This month’s update is dominated by the publication of the FCA’s 2018/19 Business Plan and Sector Views. Alongside this we also bring you details of the regulator’s plan to measure the effect of its activities and the fees and levies it is proposing to raise in 2018/19.

The FCA’s business plan and accompanying 'sector views' provide the industry with valuable insight into the regulator’s priorities for the year ahead. Its 'sector views' draw attention to the issues and developments it sees in the sectors it regulates.

The FCA’s cross-sectoral priorities come as no surprise, as many have been carried over from previous years and include the important subjects of 'culture,' 'value for money' and 'transparency.' The business plan highlights the regulator’s keen interest in distribution chains, relationships between firms and the conflicts between the interests of customers and the commercial interests of firms.

Although the FCA does not include the vulnerability of customers on its list of priorities, as it has done in previous years, its obsession with the effect of firms’ activities on people who are vulnerable to harm permeates the whole document.

Preparations for Brexit

The word 'Brexit' does not appear once in the business plan. Instead, the FCA uses the phrase 'EU withdrawal' 36 times. A significant proportion of the FCA’s activity has been allocated to preparations for the UK’s exit from the EU, which explains some of the delay in previously planned work.

The FCA wants to:

• provide any technical assistance to other organs of HM Government that is necessary during negotiations;
• provide any technical assistance that might be necessary when new legislation on the subject is drafted or comes into force;
• review its rulebook to accommodate changes in the law;
• tell other parts of HM Government how the UK's future relationship with the EU may affect the financial services industry and its users;
• take action to offset any risks that might arise from transitional arrangements; and
• collaborate with the Bank of England in areas of joint responsibility.

Cross-sector priorities

The FCA’s seven cross-sector priorities will form the basis of its main activities over the coming months and are as follows.

• Firms’ culture and governance.
• Financial crime, especially money laundering.
• Data security, resilience (i.e. recovery from cyber attacks) and outsourcing.
• Innovation, 'Big Data' and competition.
• The way firms treat their existing customers.
• Long-term savings, pensions and differences between generations.
• High-cost credit.

Culture and governance

The FCA is still trying to ensure that each firm has an appropriate, customer-centric culture, supported by its business models, strategy and governance arrangements.

The FCA, among other things, will endeavour to:

• finalise the Senior Managers and Certification Regime (SM&CR) regime for all firms;
• establish a public register, having received comments from the industry; and
• review the remuneration arrangements at firms not subject to the FCA’s remuneration code to identify any harm that might befall consumers.

At all times, British financial firms are being used to further financial crime and launder money. The FCA is always trying to ensure that firms have the appropriate controls in place to deal with the problem.

Across all sectors, the FCA wants to:

• form a picture of how capital markets are being used to launder money;
• review the money laundering risks in the e-money market;
• 'embed' the new Office for Professional Body Anti-Money Laundering Supervision (OPBAS) and improve the way in which supervisors share information with each other;
• change its AML supervisory approach in line with the recommendations of the Financial Action Taskforce (FATF), the world's AML standard-setter;
• make consumers more aware of frauds and scams; and
• share more information and collaborate more closely with other relevant agencies.

Data security, resilience and outsourcing

Although the FCA acknowledges the benefits that new technology (i.e. new information technology or IT) can bring to the market, it knows that it can also harm consumers and make business a riskier proposition in places.

The prevalence of cyber-attacks and the devastating effect that they can have on markets and consumers has led the FCA to make strenuous efforts to make firms 'resilient' (an oft-used word) against cyber-attacks and service outages. It has been studying ways in which culture, governance, risk management structures and systems architecture might make data more secure. From August onwards, it plans to start monitoring the roll-out of technology in line with the UK's 'open banking' policy and PSD2, the European Union's second Payment Services Directive.

Innovation, Big Data and competition
 
The FCA wants to help consumers and firms enjoy all the benefits that innovation, Big Data and competition might bring, while also trying to offset any potential harm. It proposes to do the following.

