“Tougher, bolder and more engaged”: the approach of the Financial Conduct Authority

On 27^th June 2011, the Financial Services Authority (“FSA”) released an “approach” document outlining how its successor body for conduct and markets regulation, the Financial Conduct Authority (“FCA”), would be tougher and bolder than the FSA itself when it commences its operations in late 2012 or early 2013.

The FCA document adds (a little but not a lot) to previous publications on change to the infrastructure for the authorisation and supervision of UK financial services firms. No major structural changes were announced in the FCA document but the key message is to expect a material change to the regulatory and supervisory approach in certain sectors of the market. Indeed, when publishing the FCA document, FSA chief executive, Hector Sants, noted how trust in the financial services sector is at an all time low and that these new regulatory arrangements provide an opportunity to restore confidence. Publication of this document seeks to open a debate as to what sort of regulator stakeholders want and need.

Scope of the FCA

The proposed new regime vests in the FCA responsibility for:

• regulating the conduct of an anticipated 27,000 firms operating in both retail and wholesale markets (in this context, markets includes exchanges and also over-the-counter dealing)
• supervising the trading infrastructure that supports these markets
• the prudential regulation of around 24,500 firms not systemically significant enough to be regulated by the Prudential Regulatory Authority.

In practice this means that the FCA will be the sole regulator for advisory firms, investment managers, corporate finance firms and agency brokers.

Objectives

The FCA will have the single strategic objective of protecting and enhancing confidence in the UK financial system and will also have three operational objectives:

• securing an appropriate degree of protection for consumers
• promoting efficiency and choice in the market for financial services
• protecting and enhancing the integrity of the UK financial system.

This is fairly familiar stuff with the exception of the addition of the duty for the FCA to discharge its functions in a way that promotes competition, so far as is compatible with its objectives.  The FCA will also have a “free-standing duty” to have regard to the importance of taking action to minimise the extent to which regulated businesses may be used for a purpose connected with financial crime.

Proportionality

A cause for concern is the fact that the FCA document defines “consumer” as practically every type of market participant, including investment banks, hedge funds, prop desks, day traders and infrastructure providers.  This has triggered fears that the decades’ old approach of distinguishing between the regulation of wholesale and retail markets and their participants will be materially diminished. A conference held contemporaneous to publication of the FCA document was told that the government had chosen to define “consumer” extremely widely.   However, the regulator would be allowed to design its own way of differentiating between retail and wholesale “consumers” and would do so on the basis of “risk and detriment” and thus ultimately achieve a suitably differentiated approach.

Perhaps most comforting is the following statement in the FCA document which exhibits that the regulator has not forgotten – in a helpful way - that small and medium sized wholesale firms exist and present different types of risk (generally lower) to the objectives of the regulator:

“The FCA will be the prudential and conduct regulator for a significant number of wholesale small and medium sized enterprises (SMEs), covering such activities as corporate finance advice, hedge fund asset management and other institutional wealth and long-only management boutiques. The FCA recognises that this community is an important part of the City of London and that the oversight of this group will need to be tailored to reflect its own particular set of issues.”

How will “tougher, bolder and more engaged” feel?

The FCA will certainly wish to ride the wave of the FSA’s recently achieved momentum in creating “credible deterrence” to serious misconduct and shortcomings and will therefore look to levy increasing penalties, bring criminal prosecutions and exact high standards from registered individuals, especially senior staff. Demonstrative of this enforcement focus is the controversial new power allowing the FCA to make public a “warning notice” at the earliest stage of enforcement proceedings even before a full investigation has been completed with the consequence that firms could face reputational damage despite perhaps being exonerated at a later stage.  The counter to this argument is how comparatively rare it is for a  party to be so exonerated as compared with the value of making potential clients and  counterparties aware of a serious issue with the firm at the earliest possible opportunity.

The FCA’s stall is also set-out as being a tough yet proportionate regulator that will protect consumers more proactively than ever before. It will look to investigate activity even before the point of sale and ban products and also advertisements when necessary. Accordingly, the FCA is set to be more intrusive and judgement based, using suitably expert staff to properly investigate actual or potential issues arising with complex products and markets – the sale and resale of securitised asset-backed securities and derivatives thereof springs to mind.

This attitude of earlier investigation and action appears to be the area which best evidences the “huge cultural shift” in the UK’s approach to the regulation and supervision of firms.  Of huge comfort to firms that advise, manage assets or trade for institutional clients or investors is the deliberate reference at this time to the UK’s expensive history of mis-sold financial products. This should indicate the areas of “risk and detriment” where the FCA’s resources will likely be more intensively deployed.

Wholesale firms should note that the FCA also intends to focus more closely on wholesale conduct (but how could it not say this?).  It will adopt a more “issues and sector-based” supervisory approach across all the 24,500 firms.  To non-relationship managed firms, particularly those that have not seen the FSA for some time – or even at all – this approach should not be feared and should even be welcomed as it will be constructive in identifying regulatory priorities and sectoral standards. And if you do see the FCA at your premises (other than in an enforcement situation), it will be a much briefer visit than a top-to-toe review of all aspects of your business, a supervisory methodology which has long been out of favour other than in respect of very high impact firms.

The reality though is that the FCA will be staffed with the majority of the staff that previously worked at the FSA, funded in the same way as the FSA (via fees, levies and fines) and even located in the same offices. The goals set out in the FCA document are not so strikingly different from those of the FSA in terms of desired outcomes. Moreover, the stark reality is that the regulatory agenda is now primarily set by Europe (when not being set by Washington).  As such, the FCA will have limited scope to change or even gold plate the current MiFID (and other EU directive) based rules in the FSA Handbook. And we also await with interest the extent to which the European bodies will increasingly become involved in not just rule-setting but also the supervision of firms.

Next steps

Feedback on this specific document should be directed to FCAApproach@fsa.gov.uk by 1^st September 2011.  No specific action is required of firms at this point but if you wish to influence how you are regulated in future then, as always, you should take the opportunity to have your voice heard.

The FCA approach document follows publication of a Government White Paper on 16^th June 2011 which outlined further detail on the proposed changes to the UK regulatory system. (Click here for our article on the white paper)

If you have any questions regarding this subject, please contact Peter Moore, Stephen Burke or Alan Leale-Green. Alternatively telephone 020 7408 2448 to speak to your usual IMS contact.