Earlier this year, the FCA set out its ‘Approach to Supervision’ and ‘Approach to Enforcement’ (the “Documents”) to provide more clarity and detail around the FCA’s approach to regulating authorised firms. The Documents are part of a series planned by the FCA following on from the launch of their new mission statement in November 2016, in which it committed to publishing documents that explained its approach to regulation and how they will add ‘public value’ by improving how financial markets operate, such as by enhancing trust in markets and working to prevent harm. The Documents do not reveal any new policies or changes but form part of the FCA’s wider aim in improving transparency and accountability within financial markets. The FCA invites answers as to whether the approaches are clear enough.
The Documents set out how the FCA will use its enforcement and supervision powers in combination with its other powers and functions to further their objectives through investigation or early intervention, informal guidance or even using their powers to take civil, criminal or disciplinary action. The Approach to Supervision involves the oversight of regulated firms to identify, prevent and reduce harm to consumers and markets. The Approach for Enforcement outlines the FCA’s powers, and how it conducts investigations, highlighting their overriding principle to provide substantive justice.
Approach to supervision
The Approach to Supervision sets out the FCA’s purpose and key supervisory principles that help guide and prioritise their work. The supervisory principles are complementary to the principles for businesses contained in the FCA Handbook that outline the FCA’s expectations for firms. The supervisory principles show how they aim to be more forward-thinking and pre-emptive in their supervision of firms and individuals in pursuance of their objective to deliver the best public value.
The Approach to Supervision sets out:
- how in practice the FCA supervises firms and individuals and how they prioritise their supervision work;
- the FCA’s role in ensuring fair and honest markets; and
- why and how the FCA prioritises its supervision work.
In addition to understanding a firm’s financial risk, its proximity to failure and how harm can be minimalised in failure, is key to the FCA’s role as prudential supervisor. The FCA will set out its prudential approach in more detail later in the year.
In order to use their regulatory tools appropriately and effectively, the FCA implements a four-step decision making process that is used across the Documents. It sets out the framework for how they prioritise their supervision work, identify harm and mitigate the risk of harm. The overriding objective for supervision is to oversee regulated firms to identify, prevent or reduce harm to consumers and markets.
The FCA’s decision-making process in how they prioritise their work is as follows:
- identification of harm;
- diagnostic tools;
- remedy tools; and
Identification of harm
The FCA aims to be more pre-emptive in its identification of harm, using multiple types of analyses to anticipate potential problems in firms and markets. Supervision focuses on the drivers of behaviour in firms and their business models as these are most often found to be the root cause of harm to both consumers and markets and, as a result, the FCA aims to provide proactive engagement with firms. This is in line with how the FCA has increasingly placed importance on a firm’s culture in previous communications, most recently publishing a discussion paper on transforming culture in the financial services (to read more on the discussion paper, please click here).
To inform their analyses, the FCA divides the financial industry up into sectors and each sector further into a series of portfolios of firms with similar business models. Portfolios are maintained on an ongoing basis, supported by sector experts using a combination of analyses and firm regulatory histories and assessments of their financial soundness to identify key risks of harm. Following this analysis, the FCA communicates to firms their programme of work, views on the main risks of harm and the steps firms should take.
Acting on intelligence
When deciding what action to take, the FCA takes several factors into account, prioritising the intelligence it receives according to the greatest risk of harm. Once harm has been identified, the FCA acts to minimise the impact and prevent it from happening again. The quality of the intelligence is looked at first, followed by an assessment of the scale and severity of the potential harm and finally the seriousness of the potential misconduct. Where potential harm is identified, the FCA employs a variety of tools. Which tool is used depends on the extent of the harm and whether the issue is with a single firm or concerns several firms. For single firms‘, this means senior managers will be identified and assessed to discover what steps they have taken to prevent or reduce the harm, resulting often in an immediate change to the business model.
Where the FCA identifies harm across a number of firms, they will do a wider investigation as is set out in their annual Business Plan and thematic reviews. If more data is needed to conduct an investigation, the FCA can request more information from the firms, including compelling firms to provide data using their statutory information gathering powers (s165 of the Financial Services Markets Act 2000), undertake desk-based reviews, visit firms and meet management or appoint a suitably skilled person to undertake a review on their behalf.
The FCA expects firms to notify them once they become aware of a mistake and to take prompt action to correct the wrong, emphasising however, that it is the firm’s responsibility to do the best to prevent breaches and remedy them when they can.
The FCA has four main objectives when things go wrong:
- to stop actual harm as quickly and proportionately as possible. For example, preventing firms selling inappropriate products to customers, especially if those customers are vulnerable;
- to ensure firms have put things right, including redressing customers affected;
- to address the root causes of potential harm. For example, requiring firms to remedy poor anti-money laundering systems; and
- to hold the firm and/or individuals in the firm to account, as appropriate, where there has been misconduct, that could potentially involve enforcement action.
