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The FCA's approach to supervision and enforcement
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In this article, Victoria Turner, solicitor at Pannone LLP, examines the FCA’s approach to supervision and enforcement and the tools available to it to achieve its objectives.
On 1st April 2013 the Financial Services Authority (“FSA”) was replaced by the Financial Conduct Authority (“FCA”) and the Prudential Regulation Authority (“PRA”). These changes were brought into effect by the Financial Services Act 2012 (the “Act”).
The FCA has three operational objectives:
- Consumer protection;
- Integrity of the market; and
- Promoting effective competition.
In March 2013, the FCA business Plan for 2013/14 was published* which details the areas on which the FCA will focus in its first year. Tackling market abuse and the prevention of financial crime are key areas of focus for the FCA. The newly created Policy, Risk and Research division of the FCA will work to identify and assess risks in the market to consumers and firms which will inform the FCA’s authorisation, supervision and enforcement decisions.
The FCA is the conduct supervisor for approx. 26,000 firms across all industry sectors and the prudential supervisor for approx. 23,000 firms not regulated by the PRA. The supervision of these firms will be approached on a risk/judgment basis. The focus will be on carrying out in-depth supervision of firms which are determined to have the potential to cause the greatest risk to the FCA’s objectives.
SUP 1A of the FCA Handbook contains guidance issued by the FCA on the approach it will take to supervision.
The starting point for the supervision of firms is for the FCA to categorise all firms into one of four categories:
- C1 – banking and insurance groups with large numbers of retail consumers and investment banks with very large client assets.
- C2 – firms across all sectors with a substantial number of retail customers and/or large wholesale firms.
- C3 – firms across all sectors with retail customers and/or a significant wholesale presence.
- C4 – smaller firms, including intermediaries.
Firms will be categorised according to their potential impact on the FCA’s objectives. The categorisation given to a firm will determine the style of supervision which will be applied to that firm. Firms should have now been notified of their category.
C1 and C2 firms will have a nominated FCA supervisor and will be subject to proactive supervision on a 1-2 year cycle. C3 and C4 firms will be supervised by a team of sector specialists rather than a single nominated supervisor.
Supervision of firms will be determined by the risks associated with those firms. Such supervision will be based on the following three pillars:
- Firm systematic framework – preventative work through structured conduct assessment of firms. This will involve analysing firms’ business models and strategies to enable the FCA to form a view on the sustainability of a business from a conduct perspective and to identify where future risks might occur. The FCA will also be able to see how the culture of a firm promotes market integrity and manages risks; the expectation being that culture comes from the top – the senior management should lead by example.
- Event driven work – dealing faster and more decisively with problems and seeking consumer redress or remedial work; and
- Issues & products – campaigns on sectors of the market or products within a sector that are putting consumers at risk. If the FCA identifies a sector wide risk, it will carry out cross firm issue and product work and will expose firms generally in that sector to more intensive supervision.
The FCA aims to be more pro-active than its predecessor arguably was. It will aim to identify where harm could occur and will seek to take decisive and swift action to prevent the harm from occurring. Prevention is the aim; as opposed to reacting to the aftermath.
The messages coming from the FCA is that it will continue the work of its predecessor, the FSA. In its last 12-18 months, the FSA had arguably stepped up its enforcement action and it is the intention that the FCA will continue with this hard line approach – the agenda of “credible deterrence” will remain central to the FCA’s enforcement approach.
The headlines are as follows:
- More cases and tougher penalties – building on the work of the FSA in the last 12-18 months. Failure to comply with regulation will not be tolerated;
- Pursuing cases against individuals as well as firms and imposing fines which reflect the seriousness of the action. Enforcement action will be taken if aspects of a firm’s business model or culture (i.e. record keeping, training etc) are not up to scratch and as a result are likely to cause harm to consumers;
- Criminal prosecutions for insider dealing and market manipulation – In the previous 2 years the FSA substantially increased the number of criminal prosecutions it brought. This has been a priority and will continue to be so for the FCA; and
- Action against unauthorised business – shutting down unauthorised firms, issuing appropriate fines against unauthorised individuals and pursuing criminal prosecutions where appropriate.
The FCA enforcement division intends to work more closely with other departments of the FCA (i.e. the supervision division) to determine the causes of problems and to identify risks and address these before the need for enforcement arises – evidence of a more pro-active approach.
