The FSA Business Plan and FSA Risk Outlooks have now been published - the risk outlook this time has separate retail and prudential outlooks, in line with the forthcoming transition from the FSA to the Prudential Regulatory Authority ("PRA") and the Financial Conduct Authority ("FCA").
So what do they tell us and why are they relevant?
They are important because they tell us what issues the FSA will focus on over the coming year alongside their current outcomes focused (forward looking proactive) on a highly intensive supervisory regime. They essentially state the areas where the FSA will focus their resources over the coming year, including enforcement action in line with their credible deterrent philosophy.
The FSA has made it clear that it is now attempting to prevent issues before they crystallise, and it is clear that this will continue when the FCA takes the reins. In order to do this it needs, amongst other things, to focus on where it perceives the risks are ahead.
In the Retail Conduct Risk Outlook ("RCRO") the FSA has helpfully separated risks into current risks where damage has already occurred, emerging risks where damage is likely to occur and potential future risks.
Current risks include:
- compliant handling by banks;
- TCF weaknesses by mortgage brokers;
- misselling of PPI; and
- sales and marketing of structured investments and structured deposits (in particular, misuse of the terms "guaranteed" and "protected").
Emerging risks include:
- banking conduct of business compliance;
- implementation of the Retail Distribution Review ("RDR"), in particular for platforms;
- advisers extending services to portfolio advice and portfolio management in order to justify the payment of continued fees;
- firms' remuneration and reward policies and practices and their effect on TCF;
- firms making poor suitability assessments when carrying out investor profiling ;
- the increasing popularity of complex investments such as ETFs; and
- unsuitable sales of unregulated collective investment schemes.
Potential concerns include:
- the effect on TCF of banks seeking fee income generation;
- increased cross selling of products to existing customers to generate fees;
- cost cutting and efficiency improvements resulting in marginalisation of low-value clients and an increased risk of customer detriment; and
- business model changes as a result of the RDR.
The key issues raised in the Prudential Risk Outlook include:
- the need for firms to strengthen their capital positions and to ensure that their dividend and remuneration policies are consistent with maintaining capital to their revised standards;
- the likely removal of tier three capital
- the appropriateness of sales targets linked to remuneration.
- the danger of focusing on short term wholesale funding as opposed to medium and long term funding is highlighted; and
- the issue of shadow banks.
Those firms whose services are caught by the FSA Risk Outlooks, in particular the RCRO, should review their procedures and ensure there are no holes.
The biggest challenge/current and emerging risk to regulated firms is, in fact, the upheaval caused by the move from the FSA to the Prudential Regulatory Authority and the Financial Conduct Authority which will take place at the end of 2012/early 2013 but is already in motion now. As practitioners, we have noticed that recently authorisations, variations of permission, approved persons changes and change of control consents are taking a long time.
The impact of the change in supervisory structure can only get worse for significant institutions (banks, insurance companies, investment banks and large broker dealers) going forwards, who will be jointly regulated by the PRA and FCA. They will have two supervisors requiring input to authorisations, variations etc. which will lead to further delays. They will also be monitored and supervised and be at risk of enforcement action by two supervisory bodies as well as having to pay two lots of fees.
The change in supervisory structure also carries the risk of the UK not being represented properly on each of the European Supervisory Authorities ("ESAs") which are playing more of a key role in making legislative changes and will be able to make rules with direct effect. There will only be a representative on the PRA on the boards of the European Banking Authority and the European Insurance Authority, with only the FCA being represented on the European Securities and Markets Authority. It will be imperative for the PRA and FCA to co-ordinate and co-operate with one another in order for there to be proper representation on the ESAs. Intense interpretation and lobbying efforts in relation to EU regulatory reforms, in particular in relation to rules emanating from the ESAs, will be necessary to protect UK interests. The FSA has had a very good track record for representing UK authorised entities in the international arena and it is important that this is continued by the PRA and FCA.
Another current and emerging risk for UK authorised firms is the extent of EU regulatory reform affecting them. Every sector of the financial services industry has a European initiative to contend with, whether it be MiFID 2, MAD 2, AIFMD, PRIPs, UCITS IV, CRD 4, Prospectus Directive 2, Transparency Direcitve 2, EMIR, Solvency II or IMD 2. Those affected will not require these abbreviations to be expanded! We have experience of advising on all of these reforms, so please contact us if you require further information on them.
In addition, the domestic Mortgage Market Review and Retail Distribution Review together with the FSA's focus on safety of client assets, complaints handling, proactive approach to Treating Customers Fairly are all impacting on in particular those providing services to retail clients.
It is likely that the FSA will need to pull back on the Retail Distribution Review once PRIPs and the IMD2 come into force. It has also acknowledged in the Business Plan that it will need to pull back with its UK liquidity reforms. It is therefore questionable whether the FSA should be pursuing its efforts so vigorously on these issues at this time. The FSA should know that the move is towards full harmonisation of Directives across the EU, and it is now very difficult for Member States to gold plate.
Those firms providing services to retail clients should also keep an eye on client assets, complaints handling and TCF, in addition to dealing with the EU reforms as the FSA will take enforcement action where possible in these key consumer protection areas under its credible deterrent philosophy. The FSA will also be reviewing compliance by banks with BCOBs, so beware!