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The tougher face of financial regulation

The FSA has published the first detailed document on the structure of the Financial Conduct Authority.

The document, Approach to Regulation, sets out four new powers or approaches:

  • The FCA will provide “a new approach to conduct regulation”, although much of what the FCA will do is little different from FSA’s more focused approach adopted during the past three years. Larger firms, and especially banks and insurers, will already be familiar with the more judgemental and interventionist-style promised for FCA.
  • The Government intends that the FCA will have new powers in three areas – product intervention, to amend or withdraw a misleading financial promotion and to publicise the issue of a disciplinary warning notice. The FSA already possesses the first two powers and has exercised them on a number of occasions. What is significant is that the FCA is being given them as featured powers, indicating that they will be used more often.
  • The FCA will adopt “a more issues and sector-based” supervisory approach. This makes sense in that the only way the FCA can maintain a grip on the disparate group of 27,000 firms it regulates is periodically to select an issue or a group of firms of varying sizes and dive into the detail. Even so, it sounds much the same as the FSA’s current “thematic” approach, which, looking over the past year into client money, with-profits governance and sale of structured products, has resulted in significant enforcement action across a wide range of firms.
  • The focus on promoting efficiency, choice and competition is significant and likely to be used by the FCA to reshape aspects of the retail market in particular.

The FCA will have a single strategic objective of protecting and enhancing confidence in the UK financial system, plus three operational objectives – securing an appropriate degree of consumer protection, promoting efficiency and choice and protecting and enhancing the integrity of the UK financial system.

Within these objectives it has the functions, currently discharged by the FSA, of regulating market conduct as well as exchange infrastructure and seeking to minimise the extent to which a regulated firm can be used in connection with financial crime.

The FCA is likely to build on the sound progress already made by the FSA in combating market abuse and money laundering.

Most of the FSA’s rules are derived from EU directives, notably Mifid, and this will be unchanged for the FCA, which will remain principally an implementer of EU policy rather than a maker of its own policy. Nonetheless, the FCA will retain some autonomy in determining its policy for authorisation, supervision and enforcement.

What is the FCA’s supervisory approach?

For the great majority of firms for whom the FCA will be the prudential and conduct regulator, the authorisation and approval process will remain similar to present FSA procedures, although some developments are likely. In particular, one assessment criterion for approving a firm’s application for authorisation will be how this would affect competition in the market.

The FCA’s policy and rules will, being constrained by the same EU directives, remain similar to those of the FSA, although Hector Sants has indicated the rules will be more detailed and prescriptive than at present. There will be further differences in that policy development and rulemaking will now explicitly include competition considerations and be driven by more rigorous market and economic analysis. The FCA promises to be “open, listening, consultative and sensitive” in this area.

What is the FCA’s supervisory approach?

The model requires a new supervisory assessment framework to replace Arrow. This will include both firm-based assessments and comprehensive market, sectoral and product chain analysis.

Central to its design, however, will be simplicity and a recognition that the approach must be understandable not just to regulatory specialists but to company boards as a whole. At a micro or firm-specific level, firms – especially large and mass-market retail firms – will experience a regulator with lower risk tolerance than the FSA and one that has a more intensive supervisory style and a greater willingness to intervene. Elements of this will probably include:

  • increased regulatory contact for all firms, with a reduction in relationship management for mid-sized firms and a concentration of resources on the biggest firms;
  • earlier intervention in the development of new products and distribution paths, with the FCA assessing potential change from a risk perspective;
  • a more interventionist approach to securing redress than firms currently experience with the FSA;
  • a focus on culture as a driver of a firm’s conduct, building on the FSA’s recent statements on this topic; and
  • possibly an expectation that instigating disciplinary action where there is material consumer detriment, weak systems or consumers have been exposed to risk will be the norm rather than the exception, as is now the case.

How will things differ for firms?

The FCA will be prepared to intervene earlier to tackle risks, especially emerging or potential risks, where it believes the market for a product or a service “is not operating in the interests of retail customers or the wider economy”. The FCA may review a firm’s retail complaint-handling processes and require the firm to withdraw the product and offer recompense to purchasers whether or not they have complained.

The FCA will be “tougher and bolder” in taking enforcement action, building on the FSA’s policy of credible deterrence.
Anyone familiar with the FSA’s current approach to enforcement will recognise this as a further step-change, presaging disciplinary action against both firms and individuals that is more frequent, seeks higher penalties and is more driven to provide graphic illustrations of failing and punishment to further the FCA’s objectives.

One of the six regulatory principles to which the FCA must “have regard” is that a firm’s senior management is responsible for his or her firm’s compliance with regulatory requirements. This is a sharpening of the current “principle of good regulation” to which the FSA is subject and makes it clear the FCA will go further than the FSA in identifying where a senior manager has responsibility for his or her firm’s failings and in taking individual disciplinary action.

The fifth and sixth regulatory principles require the FCA to act openly and transparently. This is likely to result in the FCA making public additional information about the firms it regulates and its dealings with them or requiring them to publish this information themselves.

Simon Morris is a partner at CMS Cameron McKenna


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