In this regulatory update we look at some major publications from the UK's Financial Conduct Authority, including the FCA’s plans to keep regulation going in the event of the UK leaving the European Union without an 'implementation period.' A post-implementation review of the Retail Distribution Review (RDR) and the Financial Advice Markets Review (FAMR) is also on the cards.

The FCA wants to give small and medium-sized enterprises (SMEs) access to the Financial Ombudsman Service for the first time. It has issued a policy statement (PS18/21) containing some 'near-final' rules which, if they become real rules, will draw an extra 210,000 British companies - many of them financial - into the ombudsman’s net.

The regulator has already consulted interested parties about these plans and is now consulting them again. On the strength of the first responses, it is now proposing to make it easier for SMEs to become eligible than it originally planned to do. The idea is only to include SMEs with an annual turnover of less than £6.5 million and either fewer than 50 employees or a balance-sheet total of less than £5 million.

Around a fifth of people who wrote to the FCA expressed concerns about the FOS’s ability to handle the volume and complexity of the prospective complaints. To allay their fears, the FCA published an outline of the way in which it expects the FOS’s specialised, ring-fenced SME unit to operate. The regulator wants it to contain the following.

• A team of 20 SME investigators with specialist knowledge and skills.
• Specialist SME ombudsmen and team leaders.
• A dedicated 'legal resource,' whatever that may be, and access to additional expertise and advice.
• An external panel.
• An SME advisory group to provide various parties with expertise and 'insight' in respect of the sector.
• A dedicated phone line and microsite for SME-related complaints.

Climate change and 'green finance'

The FCA has published a discussion paper about the ways in which the disruption of the earth's climate and the UK's attempts to wean the British economy away from carbon-producing fuels are relevant to its statutory objectives.

'Climate change' is likely to have a fundamental effect on the economy, with the physical consequences of it, the political reaction to it and the response to those things from firms and individuals reshaping the financial services industry.

The discussion paper outlines:

• the ways in which the effects of climate change could affect the FCA’s long- and short-term objectives;
• the opportunities and threats in store for the UK's market in financial services as it moves towards a low-carbon economy;
• the specific, near-term steps that the regulator will take to keep markets functioning well; and
• the effect that these things might have on the FCA's objectives.

The risks that arise from the world's changing climate are bound to affect the riskiness, and value of, certain kinds of investment. The regulator hopes that the industry will support the UK's transition to greater 'carbon neutrality,' defined as the absence of a carbon footprint, by telling people about the risks and opportunities that it presents.

The FCA has considered a wide range of factors, including access to the market for new entrants, the needs of consumers and innovation. It is the regulator’s view that beneficial innovation in ‘green finance’ will help a new carbon-free economy to emerge and help keep the UK an attractive prospect for international business and financial services.

Opportunities and threats

No commonly used or universally accepted standards exist for measuring the effect and performance of green financial products. Such standards can be helpful in the process of convincing markets to trust such products and in helping investors choose between them.

When financial firms tell people about the effects of climate change, so the argument goes, they are helping them make good long-term investment decisions, particularly in the pensions and insurance industries.

The FCA's actions

The regulator believes that it could do many things in this area. In the short term, it has chosen to do the following four.

• Deal with the recommendations of the Law Commission’s report on pension funds and social investment.
• Take steps to increase innovation in specialist green products, ensuring that the market functions well and that results for customers are good.
• Try to find out whether it has to do more work to encourage issuers to provide investors with appropriate information and whether it should articulate its expectations more clearly.
• Ask firms about the value of obliging them to issue public reports about the ways in which they are offsetting climate-related risks.

The FCA and the Pensions Regulator: a joint strategy for pensions

‘Regulating the pensions and retirement income sector’, the FCA's and the Pensions Regulator's newly-published strategic document, is designed to improve pensions and retirement income products and improve consumers' financial prospects in later life.

The FCA's main concern in this sector is the prospect of those consumers not having adequate income, or the income levels they now expect, in retirement. This is of no concern to wealth managers, but some will be obliged to deal with the following initiatives in some cases.

