regulation of the stability and resilience of the financial system as a whole.
What is the FCA’s strategic objective?
To ensure financial markets function well.
FCA Operational objectives?
- secure an appropriate degree of protection for consumers
- to ensure the effective competition in the interests of consumers
- protect and enhance the integrity of the UK financial system
FCA key priorities for the strategic objective
- renewed focus on wholesale conduct
- trust in the integrity of markets
- preventing market abuse
What does the FCA define enforcement as a regulatory tool?
a ‘credible deterrence’
Selecting cases to enforce against to send a strong and clear message to other firms not to engage in wrongful activity
The FCA’s integrity objective
Includes within it the ‘soundness, stability and resilience’ of the UK financial system.
They expect firms to operate high standards in their risk management, having procedures in place to ensure continuity of critical services.
Firms are required to comply with standards for resilience and recovery
Judgement based supervision work
The FCA needs strong, relevant skills and experience.
Conduct regulation requires a different skill set.
Supervisors will mean that supervisors conduct in-depth and structured supervisory work on those firms with great potential to cause risk to consumers, market integrity or competition.
Objectives of security an appropriate degree of protection for consumers
The aim’s and objectives are to:
- ensure customers are treated in a way that is appropriate for their level of financial knowledge
- be more outward-looking, by engaging more with consumers and understanding more about their concerns
- set clear expectations for firms and be clear about what they can expect from the FCA
- intervene early to tackle potential risks to consumers before they occur
- maintain a strategy of ‘credible deterrence’ including intervening earlier and holding individuals to account
Protecting and enhancing the integrity of the UK Financial System
Support a healthy and successful financial system, where financial markets are efficient and transparent.
The markets need to be supported by appropriate infrastructure, access and transparency to meet the needs of customers.
To achieve this, they seek to ensure that:
- senior management is accountable for their firm’s activities, including agency and principal responsibilities
- positive culture of identifying and managing conflicts of interest
- orderly resolution and return of client assets
- firms’ business models, activities, controls and behaviours maintain trust in the integrity of markets and do not allow market abuse
- market efficiency, cleanliness and resilience are delivered through transparency, surveillance and supervision of infrastructure
- firms acting as agents on behalf of their clients put best interests at the heart of their business
- early intervention in wholesale markets to mitigate the risk of harm being transmitted to retail consumers
The wide range of market failures
- unilateral market power
- barriers to entry and expansion
- coordinated conduct by firms
- vertical relationships
- weak customer response
- principal-agent problems
What is the FCA responsible for?
- conduct regulation of all firms covering dealings with retail customers, regulating around 50,000 in total including those supervised by the PRA
- prudential supervision of firms not supervised by the PRA (around 48,000)
- supervision of trading infrastructure including the investment exchanges and over the counter markets
- investigating and prosecuting insider dealing
- acting as the UK Listing Authority
- overseeing the FOS and the FSCS (jointly with the PRA)
What is the role of the FCA Policy, Risk and Research Division?
it acts as the radar of the organisation, combining research into what is happening in the market and to consumers with better analysis of the types of risk and where they appear
- It identifies and assesses risks to consumers, firms and markets - both emerging and current
- creates a common view of the risks in financial markets to inform - - the FCA’s authorisation, supervision and enforcement decisions
uses the knowledge of these risks to make evidence-based policy
It brings the information gathering, analysis and research into one place.
PRA’s 8 Fundamental Rules
- conduct business with integrity
- conduct business with due skill, care and diligence
- act in a prudent manner
- maintain adequate financial resources at all times
- have effective risk management strategies
- organise and control affairs responsibly and effectively
- deal with regulators in an open and cooperative way
- prepare for resolution so, if the need arises, it can be resolved in an orderly manner
key difference between the PRA statutory objectives and fundamental rules
How does the FCA achieve statutory objectives?
- seeking to ensure that any firms that fail, do so in a way that avoids significant disruption to the supply of critical services
- emphasizing resolution planning to permit orderly failure
- cooperating closely with the FPC and the FCA to ensure macro and microprudential regulation is aligned across the markets
- working with the FCA and others to ensure the UK authorities have a strong global voice
The FCA focuses on material issues when engaging with firms
The approach is based on the judgement of its staff
PRA developed a risk framework, capturing three elements
- potential impact a firm could have on financial stability in the UK
- how the external context in which a firm operates, and the business risks it faces might affect the viability of the firm
- mitigating factors including: a firm’s management and governance and its risk management and controls; its financial strength, specifically capital and liquidity
Enforcement Powers
PRA’s preference is to use powers to secure remedial action, given its approach to intervening early to address emerging risks.
But the PRA has the authority to impose financial penalties and public censures in cases where sanctions are inappropriate.
Also has powers when directions or restrictions are ignored by the firm.
How does the PRA deploy its disciplinary powers?
- reinforces the PRA’s objectives and priorities
- promoting high standards of regulatory behaviour
- the need to send a clear signal to a firm about the circumstances in which the PRA considers a firm’s behaviour
- deterring future misconduct
Role of the Enforcement Decision Making Committee
Role of the Enforcement Decision Making Committee is a committee of the Bank of England.
Helps the BoE discharge its responsibilities and strengthen enforcement process by ensuring that there is a functional seperation between investigation teams and decision makers in contested enforcement cases
Members of the EMDC will be independent of the BoE’s executive team
PRA Approach to supervision
Relies significantly on judgement
Supervises firms to judge whether they are safe and sound, whether they meet the threshold conditions.
Has a statutory objective to promote the safety and soundness of firms
- does this by seeking to avoid adverse effects on financial stability
seeking to avoid adverse effects resulting from disruption to the continuity of financial services that can be caused by the way firms run their business
PRA Key Objective
Focusing on issues and the firms that pose the greatest risk to the stability of the UK financial system
Does not operate a ‘no-fail’ regime
Who sits on the PRA board?
