The FCA has published a consultation paper on industry codes of practice and a discussion paper on FCA Principle 5 (CP 17/37). The consultation considers the process and impact of the FCA recognising industry codes of conduct for unregulated markets as indicating a proper standard of market conduct under the SM&CR Conduct Rules. This is followed by a discussion paper in which the FCA puts forward the case for extending the scope of Principle 5 to cover the unregulated activities of authorised firms. The FCA has requested responses to both by 5 February 2018.
In its consultation, the FCA proposes:
- A general approach to supervising and enforcing the SM&CR rules for unregulated markets and activities, including those covered by industry-written codes of conduct. The FCA states that it expects firms and their senior management to consider market codes in determining the ‘proper standard of market conduct’ as part of the SM&CR requirements (e.g., individual conduct rule 5, certification and regulatory referencing), including where the FCA does not have a framework of rules; and
- Formally to ‘recognise‘ certain industry codes of conduct that, in the FCA’s view, set out proper standards of market conduct for unregulated markets and activities. The FCA will review and assess industry codes against new criteria and then publically state that the FCA views certain codes as a helpful explanation of the proper standard of market conduct for particular markets. This would be done on a list published on the FCA’s website. The FCA believes that this process will encourage market participants to adhere to relevant codes.
Under the SM&CR the FCA expects individuals to observe proper standards of market conduct (COCON 2.1.5) whether they are carrying out regulated or unregulated activities. For regulated activities, the FCA’s handbook rules and other binding provisions are the primary source of standards. For unregulated activities,the FCA considers that industry codes of conduct may assist in identifying such standards. The FCA hopes that the recognition process will encourage senior managers (and their more junior colleagues) to follow industry codes, such as, for example, the Global Foreign Exchange Committee’s FX Global Code.
There are potential benefits in encouraging compliance with industry-led and internationally agreed codes of conduct, and for firms adopting those codes to have some reassurance that they are meeting regulatory expectations , Under the FCA’s proposals, the recognition of industry codes would act as a benchmark for the FCA’s expectations, offering firms greater clarity and potentially a safe harbour to demonstrate compliance. Some firms may consider it helpful for the FCA to promote compliance with industry codes so that there is a ‘level playing field’ between firms.
Nevertheless, there are also potential risks with the FCA’s proposals:
- Where industry codes have been drafted in aspirational terms, to reflect best practices rather than reasonable standards of behaviour, there is a risk that they may, when used as a benchmark against which to judge the conduct of individuals and firms, set the bar too high. The FCA has stated that market code breaches may be an indicator of failure to observe proper standards of conduct, and that it may in such circumstances take enforcement action against senior managers or their firms (on the basis of certification by the firm of an individual who breaches market codes as fit and proper). There is clearly a tension between this and the FCA’s assertion that codes are voluntary in nature.
- It is unclear how the FCA will decide whether to recognise codes in respect of areas where there are multiple potentially applicable codes, or where codes are not accepted by the industry generally as representing a proper standard of conduct. The FCA helpfully states that it will not recognise an industry code unless it is “agreed”. However, it may not be obvious to the FCA whether a code is agreed between market participants. Formal FCA guidance and rules are subject to a detailed consultation process. Industry codes are not necessarily subject to an equivalent process, giving rise to a risk that regulatory benchmarks are developed without sufficiently wide opportunity for public consultation. The FCA is not currently proposing to consult on the recognition of codes, on the basis that it will only recognise codes where there has been some form of public consultation. Firms may consider that it would be helpful for the FCA to publish a list of industry codes that it is considering recognising (not just those that have been recognised) so that market participants have the opportunity to comment before a code is recognised by the FCA.
- The FCA states that industry codes will remain voluntary but, in practice, firms and senior managers may feel under pressure to follow them if they are recognised by the FCA in the manner proposed. If a firm decides not to follow an element of a recognised code, then it will be likely to wish to record carefully why that decision has been taken in order to mitigate the potential enforcement risks. Firms are likely to need to treat codes as binding upon them if they have agreed to follow them.
Potential extension of Principle 5
The paper does not contain a firm proposal to extend the scope of Principle 5 of the FCA’s Principles for Businesses to unregulated activities of firms. Instead, it puts forward a case for doing so, with the prospect of a formal consultation in the future.
At the moment, Principles 3, 4 and 11 are regarded by the FCA as extend ing to the unregulated activities of authorised firms, whilst the FCA accepts its other Principles extend beyond regulated activities only to the activities ancillary to provision of regulated activities.
The FCA believes that an extension to Principle 5 would give it an enhanced ability to bring enforcement action against firms for serious firm-level misconduct and thereby create a greater deterrent to serious market misconduct.
The FCA emphasises that this extension of Principle 5 would bring the rules for firms in respect of their market conduct in relation to unregulated activities in line with its expectations of individuals in respect of market conduct under the Conduct Rules.
Some firms may consider the FCA has sufficient enforcement powers in this regard already – the FCA acknowledges that it was able to bring enforcement action against firms relating to LIBOR submissions and FX trading (primarily on systems and controls rather than conduct grounds) without extending the scope of Principle 5. In addition, it is unclear how, beyond the industry codes, firms (and the FCA) would go about determining proper standards of conduct in markets which are not regulated by it.
In addition to the specific points set out above, the consultation may provide an opportunity for the industry and FCA to clarify the scope and nature of the FCA’s powers in respect of the unregulated activities of authorised firms.