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FCA and PRA policy update: Q3 2014

Over the summer, the FCA and the PRA published a number of key policy documents including:

  • a joint Consultation Paper setting out their proposals for implementing the new Senior Managers and Certification Regime, as well as a new Code of Conduct;
  • the FCA's Annual Report, which provides an overview of key areas of focus for the FCA (including from an enforcement perspective); and
  • policy statements regarding their approach to supervising firms that are found to have serious failings in culture, standards and governance.

An overview of each of these important publications is set out below, along with links to Allen & Overy's more detailed briefings on them.

The FCA and PRA Senior Managers and Certification Regime and new Code of Conduct

At the end of July 2014, the FCA and the PRA published a lengthy joint Consultation Paper setting out their proposals to overhaul the current approved persons regime by introducing a new Senior Managers and Certification Regime, as well as a new Code of Conduct. The new regime will apply to UK banks, building societies, credit unions and PRA-designated investment firms. HM Treasury is also proposing to extend the application of the new regime to UK branches of overseas banks.

As anticipated, the new Senior Managers and Certification Regime will result in significant changes to the way in which individuals working in financial institutions are regulated. Firms will also have significantly increased responsibilities in relation to individuals who fall within the new Senior Managers and Certification Regime and a much wider group of individuals will be subject to the new Code of Conduct and exposed to the risk of potential FCA or PRA enforcement action. As a result, firms may be required to change or adapt their existing internal processes in order to comply with the new Senior Managers and Certification Regime, as well as the new Code of Conduct. The new Senior Managers and Certification Regime will also have practical repercussions on every aspect of firms' relationships with the FCA and the PRA, ranging from authorisations (for Senior Managers) to enforcement (for all employees subject to the new Code of Conduct) and, in particular, day-to-day supervision. Even though the proposals set out by the FCA and the PRA are still in the consultation stage, it is likely that the current proposals will not change significantly before they are implemented in 2015. As a result, there is much that firms can be doing now in terms of considering how they will need to adapt existing internal processes or implement new ones in order to comply with the new Senior Managers and Certification Regime when it comes into force in 2015.

The proposals have been widely covered in the press1 and are causing much concern. There is considerable uncertainty, with a large amount of work still to be done by the regulators in terms of analysing the responses to the current Consultations and also the further Consultations they will need to hold about transitional arrangements and how far to extend the scope of the new regime to UK branches of overseas banks. The Treasury's plan is to extend the regime to all banks that operate in this country at the same time, including branches of overseas banks. This is also not something that can be done without further consultation. Further, the Policy Statement which will follow the consultation on the regime for UK banks, which was previously due for publication in December 2014, has been recently re-listed by the FCA for publication on a date "TBC". Given the need to plan the significant upheaval that the design and implementation of the new regime will bring, it is rather unsatisfying that crucial questions on timetable and scope are still to be confirmed.

FCA Annual Report

The FCA Annual Report, also published in July 2014, documents the FCA's activities in its first year in existence but also gives a clue as to the FCA's agenda for the coming year and the issues this presents firms.

Change in the way the FCA deals with enforcement and supervision

Many firms will have already noticed several changes in the way the FCA deals with enforcement and supervisory matters: higher financial penalties in 2013/14 compared to 2012/13 and more early intervention. Firms should expect continuing use of early intervention by the FCA. There will be more publication of warning notice statements (including, perhaps, those more against firms rather than individuals, which has been mostly the case to date) and possible further use of the FCA's product intervention powers (following the FCA's first use of these powers to ban the sale of CoCos to retail customers). Firms should also expect to see continuing use of the attestation power.

Enforcement relating to benchmarks

The warning notice statements to date have mostly concerned enforcement relating to the regulation of benchmarks, which continues to be one of the main priorities for the FCA. A significant amount of FCA Enforcement resources are being dedicated to ongoing investigations relating to benchmarks, and the FCA has established a dedicated "Benchmarks team" within its Supervision Division. A section of the Annual Report is dedicated to the subject of "restoring confidence in benchmarks" and highlights the fact that the FCA has developed new analytical tools to monitor for market abuse and attempts to manipulate LIBOR.

