Financial services, regulation and ethics

Although the powers of the regulators cover many different sectors and firms with...

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...nt regime, their supervision of firms and their overall responsibility for regulation.

The present regulatory regime was established in the UK on 1 April 2013, when the Financial Services Authority was abolished and replaced by the Financial Policy Committee (FPC), the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA).

Financial Policy Committee (FPC)

The FPC of the Bank of England is responsible for identifying the systematic risks that are attributable to structural features of financial markets or to the distribution of risk within the financial sector and identifying unsustainable levels of leverage, debt or credit growth. Having identified risks, it is able to take various measures to counteract them. These macro-prudential tools are:

Setting countercyclical capital buffers - ensuring that banks increase capital in good times, which should also temper lending during a boom and thus dampen the effects of the credit cycle

Variable risk weights - enforcing capital requirements on specific sectors or asset classes (requiring firms to hold more capital against their riskier investments)

Leverage limits - limiting excessive build-up of on-and-off balance sheet leverage

In addition, it also has the objective to limit the impact of its policies on economic growth.

The Committee has 13 members:

It is chaired by the Governor of the Bank of England, plus

Four deputy governors for monetary policy, financial stability, prudential regulation, and markets & banking

The executive director for financial stability

The chief executive of the FCA

Five members from outside the Bank appointed by the Chancellor

One non-voting Treasury member

The Treasury provides the FPC with guidance and it is required to respond to the...

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...s to entry/fostering diversity of business models

Growth – ensure financial services makes a positive contribution to sustainable growth in the UK economy

Competitiveness – ensure the UK remains an attractive option for international institutions, contributing towards economic growth

Innovation – recognising differences in the nature and objectives of business

models and ensuring burdens are proportionate. Engaging with consumers and encouraging new ways of raising capital 

Trade – encourage trade internal investment in the UK to boost productivity and growth

Better outcomes for consumers – ensure financial service industry works in the best interests of consumers and the businesses they serve

Financial Conduct Authority (FCA)

The FCA ensures that business across all aspects of financial services and markets is conducted in a manner which advances the interests of all consumers and market participants. It has a single strategic objective of ‘ensuring that markets function well’ and three operational objectives:

Protecting consumers - securing an appropriate degree of protection for consumers

Protecting financial markets - enhancing the UK system’s integrity

Promoting competition - in the interests of consumers

To assist with the FCA’s proactive approach, it has been given powers by Government to ban or restrict financial products, to publish details of warning notices issued in relation to disciplinary actions and to take formal action against misleading financial promotions and disclose that it has done so.

List the three operational objectives of the FCA.

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Protecting consumers

This objective aims to protect consumers from potential or actual detriment by early intervention. This will necessitate a focus not only on a firm’s conduct towards consumers directly but also on the knock-on effects and implications that may result from activities in retail-related wholesale markets. In working towards consumer protection, the FCA will take account of the risk posed by some financial products, the experiences of consumers and the need for information and advice.

Measures taken by the FCA that promote competition aim to remedy both market power and information asymmetry, and this promotes consumer protection.

The FCA introduced the Consumer Duty in July 2023, which sets higher expectations for the standard of care firms provide to customers. The new duty introduces a 12th Principle to the existing 11 Principles for Businesses – the Consumer Principle – together with supporting cross-cutt...

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...cisions

Senior management responsibility – holding senior managers responsible for risk management and controls, thereby securing adequate but proportionate regulatory intervention

Recognising the differences in the businesses carried on by different regulated persons - and exercise its functions in light of this

Openness and disclosure - publishing of information about regulated persons, or requiring them to publish information to reinforce market discipline and enhance the understanding of members of the public about financial matters

Transparency – exercise functions transparently, provide appropriate information on regulatory decisions, and be open and accessible to the regulated community and the public

Which of the Regulatory Principles that the FCA deals with is to ensure that any restriction imposed on an individual or activity is appropriate in relation to the potential benefits?

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The FCA has a considerable part to play in the policing of the financial services industry in the UK. Any individual wishing to carry out one or more regulated activities must apply directly to the relevant regulator for authorisation, unless they are considered exempt.  This is termed ‘applying for Part 4A permission’. The PRA will authorise institutions that accept deposits or insurance contracts and the FCA will authorise smaller firms which advise on and sell investments, home finance activities and general insurance.