The FCA’s supervisory and enforcement tools
The FCA has a range of tools available to it, as the FSA did. These can be grouped under the following four headings:
- Diagnostic – to identify, assess and measure risks (i.e. meetings with management of firms, desk based reviews, use of skilled persons, s. 165 information requests etc)
- Monitoring – to track the development of identified risks (i.e. review of past and current business, transaction monitoring, on-site inspections etc)
- Preventative – to limit or reduce identified risks and prevent them from escalating
- Remedial – to respond to risks which have crystallised (i.e. varying a firm’s permission, imposing requirements, providing guidance etc)
A range of new powers are now available to the FCA as a result of the Act. These include:
- Power to ban investment products, subject to a consultation process;
- Where immediate action is required, the power to ban investment products that pose a risk to consumers for a period of up to 12 months, without any consultation;
- The power to remove misleading financial promotions immediately from the market without the use of any formal enforcement process;
- The ability to announce publically that disciplinary action is being taken against a firm or individual (prior to a decision notice being issued); and
- The ability to directly contract with skilled persons where a s. 166 report is required.
Skilled person reports (s. 166 and s. 166A FSMA (as amended))
This is a tool available to the FCA which can be used for diagnostic, monitoring, preventative and remedial purposes. There are two types of report (collectively referred to as s. 166 reports):
- S. 166 FSMA – FCA can require the firm to appoint, or the FCA can appoint, a skilled person to prepare a report.
- S. 166A FSMA – FCA can require the firm to appoint, of the FCA can appoint, a skilled person to collect and update information.
The FCA can require a s. 166 report where it requires information or documentation to be provided with respect to any matter. The FCA can require s. 166 reports not only on an authorised firm but also on an entity or person connected with the firm (i.e. a subsidiary or other company within the group (even if not regulated), an authorised person within the firm and any partnership which the authorised person is a member of), as long as the connected person was carrying on a business at the relevant time.
The power for the FCA to contract directly with a skilled person is new and was created by the Act. Where the FCA directly appoints a skilled person, the cost of doing so will be paid for by the firm in question by way of a fee levied by the FCA. Skilled person reports are generally expensive and in some way acts as a deterrent as most firms normally wish to work with the FCA to try and avoid a situation where such a report becomes necessary.
It is not yet known how many skilled person reports the FCA will require going forward. The FCA is likely to contract directly with skilled persons in cases where the FCA feels it needs more control of the situation, particularly if a firm has had a poor relationship with the regulator in the past and the regulator has found it difficult to obtain the information it requires. Alternatively there may be cases where the FCA requires a s. 166 report on a subject which covers more than one firm. In such cases it would seem logical for the FCA to appoint one skilled person rather than each firm involved appointing separate ones.
Where the FCA determines that a s. 166 or s. 166A report is necessary, a formal notice will be served on the firm in question. This will detail what form the report should take, who is to appoint the skilled person, the scope and purpose of the report, provide relevant background details (where possible) and will provide a timetable for completion.
When instructed to appoint a skilled person, a firm will be expected to appoint someone from the FCA’s skilled person panel. If a firm fails to appoint a skilled person where required to do so by the FCA (pursuant to s. 166 or s. 166A), this can be treated as contempt of court. Where the FCA appoints a skilled person, they will also appoint from the panel.
SUP 5, Annex 1 of the FCA handbook provides some examples of when skilled person reports may be used. These include situations where there is:
- concern about the effectiveness of a firms internal audit department;
- an inability of a firm to quantify its current financial position;
- concern about quality of systems and controls;
- an indication of financial crime or money laundering;
- has been a failure by a firm to provide information to the FCA; or
- a need to develop a remedial action plan.
The message from the FCA is that a number of factors will be taken into account when determining whether to use its s. 166 or s. 166A powers. Each case will be dealt with on its merits and there is no checklist of criteria which has to be met before such a report can be commissioned.
The FCA clearly intends to continue and build on the work of its predecessor, the FSA. The FCA is keen to ensure that the image of the financial services industry is “cleaned up”. Firms will be subjected to more intense supervision and enforcement action where it is deemed appropriate. Poor conduct and inadequate internal procedures to prevent financial crime and breaches of regulation will not be tolerated.
Prevention is clearly the aim but, where necessary, the FCA will not hesitate to use the wide range of powers it has to achieve its objectives.
This article was originally published on Thomson Reuters.
Thomson Reuters © 2013
If you need advice in respect of FCA supervision and enforcement contact Victoria Turner in our Regulatory department on 0161 909 3000.