Governor of the Bank of England
Deputy governor for financial stability
Deputy governor for Markets and Banking
CEO of the PRA
independent non-executives of the board
FCA Approach to Supervision
Supervision is the continuing oversight of regulated firms and individuals controlling these firms to reduce actual and potential harm to consumers and markets
FCA adopts a ‘pre-emptive’ approach based on making forward looking judgements about firms business models, product strategy and how they run their business.
supervision contributes to the delivery of the statutory objective to protect and enhance the integrity of the UK financial system
The FCA has responsibilities for prudential supervision, its focus will be on the reduction of impacts to customers and the integrity of the financial system where firms fail
The FCA’s supervisory principals
protect consumers
promote competition
enhance market integrity
The FCA’s Principles for Business
Forward Looking
- pre empt poor conduct so that the risk does not crystallise
Focus on strategy and business models
- assessment on firm’s business models and strategies to identify emerging risk of harm
Focus on culture and governance
- assess the drivers of behaviour within firms
Focus on individuals as well as firm accountability
Proportionate and risk based
Two way communication
Coordinated
- FCA supervision teams work closely with other FCA departments
Put right systematic harm that has occurred and prevent it from happening again
FCA Supervision model
Proactive
- preventative work through conduct assessment of firms
PRESCRIBED RESPONSIBLITIES for CORE AND ENHANCED FIRMS
HANDBOOK PR REF
- Performance of obligations under SMR
- Performance of obligations under the Certification Regime
- Performance of obligations and training of the CONDUCT RULES
- Responsible for the firm’s policies and procedures for countering the risk that firms might be used to further financial crime
PRESCRIBED RESPONSIBILITIES FOR ENHANCED FIRMS
- Performance of obligations under SMR
- Performance of obligations under the Certification Regime
- Performance of obligations and training of the CONDUCT RULES
- Responsible for the firm’s policies and procedures for countering the risk that firms might be used to further financial crime
- Compliance with the Responsibilities Map
- Safeguarding and overseeing the independence of the Independent Audit function
- Safeguarding and overseeing the independence of the Risk function
- Ensuring the internal audit function is independent and everyone involved is independent
- Developing the firm’s business model
- Managing the firm’s internal stress tests and ensuring the accuracy and timeliness of the firm’s information
Outline the application of SM&CR to Benchmark Administrators
applied in 2020 for benchmark administrators that do not perform any other regulated activity
They are automatically subject to CORE SM&CR
Prescribed functions
SMF 1 - Chief Executive function
SMF 3 - Executive director
SMF 9 - Chairman positions
SMF 27 - Partner
As the firms are subject to UK BMR - they do not require the SMF16 and SMF 17 role
Three prescribed responsibilities
- Performance of the firm’s obligations under SMR
- Performance of the firm’s obligations regarding notifications and training of CONDUCT RULES
- Responsibility for the firm’s policies and procedures
Has not applied certification regime to these administrators
Some might be limited scope and then only require SMF29 - Senior Manager
CONDUCT RULES APPLY
How to outline RESPONSIBILITY MAPS
Only apply to enhanced firms under SM&CR
They are used to map governance and individual accountability for roles
- they ensure there are no gaps in accountability for individuals
- assigns each responsibility
firms must explain why a role might be shared jointly as they are only allowed in specific circumstances
What are Statements of Responsibilities?
firms must provide statements of responsibilities and they MUST be approved by the regulators
they outline which areas/maps of the business that senior managers are responsible for
they are used by the regulator when there has been a breach
individuals must sign them
DUTY OF RESPONSIBILITY
the ‘burden of proof’ that regulators must have sufficient evidence before bringing an SMF on proceedings
u-turn after FINANCIAL SERVICES ACT 2016 - burden of proof shifted to regulators rather than individuals to prove an individual did not take appropriate steps to avoid a firm’s contravention occurring
What are the Consumer Duty implications for ‘SENIOR MANAGERS’ ?
From 31 July 2023 - FCA consumer duty implementation date.
- CD should be reflected in policies, governance, leadership and people policies
- Senior Managers should ensure that firm’s have appropriate oversight of customer outcomes through systems and controls
- Risk functions should pay attention to consumer risks for internal audit
- Senior managers will be held accountable for ‘good consumer outcomes’
- Must appoint the CONSUMER DUTY CHAMPION at board level
FINMAR SOURCEBOOK
Introduced in 2010 following Financial Services Act 2010
- Financial Stability information power - person has to provide information relevant to the stability of the UK financial system
- Overseas financial stability information power - exercisable at the request of an overseas regulator to require a person to provide information relevant to the stability of the financial system of the country
SHORT SELLING REGULATION (SSR)
EU Short Selling Regulation 236/2012 applies to EU member states
It covers - sovereign debt, sovereign credit default swaps listed for trading on an EU trading venue including MTFs
The location does not matter, a person in a third country selling is covered by the regulation
Brexit UK firms must comply with UK SSR
KEY ELEMENTS
- transparency requirements for short positions in shares and sovereign debt
- Restrictions on uncovered short sales in shares, sovereign debt and sovereign CDs
- Central counterparty procedures to deal with settlement failure
- emergency measures that must be taken in exceptional circumstances
DISCLOSURE REQUIREMENTS OF THE SHORT SELLING REGIME
Requires
- Short positions in equities to be disclosed to the regulator where they reach or fall below 0.1% of the issued share capital of the company. Short positions reaching 0.5% of the issued share capital need to be disclosed to the market.
- Short positions in sovereign debt above thresholds need to be reported to the regulator. where the outstanding amount is 500 billion or less, the thresholds are 0.1% then each 0.5%
if sovereign debt is above 500 billion the thresholds are 0.5% and then 0.25%
What are the restrictions on uncovered short selling?
UNCOVERED SHORT SELLING is selling a security when you do not own it.
Person may enter into uncovered short selling only if if they have
- pre-borrowed the security
- entered into an agreement to borrow the security
- made arrangements with a third party to ensure the security will be available for settlement
- the market making exeption
Uncovered short positions in sovereign Credit Default Swaps are not permitted
SYSC 7 RISK CONTROL
Common platform firms must implement and maintain adequate risk management policies and procedures.