Scope

The following powers are available to the FCA over firms and individuals.

Enforcement matters

To impose penalties for market abuse

To carry out investigations

To take disciplinary action against authorised persons

To instigate criminal proceedings for offences under the FSMA

Supervision matters

To make rules including those for conduct of business, client money, financial promotions and fighting money laundering

To require authorised persons to provide information or documents

To regulate changes of control over UK authorised persons

To keep the Lloyd’s insurance market under review

To co-operate with other regulators

Authorisation matters

To grant, vary and cancel authorisations for permitted activities

To approve individuals to perform certain controlled functions and to issue codes of conduct

To be represented in court in cases of banking or insurance transfers

To authorise unit trusts

To recognise overseas collective investment schemes

To recognise investment exchanges and clearing houses

To maintain a public record of authorised persons and prohibited persons

The FCA’s roles

Direct authorisation and regulation of the UK financial services system:

Authorising businesses

Prudential regulation – ensuring authorised businesses are financia...

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...g in misleading conduct to induce an individual to make or refrain from making actions in relation to investments is a criminal offence.

The Criminal Justice Act 1993 sets out the additional criminal offence of insider dealing, where individuals use or encourage others to use information about a company which is not generally available to make a profit or avoid loss

The civil offences under s.118 of the FSMA can be any of several behaviours, as laid out in the Market Abuse Regulation 2016, onshored into UK law in 2020:

Insider dealing – dealing based on inside information

Unlawful disclosure – the disclosure of inside information to another person

Manipulating transactions – trading in a way that gives a false impression of the supply and demand for an investment to raise the price to an artificial level

Manipulating devices – trading by employing the use of fictitious devices

Dissemination – deliberately conveying false or misleading impressions about an investment or its provider

Distortion and misleading behaviour – behaviour that distorts the market in an investment

Money Laundering

The FCA can:

Levy penalties on registered businesses that are in breach of the regulations

Prosecute an officer of a registered business that is in breach of certain regulations, with a fine or up to two years in prison or both

In addition, there are the formal statutory offences of:

Acquiring, possessing, using, concealing, disguising or converting criminal property or assisting another in these actions – punishable by up to 14 years in prison

Failing to report knowledge or suspicions of money laundering activities – punishable by up to five years in prison and/or a fine

In addition to Parliament, to which other three bodies is the FCA accountable?

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Supervision is used to describe the FCA’s day-to-day regulatory relationship with authorised firms and the monitoring and regulating of them to ensure they are complying with the regulatory requirements. The overall approach to regulation is early intervention, seeking to address root causes of problems for consumers. The FCA says that it will ‘act more quickly and decisively and be more pre-emptive identifying and addressing issues before they cause harm’.

The FCA is able to deal with complaints on behalf of a large number of customers, which are known as super-complaints. An example would be the scandal of the sale of PPI insurance.

Risk based approach

The FCA has adopted a ‘risk-based’ approach for authorised firms. Firms are risk assessed and it carries out most supervisory activity on firms that it believes offer the highest risks against its objectives. It takes into account:

The likelihood of a major failing (probability)

The possible impact of that failing on the FCA’s regulatory objectives (impact)

The frequency by which a number of firms focus on higher-risk products and services

Some sectors are perceived as higher risk than others and some firms within those sectors will hold higher ratings than others

FCA supervision

Firms are required to base their business models and culture on a foundation of the consistent fair treatment of customers. This approach requires a more flexible focus on bigger issues arising either in individual firms or across entire markets. Some firms may therefore have intensive supervisory contact while others may only be contacted every few years.

This approach requires a more flexible focus on bigger issues as they emerge, either in individual firms or across sectors. Larger-risk firms might have an assigned supervisor with highly intensive contact, while others might only be contacted once every three or four years.

Risk framework – the FCA’s three-pillar supervision model

The FCA’s supervision work is based around three pillars of activity, which are based on continuous analysis of the industry by sector and the risk within them:

1. Proactive firm/group supervision .

This is designed to assess a firm’s conduct risk, asking the question: ‘are the interests of customers and market integrity at the heart of how the firm is run?’ It entails analysing the firm’s business model, and how the fair treatment of customers has been embedded into governance and culture, product design, the sa...