Market abuse

Firms have long been aware of the need to ensure traders' compliance with market abuse regulations and, in 2013/14, the FCA conducted market abuse cases against two individuals and one firm and secured one criminal conviction relating to market abuse. Firms will be aware of the relaunch of the FCA's MarketWatch publication and the FCA's visits to assess market abuse systems; in addition, the FCA confirms in the Annual Report that it has developed new tools which are specifically designed to monitor for market abuse.

Market abuse is high on the political agenda too. The Fair and Effective Markets Review was announced on 12 June 2014 and will report next June. This market abuse review, chaired by Minouche Shafik, the Bank of England's newest deputy, is designed to restore confidence in wholesale markets and influence national debate.

In the meantime, while the review is still ongoing, George Osborne has said that the Government will take action to extend the new legislation which the Government put in place to regulate LIBOR to cover further benchmarks in foreign exchange, fixed income and commodity markets and to extend the criminal regime for market abuse. On 25 September 2014 HM Treasury published a Consultation on implementing the Review's benchmark recommendations, together with a draft of the statutory instrument amending existing legislation in this area. The proposal is to widen the legislation to a range of benchmarks including the WM/Reuters 4pm London fix and oil, gold and silver. The Consultation closed on 23 October 2014.

Conflicts of interest

Martin Wheatley highlights in his Chief Executive's Report in the Annual Report that the FCA has already seen significant improvements in the way firms remunerate their staff, removing conflicts of interest that posed a risk of mis-selling. In 2014/15, the FCA is proposing to carry out two thematic reviews relating conflicts of interest:

  • The first will review how investment banks effectively control the conflicts of interest that may exist between their obligations to clients and proprietary sales and trading positions.
  • The second will consider the controls that investment banks have in place over flows of information and how such firms effectively ensure that confidential information received in one part of their business is not used by another business area in an inappropriate way.

In particular, the FCA intends to review firms' business models to assess whether they create information asymmetries between firms and clients and, if so, whether firms profit from these information asymmetries (either by using information to support their own activities, or by withholding information from clients that should be disclosed).

Both of these thematic reviews are expected to take place in Q4 2014 and both Martin Wheatley and Clive Adamson have been foreshadowing these reviews:

  • "[The risk of conflicts of interest arising]…is a flag for regulators and reason enough for firms' senior management to be wary. Managing conflicts of interest around information properly should be part of any firms' DNA." Martin Wheatley (31 March 2014)
  • "Clearly, conflicts of interest [are] an inherent risk in most investment banks. It is something we'll look at on a continuing basis…" Clive Adamson (speaking at the FCA's Annual Public Meeting on 17 July 2014)

On 12 September 2014 the FCA published a Guide on how firms should avoid conflicts of interest. It states that it is the senior management's responsibility to set clear standards for their firm: "responsibility for identifying conflicts and how to manage them should be clearly allocated to accountable individuals, and controls to reduce the impact of conflicts should be regularly reviewed. One way of doing this is by using management information. This can be used to identify the amount of business placed with a product provider to spot unusual patterns or volumes of business." The Guide states that firms should have a formal conflicts of interest policy in place which should be regularly reviewed. Clear guidance should also be in place for staff on how to recognise a potential issue and when to escalate it to management.

Prevention of financial crime

Prevention of crime may have an even higher profile than previously. In 2013/14, the FCA imposed over GBP10 million in financial penalties on firms that were found to have inadequate controls to prevent financial crime and two of these fines were for banks with serious AML failings. Four of the FCA's early intervention projects in 2013/14 involved AML in banks.

Interestingly, the Anti-Money Laundering Annual Report for 2013/14 recognises that much of the FCA specialist resource has so far been dedicated to AML work in the biggest banks, but the FCA acknowledges that money laundering risk is not necessarily correlated with the size of a firm so this year the FCA is developing a new strategy to target resources at firms which pose a higher money laundering risk.