Firms must adopt effective arrangements processes and mechanisms to manage the risk
Senior managers in a firm must approve and review the strategies and policies for taking up and monitoring the risks the firm might be exposed to
- adequacy and effectiveness of the firm’s risk management policies and procedures
- level of compliance and relevant persons with the arrangements, processes and mechanisms
- the adequancy and effectiveness of measures taken to address deficiencies in the policies
SYSC 7 RISK
RESIDUAL RISK
MATERIAL RISK
INTEREST RATE RISK
OPERATIONAL RISK
SYSC 8 OUTSOURCING
Firms which rely on third parties to perform operational functions which are critical for their adherence to regulatory obligations must ensure they review and monitor the performance of the third party
The firm will still be held accountable by the FCA/PRA for its performance. It is the firm’s best interests to monitor the performance of third party against SLAs
Firms must take steps to avoid undue operational risk and not undertake the outsourcing of important functions that impair internal control and the ability of the regulator to monitor the firm’s compliance with obligations under the system.
A function is regarded as critical if a defect or failure would impact the compliance of a common platform firm with the conditions and obligations of its authorisation
SYSC 8 OUTSOURCING FUNCTIONS - What functions are not considered as critical?
Provision of advisory services which do not form part of the relevant services including provision of legal advice
Purchase of services such as market information services and price feeds
recording and retention of relevant telephone conversations
SYSC 8 OUTSOURCING - What must firms comply with?
- Outsourcing must not result in the delegation by senior personnel of their responsibility
- Relationship and obligations of the firm under the regulatory system must not be altered
- The conditions the firm must comply with to be authorised must not be compromised
- None of the conditions subject to the firm’s authorisation must be altered
What steps must firms take to ensure firms comply with SYSC 8 Outsourcing?
- the service provider must have the ability, capacity and any authorisation required by law
- service provider must carry out the outsourced services effectively
- service provider must supervise the carrying out of the outsourced functions and manage the risks
- action must be taken if the service provider is not carrying out the functions effectively
- firm must retain the expertise to supervise the outsourced functions effectively
- Service provider must disclose to firms any changes that might impact the ability to carry out the outsourced functions effectively
- The firm must be able to terminate the agreement for outsourcing if necessary
- The service provider must cooperate with the regulator and any other competent authority in connection with the outsourced activities
- The firm and the regulator/any other competent authority must have effective data related to the outsourced activities
- Service provider must protect any confidential information relating to the firm and its clients
- the firm and the service provider must create disaster recovery plans
Record keeping
MiFID business must be held for five years
SYSC 10 - CONFLICTS OF INTEREST
Firms must take all steps to identify, prevent and mitigate conflicts of interest when they arise. Principle 8 of the FCA Principles
The rules in SYSC apply to common platform firms in respect of regulated business and ancillary activities that constitute MiFID business and non-MiFID business
firms need to take steps to identify, prevent and manage conflicts of interest between:
- the firm, including the managers, employees, appointed representatives
- one client of a firm and another
firms should
- employ and apply effective organisational arrangements to prevent conflicts of interest from occurring
- have appropriate information barriers - chinese walls
- ensure the general or nature of the conflict which cannot be prevented is disclosed
- prepare and maintain an effective CoI policy
- provide retail and professional clients with this policy
- have a segregation of duties
- policy of independence
common platform firms must keep and update a record of the kinds of services or activity carried out by or behalf of the firm which a conflict of interest entailing a material risk has arisen
Potential conflicts of interest
When a person directly or indirectly linked by control to the firm
- is likely to make a financial gain or avoid a financial loss
- has an interest in the outcome of a service provided to the client
- has a financial incentive to favour the interest of another client or group
- carries out the same business as the client
- receives or may receive an inducement in relation to a service provided by the client
for non-common platform firms - not subject to UK CRR/CRD or MiFID - must take it as guidance or a rule
How should firms manage conflicts of interest?
- Information barriers
- delegation of responsibilities
- Renumeration structures
- policy of independence
They must:
- be designed to ensure that relevant persons engaged in different activities involving a conflict of interest carry the role at a level of independence
- include effective procedures to prevent or control the exchange of information between relevant parties engaged in activities involving a risk of conflict of interest
- seperate supervision of relevant persons whose principal functions may conflict or represent different interests that may conflict those of the firm
- removal of link of any direct link between the remuneration of relevant persons engaged in one activity and the remuneration of revenues generated by different relevant persons
- measures to prevent a person exercising inappropriate influence over the way a relevant person carries out activities
Outline the function of CHINESE WALLS and how they should be structured as effective?
If a firm establishes and maintains information barriers it must:
- withhold or not use the information held
- permit its employees in one part of the business to withhold the information from those employed in another part of the business - one parts of the business is carrying on regulated activities or another activity carried on in connection with a regulated activity
- take reasonable steps to ensure that these arrangements remain effective and are monitored
EXAMPLE - corporate finance section of the company is separated from the research function
Disclosure must be made in a durable medium and include sufficient detail taking into account the nature of the client to allow them to take an informed decision with respect to the service
overdisclosure without adequate consideration as to how the conflict of interest could be mitigated is not permitted
Disclosures must be taken as a LAST RESORT
REMUNATION SYSC 19B - what is the objective?
To sustain market confidence and promote financial stability by removing the incentive for inappropriate risk-taking by firms.
Remuneration policies and practices are consistent with and promote effective risk management
The code limits the risk of damage to the UK’s competitiveness
The objective of the remuneration policy is to sustain market confidence and promote financial stability
The need to ensure that remuneration policies are consistent with and promote effective risk management
It applies to
- banks
- building societies
- UK designated investment firms
The regulators will seperate firms into three streams
1. HIGH IMPACT GROUPS - need to prepare a remuneration policy statement ahead of the financial year and have remuneration meeting with the PRA and the FCA may not be able to pay bonuses without agreement
- Medium high risk groups will have to prepare a reported that will be prepared as part of the risk assessment review
- Low impact firms will only need to prepare a report if part of a thematic review
WHAT ARE THE RENUMERATION PRINCIPLES?