Access and participation

• Enforcement activity against non-compliance among employers.
• Greater support for employers, scheme providers and intermediaries.
• The development of public policy regarding access to - and participation in - pensions, keeping a weather eye on intergenerational issues.

Funding and investments

• The Pensions Regulator embarking on "one-to-one supervision" in respect of an initial group of defined benefit schemes.
• The parallel supervision of the governance and oversight of defined contribution default funds.
• Interventions that have already been proposed as a result of the Retirement Outcomes Review (ROR) and an asset management market study.
• A greater regulatory emphasis on environmental, social and governance (ESG) factors in the decisions that people make about investments.

Governance and administration

• Intervention to deal with poor governance and administration.
• Work (which has already begun) to do with operational resilience and cyber-risk.
• The development of principles and standards that concern value for money, separately from existing guidance.
• A review of non-workplace pensions.
• New rules to govern disclosures about costs and charges for contract-based workplace pension schemes, the aim being to align them with the Department of Work and Pensions' rules for occupational pensions.

The way consumers understand things and make decisions

• A joint review of the "consumer pensions journey."
• A continuance of support for innovative IT through the FCA’s advice units, Project Innovate and TechSprints.
• A post-implementation review of the Retail Distribution Review (RDR) and the Financial Advice Markets Review (FAMR).
• A joint protocol for regulatory oversight during significant 'defined benefit' events.
• A continuance of support for Project Bloom, a multi-agency group that concentrates on counteracting pension fraud.

The effect of credit broking remuneration at point of sale

By total volume, credit brokers represent the largest population of FCA-regulated firms and the regulator is keen to understand how inter-firm remuneration practices, including commission arrangements, affect results for customers. The FCA’s recent thematic review asked whether these arrangements were leading firms to remunerate people to the detriment of customers.

As part of that review, the FCA interviewed 1,208 consumers who had recently applied for credit, reviewed the commission-related arrangements of 349 firms and interviewed 32 credit brokers. It found no general evidence that commissions are arranged in ways that harm consumers in general, but it is talking to a small number of firms about some problems it has identified.

Evidence suggested that harm may be occurring for other reasons. In the finance broking sector, the FCA found that when a salesperson visited a consumer’s home, that person was more likely to feel pressure to buy something. It wanted to remind firms about its guidelines to do with incentives for staff, remuneration and performance management (FG18/2) and the effect that these practices can have on the sale of financial products.

In future, the FCA will continue to monitor the broking sector and tackle poor practices wherever it sees them.

The FCA's research update in the wake of FAMR

The FCA has published its latest research about consumers and the development of the advice market, having implemented the recommendations of the Financial Advice Markets Review. It has been trying to determine whether consumers have changed their behaviour as a result of "the FAMR interventions."

Generally speaking, consumers appear to be satisfied. Over the past 12 months the number of people who have taken financial advice increased by 3.2 million and they reported satisfaction with the quality of the service they received and the associated costs. However, as with the previous data set that was published in 2017, 15% of consumers whom the FCA surveyed said that affordability was a barrier to access to financial advice.

The FCA uncovered little evidence of consumers shopping around, with 89% using the same firm for all their needs. Only 9% of people it surveyed had switched advisors in the previous 12 months. Less than 1% of those whose circumstances suggested that they would benefit from financial advice struggled to find and consult an appropriately-qualified advisor.

This research served as a ‘temperature check’ for the FCA. It will follow it up with a full review of FAMR implementation next year and a post-implementation review in 2020.

New rules to improve the quality of pensions transfer advice

The FCA has published some final rules and guidance with the aim of improving the quality of advice that consumers receive when thinking of giving up safeguarded pension benefits.

The new rules and guidance include the following.

