This briefing discusses the new approach of the UK’s regulator, the FCA, to regulatory enforcement of wholesale markets, as revealed by the recent settlements between the agency and five banks relating to FX manipulation. These are the largest regulatory settlements in UK history, a total of £1.1 billion (or $1.72 billion), the largest slice of a $4.3 billion total figure across four international regulators. The size of the penalties, and, perhaps more importantly, the FCA’s methodology in arriving at the final figures, should be of real concern for UK-regulated entities.

The bottom line is that there is now very little room for error in compliance, especially in relation to contributing to benchmarks or other conduct affecting wholesale markets.

A study of the relevant FCA Notices in the FX cases reveals a lot about the current approach of the agency. A few points stand out:

  • The FCA is not shy about basing very large penalties on a narrow jurisdictional base. In each of these cases, the sole foundation for the penalty is Principle 3 of the FCA’s Principles for Business, the requirement to have proper risk-management controls. Of course, alleged failures under Principle 3 do not imply any lack of integrity or failure to meet standards of market conduct (as was the case in the LIBOR cases, for example).
  • The FCA made no findings of actual harm or detriment to customers or third parties, stating merely that the conduct in question gave rise to the “potential” for such harm.
  • The FCA was unable to determine whether the firms in question made illicit profits as a result of the behaviour.
  • In none of the cases does the FCA find that the firm in question "acted deliberately or recklessly" in relation to the breach.
  • The industry as a whole is being required to take further compliance measures. The FCA is imposing a remediation programme on dozens of other UK-regulated banks “to ensure firms address the root causes of these failings and drive up standards across the market”. Senior management at these firms will be required to provide attestations as to the completion of remediation work in improving compliance standards. This will be a major task for in-house counsel and heads of compliance in the coming year.

So what justifies these very large penalties, not to mention a compulsory remediation programme for firms which have not even been found wanting? How can non-deliberate systems and control failures, with no identified customer detriment, lead to such huge amounts being payable? The key reasons seem to be the following:

  • The importance of the FX benchmarks to markets generally. The FCA makes the strong point that the breaches "potentially had a very serious and adverse effect on markets". However this element only accounts for a small proportion of the penalty figures.
  • The seriousness of the conduct. The notices are less convincing on this issue. Much is made of the knowledge of some front-office staff of these practices, but it seems clear that they were common across the industry, not prohibited by any specific rules and known to the Bank of England at material times. The notices do not disclose any actual deceit or fraud; the most serious behaviour is limited to coordinating trading strategies in what were, after all, un-regulated markets. Be that as it may, the FCA still considers the cases all to reach the highest level of seriousness, justifying a penalty at 20% of the revenue (not profits) of the banks related to FX trading in the relevant period. This generally gets the base figure into the mid-tens of millions.
  • However, by far the largest element of each of the figures is the adjustment for deterrence. The FCA is quite open that “penalties imposed under [the current penalty policy] should be materially higher than penalties for similar breaches imposed pursuant to [the previous policy”]. It seems to have been a key purpose of the FCA that the penalty in each case should exceed the highest penalty in any past case. The highest previous penalty was £200 million (in relation to falsification of LIBOR submissions). So in each of the FX cases, the deterrence adjustment alone is more than £200 million.

This reasoning will be unattractive to many – at least to those who believe that sentences and penalties should be driven by the gravity of the offending behaviour. Courts may not sentence based on a wish to beat a previous record. Of course the FCA is a regulator rather than a court, and it is legitimate to take into account the effect which enforcement action will have on the markets generally. Nevertheless, firms may well be concerned that these cases set a precedent for un-controlled inflation in future penalties. It will be much more difficult to predict the level of fine applicable to some future breach, however minor.

This is particularly relevant for general counsel and heads of compliance with responsibility for regulatory risk. Firms must take a great deal of care to ensure that remediation work is done to the proper standards, and that it is tested and re-tested so that attestations can be provided with confidence. Getting it wrong may end up with the FCA trying for a new record.