Principle 1 - Risk management and risk tolerance
- Must ensure the policy is consistent with and promotes sound/effective risk management
Principle 2 - Supporting Business Strategy, Objectives, Values and Long-Term Interests of the Firm
Principle 3 - Avoiding conflicts of interest
Principle 4 Governance
- Must ensure the governing body in its supervisory function adopts and reviews the principles of the remuneration policy.
- The committee must be constituted to exercise competent and independent judgement over remuneration policies
- The remuneration committee must be responsible for the preperation of decisions regarding remuneration
Principal 5 CONTROL FUNCTIONS
- Employees enjoyed in control functions are
independent
have appropriate authority
remunerated to attract qualified and experienced staff
the procedures for setting remuneration input into setting the remuneration policy for other business areas. Risk and compliance functions should have significant input into the setting of individual remuneration
Principle 6 - Capital
Remuneration must not disallow a firm to limit the firm’s ability to strengthen its capital base
Principle 7 - Exceptional Government Intervention
A firm that benefits from exceptional government intervention must ensure variable remuneration is strictly limited as a percentage of net revenues when it is inconsistent with a sound capital base
Principle 8 - Profit based measurement and risk adjustment
Any measurement of performance used to calculate variable remuneration components takes into account the cost and quantity of capital and the liquidity required and the need for consistency with timing and likelihood of the firm receiving revenues incorporated into current earnings
Principle 9 - Pension Policy
Firm must ensure the pension strategy is in line with the business strategy, objectives, interests and values
Discretionary pension benefits are paid to the employee in the form of instruments and subject to a five year retention period.
PRINCIPAL 10 Personal Investment Strategies
Employees should not use personal hedging requirements or liability related contracts of insurance that would undermine the limiting risk of the remuneration policy
PRINCIPAL 11 - Avoidance of the remuneration code
Employees should ensure that remuneration is not paid through vehicles to avoid the remuneration code
PRINCIPAL 12 - REMUNERATION STRUCTURES
The purpose of this principle is to ensure that the structure of an employee’s remuneration is consistent with, and promotes, effective risk management.
- remuneration must be based upon the performance of the individual concerned
- Firms are only permitted to offer guaranteed variable remuneration in the first year of service
- Firms must set appropriate ratios of fixed versus guaranteed remuneration
- Firms must ensure that any variable remuneration, including a deferred portion, is paid or vests only if it is sustainable according to the financial situation of the firm as a whole
AIFM REM CODE SYSC 19B
AIFMS are required to establish, implement and maintain remuneration policies for code staff that are consistent with and promote sound and effective risk management, which do not encourage risk taking inconsistent with the risk profile of the AIFM they manage
Code staff comprise those who have a material impact on the risk profiles of the AIFM or AIFs the AIFMs manage
What are the AIFM REM CODE PRINCIPLES?
1 - Risk Management
2- Supporting Business Strategy, Objectives, Values and Interests
3 - Governance
4- Control Functions
5 (a) - Remuneration Structures - Performance
5 (b) - Remuneration Structures - Variable Remuneration
5 (c) - Rem structures - Ratio between fixed and variable components of total remuneration
5 (d) - Rem structures - payment related to early termination
5 (e) - Rem structures - retained units, shares or other instruments
5 (f) - Rem structures deferral
5 (g) Rem structures - Performance adjustments
6 - Measurement of performance
7 - Pension Policy
Dual Regulated Rem Code
The FCA Remuneration Code (19D) applies to dual-regulated firm within the scope of UK CRD/CRR that is banks, building societies and PRA designated firms.
The FCA adopted a proportionate approach to implementing the Remuneration Code including the CRD and CRR.
The code sets out the standards and policies that dual-regulated firms within the scope of UK CRD IV have to meet when setting pay and bonus awards
Firms are required to ensure that variable remuneration is only paid or allowed where sustainable and justified by performance, subject to clawback.
A balancing mechanism for firms to reduce, cancel or recover awards to the extend the awards are no longer justified by performance.
For dual-regulated firms, the FCA is responsible for all Remuneration Code requirements from a conduct perspective. For larger and most significant firms by balance sheet size, the FCA carries out an annual review of firms remuneration policies and practices. This is carried out jointly with the PRA
UCITS V Remuneration Code (SYSC 19E)
The UCITS provision include a principle of proportionality based on a similar overarching requirement that fund managers are required to comply
Same principles as AIFM Remuneration
MiFID Investment firms’ remuneration code sysc19g
On 1 January 2022 the UK MiFID Investment Firm Prudential rules came into effect
All MiFID Investment firms are subject to the same Remuneration Code
SNI will have to comply with basic remuneration requirements
Non-SNI firms with a balance sheet of less than £300 million would not have to apply deferral rules on variable remuneration.
Basic remuneration rules apply to all staff in firms
BASIC REMUNERATION REQUIREMENTS UNDER MIFIDPRU
The policy should set out how:
- How the firm aligns risk and reward - the appetite and strategy including ESG factors
- How the policy is proportionate to the size and complexity of the firm
- How the policy is gender neutral and in line with the Equality Act 2010
- The criteria on which remuneration is based, making sure there is appropriate balance between fixed and variable remuneration
STANDARD REMUNERATION UNDER MIFIDPRU
Non-SNI firms are subject to the ‘standard’ requirements in addition to the basic requirements
Non-SNI firms must apply the standard requirements to the ‘material risk takers’ and would not be compelled to apply them to any members of staff
EXTENDED REMUNERATION REQUIREMENTS
Establish a remuneration committee
Pay 50% of remuneration out in shares, instruments or alternative arrangements
Defer at least 40% of variable remuneration (or 60% where the remuneration is £500,000 or more) for at least three years
SYSC 12
GROUP RISK SYSTEMS AND CONTROL REQUIREMENTS
Firms are required to have appropriate risk management systems and internal control mechanisms for the purpose of assessing and managing their own group risk
SYSC 20
As part of the firm’s business planning and risk management obligations under SYSC, it should undertake reverse stress testing of its business plan
SYSC 21
Firms should appoint a chief risk officer and establish a risk committee
The chief risk officer would be accountable to the firm’s governing body for oversight of the firm-wide risk and be fully independent of business units. They should have sufficient authority and resources for the execution of their responsibilities, which will mean that there should be no restrictions on access to the business or data, or other information.
