What to expect from the FCA in 2014/15

Financial Services analysis: Robert Finney, a partner in the regulatory practice at Holman Fenwick Willan, reviews the Financial Conduct Authority’s (FCA’s) Business Plan 2014/15 and points out that the combination of a number of the initiatives could threaten the profitability or even viability of many firms, but also creates opportunities, particularly for those whose house is already in order.

Original news

Policy Paper: Business plan—FCA, LNB News 31/03/2014 75

New activities to be undertaken by the FCA during 2014/15 include the integration of consumer credit, when it takes over responsibility for this from the Office of Fair Trading (OFT) on 1 April 2014, which will affect around 50,000 consumer credit firms, and working with the Prudential Regulation Authority to implement the measures set out in the Financial Services (Banking Reform) Act 2013 on the recommendations of the Parliamentary Commission on Banking Standards. The FCA has published its Business Plan setting out the activities it intends to carry out in 2014/15 to protect consumers, enhance market integrity and promote competition.

What are they key points in the FCA’s Business Plan 2014/15?

I see the big themes in the FCA’s 2014/15 Business Plan as the following:

Cultural change—across the financial services industry, not at the regulator

The FCA’s drive to change culture across the financial services community, to ensure clients’ interests are paramount, will manifest itself in much of the FCA’s work, in authorisations, supervision and, as we are already seeing, in enforcement.

New regulation and regulatory responsibilities

A big part of the FCA’s work will continue to be EU regulation. Before the European Market Infrastructure Regulation (EU) 648/2012 (EMIR) and the Alternative Investment Fund Managers Directive 2011/61/EU (AIFMD) are fully effective, the Markets in Financial Instrument Directive 2004/39/EC (MiFID II) and Market Abuse Directive 2003/6/EC (MAD II) packages and a host of other EU initiatives listed in Annex 2 to the Business Plan. MiFID II will have a massive impact in the investment world, and in the commodities trading, but the impact of the new EU market abuse legislation is not to be underestimated even though the UK already has a broader regime than that set by MAD IIand stronger investigative and enforcement powers than many other EU member states.

The FCA has just (from 1 April 2014) assumed the mantle of consumer credit regulation and supervision, which has effectively doubled the number of firms it supervises, and launches the new retail payment systems regulator in April 2015. These are major challenges, not least the integration of consumer credit firms into the FCA regime, their re-authorisation and the culture shock many will experience. The FCA is already targeting certain groups (such as payday lenders) and issues (such as advertising).

In addition, the FCA will continue to initiate rule changes, the ongoing review of client money and assets being among the most important.

Competition: after so many years’ debate as to the FSA's and FCA's role in fostering competition, this is now a major theme

The Financial Services Act 2012 gave the FCA a competition objective of ‘promoting effective competition in the interests of consumers’ in the markets for regulated financial services the exempt services provided by a recognised investment exchange.

In addition, the payment systems regulator will have objectives to promote competition and innovation, and from next April the FCA will have concurrent competition enforcement powers with the new Competition and Markets Authority (CMA).

The FCA is staffing-up accordingly and I anticipate it having a significant impact.

Long-term savings

The apparent mishandling of communications concerning its intentions to review legacy life insurance products may affect the timing and approach somewhat, but you should not doubt the FCA’s intention to proceed with its review of whether policies purchased many years ago are being operated in a fair way and whether insurers ‘exploit existing customers’.

The FCA also proposes a range of other initiatives in relation to long-term savings, including sales practices at retirement (an area in which we can expect broader supervisory activity in light of the relaxation of pension drawdown rules (including the scrapping of compulsory annuities) and related changes announced in the Budget on 19 March 2014.

Several initiatives follow up on the Retail Distribution Review, for example looking at whether advisers undertake appropriate due diligence to ensure suitability.

Supervision and enforcement

Annex I sets out an ambitious list of current and planned thematic work and market studies, reflecting the above points and much more. Culture will be at the heart of supervisory work—have firms ‘embedded a culture that promotes the fair treatment of consumers and market integrity’? Firms’ governance, risk-management, controls and monitoring (of sales practices) will be under the spotlight, but also their business models and economics—how does the firm make money?

Although the budget summary in section 8 of the Business Plan identifies a substantial reduction in enforcement case costs, be under no illusion that high profile and effective enforcement activity will continue—as will the many smaller cases against small financial intermediaries and (taking over from the OFT) consumer credit firms. There will be an increased focus on individual accountability.

What are the key features of the FCA’s Risk Outlook?