• Keep running its Innovate and Regulatory Sandbox projects.
• Test and apply Regtech to its own processes to make itself more efficient.
• Review retail banking business models to understand the differences between traditional and emerging banks’ business models.
• Introduce new crowdfunding rules.
• Review the cryptocurrency market in tandem with the Treasury and the Bank of England.

Existing customers

The FCA is keen to ensure that competition does not put existing customers at a disadvantage in relation to new customers. Its plans the following.

• A review of general insurance pricing practices and the effect that these have on consumers.
• To tell claims management companies what it expects of them, with an eye on the date in spring 2019 when it begins to regulate them.
• Improvements to competition in both the cash savings and current account markets.
• The publication of rules to allow more small and middle-sized businesses to appeal to the Financial Ombudsman Service.

Long-term savings, pensions and intergenerational differences

The UK's 'pension freedoms' (a vast expansion of the options that people have when managing their pension pots, introduced by the British Government in 2015) have made the market riskier, with people recklessly making unsuitable transfers and saving too little for their retirement. The FCA wants to:

• impose some remedies it outlined in its Retirement Outcomes Review, whose final report (a provisional one has come out already) is timed for this quarter;
• act upon the data it has gathered about pension transfer practices;
• understanding the things that inspire people to save too little; and
• publish the comments that people have made about its investigation of competition in non-workplace pensions.

High-cost credit

The FCA scrutinises the high-cost credit sector more closely than most. It is keen to promote alternatives to it, especially for people who have previously struggled to make use of other options. It is putting the finishing touches to its review of high-cost products in the rent-to-own, home-collected credit, catalogue credit and overdraft sectors.

A shock

The FCA has said that it will intervene in unregulated activity if it has the potential to affect markets or a regulated activity. It rests this disconcerting statement on section 1F Financial Services and Markets Act 2000, as amended by the Financial Services Act 2012. The latter Act states, at section 1F (which 'interprets' terms to be used in relation to the FCA's general duties, in this case the meaning of “relevant markets” in the regulator's strategic objective), that "the relevant markets” are: (a) the financial markets; (b) the markets for regulated financial services; and (c) the markets for services that are provided by persons other than authorised persons in carrying on regulated activities but are provided without contravening the 'general prohibition.'

This 'general prohibition' (found in s19 Financial Services and Markets Act) says that a person cannot carry out a regulated activity in the UK, or purport to do so, unless he/it is either authorised or exempt.

How the FCA measures the effect of its regulation

To coincide with the publication of its business plan, the FCA has also released a discussion paper outlining the way it measures the effect of its interventions using "ex-post evaluation" and other methods.

This type of evaluation concentrates on the effect of regulatory changes on a whole market, rather than on a firm. Having canvassed public opinion about the 'mission' it publicised two summers ago, the FCA has promised to undertake one ex-post evaluation per annum. Three are underway at the moment, touching on: the inclusion of additional benchmarks in the regulatory regime; the introduction of guaranteed asset protection insurance remedies; and the lowering of barriers to entry for retail banks in 2013.

When deciding whether to evaluate this-or-that phenomenon, the FCA will consider:

• whether enough time has elapsed for change to have occurred;
• the scale of the thing it did;
• whether, at the time of it taking the action (or, in its parlance, the time of 'the intervention') it was uncertain about the outcome;
• whether it is likely to learn any useful lessons from the evaluation; and
• whether enough data is readily available.

Regulated fees and levies 2018/19

For the second time, the FCA is canvassing public opinion about the charges it wants to levy on firms in 2018/19, outlining the various ways in which it intends to raise the necessary amounts to fund the:

• FCA – its own annual funding requirement for 2018/19 is £543.9 million, an increase of 3.2%;
• Financial Ombudsman Service – the FOS general levy stands at £24.5 million, which the FCA will allocate among fee-blocks in a way similar to that of previous years;
• Money Advice Service, whose total budget is £83.5 million, split between the cost of providing advice about money and debt;
• Pension Wise service, the required funding of which is estimated to be £20.3 million, although this may be revised when the pension guidance levy rates are finalised;
• Single Finance Guidance Body – a new body for whose creation the FCA has been instructed to raise £3.6 million, to be recovered in proportion to the existing levies of the services it will replace; and
• expenses that HM Treasury has incurred in relation to illegal money lending, currently estimated at £5.6 million.

