In December 2007, the FSA published Consultation Paper 07/23 containing proposals to extend the common platform provisions in chapters 4 to 10 of the Senior Management Arrangements, Systems and Controls Sourcebook (“SYSC”) to firms not subject to the Markets in Financial Instruments Directive (“MIFID”) and/or the Capital Requirements Directive (“CRD”) (apart from insurance companies,managing agents and the Society of Lloyds,which will be considered when the final Solvency 2 Directive requirements are known).
Comments on the CP should reach the FSA by 19March 2008.
Non-MIFID/CRD firms are currently subject to the requirements of chapters 2 and 3 of SYSC, whilst common platform firms (MIFID/CRD firms) are subject to the requirements of chapters 4 to 10 of SYSC (which stemfrom MIFID and the CRD).
The proposal is to disapply chapters 2 and 3 to non-MIFID/CRD firms from1 October 2008 (apart from insurance companies,managing agents and the Society of Lloyds) and to apply chapters 4 to 10 of SYSC as rules where the common platform rules are in substance equivalent to rules currently applied to non-MIFID/CRD firms and as guidance where the FSA proposes an extension of provisions. All guidance is stated in the CP as being proportionate to the size, nature and complexity of the firm’s activities.
Changes of note
Non-MIFID/CRD firms are currently subject to guidance in SYSC 3.2.4G to the effect that firms cannot contract out of their regulatory obligations. The FSA proposes to extend SYSC 8.1.6R to non-MIFID/ CRD firms: this requires a firm which outsources a critical or important operational function or regulated services/activities to remain fully responsible for discharging its obligations under the regulatory systemand proposes as guidance, conditions a firm may seek to satisfy, usually via a contractual agreement when outsourcing.
Conflicts of interest
Most non-MIFID/CRD firms are currently subject to high level Principle 8 which requires firms to manage conflicts of interest fairly and additional conduct of business requirements (eg, in COBS 2.4, 7.1 and 7.16 and ICOB 8.3.3 and 8.3.4 (for insurance intermediaries)). The current proposal goes beyond this by changing the status of disclosure, requiring firms to effectively manage conflicts and to not over-rely on a policy of disclosure. Under the proposals, disclosure without adequate consideration as to how conflicts are appropriately managed will no longer be permitted. In addition the conflicts rule will cover eligible counterparties where currently existing conflict of interest provisions only apply to retail and professional clients, and firms which are part of a group will be subject to additional guidance on dealing with conflicts.
Non-MIFID/CRD firms are currently subject to guidance that the firm’s reporting lines should be clear and appropriate, having regard to the nature, scale and complexity of the business and be communicated as appropriate within the firm. The proposal is for firms to be subject to SYSC 4.1.1R which requires common platform firms to have robust governance arrangements which include a clear organisational structure, effective processes to identify, manage, monitor and report risks, internal control mechanisms and control and safeguard arrangements for information processing systems. The proposal is also to apply SYSC 4.1.2R, which contains specific technical criteria to be taken into account in relation to SYSC 4.1.1R, as guidance for non-MIFID/CRD firms.
Non-MIFID/CRD firms are currently subject to guidance to the effect that, depending on the nature, scale and complexity of its business, itmay be appropriate for a firm to have a separate compliance function which is documented, is adequately staffed and is independent. The proposal is to require non-MIFID/CRD firms to be subject to SYSC 6.1.1R which requires common platform firms to establish, implement and maintain adequate proportionate policies and procedures sufficient to ensure compliance by the firm, relevant individuals within the firm and its appointed representatives (where relevant) with their obligations under the regulatory systemand to counter the risk of the firmbeing used to further financial crime. It also contains a proposal for non-MIFID/CRD firms to comply with rules in SYSC 6.1.2 to 6.1.5R requiring common platformfirms to implement andmaintain adequate proportionate policies and procedures to be able to detect any risk of failure by the firm to comply with the risks set out in SYSC 6.1.1R and tominimise these risks. This proposal would take effect proportionately as guidance.
In addition to the above, in most other cases where common platform firms are subject to rules where none currently exist for non-MIFID/CRD firms, the proposal is for the rules in SYSC 4 to 10 to be applied by non-MIFID/CRD firms proportionately as guidance.
Having rules applied proportionately as guidance is not wholly satisfactory as it raises issues regarding clarity for non-MIFID/CRD firms as to what is required of them. The status of guidance is as follows: the FSA will not take action against a person for behaviour that it considers to be in line with guidance, other materials published by the FSA in support of the Handbook or FSA-confirmed Industry Guidance which were current at the time of the behaviour in question (DEPP 6.2.1(4)(G). Therefore, subject to the proportionality issue, firms would be generally advised to follow the guidance. Asmost of the common platform rules are being applied proportionately as guidance, the FSA has not had to carry out a cost benefit analysis (“CBA”) in respect of the guidance. It has only carried out a CBA in respect of the extension of the outsourcing and conflicts rules. It is likely that complying with all of the guidance provisions and trying to decipher what is proportionate for a firm will be a potentially costly exercise.