The UK Financial Services Authority (“FSA”) was abolished on 1 April 2013 and replaced by three new regulators. The Financial Services Act 2012 introduced the Financial Conduct Authority (“FCA”), the Prudential Regulatory Authority (“PRA”) and the Financial Policy Committee (“FPC”). This new regime not only provides a clearer division of responsibilities between regulators, but new enhanced investigation and enforcement powers show a clear commitment by regulators to investigate and take enforcement action.
Overview of New Regulators
The FCA is responsible for regulation of the conduct of firms authorised under the Financial Services and Markets Act 2000 (“FSMA”).1 It is also responsible for:2
regulation of conduct in retail and wholesale financial markets;
supervision of the trading infrastructure that supports retail and wholesale financial markets; and
prudential regulation of firms not regulated by the PRA.
The FCA has three operational objectives:
to secure an appropriate degree of protection for consumers (the consumer protection objective);
to protect and enhance the integrity of the UK financial system (the integrity objective); and
to promote effective competition in the interests of consumers in the markets for regulated financial services and services provided by recognised investment exchanges in carrying on certain regulated activities (the competition objective).
The FCA has responsibility for taking regulatory action to counter financial crime:
It has a “free-standing duty” to have regard to measures to minimise the extent to which regulated business could be used for purposes connected with financial crime.
It is required to maintain arrangements designed to enable it to determine whether people that are not authorised persons are complying with regulatory requirements and, where appropriate, for enforcing compliance.
In a speech in September 2012,3 Bob Ferguson (then FSA Head of Financial Crime and Intelligence) discussed the top concerns of the FSA, which may be assumed to be top concerns of the FCA. The areas he highlighted include money laundering risk, corruption risk, investment fraud against consumers and insider dealing. Prior to its replacement by the FCA, the FSA set in motion its initiative on these issues.
In March 2012, the FSA published the findings of its thematic review into anti-bribery and corruption systems and controls in investment banks.4 It found that, despite a long-standing regulatory requirement to mitigate financial crime risk, the majority of firms in the sample had more work to do to implement effective anti-bribery and corruption systems and controls. In particular, it found:
Most firms had not properly taken account of FSA rules on bribery and corruption (pre- or post-the UK Bribery Act 2010).
Almost half of the firms did not have an adequate anti-bribery risk assessment.
Only two firms had started or carried out specific anti-bribery and corruption audits.
Management information on anti-bribery and corruption was poor, which led the FSA to wonder how senior management could provide effective oversight.
There were “significant” issues in firms’ dealings with third parties used to win or retain business.
Although gifts/hospitality/expenses processes had been tightened up in many firms, few had processes to ensure that gifts or expenses in relation to particular clients/projects were reasonable on a cumulative basis.
The FSA’s report raised the concern that the investment banking sector had been too slow and reactive in managing bribery and corruption risk. The report also stated that “The FSA, and from next year, the Financial Conduct Authority will continue to focus on ABC [anti-bribery and corruption] issues in this sector and beyond to ensure firms are meeting their legal regulatory obligations.” In a press release regarding the findings, the FSA indicated that it was considering whether further regulatory action was required in relation to certain firms that it had reviewed.
At the same time, the FSA was continuing work on its largest and most complex investigation into insider dealing (“Operation Tabernula”, conducted along with the UK’s Serious Organised Crime Agency).
Currently, a thematic review of asset managers on anti-bribery, sanctions and anti-money laundering compliance is ongoing, with the results due to be published in the third quarter of 2013.
The PRA is responsible for the authorisation, prudential regulation and day-to-day supervision of all firms that the government considers should be subject to significant prudential regulation. These include banks, building societies, insurers and certain systemically important investment firms. Firms that fall within the regulatory scope of the PRA are known as “PRA-authorised firms”, or as “dual-regulated firms”, as the FCA is their conduct regulator.
The PRA’s general functions are:
making rules under FSMA (considered as a whole);
preparing and issuing codes under FSMA (considered as a whole); and
determining the general policy and principles by reference to which it performs particular functions under FSMA.
