This month we take you on a whistle-stop tour of the British Financial Conduct Authority’s latest preparations in the event of a 'no-deal' independence and bear welcome news about the future of the FCA Directory.

Many wealth advisors have been asking recently whether the growth of passive investing has had any effect on the performance (in terms of efficiency and effectiveness rather than price) of the equity markets. The FCA has now published the results of recent research on the subject.

Investors who make passive investments have fewer costs to pay, but it is active fund management that pays for the research, monitoring and trading activities that are essential if the market is to perform well. The FCA is well aware of this paradox.

In 2017, passive investments accounted for 30% of the assets of all funds in the European Union, up from 15% in 2007. Although the rise of this type of investment has created opportunities for active investors, it has also limited their ability to take advantage of them. It is not yet possible to draw conclusions from the emerging literature on the subject, so the regulator has decided to wait and see.

Regulators trying to tackle market abuse

Julia Hoggett, the FCA’s Director of Market Oversight, told a recent gathering that the FCA was worried that firms were not looking for information leaking out beyond their walls as diligently as they were doing when looking for signs of their own people sharing it inappropriately. She reminded firms that they had to 'manage' risks associated with market abuse and do more to improve the ways in which they monitored people, particularly for signs of market manipulation.

Hoggett thought that firms assumed that people who had legitimate access to information would use it legitimately. She wanted them to review information access levels regularly, thereby offsetting some of the risks associated with 'insider information,' a term that the FCA rulebook defines very strictly. She reminded firms, as if they did not know, that risks of various kinds were evolving all the time in the financial services market and thought that they ought to be 'dynamic' when dealing with them.

The FCA’s latest preparations for Brexit

This month the FCA has said more about its preparations for the UK’s departure from the EU. It has done so in tandem with the Bank of England and the US Commodities Future Trading Commission, trying to reassure market participants that trading in derivatives and clearing activities that occur between the UK and US will continue.

The regulators' joint statement says the following.

• The Bank and the CFTC are updating their memorandum of understanding (MoU) on the subject of clearing.
• The FCA and the CFTC are updating their MoU to deal with certain firms in the derivatives and alternative investment fund industries.
• The CFTC will extend the existing 'regulatory relief' that it grants to EU firms to British firms at the point of withdrawal.
• The British authorities say that access to their markets will continue for US trading venues, firms and counterparties registered by the CFTC, according to the 'equivalence' (the British are presumably now using that EU term for their own ends) of their laws and regulations.

ESMA’s temporary intervention

The European Securities and Markets Authority’s "temporary intervention" to prohibit the sale of binary options and restrict the sale of contracts for differences to retail investors will become part of British law on D-day.

The FCA is analysing people's comments about its proposals to make these "temporary product interventions" permanent in the UK. It is likely that new rules, if any are to appear, will come into effect very shortly.

If the FCA does not finalise its policy before ESMA’s "temporary interventions" come to an end, it will consider doing some of its own.

The MiFID transparency regime and other obligations

The FCA has published some statements of policy that lay out the ways in which it will operate the MiFID 'transparency regime' in the event of a 'hard' independence. If this does happen, the regulator will be solely responsible for operating this regime in the UK; the Government has given it new powers to help it do so. This includes some discretion within a four-year transition period that ought to allow the FCA to build and adapt the systems necessary to implement and oversee the regime.

The FCA has also spoken about some of its other obligations to support MiFID II.

• Post-trade 'transparency' and position limits. British trading venues will operate to the same standards on Day One of independence as they did before.
• Post-trade transmissions of data for over-the-counter transactions between British firms and their counterparties in the EU. British investment firms that do not report transactions will not be required to do so after Brexit. Every EU firm with a British branch that is benifiting from the British "temporary permissions regime" will still have to report information through the EU APA - an Approved Publication Arrangement, called for by MiFID II, which goes alongside Approved Reporting Mechanisms or ARMs.
• Trading obligations for derivatives. Because of the "onshored MiFID regime" and binding technical standards, certain derivatives can only be traded on regulated markets, multi-lateral trading facilities or organised trading facilities.
• Benchmarks. The FCA will establish a public register for benchmarks and administrators authorised in the UK.

How things stand with PRIIPs

The FCA published a 'call for input' last July, hoping to find out how firms are faring in their efforts to obey the rules surrounding PRIIPs, i.e. packaged retail investment products or insurance-based investment products, in the following areas.