What should be included in a regulatory reference?
Attaining one
- must get the reference before certification
-best efforts to attain reg references for the past 6 years
Providing one
- include breaches of Conduct Rules
- update references that would affect reference given in the last six years
- make disclosure of the mandatory template provided
- do not enter an arrangement that limits the firm’s ability to disclose information
- includes breaches of Conduct Rules
Firms need to be careful when providing regulatory references where there may have been ‘alleged misconduct’ - references need to be
- fair and accurate
- contain all relevant information
- not be misleading
- be supported by document fact
- provide a complete picture of the individuals conduct record
- balance the competing interests
SYSC 23
SENIOR MANAGERS AND CERTIFICATION REGIME
Outline the Threshold Conditions
Represent the minimum conditions which a firm is required to satisfy and continue to satisfy to retain Part 4A permission
The COND Sourcebook gives guidance on the threshold conditions set out under Schedule 6 of FSMA
Under Section 41(2) of FSMA in giving or varying a Part 4A permission - the PRA/FCA must ensure the firm can or will continue to satisfy the threshold conditions in relation to all the regulated activities for which it will have permission
Financial Services Act 2012 provides the FCA/PRA to make threshold condition codes which elaborate on these conditions and how they apply to different classes of firms
GENERAL AND FCA CONDITIONS
LOCATION OF OFFICES
EFFECTIVE SUPERVISION - must be able to be effectively supervised by the FCA and/or the PRA - having regard to the nature and complexity by the way in which the firm operates and the regulated activities it carries out
APPROPRIATE RESOURCES
SUITABILITY - must satisfy the FCA that it is a fit and proper person
BUSINESS MODEL - firms must be able to demonstrate the ability to put forward an appropriate, viable and sustainable business model, given the nature and scale of business that they intend to carry out. In addition, the FCA expects firms to be able to demonstrate adequate contingency planning in their business model application.
WHAT ARE THE PRA CONDITIONS
The threshold conditions are the minimum requirements that firms must meet at all times to carry out the regulated activities in which they engage
- Location of offices
- Effective supervision by the PRA in reference to business organisation
= Suitability condition - require compliance with obligations imposed and information requests made by the regulator. - Financial Services Act 2012 bestowed responsibility for a new threshold condition on the PRA, namely for business to be conducted in a prudent manner. The new threshold condition is broadly the equivalent of the appropriate resources and business model conditions for which the FCA is responsible.
Section 59 of FSMA - The fit and proper test
It requires persons fulfilling either a controlled function or a senior management function to be first approved by the FCA as fit and proper
An individual may only be allowed to carry out a certain function once they have been assessed and granted ‘approved person’ status by the FCA/PRA. Responsibility lies with the firm making the application to satisfy the FCA that the candidate is fit and proper to perform the controlled function applied for.
The assessment will look at
- the honesty, integrity and reputation
- competence and capability
- financial soundness
WHAT IS COMPETENCE AND CAPABILITY IN THE F&P TEST?
The FCA will have regard to whether the person
- satisfies the relevant requirements laid down in the FCA’s TRAINING AND COMPETENCE SOURCEBOOK
- Has demonstrated the experience and training needed for them to fulfilled the controlled function
The FCA will consider convictions/dismissals/suspensions from employment for drugs/alcohol/other abusive acts
WHAT IS THE FCA’s approach to Supervision?
It is risk based so businesses that pose the greatest risks to money laundering receive an increased level of attention from the FCA
Businesses must show they have policies, procedures and controls in place to manage money laundering and risks
Crypoasset businesses should carry out regular assessments of their policies and controls to ensure they remain relevant and appropriate - must be alert to their operating model
What steps must businesses (including cryptoasset businesses) adhere to?
- take appropriate steps to identify, assess the risks of money laundering and proliferation financing
- appoint an individual who is a member of the board or senior management to be responsible for compliance with the MLRs and the nominated officer.
- if it is big enough, establish the internal audit function to evaluate the adequacy and effectiveness of the policies, controls and procedures
- undertake CDD when entering into a business relationship or transaction
- apply more intrusive due diligence when entering into a business relationship or transaction
- undertake ongoing monitoring of all customers to ensure transactions are consistent with the businesses’ knowledge of its customer
DISTANCE COMMUNICATIONS COBS 5
Firms must provide consumers with distant marketing information in good time before the consumer is bound by distance contract or offer
Information about the firm
- the firm’s name and business, geographical address
- if the firm has a representative established in the UK
- Where the consumer’s dealings are with any professional other than the firm, the identity of that professional, the capacity in which they are acting with respect to the consumer
- an appropriate regulatory disclosure
INFORMATION ABOUT THE FINANCIAL SERVICE
- a description of the characteristics the service the firm will provide
- the total price to be paid by the customer to the firm for the financial service, including all related fees/charges and expenses
- whether the service involves special risks related to their specific features or the operations to be executed
- possibility of other taxes or costs that may exist which are not paid via the firm
- limitations on the period of the information provided and how long it is valid for
INFORMATION ABOUT THE CONTRACT
- existence or absence of a right to cancel or withdraw under the cancellation rules
- minimum duration of the contract
- instructions including the right to cancel
REDRESS
- how to complain to the firm
- whether compensation is available to the firm or whether it is able to be referred to the FOS
E-COMMERCE
A firm must make the following information easily, directly and permanently accessible to the recipients of the firm
- the name
- geographical address
- details of the firm, including the email address
- whether the firm is regulated or not by the FCA/PRA - authorisation number
- if it is a professional firm or designated professional body
- if it undertakes activity subject to VAT
COBS 6 INFORMATION ABOUT THE FIRM - what information does this include and who does it apply to?