The PRA has a general objective of “promoting the safety and soundness of PRA-authorised persons” (that is, PRA-authorised firms). The PRA is required to advance this objective primarily by seeking to ensure that the business of PRA-authorised firms is carried on in a way that avoids any adverse effect on the stability of the UK financial system. In addition, the PRA seeks to minimise the adverse effect that the failure of a dual-regulated firm could be expected to have on the stability of the UK financial system and, in particular, adverse effects resulting from the disruption of the continuity of financial services.
Unlike the FCA, the PRA does not have a mandate under its statutory objectives relating explicitly to financial crime. However, the PRA will take into account financial crime issues affecting firms’ integrity. For example, in his September 2012 speech, Mr. Ferguson commented that, for insurers, insurance fraud was an operational risk that might have the potential to undermine insurers’ solvency.
The PRA has a number of powers relating to firms in difficulties, including recovery and resolution powers and powers to initiate insolvency proceedings.
Like the FCA, the PRA has enforcement powers, although it is only able to impose penalties on PRA-authorised firms.
The FPC, a committee of the court of the Bank of England, monitors the stability and resilience of the financial system as a whole. It considers prudential regulation issues across the UK financial system, in contrast to the PRA’s micro-prudential role, and may direct the PRA and the FCA to take action to address systemic risks. Consequently, unlike the PRA or the FCA, it does not have direct regulatory responsibility for any particular type of firm.
Enhanced Investigation and Enforcement Powers
The new regulators, the PRA and FCA, have received new and enhanced powers related to the investigation and enforcement process. The most significant powers are set forth below.
Early Publication of Notices
The FCA and PRA are now permitted to publish the details of warning notices which they have issued. Previously, the FSA was only permitted to publish following a decision notice, which was much further along the enforcement process and after the person involved had a formal opportunity to respond.
There will be a requirement for the regulator to consult with the person involved. However, this does not mean that the regulator needs to obtain the person’s consent, and it shall be in the regulator’s discretion whether it publishes the warning notice. Although the regulator will not be required to obtain consent from the person involved, it will need to consider restrictions on publication, including whether the regulator considers that it would be unfair to the person involved.
On 19 March 2013, the FSA published a consultation paper on the FCA’s policy for publishing warning notices. The consultation sets out that the FCA will not publish a warning notice if it would be unfair to the person against whom the regulator is looking to take action, prejudicial to the interests of consumers, or detrimental to the stability of the financial system. The deadline for comments was 18 June 2013.
The FCA intends to promote transparency through the use of this power. However, its introduction has proved controversial given that warning notices can be published before the person involved has had the opportunity to fully respond to allegations and may be published even if formal enforcement sanctions are not eventually imposed.
In practice, the existence of this power is likely to lead to greater cooperation by persons under investigation, and settlement of matters at an earlier stage in the investigation process as a result.
The new regulatory regime will allow the FCA and the PRA to appoint skilled persons to produce a report into an authorised firm. Previously, the FSA was only able to require a firm to appoint a skilled person to produce such a report. A skilled person can also be appointed by the regulator in order to collect information which the firm should have collected itself under the relevant rules.
One advantage with this new approach is that it should simplify the previous potential conflicts faced by firms when a skilled person who was appointed by a firm was also under a duty to produce a report for the FSA.
One point which has given rise to discussion surrounding this new power is that the costs of appointing the skilled person shall still remain with the authorised firm, despite the regulator appointing the skilled person rather than the firm. It is difficult to see what control a firm will have over the costs that are incurred and the practical difficulties that could result.
Retention of Original Documentation
The FCA and PRA have the power to retain original documentation when using their document request powers or when seized under a warrant. Previously, the FSA could only request copies when using its document request powers and had limited ability to retain originals seized via a warrant.
