In recent months, we’ve seen the FCA begin to flex its muscles through the use of its new product intervention powers; this looks to be an on-going trend
The FCA recently received new powers which enable it to make product intervention rules (which may last for up to 12 months) - without consultation or cost benefit analysis - where it considers it necessary or expedient to do so to advance its consumer protection or competition objectives. The FCA has said that its main consideration will generally be, “whether prompt action is deemed necessary in seeking to reduce or prevent consumer detriment”.
In the FCA’s first use of these temporary product intervention powers, the FCA restricted firms from distributing contingent convertible securities (known as “co-cos”) to the retail market. The FCA’s rationale for this was that these instruments are highly complex, with investment risks which are “exceptionally challenging to evaluate and model”, making them highly unsuitable for the mass retail market. Although the ban was made without prior consultation, the FCA launched a full consultation in this area at the end of October 2014, which will enable permanent rules to be put in place on the expiry of the ban. The temporary rules enable the FCA to protect consumers whilst allowing the market in co-cos to develop for professional and institutional investors.
I see the use of these temporary product intervention powers as part of a wider initiative from the FCA to use broader risk mitigation powers as part of its policy of early intervention and consumer focus. The FCA is aware of the need to address issues at an early stage on a cost effective basis. Enforcement action is only available once damage has been done and is an expensive use of resources.
The EU also considers product intervention to be vital to the safe operation of financial markets. The Markets in Financial Instruments Regulation (MiFIR) (part of the MiFID II package) will give national regulators wide powers to intervene in product sales from 2016. Whilst this will not be a major change for UK markets, there is a further power which enables the European Securities and Markets Authority (ESMA) (and the European Banking Authority in respect of structured deposits) to take direct action in certain circumstances.
Under MiFIR, ESMA will have the power temporarily to prohibit or restrict the marketing, distribution or sale of certain financial instruments or a type of financial activity. ESMA can take this action in circumstances where the action addresses a significant investor protection concern or a threat to the orderly functioning and integrity of financial markets or to the stability of the EU financial system; or alternatively where current EU regulatory requirements do not address the threat and member state regulators have not themselves sufficiently addressed the threat. Any ESMA imposed prohibition or restriction must be reviewed (and if appropriate, renewed) at least every three months, otherwise it will expire.
As a consequence, ESMA will be able to take direct action in member state markets, overriding any action (or inaction) by the local regulator. This could place firms in a very difficult position if they are receiving conflicting directions from both national and European regulators. It remains to be seen how this Europewide power will work on a practical level, but this is an area which may well be open to challenge.
In my view, perhaps the most important message for firms is that they should focus carefully on their product design processes to ensure that their products are appropriate for the target market with minimal (or, alternatively, very clearly understood) risk of customer detriment. The FCA will continue to flex its muscles through the use of product intervention powers over the coming years, and together with the new ESMA powers, product design is an area firms will certainly need to get right to avoid regulatory action.