• An insistence on higher qualifications for pension transfer specialists, so that they hold the same qualifications as investment advisors, alongside their existing pension transfer specialist qualifications.
• An obligation for every advisor to explore his client's attitude to the general risks associated with a transfer, not just the investment risks.
• Guidelines to do with "conducting triage services without crossing the advice boundary."
• A new requirement to provide suitability reports, regardless of whether the advice is to transfer or not.
• Updated assumptions for valuing increases applied to defined-benefit scheme benefits when there are upper and lower limits of inflationary pension increases.

Pension transfer charging structures

In its previous consultative paper (CP18/7), the FCA asked interested parties whether it ought to take action to deal with potential harm and conflicts of interest in pension transfer charging structures, particularly contingent charging.

A small majority of respondents favoured an outright ban on contingent charging and many suggested alternative methods for warding off harm, including the following.

• More onerous rules to govern the management and diminution of conflicts of interest.
• An increase in data-reporting requirements for firms that operate contingent charging models.
• The use of independent reviewers to provide assurance (assessments followed by sign-offs) and reduce poor results as a result of the advice that they were giving.
• Stronger regulation to govern the disclsoure of fees and charges to customers.

The responses to the consultative paper reinforced the FCA’s view that it is difficult to prove any causal link between contingent charging and suitability. Any changes could have a significant effect, especially on the availability of advice, so the regulator intends to monitor the sector and consult interested parties about any new measures it believes are necessary in the first half of 2019.

Money laundering and terrorist finance in the e-money sector

The FCA has published the findings of its recent thematic work to do with the risk of money laundering and terrorist financing in the e-money sector. As part of this, the regulator has reviewed the anti-money laundering (AML) and counter-terrorist financing (CTF) controls of 13 authorised Electronic Money Institutions (EMIs).

Certain features of products that EMIs offer can increase the risk that money launderers and terrorists will use them. This is especially true in the case of a product that allows for frequent card loading and withdrawals; that has no limits on its usage; that permits more than one person to use it; and that can be obtained anonymously.

The FCA now understands the harm that might arise from money laundering and terrorist financing in the sector more clearly. It has found the following.

• Most EMIs have effective controls, a good awareness of their regulatory obligations and a culture that is enthusiastic about the fight against financial crime.
• Most policies and procedures are in line with the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017.
• The quality of management information being produced by EMIs is mixed. The regulator has found that senior managers pay more attention to the problem and have a better grasp of the risks involved when supported by good management information.
• Most firms use automation to monitor transactions quite effectively.
• The FCA also notes in passing that EMIs view fraud as an important risk that they run and that fraud forms a vital part of their financial crime controls.

All EMIs involved in the review received direct feedback and no supervisory action was required as a result. The FCA would like all EMIs to review these findings and consider improving their own systems and controls.

Lessons learnt from applying consumer-facing remedies

In conjunction with the Competition and Markets Authority (CMA), the FCA has published a report about the lessons it has learnt when designing, testing and implementing consumer-facing 'interventions' in the financial markets.

The evidence suggests that an increase in the volume of information available to consumers does not improve results. Instead, particularly in cases where consumers are making complex or long-term decisions, firms should provide them with substantial support.

The report outlines a series of vague principles that the regulator aims to follow when 'intervening' in future. It expresses them in the following manner.

• Understand the issue.
• Be bold when identifying potential remedies.
• Ensure that consumers are in control.
• Do not ignore lessons learnt from the private sector.
• Test all interventions.
• Review their effectiveness.

Markets, technology and the behaviour of suppliers are changing constantly, so the regulator thinks that it ought to monitor its 'interventions' to ensure that they lead to the right results. It believes that it could approach things more constructively in two areas. One is the area of 'vulnerable' customers; the other is in the digital economy. On this latter point, it believes that the rapid changes in this area represent both opportunities and threats.

Guidelines for statements of responsibilities to do with the SM&CR

As the extension of the Senior Managers and Certification Regime draws nearer, the FCA has published guidelines to govern the preparation of statements of responsibilities and 'responsibilities maps.' These guidelines are to be followed in a risk-based and proportionate manner, taking into account the nature, size and complexity of the regime.