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...ill check the firm's compliance systems to ensure that they are adequate and must be given access to all documentation they request. The areas typically checked are:

Business operations

Senior management and business culture

Permission for all activities

Effectiveness of the compliance department

The ‘fair treatment of customers’

Record keeping

Financial promotions

Complaints systems

Personnel matters

Appointment procedures for Appointed Representatives and employees

Procedures for certification

Procedures for individual registrations for controlled functions

Competence of advisers

Control of inducements

Training and competence systems

Conduct rules training

Customer matters

Giving customers client agreements

Suitability of recommendations made to customers

Suitability reports

Key Features production

Post-sales confirmations

Projection calculations

Production of cancellation notices

Client money systems

Anti-money laundering procedures

At the end of the visit, the FCA will produce a report detailing any recommended actions, which must be actioned within the specified time limits.

Internal compliance monitoring

Each firm should have its own compliance monitoring procedures. A firm’s compliance officer is primarily responsible for all elements of FSMA compliance and should be a director or senior manager (it is an SMF16 role). In larger firms, there is likely to be a compliance department to assist with the monitoring work.

Most firms are required to have a senior manager hold the Compliance Oversight function, although this is currently not required for mortgage and insurance intermediary business.

The compliance department should maintain a regular check on all the procedures and systems likely to be monitored so that there are no surprises at an FCA visit. The department may also act as checkers of advertising promotions, fact-finds, suitability letters and training. It may also carry out monitoring visits on branches, appointed representatives and advisers.

Failure to monitor compliance adequately could lead to disciplinary action by the FCA, unwelcome publicity and/or a decline in business.

In their risk-based approach for authorised firms, explain what is meant by the terms ‘probability’ and ‘impact’.

Answer: In the risk assessment, probability assesses the likelihood of a major failing and impact assesses the possible impact of that failing on the FCA’s regulatory objectives.

The PRA was formed on 1 April 2013 to have responsibility for the regulation of banks, building societies, credit unions, insurers and major investment firms. Through its supervision...

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...ll be supervised on a portfolio basis with only occasional individual examination, whereas large complex organisations will be subject to detailed supervision at an individual level.

The Financial Stability Board (FSB) is an international body that monitors and makes decisions about the global financial system. It comprises senior representatives of national financial authorities – central banks, regulatory and supervisory authorities and ministers of finance - international financial institutions, standard setting bodies and committees of central bank experts. The UK regulatory authorities are all represented as members.

Financial stability - international

The mandate of the FSB is to:

Assess vulnerabilities affecting the financial system and identify and oversee action needed to address them

Promote co-ordination and information exchange among authorities responsible for financial stability

Monitor and advise on market developments and their implications for regulatory practice

Advise on and monitor best practice in meeting regulatory standards

Undertake joint strategic reviews of the policy development work of the international standard setting bodies to ensure their work is timely, co-ordinated, focused on priorities and addressing gaps

Set guidelines for and support the establishment of supervisory colleges

Manage contingency planning for cross border ...

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...cial strength of regulated firms

The regulators monitor the financial strength of:

Banks

Building societies

Friendly societies

Insurance companies

Fund managers

If the financial strength of any of these fell below the minimum standard, they would be prevented from accepting any new business. These organisations must make the information regarding their financial strength available for public scrutiny through their accounts and reports.

An important measure in the strength of a life office is the ‘ free asset ratio (FAR) ’.

The free asset ratio is the surplus assets held by the life office over the value of its liabilities, expressed as a percentage of the total assets:

FAR = (Total Assets – Liabilities)/Total Assets  x 100

This factor is often considered by independent advisers when selecting a specific office to provide a product for clients.

Various institutions exist which give ratings to financial institutions. These ratings are publicly available, but their reliability has been called into question following the recent financial crisis.

What are firms required to do in relation to their financial resources?

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This revision test (opens in a new window) has 10 questions and tes...

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...29 standard multiple choice questions in the R01 exam for learning outcome 5