Firms carrying out MiFID or equivalent third country business must ensure they provide clients with the following
- the firm and its services
- designated investment business and strategies including guidance on risks associated with investments
- explanation of leverage and its effects - the risk of losing the investment
- volatility of the price and limitations on the available market for the investment
- if the client has entered into contingent liability transactions
- margin requirements or similar obligations applicable to certain investments
- costs and associated charges
Information on managing investments
A firm that manages investments for a client must establish an appropriate method of evaluation and comparison, such as a meaningful benchmark, based on the investment objectives of the client.
A firm must provide the client with the following information
- information on the method and frequency of valuation of the investments in the client’s portfolio
- details of any delegation of the discretionary management of the investments/funds/or clients portfolio
- specification of any benchmark the performance will be compared to
- the types of investments that will be included
- objectives/the level of risk to be reflection at the managers discretion
The disclosure of costs
firms must provide retail/professional and ECPs with information on costs/charges
- total price to be paid, including all fees/commissions/charges/expenses
- if they cannot be provided, the basis on which they will be calculated
- commissions charged be itemised
- any other costs/taxes not paid or imposed by the firm could be applicable
- information about compensation schemes
from july 2021 firms are no longer required to provide this to professional and ECPs
Clients have the ability to request (and receive) an itemised breakdown of associated costs and charges – on an individual transaction basis.
Must be provided in a DURABLE MEDIUM
What information on safeguarding investments is required to be included on money?
- if the money may be held by a third party
- what the firm’s responsibility is for any acts of omissions of that third party
- what will happen if the third party becomes insolvent
- a summary of the steps the firm has taken to protect the client money
- if the money is subject to any security interest
- full clear information in a durable medium
What is the purpose of the adviser charging rules?
- improve the clarity in which firms provide services to their customers
- address the potential for adviser remuneration to distort consumer outcomes
- increase the professional standards of advisers
What was the approach of implementing the adviser rules?
They only apply to advised sales for a defined range of retail products
- not to non-advised business such as EXECUTION ONLY and DISCRETIONARY
Advisers who are not independent (ie, do not select instruments from the whole of the market) are classified as restricted. They must describe this restricted service to consumers, with a short description to help consumers understand the service that is being provided to them.
Advisers are not allowed to be remunerated by product providers for making a recommendation.
A firm must not hold itself out to a retail client as acting independently until it has done a full review of the marketplace on an unbiased and unrestricted basis
If a firm provides restricted advice - the firm must outline the restriction
The results of the FCA’s thematic review on adviser charging?
- the removal of commission paid by providers to advisers and platforms greatly reduced bias
- product prices fell by the amount paid in commission
- advisers were now qualified to the new minimum standards
- little evidence the availability of advice had reduced
SUITABILITY COBS9
Apply to
- firms making recommendations on designated investments
- managing investments
SUITABILITY ON MiFID BUSINESS
Investment firms must obtain from clients/potential clients such information as is necessary for them to understand the essential facts about the client and have a reasonable basis for determining that recommendations, including providing a portfolio management service, satisfy the following criteria:
a. meet the client’s investment objectives, including risk tolerance
b. clients have the financial ability to bear any related investment risks consistent with their investment objectives
c. the client has the necessary experience and knowledge in order to understand the risks involved in the transaction or in the management of their portfolio.
Firms must evaluate a clients knowledge on
- the type of services, transaction and financial instrument
- nature, volume and frequency of the client’s transactions in financial instruments and the period they have been carried out
- level of education of the client
Firms must think about the client’s best interests rule when making this decision
When providing investment advice, firms must provide the client with the suitability report before the transaction is concluded
SUITABILITY ON NON-MiFID Business
When a firm makes a personal recommendation or is managing a client’s investments, it should obtain the necessary information regarding the client’s:
* knowledge and experience in the investment field, relevant to the specific type of financial instrument or service
* financial situation, including the ability to bare losses, and
* investment objectives, including risk tolerance.
A firm must provide a client with a suitability report if it makes personal recommendations to the client such as
holding parts in
- a regulated CIS
- investment trust where the shares will be held in an ISA specifically for investment trusts
- elects to make income withdrawals
- enters into a pension transfer or a pension opt-out
Firm must also provide a suitability report if it makes a personal recommendation for a life assurance policy
What are the exceptions for providing a suitability report?
- where the firm is acting as investment manager for a retail client, makes a recommendation in connection with a regulated CIS
- if client is resident outside the EEA and not present in the UK at the time of acknowledging consent to the proposal form
- if the recommendation is made by a friendly society in connection to a small life policy
- if the recommendation is to increase a regular premium
What is Honesty, Integrity and Reputation for an F&P assessment?
The FCA will regard whether a person has
- been convicted of a criminal offence
- subject of adverse media/finding
- been dismissed from a position of trust
- been disqualified as a director
- involved in an insolvent business
- subject to a justified complaint
What must client agreements include?
Designated investment business related to firms must be provided before the service to the client
- the terms of the agreement
- information about the firm and its services relating to the agreement or to those services including information on communications
Firm must provide it in a durable medium
Records must be kept for
- 5 years
-duration of the relationship with the client
- in the case of a record relating to a pension transfer, pension-opt out or free-standing additional voluntary contribution
Please outline the FCA’s finalised guidance on assessing suitability
During a review of a sample of investment files assessed as unsuitable, over half of those assessed as unsuitable were on the grounds that the investment selection failed to meet the risk the customer was willing to take.