The FCA Risk Outlook 2014, published alongside the Business Plan and twice as long, begins by reviewing the factors driving the risks that threaten FCA’s objectives of consumer protection, market integrity and effective competition. Examples are firms’ culture and incentive structures, conflicts of interest, and the growing need for individuals to have ‘financial capability’ to understand financial products and manage complex financial responsibilities (which are described as inherent, being internal to financial markets and participants) and environmental conditions such as asset bubbles, increased risk appetite among investors, likely higher interest rates and dependence on technology. However, key change in the regulatory environment are also noted, including EU rules, the FCA’s responsibilities, ongoing programmes (Retail Distribution Review and Mortgage Market Review) and, last though by no means least, crowdfunding—a development which challenges many existing regulatory notions and where the FCA and EU have each recently announced policy developments.

Part B of the Risk Outlook describes a range of risks to the FCA’s objectives, drawing out seven particular ‘forward-looking areas of focus’, which are:

  • technological developments may outstrip firms’ investment, consumer capabilities and regulatory response
  • poor culture and controls continue to threaten market integrity
  • large back-books may lead firms to act against their existing customers’ best interests
  • retirement income products and -distribution may deliver poor consumer outcomes
  • the growth of consumer credit may lead to unaffordable debt
  • terms and conditions may be excessively complex, and
  • house price growth that is substantial and rapid may give rise to conduct issues

Some of these headings are so high level as to give little clue as to the risks involved. For example, the first covers such technology risks as firms’ over-reliance on third parties and inadequate linking of legacy and new systems.

The Risk Outlook concludes by linking the risks, especially the ‘forward-looking areas of focus’, to detailed points in the Business Plan. In this context, the FCA highlights work around:

  • culture and incentives
  • conflicts of interest
  • market structures
  • technology development, and
  • impact of policy and regulatory changes

It then summarises its approach to dealing with all these across authorisations, supervision and enforcement, and in policy development and intervention.

What do these documents tell us about how the FCA has found its first year as a new regulator and the FCA’s regulatory approach for the year ahead?

The FCA started well, but risks being overwhelmed by the scale of its cultural crusade particularly in its endeavour to right historic wrongs. That is part of the reason for its current difficulty over legacy life policy review. It has also become apparent that market integrity issues are more widespread than appeared a year ago. Even without these, the new responsibilities the FCA has acquired in respect of consumer credit, payments and competition, and under EU legislation) would be a challenge for any organisation. However, the FCA also sets organisation standards for its community of regulated firms, which it may struggle to meet itself. The coming year will be critical in determining whether the FCA has the capacity to meet these challenges and deliver on its ambitions.

Are there any features of the Business Plan or the Risk Outlook that are likely to cause concern for the financial services industry?

Yes, many. Almost no firm is untouched by the FCA’s plans. The thematic reviews themselves will examine fundamental aspects of the business of a broad swathe of firms. Although retail firms (whether in consumer credit, mortgages, insurance and pensions or other investment services) will be most impacted, it is clear the FCA will also be looking closely at wholesale firms (especially in trading markets and insurance). The combination of a number of the FCA’s initiatives would seem to threaten the profitability or even viability of many firms, but that also creates opportunities, particularly for those whose house is already in order. Despite the FCA’s back-peddling on its review of the treatment of long-standing life customers, reviews of the historic business of insurers and others remains one of the greatest risks for firms.

The FCA’s programme to embed cultural change, and the specific initiatives that are part of or reinforce that, will cause the greatest concern for the greatest number of firms, affecting so many aspects of a firms business and operation and management.

How should lawyers advise their clients in light of these publications?

First, lawyers should advise their clients to review these publications, so that client firms can take steps to address the FCA’s concerns before the FCA come calling. Even the Risk Outlook contains much material of value to firms in assessing FCA thinking and priorities.

Lawyers can help their clients develop and implement plans to address the risks and FCA concerns that are relevant to the firm. An obvious example is the FCA concern about long, complex and unfair terms and conditions and marketing material.

However, firms need to consider their business models and strategies in the new environment. Whether your business is retail investment products or commodity derivatives (or both), the FCA’s plans and EU legislation is combining to have a major impact on the regulatory environment in which you operate. Good lawyers will advise what this all means for you, and help you develop the appropriate business structures and strategies to mitigate the risks and capitalise on the opportunities.

Robert Finney’s practice focuses primarily on financial services, markets and products but also covers energy regulation. He advises mainly banks, investment managers, brokers, exchanges and energy/commodity traders (utilities, energy companies, commodity houses, etc) on securities, derivatives and commodities business. Robert also advises on Islamic finance and establishing investment funds and vehicles. Robert worked in-house at Morgan Stanley and Credit Suisse before entering private practice. He has a long-standing reputation in the exchange-traded and OTC derivatives space, especially in relation to energy and commodities.

Interviewed by Kate Beaumont.

The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.

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