Powers over Unregulated Parent Undertakings of Authorised Firms
The FCA and the PRA have the power of direction over unregulated parent undertakings of firms for which they have responsibility.5
The PRA must ensure that the giving of the direction is desirable in order to advance its own objectives. The power applies equally to ultimate parent companies and to intermediate holding companies.
On 1 April 2013, the PRA published a policy statement on its power of direction over qualifying parent undertakings. The policy statement sets out the PRA’s view of the purpose of its powers:
The PRA considers that the purpose of consolidated supervision is to enable supervisors to take necessary action to protect authorised firms from the adverse effects of being part of a group. These adverse effects may include: financial contagion (losses in a group entity impacting on a firm through financial linkages); reputational contagion (an event in one entity impacting adversely on another entity in the group through reputation damage); multiple gearing (i.e. use of the same capital resources more than once in the same group);... barriers to effective resolution (e.g. complex group structures or intra-group arrangements); and the impact of intra-group relationships on authorised firms (exposures, contingent liabilities etc).6
The PRA indicated that it does not consider the power of direction to be a last resort. It also confirmed the right of an entity against which the power has been used, to make representations and appeal.
Concerns about inconsistent application where firms are regulated by both the PRA and the FCA were addressed by reference to s.192F FSMA, which requires cross-consultation between the two regulators before either gives an entity notice of a direction under the power.
The FCA must ensure that the giving of the direction enhances one or more of its objectives.
The power of direction will not apply to overseas holding companies and holding companies of broader industrial conglomerates. However, the FCA has stated (at Appendix 1 to the FCA Handbook) that where it cannot direct the ultimate holding company or the ultimate holding company fails to act, the FCA can extend its powers to a UK intermediate parent in the ownership chain.
Appendix 1 to the FSA “Policy Statement 13/5: The New FCA Handbook” also states:
Often, it is the Board of the ultimate parent undertaking that decides overall group strategy and organisation, risk management procedures and intra-group flows of capital and liquidity. Therefore, actions taken by a parent undertaking can affect the regulated entity’s ability to comply with its regulatory requirements. This could pose risks to the FCA’s operational objectives where the interests of the parent and subsidiary undertakings are not sufficiently aligned. Consequently, there are circumstances in which the FCA may wish to direct a parent undertaking of an FCA-authorised group to act, or refrain from acting, in a certain manner...The direction will be designed to bring the FCA regulated entity and the group back into compliance with its regulatory requirements
or to prevent the parent undertaking from taking action which may lead to disorderly failure of FCA regulated entities or the FCA regulated entity’s group.
A list of possible scenarios when FCA may use these powers is at Annex 1 of the policy statement. Examples include:
financial objectives set by the parent that conflict with consumers’ interests (for example, high pressure selling);
where directors of the parent company appear not to be fit and proper; and
where the holding company directors dominate the regulated firm’s board.
The FCA may require the parent undertaking to:
withhold senior management bonuses until level of redress from crystallised conduct risks are confirmed in the regulated entity;
appoint an independent board of directors; and
restrict dividend payments, or other payments in respect of capital instruments, in order to retain capital in the group.
Full Steam Ahead
On 2 July 2012, Tracey McDermott (now the FCA’s Head of Enforcement and Financial Crime) gave a speech touching on the FCA, in which she said:
[T]here will be significant changes in the way in which the FCA regulates in the future – many of those changes are already starting to take place within the FSA. We are not, however, looking to make change for change’s sake – we are trying to make regulation work better for consumers, markets and the industry. So, in some areas, enforcement being the one that is most relevant for today, there will be much continuity building on, and developing from, the solid foundations we have built up in recent years. Past performance does give some indications of what the future holds.7
It is clear she sees the new regime that has replaced the FSA as a continuation of work that started a long time ago. This is perhaps a more useful way of looking at the new regime – the new bodies introduced by the Financial Services Act 2012 are in many ways not starting out, but rather present a continuation of the desire to ensure compliance and accountability in the regulated sector. Firms should not assume that they have a grace period during any transition period. The FCA and the PRA have considerable momentum stemming from the efforts of the FSA before them.