The UK's regulator has certainly been busy over the summer. In this month’s update we bring you details of a number of communications from the Financial Conduct Authority about Brexit and the genesis of a new global 'sandbox.'

The regulator has also unveiled its proposals to improve competition in the investment platforms market, while also publishing details of its view of emerging technology and its efforts to combat financial crime.

The FCA's activities in accordance with the Enterprise Act

To fulfil some of the reporting obligations that the Enterprise Act 2016 has given it, the FCA has published its annual report in which it highlights the public value of its work and the costs it creates for businesses. The report outlines:

• the qualifying regulatory provisions (QRPs) it has introduced and discontinued during the relevant period;
• an independently-verified 'impact assessment' for each QRP; and
• the so-called non-qualifying regulatory provisions introduced or discontinued in the qualifying period.

The FCA classifies most of its activity that it outlines in the report as ‘non-qualifying.’ This includes its attempts to help the UK obey various directives from the European Union, its asset management market study and its strategic review of retail banking. The Government has passed legislation in recent years to force various - perhaps all - professional and regulatory bodies to summarise the effect of their activities on business, with some items qualifying for quantification and others not. The Insolvency Service, for example, refers to its own NQRPs as "new and updated regulatory provisions which fall under the statutory and administrative exemptions."

The majority of the FCA’s QRPs relate to the implementation of the EU's second Markets in Financial Instruments Directive (MiFID II) and its second Payment Services Directive, both of which are designed to benefit consumers and the wider markets rather than financial firms directly. Because of this, the impact assessments only present a partial view of the benefits of its work. A complete view of the costs and benefits of each change in the rules can be found in the cost-benefit analyses that always appear in the relevant consultation papers.

Calculated according to the prescribed methods, the QRPs have created a benefit of £621.4 million (€688.8 million) over a five-year period. Much of this is the result of MiFID II; here the FCA opted to extend its requirements beyond the European regulations to create a competitive and level market for all firms and to reduce the potential for confusion among customers.

The Institutional Disclosure Working Group's recommendations for the FCA

Formed after the FCA conducted its asset management market study, the Institutional Disclosure Working Group (IDWG) has published its recommendations for cost disclosure templates for asset management services that institutional investors receive.

The report proposes five recommended templates:

• A 'user template' summarising key data from providers.
• An account-level template covering most product types, fed by three sub-templates, where relevant, these being: (i) a private equity template; (ii) a physical assets template; and (iii) an ancillary services (custody) template.

The use of these templates is voluntary, although of course the IDWG recommends it to institutional investors, investment consultants and other participants in the market. It also wants institutional investors to become more aware of cost disclosure and its benefits.

In addition, the IDWG recommends the creation of a new body or group to update and maintain the rules it is proposinng, with the first review taking place no later than 12 months after the group’s inception.

The FCA has welcomed the IDWG’s recommendations and is working with the industry with the aim of establishing a group to monitor the use of these templates by the autumn.

How do we avoid becoming the prisoners of technology?

Charles Randell, the chairman of the FCA and the Payment Systems Regulator (PSR), recently gave a speech about the power of 'Big Data' (extremely large data sets that computers analyse to reveal patterns, trends and associations, especially relating to human behaviour and interactions) and the questions it raises about the adequacy of regulatory rules in the world today. Here are the highlights.

Because Big Data firms are so big, and because the services they offer are so ubiquitous, they may not always give consumers enough choice between products and services. Indeed, they might be forced to accept non-negotiable terms which they do not understand. There have been reports in the media of firms using artificial intelligence to base 'tailored pricing' on behavioural factors, which the regulator fears might allow them to exploit the weaknesses of consumers.

Randell proposed that innovators should build their efforts with "people, purpose and trust" in mind, the better to make their projects beneficial and long-lasting.

• People. Regardless of how sophisticated technology becomes, people must remain involved at every stage to stop it from harming others and to ensure that the results it produces are acceptable. Without this, civilisation might become too reliant on technology and unwilling to judge its efficacy and intervene in its development.
• Purpose. This is the main cause of a firm’s culture and, in Randell's words, "the most important lens through which to examine technological innovation." The availability of data has called some traditional business models into question, while also opening up the industry to use by people whom it previously excluded.
• Trust. This is a financial service firm’s most valuable asset. Randell thinks that firms build and maintain it by participating in 'communities' and by communicating effectively.