A statement of responsibilities should be clear in outlining the responsibilities and accountabilities of each senior manager at a firm, but without excessive detail. The FCA’s guidelines set out the questions that a firm should ask itself when completing each stage of this-or-that statement of responsibilities.

Each firm must also draw up (and keep updating) a 'responsibilities map' which outlines the way in which it governs and manages itself. The guidelines dictate the questions that all firms should ask, plus some questions that are specific to firms in group structures.

Brexit

As part of the FCA’s commitment to preparing for a wide range of 'Brexit' possibilities, the regulator has published a consultative paper that lists the changes it will have to make to its regulatory regime should the UK leave the EU "without establishing an implementation period."

For the most part, the FCA is proposing to make straightforward changes to its rulebook and so-called 'binding technical standards' to update references to EU legislation, British law that relates to/refers to the EU, EU institutions, 'EU concepts' and the European Economic Area.

The consultative paper also outlines proposals to amend a number of binding technical Standards which would not work effectively after Brexit if they were to stay in their present form. These include provisions which might affect the following.

• Credit rating agencies. The Credit Rating Agencies Regulation (CRAR) will be incorporated into UK law, with agencies required to register with the FCA and to report on all ratings issued to
• Fund managers. Here the FCA plans to replace references to EU laws with references to their British counterparts.
• The registration of trade repositories. The FCA plans to amend its "format and information requirements" that obtain when firms are applying for registration.
• MiFID/MIFIR. Each provision will contain a description of its scope and application.
• Short selling. There are to be 'disclosure amendments.'
• Capital requirements. Guidelines are to apply to the 'anticipated' approach that firms should take when reporting and disclosing capital requirements in accordance with EU concepts.

Funds that invest in illiquid assets

When Britain voted for independence from the EU in June 2016, a number of property funds had to declare 'redemption suspensions' (i.e. ban withdrawals) because investors were clamouring to take their money out. The regulator started to worry about the harm that open-ended funds that invest in illiquid assets might be doing to customers, particularly in stressful market conditions.

The regulator looked at the different approaches that it might take to the way in which firms manage liquidity and how it might strike a balance between the interests of people who wanted to redeem their holdings and the interests of people who did not.

Having investigated the market, the FCA has concluded that suspensions and other ways of managing liquidity are working as intended and does not feel obliged to make major changes. It is, however, consulting the public about more rules to govern the use of suspensions, along with measures to improve the ways in which firms 'manage' liquidity and disclose various things.

Suspensions

The FCA plans to introduce rules to require authorised fund managers to suspend dealings in NURS (non-UCITS retail scheme) units when a standing independent valuer (SIV) expresses material uncertainty about the value of immovable assets that account for at least 20% of a scheme’s property.

These requirements should also apply in cases where at least 20% of the scheme property is invested in funds that have suspended trading because of material uncertainty.

Liquidity management

To tackle shortcomings in fund managers’ contingency planning, the FCA is consulting the public about its proposals for new rules to require all fund managers to create and maintain contingency plans for exceptional circumstances. These plans will, if all goes well, have to outline:

• the ways in which the fund manager in question is to respond to a 'liquidity risk' coming true;
• the range of 'liquidity tools' and tactics that he/it may deploy;
• the operational challenges associated with each tool and the potential effect on investors; and
• communication plans for internal and external people with an interest in the outcome.

The FCA also wants to dictate the ways in which firms should use certain 'liquidity tools' in different cases.

Disclosure

To reduce the incidence of retail clients investing in unsuitable funds, the FCA thinks that a fund that invests in inherently illiquid assets should signpost the attendant risks with prescriptive risk warnings. It is also going to oblige the manager of each fund to use the fund's prospectus to detail the nature of these risks and the tools and arrangements that he/it has in place to offset them. This, it hopes, ought to improve people's confidence and participation in the markets, make the effects of illiquidity easier to see and ensure that investors obtain fair prices when selling their investments.