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TCC's regulatory update for the end of January

Regulatory team, TCC, London, 25 January 2018

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It has been a busy month for the UK's Financial Conduct Authority with the appointment of a new chair, work to overturn failures in the contracts-for-difference market and a further consultative exercise to do with changes to the way in which the Financial Services Compensation Scheme is funded.

The FCA, moreover, has commissioned the economist Benedict Guttman Kenney to examine the available data to identify the risks that might arise from the recent growth in consumer credit indebtedness. It has also been active in the field of enforcement.

Feedback on the development of DLT

The FCA recently consulted interested parties about the future use of distributed ledger technology in the financial markets and way in which it ought to support it. It has now revealed its findings.

DLT, as everyone knows, underpins Bitcoin and all other crypto-currencies, but the FCA is concentrating on the wider use that DLT could find in the financial services industry and the regulatory implications that this may have. Respondents were in broad agreement with the regulator’s ‘technology-neutral’ approach and suggested no changes to the existing regime, which suggests that the rules might be flexible enough to accommodate any new developments.

However, the FCA's 'feedback statement' did highlight some worries, especially about the possibility that permissionless networks might not be compatible with its regulatory regime. The FCA has stated that it is open to all forms of DLT deployment and will try to co-ordinate its approach to them with other quangos.

Fines and penalties: an unlawful forex investment scheme

Following an application by the FCA, the High Court has made orders against people involved in an unauthorised foreign exchange (forex) investment scheme, which took at least £1.2 million from 65 investors and invested/used none of it in forex trading. The defendants were found to have unlawfully promoted and operated a managed forex trading facility between December 2014 and November 2015.  

The court issued injunctions to prevent further unauthorised activity and continued with a freezing injunction against them. It also issued a restitution order for the sum of £1,203,298.41; this was designed to cover the losses that the investors suffered, although they are unlikely to receive their entire due.

Fines and penalties: the unauthorised investment scheme

Three people have been sentenced for participating in an unauthorised investment scheme through which investors lost more than £1.4 million. Two defendants, who are already serving custodial sentences for the parts they played in a separate investment scheme, were sentenced to 15 and 9 months’ imprisonment respectively and disqualified from holding directorships at any business for 10 years. A third individual has been sentenced to 15 months’ imprisonment and disqualified from being a director for 8 years. The final defendant, described by the judge as ‘the prime mover’ in the scheme, has had his sentencing adjourned until the end of this month.

Fines and penalties: the banning of a former trader

The FCA has banned a former trader from performing jobs in financial services and fined him £250,000. The defendant was involved in the trading of products linked to the Japanese Yen (JPY) LIBOR for a leading bank, as well as making LIBOR submissions to the British Bankers' Association (BBA) when the primary submitters were unavailable.

An FCA investigation found the defendant to not be a 'fit and proper' person to do investment business and was knowingly involved in the firm’s failure to observe proper standards of market conduct. Between 14th February 2007 and 22nd November 2010, the trader:

  • made routine requests to the primary submitters to benefit the trading positions in which he was involved;
  • took his own trading positions into account when acting as primary submitter;
  • attempted to manipulate the JPY LIBOR submissions of other banks on two occasions, with the help of a broker; and
  • conducted 28 wash trades, paired to cancel each other out, in conjunction with the above broker provide brokerage payments to two firms following the receipt of personal hospitality.

The FCA's new chair

The FCA has announced that Charles Randell CBE is to be its new chair. Charles has extensive experience in regulation and has a background in corporate finance. He advised HM Treasury on resolutions to help failing financial institutions after the financial crisis began in 2008 and has played a vital part in financial stability and bank restructuring projects.

Andrew Bailey, the FCA's chief executive, said that Charle had "a strong understanding of the challenges that the FCA faces." Charles currently works as:

  • a member of the Prudential Regulation Committee of the Bank of England;
  • a non-executive director and chair of the Audit and Risk Assurance Committee at the Department for Business, Energy and Strategy; and
  • visiting Fellow in financial services regulation at Queen Mary University of London.

The European Commission's plans to delay IDD implementation

The European Commission (EC) is proposing to persuade the other parts of the European Union to delay the implementation of the Insurance Distribution Directive (IDD) to 1st October 2018, having received requests from the European Parliament and EU countries. It still wants the EU to oblige member-states to enshrine the directive in their laws by the original date of 23rd February 2018, however. This requires confirmation from the European Parliament and Council through an accelerated legislative process.

What does the FCA think is causing consumer credit to grow?  