The rate of technological innovation in the UK gives the kingdom the opportunity to become the world leader in FinTech because it stems from two of its greatest assets – regulatory leadership and digital expertise.

MiFID II’s part in tackling financial crime

A recent speech by Mark Steward, the director of enforcement and market oversight at the FCA, examined parts of MiFID II that contribute to its efforts to tackle financial crime.

Steward was speaking on the first day on which firms were required to have Legal Entity Identifiers (LEIs) in place to trade on behalf of clients. This forces every entity involved in a transaction to identify itself, regardless of its location. Under MiFID II there are now 130,000 LEIs and more than 2.3 million national identifiers.

Since the implementation of MiFID II, the FCA has processed nearly 3.5 billion transaction reports and is forming a much clearer picture of the market. Thanks to significant investment in software, the regulator is now able to track potentially related activity through several trading venues and detect cross-market manipulation.

As a result, the FCA is investigating several capital market transactions that appear to have no purpose or function. It is also investigating a small number of firms’ systems and controls to see whether any misconduct has occurred that may attract criminal charges under the Money Laundering Regulations.

Competition in the investment platforms market

The 'interim findings' of the FCA’s study of the investment platforms market show that competition is working well. It is worried, however, about the ways in which platforms compete for certain groups of customers. The market, which has nearly doubled in size since 2013, relies on investment platforms working well because its customers are relying on them more and more.

The regulator was worried about the following five things.

• Barriers to switching platforms, such as costs. These may reduce the incentive for platforms to keep their charges low and provide good service.
• The fact that consumers struggle to determine the best price on direct-to-consumer platforms. Fees and charges are often difficult to compare.
• Unclear risk labels on model portfolios. Firms often identify investment packages using the same labels, e.g. ‘cautious’ or ‘balanced’, but with different assets/ volatility which makes comparison difficult.
• The fact that consumers are not very aware of various things. HNWs with large cash balances are often unaware of the risks inherent in foregoing interest or losing returns by holding cash in this way.
• Orphan clients. Some customers are no longer associated with their old advisors but are still paying for services to which they no longer have access.

The FCA wants to tackle each of these five problems. It is still overseeing the implementation of MiFID II, with the aim of helping and encouraging customers to shop around and compare prices. It is asking interested parties for feedback about its initial findings and the remedies it is proposing before it publishes its conclusions early next year.

FCA publishes consultation on proposed duty of care

The FCA has published a consultation paper in which it expresses a desire to impose a duty of care on firms with the aim of ensuring, for the first time, that all customers are protected from sharp practice and the consequences of their own inexperience. The paper aims to determine:

• whether there is a gap in FCA's 'consumer protection' rules and whether it might close it by imposing a new duty of care on firms;
• the effect that this new duty would have on firms, consumers and its own operations;
• whether there are alternatives to this duty that might allay people's worries; and
• if such a duty would improve 'conduct' and 'culture' at firms and how it would sit alongside the Senior Managers' and Certification Regime.

The paper has been prompted by various people's worries that the rules do not protect consumers well enough. Some believe that the FCA's existing 'principles for business' do not remove conflicts of interest or deter firms from misselling products and services.

Update on the 'temporary permission' regimes
 
If the UK were to leave the EU in a way that stopped its firms from benefiting from the EU's 'passporting' regime, that governmental club's 'temporary permissions' regime would allow British firms to continue operating in its market. The FCA has published another paper about the way it sees the regime working, with a formal consultative exercise to follow in the autumn.

The Treasury has now drafted up a Bill to impose yet another regime on financial firms and funds, with legislation for payments and e-money providers to follow.

What will change after Brexit?