The FCA found that investment advisors and investment firms failed to look at the capacity for loss
If a firm used a questionnaire to collect information from customers, the regulator was concerned these often-used poor question and answer options
- regulator saw poor analysis of customers that should have put their money in cash deposits out of fear for the risk of loss
What does the FCA view as a priority for guidance on suitability?
- can assess a customer’s capacity for loss
- identifies customers that are best suited to place their money in cash deposits
tools are fit for purpose and any limitations recognised and mitigated
questions and answers are fair, clear and not misleading
robust and flexible process for ensuring investment selections are suitable
it engages customers in a suitability assessment process which acts in the best interest of those customers
Who does appropriateness apply to?
firms providing MiFID investment services other than personal recommendations or managing of investments
firms arranging in deals, warrants or derivatives
firms assessing appropriateness on behalf of other firms
What should a firm establish for appropriateness?
- the types of service, transaction or investment a person is familiar
- the nature, volume and frequency of an individual’s involvement in the transactions
- their level of education, profession or relevant former profession
When is it unnecessary to assess appropriateness?
- if it is execution only, or for the receipt and transmission of client orders
- client has been informed the firm is not required to do so
- the firm is complying with obligations under Principle 8 - conflicts of interest
- relates to distribution activity
Shares in companies listed on a regulated market or an MTF
Bonds or other forms of securitised debt
Money market instruments
Shares in a UCITs
Structured deposits
KIIIDs - KEY INVESTOR INFORMATION DOCUMENTS
For each UCITS scheme that an authorised fund manager will manage, it must produce a key investor information document
- must be clear, fair and not misleading
- must include appropriate information about the essential characteristics of the UCITS scheme, which is to be provided to investors
- identification of the scheme
- short description of the investment -
- objectives and policy
- past performance and performance scenarios
- costs and associated charges
- risk/reward profile of the investment
What should KEY FEATURE DOCUMENTS include?
must include enough information about the complexity of the product, how it works, limitations
- arrangements for handling complaints about the product
- compensation available from the FSCS
- if a right to cancel or withdraw exists and the time to exercise it
Who do KEY FEATURE DOCUMENTS APPLY TO?
- Each packaged product
- cash deposit ISAs
- cash deposit child trust funds
Should a client who receives a cancellation notice in respect of an advised purchase of an authorised unit trust or open-ended investment company (OEIC) - how long do they have?
14 days
What should a firm do if cancellation rights apply?
- show the existence of them and let the person know
- how long they exist for
- the conditions for exercising it
- what happens if they do not exercise it
- how to exercise it
What are the record keeping records for certain products on cancellation rights
- indefinitely for pension transfers, pension opt-outs and FSAVCs
- five years for a lift policy, pension contract, personal pension scheme
- at least three years in any other case
What is a KID?
It is a simple document providing information to investors with respect to collective investment schemes and other packaged products
What can the scope of PRIIPS be defined by?
Performed for retail products
provide exposure to multi-underlying assets
deliver capital accumulation over a certain amount of time
entail a degree of investment risk
they apply to a manufacturer and an adviser - they have to produce a KID for each PRIIP they produce
The PRIIPs four categories
- investment funds
- insurance based investment products
- structured securities
- structured term deposits
Who do PRIIPs apply to?
- retail investment product providers
- life companies
- discretionary investment management firms
- fund managers
- stockbrokers providing advice to retail clients on funds
- financial advisers
Products that are NOT defined as PRIIPs
- non life insurance/general insurance and life insurance that only pays benefits on death
- deposits other than structured deposits
- investment funds dedicated to institutional investors
- corporate shares and bonds held directly
- pension products
- certain securities issued by member states, central banks
Outline the contents of a KID?
can be a maximum of three A4 pages
- purpose
- what is the product?
- what are the risks and what could I get in return?
- what happens if a manufacturer is unable to pay out?
- how long should I hold it for?
- what are the costs?
- how long should I hold it?
- how can I complain?
What were the changes to PRIIPs?
Came into effect on 31 December 2022
- the presentation of performance scenarios in the KID to be replaced with a requirement for narrative information
- address the potential for some PRIIPs to be assigned an inappropriately low risk indicator
- address concerns on the slippage methodology
Please define product governance
Product Governance and oversight refers to the systems and controls that a firm has over the design, approval and marketing of a product through its ‘life cycle’ to meet legal and regulatory requirements
What constitutes a manufacturer and a designer under MiFID on the PROD rules?
The scope of what constitutes a manufacturer and a designer is purposely wide
It includes firms advising on the corporate issuing on the launch of new products
What is the product approval process for PROD?
- manufacturers must identify the target market for each product
- implement management product oversight of the product governance framework and identify any potential conflicts of interest
- establish a product review process to gather information from other distributors to determine if the product remains consistent with the target market
- review charging structures
What must distributors do for PROD?
- at a business level, conduct target market analysis of their distribution strategy
- ensure the products they distribute are appropriate for the target market
- conduct a scenario target market analysis
What must manufacturers do in their target market assessments?
- identify and outline the target market
- the needs and objectives of the target market
- identify negative target market
- whether the financial instruments profile meets the target market
-identify whether the design of the financial instrument is driven by features that benefit the client
manufacturers that distribute their products through other firms must determine the needs and objectives of the clients for whom the product is compatible based on
- knowledge and experience of financial instruments or similar financial instruments
- needs and objectives of potential end clients
What must distributors think of when identifying the target market?
They must determine it even if it is not defined by the manufacturer
they must consider
- the client type
- knowledge and experience
- financial situation and focus on the ability to bear losses
level specified in the product
beyond the product
up to the amount invested
- risk tolerance and the compatability of the risk/reward
- client’s objectives and needs
What must a scenario analysis conducted by manufacturers cover?
Must cover negative market conditions, such as
- what would happen if a market condition deteriorates?
- manufacturer experiences financial difficulties
- financial instrument is not commercially viable
- demand for the instrument is higher than expected
Under PROD what must manufacturers consider?