The FCA on Brexit

Between 29th March 2019 and 31st December 2020, EU law will remain in effect in the UK and all firms will be expected to continue preparing for any new EU law that will come into effect before the end of this period.

Firms and funds will continue to benefit from existing passporting arrangements, but should contact the relevant EU regulator about the implications of the transition period for their contingency planning. At this stage, firms with an EU passport need not apply for authorisation.

Andrew Bailey, the chief executive of the FCA, recently noted that HM Government plans to legislate for a "temporary permissions regime" to allow British firms in the European Economic Area to operate as normal between March 2019 and December 2020.

ESMA’s product intervention measures for retail contracts for differences and binary options

The European Securities and Markets Authority is taking steps to restrict the sale of contracts for differences, including rolling spot forex, financial spread bets and binary options, to protect retail investors.

These restrictions include:

• debt limits set at between 30:1 and 2:1, depending on the price volatility of the underlying asset on the opening of a position;
• a 50% close-out rule per account;
• negative balance protection to limit retail investors’ liability to the underlying funds in the accounts through which they trade contracts for differences;
• a prohibition against the offer of monetary and non-monetary benefits (excluding research and information tools) to retail investors; and
• standardised risk warnings, including data about the percentage of clients at this-or-that firm who have lost money as a result of trading contracts for differences.

Once these new rules have been published in the Official Journal of the EU, firms will be required to implement some restrictions to do with binary options within a month and some to do with contracts for differences within two months. These restrictions will be in place for three months, after which time ESMA may remove them. The FCA supports these measures and plans to consult interested parties about the possibility of imposing them permanently.

Crypto-derivatives

Unless they form part of another regulated service, cryptocurrencies and cryptocurrency-related assets are not currently regulated by the FCA. However, cryptocurrency derivatives can be financial instruments under MiFID II, so firms involved in regulated activities involving cryptocurrency derivatives must comply with the relevant EU and FCA rules. Non-compliance is a criminal offence.

Next steps to improve competition between asset managers

Having conducted an enormous asset management market study, the FCA has outlined its next steps towards reform. Policy statement PS18/8 outlines the FCA’s remedies to protect consumers from weak competition, which are as follows.

• A requirement for fund managers to decide every year whether their charges are justified in relation to the overall value of the funds.
• At least 25% of the boards of fund management firms to be made up of 'independent' directors, of whom there must be at least two.
• A new SM&CR 'prescribed responsibility' for fund management firms, each of which will (when the rules come into force) have to require a senior manager, usually the chairman, to take reasonable steps to ensure that it meets its regulatory obligations and acts in the best interests of investors.
• The prohibition of the retention of risk-free box profits.
• New guidelines to nudge fund managers in the direction of moving investors into cheaper share classes more easily, if and when this is in their best interests.

Alongside PS18/8, the regulator is also consulting interested parties about its plans to improve the quality, comparability and 'robustness' of information that fund firms give investors. These proposals include:

• guidelines to govern the way they communicate "fund objectives" and investment policies to ensure that they are useful to investors;
• new rules to require fund management firms to explain the rationale behind the use of benchmarks or, if they do not use them, how investors can assess the performance of this-or-that fund; and
• amendments to performance fee rules to ensure that firms calculate these fees on performance net of fees.

The FCA has undertaken some research to determine how the ways in which firms present their charges influence the ways in which investors make decisions and whether they understand those charges well enough. The research involved a simulated online platform which displayed charges in four ways. All four of the methods 'improved' the proportion of investors opting for a cheaper fund and did not appear to distract them from paying attention to other important things such as performance or risk. Warning messages appeared to improve the quality of the decisions that investors were making, particularly when accompanied by summaries of charges. Information about charges had the greatest effect when it was displayed prominently on 'mandatory' pages.

There is never any guarantee that an investor will act upon information if he sees it on display, but the study does show that firms can improve the disclosures they make by presenting them in different ways.