The AML Annual Report states that its findings from SAMLP assessments (as well as its thematic reviews and general case work) have been "disappointing". In particular, the FCA commented that "significant weaknesses have been identified in a number of firms, particularly in relation to the assessment and management of higher risk businesses". The FCA stated that the most common issues it identified during SAMLP assessments include:

  • inadequate governance and oversight of money laundering risk, especially historically;
  • inadequate risk assessment processes to identify high-risk customers;
  • poor management of high-risk customers and those who are Politically Exposed Persons (PEPs), particularly in relation to establishing the source of wealth and sources of funds for PEPs;
  • inadequate due diligence on correspondent banks;
  • inadequate or poorly calibrated anti-money laundering/sanctions-related IT systems;
  • weaknesses in the handling of alerts relating to sanctions and/or transaction monitoring; and
  • poor judgements or questionable decisions leading to a firm taking on unacceptable money laundering risk.

The FCA states that it is considering whether more firms should be referred to FCA Enforcement in Q4 2014 in connection with their financial crime controls, especially as a result of the FCA's on-going thematic work into smaller banks' anti-money laundering and sanctions controls. The FCA does, however, acknowledge that in contrast many large banks now recognise AML as an issue requiring senior management attention and a strong tone from the top.

A final point to note from the AML Annual Report is that the FCA states that 1%-2% of whistleblowing reports made directly to the FCA relate purely to money laundering concerns.

FCA and PRA approaches to supervising firms found to have serious failings in culture, standards and governance

On 19 June 2014, the FCA and PRA published documents outlining their approaches to tacking "serious failings" in standards, governance and culture within firms that they supervise. The FCA intends to subject firms that are found to have serious failings to a new type of supervision – "Enhanced Supervision" – which, in some cases, may be a precursor to referring firms to FCA Enforcement.

If a firm is under Enhanced Supervision, it will experience a more intense relationship with its supervisors and its activities are likely to be subject to greater scrutiny. In addition, a firm's senior managers may be required to commit to implementing certain remediation measures and may be held responsible if such measures are not adequately implemented. This is consistent with the FCA's continuing focus on senior management accountability.

A firm which is subject to Enhanced Supervision will also typically be required to take the following steps (which are similar to those that the OCC requires firms to take in the United States):

  • The firm's Board may be required to commit to implementing certain remediation measures. Where the FCA thinks that oversight by an independent person would be valuable, the firm may also be required to appoint a Skilled Person.
  • The FCA is likely to review the effectiveness of implemented remediation measures and determine whether the firm could revert to "normal" supervision.
  • If the FCA believes that the outcome obtained from the Board commitment is not effective in addressing its concerns, the FCA will consider using its other supervisory and enforcement powers.

In its publication, the PRA also states that if serious failings relating to culture, governance and/or standards are identified then it is likely to also subject firms to an enhanced form of supervision. The PRA described its version of enhanced supervision as a more intense style of supervision and also stated that additional resources would be devoted to supervising firms that are subject to enhanced supervision.

The concept of "Enhanced Supervision" appears to be a development of the FCA's existing "Watch List" scheme. Under the FCA's "Watch List" scheme, firms who are considered to pose the greatest risks to the FCA's statutory objectives are identified and reported to the FCA's Board. The FCA did not address in its document how the concept of "Enhanced Supervision" will interact with its existing "Watch List" scheme.

In addition, the requirements that the FCA may impose on senior management at firms that are subject to Enhanced Supervision may provide the FCA with a further and more formal way in which it may hold senior managers accountable for failings in the businesses for which they are responsible, including failings relating to the implementation of remediation measures. This will be further enhanced by the introduction of the proposed new Senior Managers and Certified Persons Regime.

Concluding thoughts

The regulatory developments described above are each significant and raise substantial challenges and work for firms. As firms know only too well, these are just the tip of the iceberg in terms of the changes which firms are currently being asked to address.

We have produced three Bulletins2 to help firms manage the information and we are of course always happy to discuss this in more detail with clients.


1 See for example the FT headline on 9 October 2014 "Bankers fear new UK rules will scare off talent":

2 The new FCA and PRA Senior Managers and Certification Regime and Code of Conduct – a guide to the current proposals (August 2014):
FCA Annual Report 2013/14 - an enforcement perspective:
The FCA and the PRA confirm approaches to tackling serious failings in standards, governance and culture in firms:

Legal and Regulatory Risk Note
United Kingdom