- whether the costs/charges are compatible with the needs, objectives of the target market
- whether the costs/charges undermine the financial instruments return expectations - such as removing the tax advantages of an instrument
- whether the charging structure is transparent for the target market
What must a manufacturer make available to any distributor of financial instruments?
- information on the instrument
- information on the product approval process
- information about all distribution channels
- the information is of adequate standard for distributors to understand the instrument
Outline BEST EXECUTION
MiFID II requires firms to take ‘all sufficient steps’ to obtain the best execution for clients instead of ‘all reasonable steps’ from the previous MiFID legislation
for each transaction (the four-fold test if a client is placing legitimate reliance on the firm)
for over the counter transactions, firms must have in place procedures to check each steps of the transaction and retain relevant market data to justify their price decision
Who does best execution not apply to?
Operators of a regulated CIS when purchasing or selling units/shares in that scheme
Outline the four fold test
Applies to firms where a client places legitimate reliance on the firm
- did the firm initiate the transaction?
- did the client only ask you for a quote?
- will the client be unable to identify the relevant levels of price transparency within the market?
What factors go into best execution?
PRINCE
COSTS
SPEED
LIKELIHOOD OF EXECUTION
SETTLEMENT
SIZE
NATURE
For retail firms, firms must take into account the price of the instrument, the costs relating to the execution, all expenses paid to it such as execution venue fees
If a firm is able to execute the order on more than one execution venue, the firm must be able to justify why it chose that execution venue
Order Execution Policies
Firms are required to monitor the execution quality obtained and the quality/appropriateness of their execution arrangements and policies.
Senior management/Committees must monitor this.
Must include information about the different execution venues and what affected their choice of venue used
Firms must review their execution policies when a material event occurs and monitor the effectiveness of the policies and identify any deficiencies
If a client gives specific instructions on execution of an order, firms must abide by the specific instructions
Portfolio managers, and receivers or transmitters of orders, must also maintain order execution policies, but need not get client consent to them.
Outline the Client Order Handling procedures
Firms must apply procedures and arrangements which provide for the prompt, fair and expeditious execution of client orders.
firms need to avoid conflicts of interest where possible
Client orders should be executed in the order they are received
Firms should ensure client orders are:
- executed promptly, accurately and recorded
- comparable orders are executed one after the other in the order they came in and promptly
- retail clients are informed of any material difficulty in executing the order
- if the firm is responsible for overseeing or arranging settlement, that the assets or money are delivered promptly and correctly.
Firms’ Order Handling Policy will deal with orders left by a client which state ‘good till cancelled’ or ‘good to the close’
When are firms allowed to aggregate their own-account deals with those of a client?
- it is unlikely to disadvantage any of the clients
- the fact that aggregation may disadvantage the clients is disclosed to them
- an order allocation policy has been established which covers how volume and price of orders will affect allocation
When an aggregated order is only partly executed, the firm must then allocate the various trades in order with this allocation policy.
A firm’s allocation policy must incorporate procedures that prevent the reallocation of own account orders aggregated with client orders that disadvantage the client
what are the requirements for a limit order?
unless a client instructs otherwise, a firm that cannot execute a limit order fully under the market conditions must make the limit order public so it can be executed as quickly as possible
can do this by
- transmitting the order to a regulated market or MTF
- ensuring the order is made public and can be easily executed when market conditions allow
What should the PA Dealing rules prevent?
entering into a transaction that is contrary to UK MAR
involves or misuses disclosure of confidential information
conflicts with the firms duties to a customer
improperly advising or procuring that anyone else enters into a transaction
improperly disclosing information or opinion
Who do the PA Dealing dealing disapplied for?
- deals under a discretionary management service, if there is no prior communication between the portfolio manager and the relevant person
- investments into certain units or funds if the person is not involved in the management of the fund
Definition of churning
Churning is the activity of dealing excessively frequently for a client, in order to generate additional fees and/or commissions for the firm.
Definition of switching
Switching is the activity of selling one investment and replacing it with another frequently in order to generate additional fees or commissions for the firm
What information that firms who provide underwriting and placing needs to be provided?
Firms that provide corporate finance strategy and provide the service of underwriting and placing must provide the following:
- various financing alternatives available within the firm
- timing and process with regard to corporate finance advice on pricing
- details of the targeted investors to whom the firm intends to provide the offering
- the firm’s arrangements to prevent or manage conflicts of interest that may arise with placing the financial instruments with the firm’s own proprietary book
Firms are required to be able to identify all underwriting and placing operations and ensure that adequate controls are in place to manage any potential conflicts of interest.
COBS 16 AND 16A - REPORTING INFORMATION TO CLIENTS
Firms are required to ensure that clients receive adequate reports on the services they provide to them. These must include any associated costs.
If a firm (other than one managing investments) carries out an order for a client it must:
- provide essential information on it promptly
- provide the client with information on the status of their orders
- send a ‘notice’ confirming the deal details as soon as possible
What must be in a ‘notice’ that firms provide to clients?
- the name of the firm
- the name/designation of the firm
- the trading day and time
- the type of order (limit order/market order/
- the venue the transaction was executed
- the financial instrument
- the buy/sell indicator
- the nature of the order if other than buy/sell
- the unit price
- the total consideration
- total of the commission
Firms do not need to send the required information where the client is receiving the same information from another person
For non-MiFID business, this must be kept for three years
For MiFID business, this must be kept for five years
What are the requirements on periodic statements?
For firms managing investments to retail clients, these need to be at least quarterly unless
- if the client receives deal-by-deal confirmations and the higher risk investments are excluded, it may be sent every 12 months
- if the client has authorised for the portfolio to be leveraged
for MiFID business - at least 5 years
for other business - at least 3 years
Firms must report any losses over a pre-approved limit on a contingent liability transaction
If the order is executed in tranches, firms may supply clients with the information about the price of each tranche
What section of COBS 18 do not apply?
Trustee firms
Energy market activity
Corporate finance business
Stock lending activity
Residual CIS operators and small authorised UK AIFMs
Depositaries
Authorised professional firms