• The reach of those rules.
• The calculation of transaction costs.
• The calculation of "performance scenarios" that they have to discuss in their key information documents (KIDs).
• The calculation of summary risk indicators (SRIs) and other risk-related things.

People who responded to the FCA's questionnaire were not sure how to apply PRIIPs to certain types of investment, particularly corporate bonds, and this was causing them some worry. The FCA has passed the responses on to its masters on the continent and wants them to make some pronouncements in this area.

The survey also taught the FCA that the SRIs produced lower risk ratings than the firms had expected in cases involving illiquid underlying assets. The FCA is asking the EU's super-regulators to make SRIs representative of the risks that such assets pose. It is also worried that the scale rating presented by an SRI can be confusing for consumers, who might confuse it somehow with the product's risk rating.

Another problem is that people are displaying performance scenarios for all asset classes in a misleading way. Everyone agrees that this stems from their reliance on past performance in the PRIIPs regulatory technical standards (RTS) methodology.

Costs and charges in workplace pension schemes

The FCA is consulting interested parties about new rules and guidelines to govern the way in which workplace pension schemes tell their members about costs and charges. It is the duty of the regulator, in conjunction with the Department for Work and Pensions (DWP), to make rules on the subject.

Since January 2018, every asset manager has been required to report transaction costs and charges to the operator, trustee or manager of a workplace pension scheme. Now, the FCA is proposing to introduce new rules that require scheme governance bodies to disclose this information to scheme members continually.

The effect of MiFID II

The FCA’s Chief Executive, Andrew Bailey, recently spoke about the good points of MiFID II, the European Union's second Markets in Financial Instruments Directive, and about the complaints that market participants have raised with him.

It has been 15 months since the introduction of MiFID II and the market has experienced some fundamental shifts in that time. The vast majority of fund managers have opted to fund research from their own revenues rather than from clients’ funds. The scale of this has been beyond the FCA’s expectations and it appears that the market is going through a period of 'price discovery,' i.e. the process of determining the price of an asset in the marketplace through the interactions of buyers and sellers. The emergence of new technology is also changing the nature of how 'buy side'   firms supply, monitor and value research.

The FCA has visited some firms recently and deduced that MiFID II is driving down the cost of execution and making the 'buy side' more accountable and disciplined when procuring research. It thinks that investors saved £180 million in charges in 2018 as a result of it. If this continues, the FCA expects to see £1bn of savings over the next five years.

However, firms are still worried about pricing, the scope of the inducements regime and the fact that it may have unintended consequences. To deal with this the FCA has:

• allowed the free distribution of research that supports capital-raising events;
• allowed the free circulation of issuer-sponsored research; and
• stated that it will not classify publicly available research as an inducement.

The FCA is wrapping up its assessment of the 'bedding in' of these rules and their effect on asset owners, consumers and the wider market. It intends to publish its findings before 21st June.

Ending our reliance on LIBOR

The notoriously manipulated London Interbank Offered Rate is the rate that banks charge each other for short-term loans. Financial institutions also use it as a benchmark for other debt instruments such as government bonds and corporate loans. It is likely that in two years' time it will come to an end and this will cause problems for banks which will then have to manage their exposures to it. Megan Butler, the FCA's Executive Director of Supervision for Investments, Wholesale and Specialists, recently outlined the progress so far.

Many firms, she said, have already begun to move their portfolios over to SONIA-based swaps. The volume of overnight cash transactions supporting the calculation of SONIA is, on average, £50 billion a day. Transactions which underpin the three- and six-month Sterling LIBOR, by contrast, are of the order of £187 million and £87 million a day respectively.

Butler said that the FCA and PRA are beginning to assess firms’ readiness for the end of LIBOR and the results so far have been patchy. One of the biggest obstacles to a smooth transition is inertia. The FCA is therefore urging all firms to take action now. It will not tell them how to do it, except in cases where it finds out that this-or-that firm is delaying its preparations for fear that the FCA will change its approach.

How the FCA saved credit-card customers' money

The FCA has recently reviewed fees and charges relating to various products in the high-cost short-term credit-card market, and is worried that firms are charging customers who might be in financial difficulties. It has found evidence of many a firm charging more than one fee during a single billing cycle.

Since the review, those firms involved have analysed their charging structures and made some changes, saving consumers £80 million in the process, according to the FCA's estimations. Now the regulator is encouraging all credit-card providers to review their policies and processes for administering fees and charges to ensure that are resulting in fair customer outcomes.