After Brexit, the UK will become a ‘third country,’ in EU parlance. Because of this, firms in the European Economic Area (Austria, Belgium, Bulgaria, the Czech Republic, Cyprus, Denmark, Estonia, Finland, France, Germany, Greece, Holland, Hungary, Iceland, Ireland, Italy, Latvia, Liechtenstein, Lithuania, Luxembourg, Malta, Norway, Poland, Portugal, Romania, Slovakia, Slovenia, Spain, Sweden and the UK) may be required to seek authorisation to retain their access to the British market. These firms will be able to obtain temporary permission to do so under Part 4A Financial Services and Markets Act 2000. If necessary, this regime will come into force at 23:00 on 29th March next year and will remain in place for a maximum of three years.

The notification process

Firms will have to notify the FCA if they wish to use the 'temporary permissions' regime through an online portal, which is expected to open in January 2019 and close the day before Brexit. Firms that do not notify the FCA win time will not be allowed to use the regime.

Once the UK has left the EU, firms will be allocated a time period in which to submit their applications for 'UK authorisation.' The regulator expects the first window to be open between October and December next year and the final one to be open between January and March 2021.

What rules will apply to firms?

The FCA says that it is "taking a proportionate approach" to regulating the temporary permissions regime with the aim of ensuring that firms experience as little disruption as possible but still protecting consumers from sharp practice. The consultative exercise is not due until the autumn. The regulator thinks that it will require firms to comply with all of its rules (including those derived from EU directives) and:

• contribute to the Financial Services Compensation Scheme;
• join the Compulsory Jurisdiction of the Financial Ombudsman Scheme;
• comply with the Senior Managers & Certification Regime when it comes into force;
• send it reports about the arrangements they have made for their clients' assets;
• divulge specific things to customers; and
• contribute to both the Single Financial Guidance Body and the Illegal Money Lending levy.

Dear CEO...

Andrew Bailey, the CEO of the FCA, has sent out many ‘Dear CEO’ letters to remind firms of the importance of keeping his office informed of their Brexit contingency plans.

Acknowledging the information that firms have already sent in, the letter urges companies to communicate with the FCA before they make any decisions. This is because contingency plans can affect firms' business models, legal entity strategies and booking arrangements. The FCA does not want to restrict business models, but does want to gain a thorough understanding of how they work and ensure that they adhere to regulations, especially in the case of firms that are trying to expand in Europe.

A basic savings rate?

To solve the problems (first identified in the FCA’s market study of 2015) that long-standing customers face in the cash savings market, the regulator has published a discussion paper that contains a range of proposals.

The paper focuses on measures to address price discrimination in the market. Proposals include the following.

• The introduction of a basic savings rate, a variable interest rate that could be applied to all easy-access cash savings accounts and easy-access cash Individual Savings Accounts (ISAs) once they have been open for a certain amount of time. This is the FCA’s preferred policy option.
• Greater use of switching boxes and return switching forms. However, evidence from the FCA’s behavioural trials indicate that external encouragement to switch has limited effect.
• The continuation of the FCA’s 'sunlight measure,' which it tried out for 18 months in 2015‒16.
• The introduction of a "superseded accounts rule" to force firms to transfer customers' deposits to comparable, on-sale accounts when their existing accounts have been superseded.
• Ratio-based price regulation to ensure that the difference between the interest paid to new and long-standing customers does not exceed a certain level.
• An outright ban on price discrimination, which happens when identical or largely similar services are performed at different prices by the same provider in different markets.

To accompany the discussion paper, the FCA has published an occasional paper which examines the effect that the introduction of a basic savings rate might have and concludes that overall interest payments to easy-access savings accounts are likely to increase.

The results of a survey by the FCA and its Practitioner Panel

The results of a survey of people's perceptions of the regulator’s performance have been published. The FCA's 'regulatory relationship' received a mark of 7.6 out of 10, with an effectiveness rating of 7.1. 86% of firms believe that the FCA can meet its objective of ensuring that markets function well (an increase of 7% on last year) but firms have less confidence in its ability to meet its 'competition' objective. The authors of the report believe that there are three areas for improvement: forward-looking regulation, greater innovation and better 'transparency.' When asked whether they believed that the FCA was speaking to the industry effectively about its preparations for Brexit, only 28% believed that it was. 50% neither agreed or disagreed. Firms rated the FCA’s wider communications at 7.4 out of 10, but the most common suggestion they made was that it should make its rulebook (which it insists on calling a handbook) more accessible and easy to use.

