In this month’s update we share news of the significant shortcomings that the UK’s Financial Conduct Authority has discovered in the governance of principal firms in investment management and examine the measures it is taking to tackle the 'dysfunctional' overdraft market. Also, in the seemingly never-ending world of Brexit, it has extended the temporary permission regime deadline.

Disappointing results

The FCA has tried to find out how principal firms in the investment management sector understand and comply with their regulatory obligations in respect of appointed representatives (ARs). Its investigation looked at firms’ understanding of and compliance with its rules in the following areas.

• The effect on business of appointing ARs and appropriate ways of managing any associated risks.
• The way in which firms oversaw and monitored ARs, the better to obey the FCA’s rules.
• Whether principals had adequate capital and liquidity to help them offset or ‘manage’ risk.

The FCA uncovered shortcomings in the governance and controls of the firms that it reviewed, noticing that the firms might be harming consumers and the market, or might harm them in future. It found the following.

• A lack of effective ways of overseeing ARs, with some conducting business outside of their principals’ core areas of expertise.
• No product governance arrangements in place.
• Monitoring that was not tailored to fit the AR business model and often relied on vague attestations rather than the gathering of appropriate evidence.
• Several AR websites that contained non-compliant financial promotions.

The FCA thought that this last point indicating that the firms in question were not reviewing those promotions or asking senior managers to approve them, in accordance with the FCA’s rules.

In response, the FCA has sent a ‘Dear CEO’ letter to all principal firms, telling them that it expects them to review their compliance with the requirements in its rulebook that concern ARs and to remedy any shortcomings.

An extension to the ‘temporary permission regime’ deadline

As the UK’s exit from the EU keeps being postponed, the FCA has extended the deadline for firms that want to enter its ‘temporary permissions’ regime to 30th October 2019. This will allow investment funds based in the European Economic Area to continue to ‘passport’ into the UK to undertake new and existing business while they apply for full authorisation from the FCA.

The application deadline for trade repositories and credit reference agencies has also been extended to the same date. The application window for EEA payment services and e-money firms has now closed but will open again between 31st July and 30th October.

How the FCA is leading the way in regulation

Karina McTeague, the FCA’s director of general insurance and conduct specialists supervision, recently gave a speech about the way in which the FCA is “leading the way” in insurance regulation. These are her main points.

The FCA’s expectations for the industry are similar to those set by many boards. They involve ‘sustainable’ business models and a customer-focused culture, underpinned by trust of customers.

Trust is not only specific to firms; the entire industry can benefit from it. It can, however, be eroded gradually or lost suddenly as the result of an incident. The implementation of the European Union’s Insurance Distribution Directive (IDD) has introduced further measures to protect the industry’s reputation, not least by making the rules regarding the design, targeting and selling of insurance products more onerous.

The regulator has the following other projects in hand which, it hopes, will make firms in the sector conduct themselves in better ways.

• Thematic work to do with GI distribution chains and delegated authorities.
• Follow-up actions resulting from its study of the wholesale intermediaries market.
• A study of the “GI pricing practices market.”

A cross-sector 'sandbox'

The FCA is consulting interested firms about the idea of a “cross-sector sandbox” to test new and emerging technologies (such as artificial intelligence (AI) and distributed ledger technology (DLT)) and enable firms that want to move into other regulated sectors to test new concepts. It believes that this might:

• enable regulators to share the things that they have learnt;
• identify themes that require a coherent nationwide approach;
• develop more efficient processes by which firms might bring innovative products and services to market; and
• stop firms from being uncertain about which regulators to talk to at different points in the innovative process.

In calling for comment, the FCA is looking for specific examples of instances where a cross-sector sandbox would have been useful for firms and industry views on the benefits and weaknesses of such a scheme. As part of its response to the mounting use of 'fintech,' the FCA has already set up a world-famous “regulatory sandbox,” a peculiar name that it has given to its policy of allowing IT firms to test their new ideas on real customers without incurring all of the normal regulatory consequences.

Innovative culture

Nick Cook, the FCA’s Director of Innovation, spoke at the FCA’s 6th Central Bank Executive Summit about how technology and innovation is affecting the way it regulates the markets. Here are the key points of his speech.

Traditionally, regulation was summed up in three verbs – “to forbid, to require and to permit.” However, the landscape has changed and a fourth needs to be added: “to enable change that is consistent with its objectives”. Much of this change is caused by emerging technologies and the growing use of data.

One of the FCA’s aims is to stimulate innovation in specific areas of the market where it can benefit the public, e.g. GreenTech or money laundering/financial crime control, through its TechSprints (IT meetings) and “calls for input.” Cook believes that these will not be the only occasions at which the FCA tries to stimulate development in the market. However, due to its mission to promote competition, it will remain “vendor-neutral.”

The FCA is also trying to:

• increase the expertise in its own workforce regarding “data science”;
• test new pieces of software to monitor things more efficiently within its walls;
• find ways to improve the flow and quality of public and commercial information that it absorbs from outside; and
• explore ways of making part of its rulebook “machine-readable and machine-executable.”

Not all of these things can happen with the help of products that are currently on the market, so the regulator will have to develop some software in-house. In order to attract the talent it needs to achieve this, it is trying to develop a culture of innovation in its offices.

Domination in the mortgage market

Since the publication of the FCA’s occasional paper 33 in May last year, the regulator has continued to research “dominated choices” in the mortgage market.

The original research paper said that almost 30% of consumers chose products that were “worse on all price dimensions” than suitable alternatives. Such choices, according to the FCA, are known as ‘dominated’ choices.

This research examines the supply of ‘dominated’ products and the available alternatives. It also asks whether consumers might be making choices by expressing preferences that had nothing to do with the characteristics of products, e.g. customer service ratings.

The findings show that the proportion of dominated mortgage transactions is largely dependent on the size of the lender in question, with smaller lenders experiencing greater instances of domination. However, the top five lenders buck this trend because more than 30% of their transactions were dominated by other products. This suggests that consumers view a mortgage from one of the top five banks as having additional benefits that this research has not detected.

New remedies to address the dysfunctional overdraft market

The FCA is embarking on a host of measures to tackle the “dysfunctional” overdraft market, as it calls it. This is to be the most significant regulatory change that the market has seen in a generation.

These measures are designed to make overdrafts simpler, fairer and easier to manage, particularly for more vulnerable consumers who are disproportionately more likely to suffer if this does not happen. The FCA is:

• preventing lenders from charging higher prices for unarranged overdrafts than for arranged overdrafts;
• banning all fixed fees for borrowing through overdrafts;
• requiring overdrafts to be priced using a simple annual interest rate;
• requiring overdraft adverts to list the price with an annual percentage rate (APR), to enable consumers to compare products easily;
• publishing new guidelines that will force refused payment fees to correspond with the actual cost of refusing payments;
• requiring banks and building societies to take steps to spot consumers in financial difficulty and put strategies in place to stop them falling into overdraft again and again.

Alongside these measures, the regulator has also published extensive research which explores the value that consumers place on seeing the cost of borrowing set out in pounds and pence. UK Finance, the relatively new trade association for the British banking and financial sector, has agreed to ask its members to do something about this.

The guidelines regarding refused payments will come into effect as soon as the FCA publishes them, with its measures to stop the repetitive usage of overdrafts taking effect on 18th December and the remainder of the new rules coming into force on 6th April 2020.