The FCA regularly evaluates its supervisory activities, using this evaluation process to inform their future choices. For example, the FCA will agree with large firms a specific work programme tailored to the individual firm. There is a dedicated specialist supervisory programme for CASS large firms holding client money in excess of £1 billion, or £100 billion of custody assets, in connection with investment business. As these firms have the greatest potential impact on consumers and the market, the programmes are designed to improve a firm’s compliance with its client assets obligations. Regular portfolio analyses are also conducted to ensure the effectiveness of previous work plans and identify any changes that need to be made to improve future performance.
Approach to enforcement
The Approach to Enforcement outlines how the FCA conducts investigations and its powers. The overriding objective for enforcement is to achieve fair and just outcomes in response to misconduct and to ensure FCA rules and requirements are followed. Through its enforcement activities, the FCA aims to identify problems early and drive out behaviour that fails to meet their standards quickly and fairly and to act as a deterrent to potential offenders.
More detailed information about the FCA’s approach to enforcement, including the use of information gathering and investigation powers, their powers to obtain injunctions and restitution and their approach to their choice of sanctions, is set out in their Enforcement Guide. Information about how the FCA make decisions and their penalty policy is set out in their Decision Procedure and Penalties Manual. Additionally, an Annual Enforcement Performance Account is published each year that looks at the previous year’s enforcement work, investigations opened and actions taken.
The FCA have also started a review of their Penalties Policy and plan to publish a consultation paper later this year. They are also starting work on a fuller review of the whole of the Enforcement Guide and aim to publish a consultation paper in 2019.
Recognising that severe penalties and sanctions alone are not effective enough in reducing and preventing serious misconduct, the FCA concludes that misconduct needs to be better detected and more efficiently investigated. As issues can extend across a sector or several firms, the FCA aims to use all their powers and functions to identify serious misconduct quickly. The FCA works with both regulators and law enforcement agencies in the UK and overseas, making full use of all intelligence and data collected to identify a broad spectrum of misconduct. This includes market data and information from firms, consumers and public databases.
In diagnosing harm through their investigations, the FCA takes an objective point of view when opening an investigation. The FCA carries out investigations on both individuals and firms together where an individual, most often in a senior management role, is involved in the breach. Using their powers of investigation such as compelling individuals and firms to produce specific documents, attend a Q&A before appointing investigators or applying to the Magistrates’ Court for a search warrant, allows the FCA to quickly get to the root of the cause of harm. Obligated to act fairly and reasonably, investigations contain several protections and guarantees to ensure employees do not breach their contractual or equitable duties of confidentiality.
Emphasising that action will only be taken once a thorough investigation has taken place, investigations are put before the firm or individual to contest the case and if they so wish, representations can be made to the Regulatory Decisions Committee (“RDC”) or referred directly to the Upper Tribunal if any disagreements are present. Notably, firms or individuals can still get a ruling from the RDC on penalty issues and remain eligible for a full discount for cooperation where no facts or liability flowing from the facts is contested.
How misconduct is assessed
As not all breaches are serious, ie. technical or minor infractions, many breaches are dealt with and remedied without the need for enforcement action. Depending on the situation and the severity of the misconduct, the FCA will either use its deterrent or remedial powers to the extent needed to address the harm. For example, the FCA will take into consideration firms that take remedial action to address harm caused by serious misconduct. This is important as sanctions may be lowered to account for the firm demonstrating honesty in response to wrongdoing, viewing this as building trust and confidence in the market. Be aware that the opposite applies, firms or individuals who fail to address harm may justify heavier sanctions. In special cases, all sanctions may even be dropped.
In situations where firms are not meeting minimum standards, for example where they have inadequate systems and controls, a firm may be invited to sign a voluntary requirement (“VREQ”) to not accept new business until the issue has been sorted to prevent further harm to consumers or the market. Where firms choose not to sign a VREQ, the FCA may impose their own initiative requirement (“OIREQ”) to stop harm. For solo-regulated firms which fall under a prudential regime, the FCA has additional powers, for example to enforce minimum level of capital and/or liquidity necessary for the individual firm. These powers are an important part of the FCA’s approach not only to enforcement but also supervision in cases involving more serious misconduct.
Recognising that investigations must be quick and efficient to be fair, each investigation is kept under review to either extend or narrow the scope depending on the circumstances. Pointing out that the timeliness of the investigations determines the public perception of the work undertaken, the FCA proposes to measure this. Most interestingly, the FCA comments that they will be more open and transparent when regulatory action has not been efficient and to focus on improving their regulatory powers.
The main theme of these Documents is how the FCA will investigate efficiently and fairly, aiming to identify problems early, stop or limit harm and putting things right when a wrong has occurred. The take away point from the publication of these documents is that the FCA aims not to penalise firms and individuals when things go wrong but rather assess their behaviour or reaction, basing their sanctions on actions taken. Firms and individuals are encouraged to voluntarily account for and do their best to redress any misconduct and the FCA will give credit to those who take action to address any wrongdoing. As mentioned, both Documents ask whether each approach is set out clearly and if not, what they could do more to explain and clarify their approach. The consultation period is open until 21 June 2018, with final documents published later this year.
To access the FCA’s Approach to Supervision, please click here.
To access the FCA’s Approach to Enforcement, please click here.
For more information on the role of the FCA and your firm, Cleveland & Co external in-house counsel, your specialist outsourced legal team are here to help.