On 2 April 2013 the Financial Conduct Authority will become the conduct regulator for all UK financial institutions. It will also act as prudential regulator for a broad range of financial institutions. In the last few months HM Treasury and the FSA have been producing numerous consultations on the changes which need to be made to secondary legislation and to the detail of the FSA Handbook in order to implement the "twin peaks" structure now contained in the Financial Services and Markets Act 2000. There is still a considerable amount of work to be done to finalise some of the details of the new regime but the direction of travel is clear.
The FCA's statutory objective is to ensure that relevant markets work well and, underpinning this, it has operational objectives, the consumer protection objective, the integrity objective and the competition objective. In 'Journey to the FCA', published in October 2012, Martin Wheatley, FCA Chief Executive-Designate, set out the FCA's vision and approach to meeting these objectives. Predictably, the FCA's focus is on 'good conduct' from 'the boardroom to point of sale and beyond'. As with TCF, senior management are given responsibility for creating a culture that promotes good conduct and for demonstrating good conduct through their dealings with customers, each other and the market. This must be evidenced by three key outcomes. Firstly, consumers getting services and products that meet their needs from firms they can trust. Secondly, markets and financial systems emerging that are sound, stable and resilient with transparent pricing information. Lastly, firms competing effectively with the interests of consumers and the market at the heart of their business. To achieve this transformation, the vision identifies the changes required within financial institutions but recognises that radical change by the regulator is also required. The FCA will be more active and better informed, intervening to prevent conduct that prejudices any of these outcomes, while promoting innovation and growth. To achieve its statutory and operational objectives the FCA will be more intrusive, interventionist and inquisitorial. At the same time, the FCA will be seeking to build up its understanding of the market and increase interaction with firms and individuals to make it a more effective regulator.
A new supervisory framework will be implemented by the FCA. There are three elements: the Firm Systemic Framework which is the on-going supervisory structure for all firms; event-driven work where the FCA will react swiftly to risks identified in the markets or at a firm outside of the normal review cycle; and issues and products focused work which will consist of fast, intensive campaigns dealing with sectors or products that may put consumers at risk, led by specialist sector teams. Only firms which are classified within the two highest risk categories will have a nominated supervisor. These firms can expect to be supervised closely by reference to their business model, forward looking strategy and culture which must demonstrate that the business as a whole is centred on treating customers fairly. These are firms which have the potential to cause the most risk to the FCA's objectives. Other firms will not have dedicated supervisors, allowing the FCA to utilise supervisors more efficiently in response to need. The Firm Systemic Framework will replace the current ARROW visits and involve preventative work through structured conduct assessment of firms. This will employ a common framework, designed to assess whether the interests of customers and market integrity are 'at the heart of how the firm is run'. The common features include business model and strategy analysis which links to the new Business Model Threshold Condition and is designed to take a view on sustainability and where future risks might lie and assessment of how the firm embeds TCF and ensures market integrity. The FCA will also review conduct risk across a sector. This sector specific analysis will review information about cross-firm and product issues that are producing poor outcomes for consumers or endangering market integrity, the resulting harm and the proposed discovery or mitigation work proposed.
The FCA does not believe there is a divide between retail and wholesale markets. Wholesale conduct can have a direct impact on consumers (as in the case of the mortgage securitisation market) and affect market integrity (as in the case of LIBOR fixing). Equally, the FCA does not believe that one part of the market can ignore the interests of its customers purely because they can be regarded as sophisticated in contrast to consumers.
To ensure that it is exercising proper oversight a new Policy, Risk and Research Division will act as the FCA's 'radar'. Addressing criticism that the FSA did not fully understand the industry it was tasked with regulating, this division will identify and assess risks for consumers, firms and markets, create a common view of the risks to inform the FCA's authorisation, supervision and enforcement decisions and use its knowledge to develop policy that changes behaviour. While whistleblowing will continue to be important, the FCA will proactively gather more data from more sources including from firms, consumers, consumer bodies, other regulators, professional firms and take into account economic and market information and analysis. Its aim is to concentrate on root causes that might create a significant market risk rather than fire-fighting as and when problems emerge.
In the future, the FCA's approval of a person to carry out a controlled function will not just depend on its assessment of the individual and his or her skills, capabilities and behaviour (including their personal integrity, financial soundness, honesty and record of treating customers fairly). The appropriateness of that individual in the context of the whole senior executive team will also be an important factor so that the firm has a board with the right management balance. For dual regulated firms, the most senior appointments will be considered by the PRA but the FCA's consent must be obtained. Although the FSA published a detailed CP on the proposed new structure of the Approved Persons regime in October 2012 the finalised policy has yet to be published. This leaves firms in a position of uncertainty shortly before Legal Cutover. It is clear that there will be "grandfathering" of existing approved persons which to some extent removes the sense of urgency. However, as and when the finalised proposals are published, firms will need to consider how their existing approved persons fit into the new framework as well as ensuring that they have appropriate procedures in place for dealing with the "right" regulator when changes occur.
Firms will need to be prepared for the FCA to take a proactive approach in ensuring that the firm has proper product governance structures in place. The FSA has demonstrated over the past 12 to 18 months that it will step in quickly and forcefully where it identifies consumer detriment and the FCA will seek to continue this approach. Many firms will, by now, have developed processes to demonstrate that their products are designed taking into account their customers' needs, that the product is sold to the customers it was designed for, achieves the intended outcomes and that complaints information is regularly reviewed and used to make changes to the product or the sales process if required. One significant change will be the FCA's focus on value-for-money and charging structures. While the FCA has ruled out product pre-approval, at least initially, it is likely to be interested in a firms' modelling and to be concerned if the product design or sales process is geared to generating excess profits or is likely to result in customers being surprised by hidden charges. The intrusive approach combined with the new rules allowing the FCA to ban products with or without prior consultation should act as a driver for a robust approach to compliance and especially TCF. Another new power for the FCA will be the power to ban misleading financial promotions, to remove promotions from the market immediately or prevent their use without going through the enforcement process. The power may be exercised by product or by channel (e.g. social media) if the FCA is concerned, for example, that a product is too complex to be marketed by a particular channel. When deciding whether to use these powers, the FCA need not measure potential financial harm. Interestingly this new power is being seen by the FCA as a supervisory tool rather than an enforcement tool.
The FCA's approach will continue to be one of 'credible deterrence' with a focus on more enforcement cases and tougher penalties, more cases against individuals and a greater emphasis on senior management accountability, criminal prosecutions and compensation for consumers. The enforcement division will make changes to its own culture, by seeking to work more closely with other FCA departments so that it can identify causes and contribute to the prevention of problems as well as taking action. This means that enforcement action can be expected in relation to particular aspects of a firm's business model. The FCA will have a new power to publicise that it has begun disciplinary action against a firm or an individual. This is effectively another deterrence measure for firms keen to protect and enhance their reputation in the market and build trust with consumers.
Although firms will have six months to change their notepaper to reflect the name of their new regulator it is likely that all firms will feel the impact of the change from the FSA to the FCA more quickly than that.
First published by the FT Adviser on 7 March 2013.