The responses from consumer credit firms are presented separately to ensure that their views are recorded, without affecting data that outlines trends in the industry. More than 70% of firms in the survey are satisfied with their regulatory relationship and the same proportion believe the FCA to be highly effective.

Behavioural research regarding persistent credit-card debt

As part of the FCA’s efforts to tackle persistent credit card debt, whilst preserving the product’s flexibility for the majority of customers, the regulator has published the results of its behavioural trials to encourage those making low repayments to repay more where possible.

The FCA tested three approaches, all based on the theory that the contractual minimum repayment amount can have a disproportionate effect on the chosen level of repayment, known as anchoring.

• Manual credit card repayments. Some consumers make most of their repayments manually, rather than by direct debit. During online testing, the FCA found that not displaying the minimum amount helped to increase the value of repayments.
• Direct debit repayments. The second trial involved the removal of the minimum repayment option from the direct debit repayment screen. Although many did opt for higher direct debit amounts as a result, overall repayments did not increase because consumers tended to offset these payments by reducing the value of their manual repayments or by not setting up direct debits.
• Disclosure remedies. Here the testers provided customers with information about the time and costs involved in the repayment of debt in different scenarios in their monthly statements. This had no effect on manual repayments. For those consumers whose direct debits were set to repay the minimum amount, it resulted in a small increase in the repayments they were making, but not a consistent reduction in debt.

As a result of these findings, the FCA is considering consulting on the removal of the minimum repayment anchor as it believes this would increase customers’ repayments where they can afford to do so.

Changes proposed to crowdfunding regulations

Having completed its post-implementation review of crowdfunding regulations, the FCA has outlined new proposals. It wants to change its rules for loan-based crowdfunding platforms because the market has changed since it last reviewed the sector in December 2016. It wants to issue prescriptive 'risk management' rules that require firms to produce a minimum amount of information so that it (or they) can assess borrowers' credit risks and to set fair and appropriate prices for agreements. It wishes to extending the strictures it has placed around marketing activity on investment-based platforms to loan-based platforms. It also wants to require firms to divulge more information to investors about their investments and the risks involved.

One issue that the FCA identified in its previous review was the potential "gap in protection" for people who took out mortgages or consumed other forms of home finance through loan-based crowdfunding platforms. To tackle this, it proposed to force crowdfunding platforms which offer such products to obey its Mortgage and Home Finance Conduct of Business sourcebook (MCOBS) and other rules.

The sale of highly risky, speculative investments to retail investors

The European Securities and Markets Authority’s temporary restrictions on the sale, marketing and distribution of contracts for differences are now in force.

The FCA, and other regulators throughout Europe, are aware that similar products, particularly those which expose consumers to significant debt, present risks to those inherent in contracts for differences. The FCA is worried that some firms may try to circumvent ESMA’s restrictions by offering similar highly risky and speculative products.

The FCA has taken this opportunity to remind firms of their obligations to act in the best interests of their customers, to communicate in a way that is fair and not misleading and to "govern their products" appropriately. It will monitor the sale of these alternative products and work with ESMA to take further action if it notices any harm.

Conduct and communication in payment services and e-money firms

To improve standards of conduct and communication, the FCA has issued a consultative paper in which it proposes to extend its rules regarding promotions and communications to a wider range of regulated firms, including payment services and e-money firms. It wants to extend its 'principles for business' to payment services and e-money issuers; to extend its retail banking rules and guidelines for customer communications throughout the sector; and to introduce new rules and guidelines to prevent the marketing and promotion of currency exchange transfer services with unachievable exchange rates or unsubstantiated claims. Once again, it aims to protect consumers and provide them with the information they need to decide whether services meet their needs.

When sandboxes girdle the globe

The Global Financial Innovation Network (GFIN) has been created in collaboration with 11 financial regulators and related organisations from around the world. It aims to encourage communication and promote the exchange of ideas and even collaboration between countries.

A consultative paper has been published to determine the GFIN’s essential functions. Its three core objectives have been defined as:

• the establishment of a collaborative network that helps the parties share their experiences of innovation, emerging technologies and business models;
• a forum for joint policy work and collaboration; and
• a 'space' in which firms can try out cross-border ventures.