Consumer credit (debts that people incur in order to buy goods and services) is growing at 10% a year and this is a source of worry for economists, regulators and financiers. In his latest FCA 'insight article,' the economist Benedict Guttman Kenney has examined the available borrowing data from credit reference agencies and the risks that it reveals.

Kenney shows: (a) that sub-prime borrowing (i.e. borrowing by people with bad credit ratings) has not caused growth; (b) that mortgage-free consumers have been the main cause of growth; and (c) that periods of indebtedness are longer than product data implies. He goes on to examine each area in turn.

(a) On the first point, by analysing borrowers’ credit scores (which analysts often use to see whether borrowers are at a higher risk of default or financial difficulty) he has found that sub-prime borrowers hold owe a small proportion of debt in the world of consumer credit. Motor finance and 0% credit cards account for most of the growth in consumer credit since 2012. People with the highest credit scores account for the majority of this, suggesting that the people least likely to default or suffer financial distress are responsible for the growth, rather than subprime borrowers.

(b) On the subject of mortgage-free consumers causing the most growth, Kenney believes that the growth in consumer credit borrowing coincides with the tightening of mortgage lending criteria in the wake of the financial crisis, which raises the question of whether mortgage borrowers have opted for consumer credit instead of extracting equity from their homes. The data suggests that 60% of the growth in credit balances has come from people without mortgages, but the question of whether this increase is due to renters or to people who own their houses outright remains. Renters tend to spend a higher proportion of their incomes on house-related expenditures, which may leave them less leeway to repay debts. High levels of indebtedness among renters could be an emerging problem.

(c) Consumer credit products are short-term in nature, so it has been argued that the risks they pose can increase or decrease quite quickly when lending standards change. From the consumer's point of view this is not strictly true; it is not uncommon for consumers to remain in debt even after paying for a product, e.g. by using balance transfers, opening a new product or drawing on existing lines of credit.

There are some positive signs. The increase is not being caused disproportionately by subprime borrowers, nor are mortgage restrictions resulting in greater borrowing. However, the industry ought still to be mindful of the risks that an increase in borrowing might engender.

Contracts for differences

The FCA has sent a ‘Dear CEO’ letter to all providers and distributors of products involving contracts for differences. This letter outlines its concerns after conducting a market review which found the following.

  • Most providers are unable to define their target market or to explain how their products meet the specific needs of consumers.
  • 76% of consumers who bought contracts for differences on either an advised or discretionary basis lost money over the course of the review.
  • There were ineffective communications, monitoring and "challenge practices" at the distributors.
  • Providers had poor 'due diligence' processes for taking on new distributors.
  • The processes by which distributors 'managed' conflicts of interest were weak.
  • Management information (MI) and monitoring structures were weak, resulting in poor oversight.
  • The quality of remuneration structures at contracts-for-difference distributors was low.
  • There were problems surrounding the categorisation of clients as elective professionals.

In the regulator’s view, these findings suggest that the providers and distributors of contracts for differences many not be acting in accordance with its 'Principles for Business,' nor indeed in the best interests of their customers. It expects all relevant firms to consider these findings and to review their own operations accordingly.

The European Securities and Markets Authority (ESMA) has also published an outline of its work regarding the provision of contracts for differences to retail clients. ESMA is thinking of intervening in this market to address consumer protection risks. This includes using its powers to prevent the marketing, distribution or sale of binary options to retail investors and to prevent the marketing, distribution or sale of contracts for differences, including rolling spot forex, to those investors also. ESMA expects to consult interested parties about this shortly.

The FSCS levy period

The FCA recently made changes to the way in which the Financial Services Compensation Scheme (FSCS) funds itself, aligning the compensation levy year with the financial year. These changes will, however, result in a different allocation of costs to the life and pensions intermediation class - something that the FCA did not intend.

To address this, the regulator is asking firms for their views about transitional arrangements to ensure that the retail pool continues to support the life and pensions intermediation class. These might include:

  • the 2017/18 compensation levy year being allowed to run to its original timeframe;
  • the introduction of a nine-month FSCS compensation levy for 1st July–31st March with pro-rated payment thresholds;
  • delays to the introduction of the arrangements (about which the FCA previously consulted interested parties) for firms which pay fees on account until 1st April 2019.

If these changes come to pass, the FCA hopes that the life and pensions intermediation class will continue to receive the same level of support from the retail pool.

The FCA and PRA are also consulting interested parties about the management expenses levy limit (MELL) that covers the operating costs of the FSCS. They want the limit for 2018/19 to be £77.66 million, not including compensation paid to consumers which is determined separately.

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