In two publications from 18 September 2015, the FCA discuss their principles and approach to supervision of flexible and fixed portfolio firms. The FCA’s publications will be of interest to both types of firms in regards to fulfilling their regulatory obligations and ensuring their investors’ best interests are sufficiently addressed.
The FCA states that following the financial crisis it has become clear that there are various issues with culture and business practices in many areas of the financial services industry. Hence, in its supervisory regime, the FCA seeks to ensure firms are considering consumers and market integrity throughout their operations and services. The FCA will seek to ensure this through looking closely at the culture and practices of firms from a variety of aspects, which are discussed below.
The FCA plans to put a focus on market level understanding of conduct on a sector and subsector basis and mitigate risks accordingly. The work to be undertaken will be divided into three separate pillars and will include:
1. Proactive firm supervision
An assessment of whether firms have the interests of their clients and the integrity of the market at the heart of their business (Pillar 1 supervision will only be applicable to fixed portfolio firms). Pillar 1 work will consist of 4 separate evaluation and supervision methods:
Business model and strategy analysis (“BMSA”), where the FCA will examine firms’ business models and strategies in order to understand possible risks to consumers and market integrity. Particular factors which the FCA have stated will serve as indicators for heightened risk include:
- fast growth;
- high levels of profitability;
- cross-selling dependent strategies;
- products with unclear features;
- products being sold into undesignated markets for their purpose; and
- inherent conflicts of interest.
Proactive engagement, where the FCA will regularly engage with firms in order to maintain an understanding of the key aspects of their operations in order to identify emerging risks and take pre-emotive measures in response to them. Proactive engagement will consist of three main elements:
- meetings with key individuals;
- regular reviews of management information; and
- annual strategy meetings.
Deep dive assessments, where the FCA will examine particular risks identified throughout engagement with firms by adopting BMSA. Deep dive assessments will focus on four risk groups:
- culture and governance;
- product design;
- sales and transaction processes; and
- post-sales/services and transaction handling.
Firm evaluation, which will consist of a summary of the FCA’s review based on previous evaluations. Taking all factors into account, the FCA will judge and explain its view in regards to the risks posed by a firm and their causes, and the FCA’s strategy and work programme for the firm’s next supervision cycle, which will be aimed at addressing and mitigating those risks.
2. Reactive supervision (EVENT-DRIVEN)
Upon becoming aware of a significant risk to consumers or markets (or upon damage being suffered), ensuring mitigation of such risk and, if necessary, using the FCA’s formal powers to hold firms or individuals accountable to those who have been treated unfairly. Reactive supervision will apply to both fixed and flexible portfolio firms.
3. Issues and products supervision
Pillar 3 will consist of sectoral analysis of current events and potential drivers of poor outcomes for consumers and markets. The work will range from large and detailed studies, such as thematic reviews, to smaller sample-based work. As Pillar 1 proactive supervision does not apply to flexible portfolio firms, Pillar 3 supervision will be the FCA’s prime form of proactively supervising such firms. It will be applicable to all types of firms.
In conducting market supervision, the FCA will also adhere to, and will ask firms to adhere to, the following ten principles:
- ensuring fair outcomes for consumers and markets
- being forward-looking and pre-emptive
- being focused on the big issues and causes of problems
- taking a judgement-based approach
- ensuring firms act in the right spirit
- examining business models and culture
- emphasis on individual accountability
- being robust when things go wrong
- communicating openly
- having a joined-up approach.
These ten principles will be reflected throughout the regulator’s three-pillar approach to supervising the markets and are applicable to all firms.
The FCA has also set a strategic objective of ensuring that the relevant markets function well and have embodied this through providing an appropriate degree of protection for consumers while protecting and enhancing market integrity and promoting effective competition.
Both fixed portfolio firms and flexible portfolio firms should evaluate the systems and controls they have in place in light of the above principals and should seek to ensure that they are adhering to the FCA’s strategic objectives.
To view the full guidance papers published by the FCA, please follow the respective links:
Should you require any further advice or information on the above, Cleveland & Co, your external in-house counsel, are here to help.