Financial Services analysis: What does the regulatory future hold for banks and corporations? Tony Watts says there is likely to be an increased focus on enforcement action against individuals.

Do regulators see fines as the most appropriate way to sanction rule-breaking banks and corporations?

It is clear that both the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA) regard fines and other enforcement action as only one weapon in their respective armouries. Despite the fact that the gross amount of fines imposed in 2016 showed a marked downturn from the previous two years, it is difficult to see this as heralding a more lenient approach in the long term (and public statements by the FCA support this).

When the new regulatory system was established in 2013, there was an apparent difference in philosophy between the FCA and the PRA in relation to enforcement action. The PRA saw itself as less of an enforcement-led regulator than the FCA, relying instead on its ‘ex ante’ powers as a proactive supervisor, making sure things did not go wrong before they did so. It is noteworthy, however, that enforcement action leading to fines and other disciplinary sanctions by the PRA has slowly but discernibly increased—most recently it imposed fines of more than £26m in total on the Bank of Tokyo- Mitsubishi and its subsidiary MUFJ Securities PLC.

Fines by the PRA will inevitably be less frequent than those imposed by the FCA because the regulated constituency of the PRA is much smaller than that of the FCA (the PRA regulates in total only around 1,700 firms as against the FCA having jurisdiction over around 56,000). I believe that disciplinary action taken by the PRA will continue to increase in number and frequency of enforcement actions. I also believe, however, that there will be an increasing focus on enforcement action against individuals by both regulators.

Are these fines accompanied by orders to improve compliance procedures?

Cautiously the answer to this is ‘yes’, but it’s not always a direct route. The majority of financial penalties imposed on firms are the result of a settlement agreement between the individual firm and the regulator (FCA and/or PRA). These usually occur at an early stage in order to achieve both the maximum 30% discount on the amount of the fine and a more favourable description of the firm’s conduct in the published final notice.

The final notice almost invariably includes undertakings by the firm to improve procedures, which are a major factor in the agreed settlement—they can be highlighted as positive points in the final notice, mitigating the financial penalty that would otherwise have been imposed and diminishing any reputational impact. This will often be accompanied (in relevant circumstances) by agreements to provide redress to consumers who have lost money (an interesting recent example concerns the agreement by Tesco in the recent market abuse case to provide £85m in redress for investors who lost money relying on inaccurate statements by an issuer of publicly traded securities).

In many cases enforcement action against regulated firms is preceded by, or combined with a skilled persons report under section 166 of the Financial Services and Markets Act 2000 (FSMA 2000) and so it is questionable in such cases whether there is any real option but to agree improve improvements to procedures and individual redress. Also, particularly in consumer credit cases, there is an increased tendency to impose limitations or requirements on regulatory permissions (including specific requirements to conduct a consumer redress scheme). See below for another increasing trend of restricting firms from taking on new business.

Has the way fines are handed out to banks and corporations changed since the financial crisis?

There was a very significant increase in fines imposed by the then Financial Services Authority (then from April 2013 by the FCA) following the financial crisis reaching £1.5bn in total in 2014 and £905m in 2015. The aggregate amount of 2 financial penalties, however, reduced in 2016 from these high water marks, returning to pre-2007 levels. I doubt that this will be a permanent trend (recent statements by the FCA tend to confirm this)—possibly more of a temporary respite. There is likely, however, to be an increased focus on enforcement action against individuals. It remains the case that only one individual director of HBOS (the unfortunate Mr Peter Cummings) was subject to individual enforcement action for events leading to the collapse of HBOS in the financial crisis. No head of any bank has been subject to any disciplinary penalty arising from those events. It seems inevitable that the focus on individuals will intensify—this is consistent with FCA statements but is also likely to be the effect of the senior managers and certification regime which will be extended beyond PRA-regulated firms to all firms in 2018.

The number of contested FCA enforcement proceedings has increased. It is likely to increase further as a result of the changes to enforcement procedures following ‘FCA PS17/1 and PRA PS2/17 Implementation of the Enforcement Review and the Green Report’. In particular the opportunity for contesting part of a case by means of a focused resolution agreement with the FCA is likely to increase the number of contested cases, where for there is substantial agreement on the facts but no agreement on the appropriate regulatory outcome. Pressure to settle early will arise from the FCA removing stage 2 and 3 discounts (of 20% and 10% respectively) but I still see the number of contested and partly contested cases increasing. It remains to be seen how far the FCA will agree to focused resolution agreements (they do not have to do so) but in view of another increasing trend—referral to the Upper Tribunal which is then critical of the FCA—it may be that there will be authoritative guidelines from the tribunal in the future.

Do the fines handed out to banks have an impact on their ability to operate or in relation to the businesses’ profitability?

In my view, there is a sharp disparity between the impact of fines on large household name firms and those further down the scale. In the case of the former, there have for example been a significant number of fines in respect of all the high street banks and their group members (referring in this case only to RBS, Barclays, Lloyds and HSBC groups). These covered a wide range of conduct, often historic events and diverse business areas. The fines will certainly have been economically significant for each institution (see for example the further £1bn provision by Lloyds for PPI claims). The impact is still likely to be proportionately greater for smaller firms for whom the prospect of a financial penalty and the costs of contesting this may be ‘life or death’ issues

Are banks and corporations seeing fines as ‘just another cost of doing business’?

I mention above (and only by way of example) the multiple fines that have been imposed on the high street banks since 2012 (there were others before this but it seemed reasonable to adopt a timescale of no more than five years). Where the number and amount of fines reach these levels, it is inevitable that the reputational impact of any single fine is diminished. There is also a risk that regulatory action may appear just as another cost of doing business, ie an occupational hazard that cannot altogether be avoided. It may be that further avenues will explored, such as restrictions on taking on new clients or doing certain kinds of business which may have an effect on financial services firm. See for example:

  • the enforcement action against Sonali Bank (UK) Limited on 12 October 2016, fining it £3.2m for money laundering failures and preventing it from accepting deposits from new customers for 168 days
  • action against WH Ireland for failings in relation to market abuse imposing a fine of £1.2m and restricting the firm from taking on new clients in its corporate broking division for a period of 72 days

This approach may be further explored and expanded by the regulators. Again, at the risk of repetition, we are likely to see a greatly increased focus on individuals.

How does the UK’s approach to dealing with corporate offences compare to other jurisdictions?

I see the UK regime as being very much a home grown product. Fines have increased in both the US and the UK since the financial crisis and UK levels still tend to be lower than in the US. I deal with this in more detail in relation to the last question below.

How much of the UK’s approach is inspired by other jurisdictions, such as the US?

I do see the UK jurisdiction as primarily home-grown. The tendency to increase fines has followed the US (though fines have yet to reach US levels). The splitting of regulatory authorities into the ‘twin peaks’ of the FCA and PRA may also be seen as involving a step in the same direction as other regulatory systems, though thankfully the position in the UK does not resemble that in the US with its complex layers of federal and state authorities which may have concurrent jurisdiction (and differing views on relevant conduct).

I see the UK regulators and the UK regulatory system overall much more as leaders than followers—I have a minority view that the EU has been mutually beneficial for both the UK and other EEA members as regards the content of regulation (and not just commercial opportunities for passporting etc)—see for example, the Markets in Financial Instruments Directive 2014/65/EU (MiFID II) and the Mortgage Credit Directive 2014/17/EU which draw heavily on the existing UK regulatory framework. I am concerned that both UK and EU regulation will suffer in terms of quality if there are not satisfactory arrangements post-Brexit for involvement of UK regulators and involvement by a larger number of authorities in setting standards.