FCA consults on approach to international firms doing business in the UK

In its overall assessment of an international firm against the relevant minimum standards the FCA proposes that it would consider the firm’s potential to cause harm (‘risks of harm’) and the level of these risks. In CP20/20, it sets out 3 potential risks that are more relevant for international firms, especially those operating from branches:

Retail harm

Protection for the UK office’s retail customers, through redress and supervisory oversight for example, could be less effective, especially if the international firm becomes insolvent or exits the UK (‘retail harm’).

Examples given by the FCA of harms that could occur with an international firm include where:

• (a) the firm is solvent, but refuses to make payment of redress, and has insufficient assets in the UK to satisfy such claims. In such circumstances:
  
  • the FSCS would be unable to pay any compensation in circumstances where the firm is simply unwilling (rather than unable) to pay its redress liabilities.
    
  • the consumer may have to seek enforcement action in the firm’s home state, which may be complex, expensive, and time-consuming
    
  • the firm may take defensive action to resist enforcement, such as by seeking judicial declarations or anti-suit injunctions in the courts of its home state. It may also seek to dissipate any assets it may have in the UK
  • it may be more difficult for UK regulators to take effective action. For example, if a fine is levied, but the firm refuses to pay, the foreign court may refuse to enforce the payment of the fine on the basis that the fine is the sovereign act of a foreign state

   

• (b) the firm is insolvent, and so cannot make full payment of redress. Under these circumstances, where the firm is subject to home state insolvency laws, then:
  
  • consumers with FSCS protected claims who are eligible will be able to claim compensation from the FSCS up to the relevant limits. However, this is not possible for certain claims that are not FSCS-eligible, such as (in general) those relating to consumer credit or loan-based crowdfunding or where customers pursue their claim themselves where their claim exceeds FSCS limits
    
  • consumers whose claims are not FSCS-eligible or who pursue their claim themselves where their claim exceeds FSCS limits may have to prove their debts under the foreign court’s insolvency procedures and the laws of thehome state. This may add significant complexity, expense, and delay to the enforcement action. If the firm is heavily insolvent, the additional expense may further reduce the funds available for unsecured creditors, to the point that it is uneconomic for the UK consumers to pursue their redress
    
  • if consumers with non-FSCS eligible claims have already taken steps to secure redress in the UK before the firm became insolvent, they may need to start afresh under foreign insolvency proceedings
    

The FCA is aware that harms may be exacerbated where a firm subsequently decides to provide some services from its home state establishment rather than its UK branch / subsidiary as, for example, FSCS protections may not apply.

Mitigants

The FCA gives examples of potential mitigating factors, including where:

• the home state regulator could obtain compensation from the firm
  
• the level of prudential scrutiny and supervision applied to the firm in its home state provides comfort
  
• the extent of any ongoing monitoring of recovery and wind-down plans (where relevant), and the degree to which UK authorities may be involved in the recovery and planning process, and
  
• reputational damage that might arise for the firm were the firm not to compensate UK customers
  

Client assets harm

The UK rules that protect client money or custody assets safeguarded through the UK office and the home state insolvency regime which become applicable if the international firm fails may not be aligned. This misalignment could negatively impact the outcome for UK clients (client assets harm).

If an international firm safeguards client assets from a UK branch, it will generally be required to comply with UK rules on the protection of client assets while the firm is a going concern (in particular, the CASS rules). However, in insolvency, it is probable that a UK branch will be subject to the insolvency regime and procedures of the international firm’s home state. There is little harmonisation of insolvency law at an international level. An insolvency practitioner appointed in the home state may not be in a position to observe UK protections when distributing assets—clients for whom assets were safeguarded under CASS could even have to prove their claims as creditors rather than beneficiaries to property.

Mitigants

The FCA expects international firms to have considered the risks to client assets and how to address them. One possibility that credit institutions can consider is to hold money that would otherwise be classified as client money as a deposit under the ‘banking exemption’ set out in CASS 7.10.16R of the FCA Handbook. For custody assets, in some cases, ensuring assets are registered in a manner consistent with both home and host state laws may be sufficient to mitigate the harm depending on the insolvency law position in the relevant jurisdiction.

Another possible option an international firm could consider is to structure its arrangements so that client assets are not safeguarded from its UK branch, to the extent that doing so would better protect custody assets. The firm may wish to choose to conduct the custody asset activity from an establishment in the home country (such as the firm’s headquarters) where the home state provides its own protections. Or the firm may wish to arrange for the client to appoint another person who has the appropriate permissions to act as its custodian in the UK (with the firm possibly retaining a mandate over the custody account so that it can still service the client’s transactions).

Establishing a UK-incorporated subsidiary is another possible option for the international firm to consider, where this could ensure that there is consistency in the treatment of client assets in the UK between the safeguarding regime that applies during the life of the firm and the law that would apply in an insolvency.

The FCA will expect reassurance as to how assets safeguarded by a UK branch would be treated if the firm entered into insolvency proceedings. This could include seeking legal advice on the specific circumstances of the firm and its proposed UK branch in the context of the insolvency regime of its head office’s jurisdiction, and assessing the implications of its recovery and wind-down plans (or resolution plans where relevant) on the customers of the UK branch. When assessing whether these harms can arise in particular situations, questions that the FCA is likely to consider include:

• recognition of property rights: Will UK clients’ rights to their assets be recognised under the home state insolvency regime? Will the segregation of client assets from the firm’s general estate at the point of insolvency be respected?
  
• client interaction with home state insolvency: Will UK clients be treated in a way commensurate to UK expectations when exercising a claim to their client assets?
  
• effectiveness of home state insolvency process: Will client assets that were safeguarded from the UK branch be distributed in a timely fashion? What influence, if any, will the FCA or other UK authorities have over the protection of clients of the UK branch?
  

Wholesale harm

Shocks or risks that originate from the international firm’s overseas offices could, in some circumstances, be more difficult to detect or prevent and could be passed easily to its UK office, affecting the stability and integrity of the UK markets in which it operates or to which it is connected (wholesale harm).

The FCA identifies 3 common underlying factors that it believes can increase a firm’s ability to impactUK markets, and so its potential to cause harm in them, include:

• a lack of substitutability of the products and services that the firm offers in the UK market(s) where it operate
  
• the firm occupying an important position in the UK market, for example where it has significant market share in a niche market or otherwise has significant influence, and
• the firm being interconnected to other firms in the industry, and spreads and amplifies risks in the system rather than reducing or absorbing them
  

   

The FCA notes that the solo-regulated international firms that it regulates would be less likely to reach a scale or scope that could cause market disruption or other related harms that undermine market integrity—in contrast with the PRA’s approach to systemic wholesale branches in SS1/18.

Mitigants

Where this risk arises, the FCA considers that relevant mitigants might include, for example, the level of supervisory co-operation; the prudential regime the firm is subject to; and the credibility and quality of its wind-down planning.

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