Cryptoasset research

The FCA has gauged British consumers’ attitudes to, and understanding of, cryptoassets with a national survey and in-depth interviews with consumers.

The interviews showed that many consumers do not understand the nature of cryptoassets fully, so their wellbeing could be at risk. Many owners of cryptoassets viewed them as a way to ‘get rich quick’, often saying that recommendations from friends or people on social persuaded them to invest. Some buyers conducted no research at all before making their purchases.

Despite the fact that consumers know little about the products, the results of the survey suggest that the scale of harm may not be as significant as first feared. Just 3% of respondents had ever purchased cryptoassets. Of those, around half had spent less than £200, primarily using their disposable income. More than 50% had opted for Bitcoin, while 34% had purchased Ether.

High-cost lending products

The FCA has issued a ‘Dear CEO’ letter to all high-cost lenders which lists the risks that consumers and markets run. In the area of high-cost lending it has detected high volumes of relending, which may be an indicator of unsuitable lending patterns, and not enough evidence that firms are checking to see if people can pay the loans back. The regulator also thinks that consumers might suffer in the guarantor lending market, as there has been a significant rise in the proportion of guarantors having to make repayments.

As a result, the FCA will organise its supervisory activity as follows.

• Re-lending. Diagnostic work to understand the motivation for, and effect of, relending on both consumers and firms.
• Affordability. More attempts to make improvements in the wake of the Dear CEO letter (issued in October) and some new rules and guidelines that came into effect on 1st November.
• Guarantor lending. Attempts to find out whether high-cost lenders are providing guarantors with enough information to appreciate the risks that they are running.

Rent-to-own price cap on horizon

Having consulted the public in November, the FCA has decided to go ahead with its plans to introduce a price cap in the rent-to-own sector, alongside other measures to protect consumers from sharp practice. It is going to impose the following.

• A total credit cap of 100% of the price of the product.
• A requirement for firms to benchmark base product prices (excluding warranties and other add-ons) against retail prices.
• Rules to prevent firms from increasing the prices of other goods or services (e.g. extended warranties) in rent-to-own agreements to cover any losses arising from the price cap.

These measures have now come into force for all new rent-to-own agreements. For products that were available before 1st April, the rules will apply either when the product price is increased or on 1st July, whichever is sooner.

Competition among platforms

The FCA has published proposals to help consumers find (and switch to) investment platforms that meet their needs more effectively and improve competition in the market.

The regulator’s recent market study tried to find out how investment platforms are competing to drum up new business and keep their customers. The study found that competition was working well on the whole, but some customers and advisors are finding it hard to switch because of the time, complexity and costs involved.

As a result, the FCA is proposing to require platforms "to offer consumers the choice to move units in investment funds that are common to both platforms via an ‘in-specie’ transfer." 'In-specie’ is a term that describes a transfer of assets whereby units in the fund are re-registered by the fund manager and the consumer's money remains invested in the fund throughout. The FCA wants every platform to ask for a conversion of unit classes in cases where this is necessary if an ‘in-specie’ transfer is to take place. It also wants platforms to offer consumers the option to convert to discounted units, if such units are available.

The FCA is also worried about exit fees, the charges that platforms levy on people who want to 'disinvest.' It has decided that an exit fee ban is likely to be the most appropriate way of stopping consumers from being hurt. It believes that this should apply not only to platforms, but also firms that offer similar retail distribution services. It is therefore inviting responses from a wider set of firms than first envisaged. It wants people's views about how to define the term 'exit fee,' whether a ban on exit fees or a charge cap would be better, and other things.

Rules for a public directory

The FCA has published rules to govern its upcoming public register, known as "the directory." This online document will let the public search for information about certain people in the financial sector. It will keep up the Financial Services Register, which contains details of people whom it has approved as part of the Senior Managers and Certification Regime.

The directory will list the details of all certified staff, non-executive and executive directors who do not perform Senior Manager Functions, and client-facing sole traders and appointed representatives (ARs) who require qualifications to do their jobs. It will allow consumers to verify the identities and professional standing of the people with whom they want to deal. It will allow firms to cross-check references and will make it harder for unscrupulous people to operate in the market. It will also help the FCA and other regulators monitor the markets and gather data.

Banks and insurers will be able to submit information to the directory in September and other firms will be able to do so in December. The directory will be open to the public in March 2020.