Readers may recall the FSA's 'close supervision' of firms, which could arise after an ARROW visit if significant failings were identified. The FCA has now re-branded 'close supervision' and, in substance, 'Enhanced Supervision' will mean much the same, albeit couched in the new judgement-based, interventionist language of the new conduct regulator.
In June 2013, the Parliamentary Commission on Banking Standards published its report"Changing Banking for Good". The Banking Commission's report recommended new powers for the financial regulators (including the FCA, PRA and Treasury) to address the recent serious failures of standards at senior levels in banks; most notably, the LIBOR scandal.
Approximately a year later, in its response to the Banking Commission's recommendations, the FCA published its paper "Tackling Serious Failings in Firms";interestingly, the FCA's paper goes beyond tackling serious failures in banks alone; the FCA's response will affect all regulated firms.
The FCA (along with the PRA and Treasury) boldly rejected the Banking Commission's recommendation that it should be bestowed with new powers to tackle the recent serious failures of standards. Instead, the FCA insisted that it can effectively address these failures by using the powers already available to it more "appropriately".
The paper outlines a new regulatory approach called "Enhanced Supervision". This approach is loosely based on a method used in America by the Office of the Comptroller of the Currency. The FCA intends to deploy Enhanced Supervision where "serious failures of culture, governance or standards" have been identified in regulated firms by third parties and/or during the course of its normal supervision. Theoretically, the model occupies the middle ground between the FCA's normal supervisory regime and its formal enforcement action. However, the FCA is keen to stress that Enhanced Supervision will not usurp and/or immediately precede enforcement action; if necessary, enforcement action can and will be taken with or without making use of Enhanced Supervision.
When will the FCA use Enhanced Supervision?
Unfortunately, there are no hard and fast rules on when it will be deployed. The FCA will generally use its best judgement, but guidance has been provided of hypothetical "serious failings" or "red-flags" which could lead to enhanced supervision, namely:
- "Numerous" or "especially significant" conduct issues or repeated failings which examined separately may not be considered serious
- Failings occurring in several areas of the regulated firm, as an indicator of a wider cultural issue within the firm
- A poorly performing board where executives are not taking the lead in considering conduct.
- Control areas such as Risk, Compliance and Internal Audit being poorly managed, under resourced or with no seat at the board level
- Weak risk management
- Other areas of weakness in which the board and/or senior management influence key cultural factors, e.g. the "tone from the top", pay incentives and adherence to the firm's values.
What will Enhanced Supervision entail?
Again, there are no hard and fast rules on what a particular Enhanced Supervision would entail. The FCA has afforded itself a measure of flexibility and again will rely on its judgement rather than any formal and rigid process. However, the FCA has indicated that it may order any of the following action(s):
- Require the board formally to commit and cooperate with prescribed remedial measures (e.g. changing the remuneration packages of the firm's employees that disproportionately reward/encourage unacceptable risk);
- Where appropriate, appoint (or require the board to engage) an independent person to oversee the prescribed remedial measures;
- Impose a timeframe within which the FCA would expect the firm to action the remedial measures; or
- If the board of a firm fails to comply/cooperate with the FCA's Enhanced Supervision, the FCA may invoke its statutory powers to impose the remedial actions.
How will Enhanced Supervision operate in the real world?
It is too early to point to real life examples of the FCA's using Enhanced Supervision. In reality, unless referred to specifically in a Final Notice, it would seem unlikely that the full details of any Enhanced Supervision will be made publicly available because the FCA will endeavour to seek the a firm's cooperation and this will likely keep the Enhanced Supervision confidential.
However, we do consider that the announcement of Enhanced Supervision is indicative of the FCA taking a more pro-active and interventionist approach to regulation; as opposed to the (heavily criticised) "light-touch" and reactive approach favoured by its predecessor, the FSA.
For example, earlier this year, the FCA fined the UK's largest retail investment manager, Invesco, £18.6m for 33 separate breaches of the FCA's rules and principles. In short, the FCA found that between May 2008 and November 2012, Invesco breached the funds' (conservative) risk profiles on numerous occasions, across 15 of Invesco's retail funds, without notice to its investors. Investors lost approximately £5m, but losses could have been higher.
The FSA reacted by initiating an investigation after complaints were raised; rather than identifying "red-flags" during its normal supervision of the firm; but what hypothetically could have happened if the FCA regulated Invesco and had Enhanced Supervision at its disposal? It is possible that the FCA would have noted the breaches of the funds' risk profiles as being systemic across the firm and that these numerous and wide ranging breaches may have been indicative of a wider cultural issue. As a result, the FCA may have used Enhanced Supervision to minimise the investors' exposure to losses. Obviously, it is difficult to speculate whether Enhanced Supervision would have been more successful in this specific situation, but it could have helped mitigate and/or prevent some of the investors' losses and therefore reduced the need for (or possibly negating altogether) a formal (and potentially public) FCA investigation and enforcement action. That would have benefitted all concerned, but do we really think it likely to happen?