Life under the new financial regulators

June 2013 | PROFESSIONAL INSIGHT | BANKING & FINANCE

Financier Worldwide Magazine

The perceived relative ease of transition from the old financial services regulatory regime to the new may have led some firms to understate the full impact of the change. They do so at their peril.

With legal cutover having taken place on 1 April and the new system of dual regulation of financial services well underway, some might assume that all work to comply with new regulatory requirements will have been completed. The relative ease of the transition to the new regime, with the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA) taking over from the Financial Services Authority (FSA), might also encourage the thought that the repercussions are relatively minor.

Such assumptions would be unwise. Substantial changes result from the new regime, with significant implications for the way regulated firms will be supervised. Evidence suggests many firms are still undertaking actions necessary to meet new compliance standards, and will be doing so for some time. A recent survey we conducted in the final days before the legal cutover found that less than half of firms were fully prepared for more intrusive elements of supervision and only 50 percent of firms were ready for the new regulatory powers potentially affecting unregulated parent companies, financial promotions and products.

Only 39 percent of firms claimed to be fully prepared for the new rules in the regulators’ two handbooks, including the new Threshold Conditions. Such findings are a cause for concern, because while some of the Threshold Conditions remain essentially the same, new requirements arise for firms in relation to effective supervision and the business model.

Firms must be capable of being effectively supervised by the FCA (and PRA, if dual regulated). They must therefore operate in a way that is transparent, cooperative and supports open communication. The regulators should be able to review documentation of procedures as and when required. In meeting the effective supervision threshold, firms must have regard to the nature and complexity of their regulated activities and products, the way in which their businesses are organised as well as their close links and group structure.

If they have not already done so, firms must also focus on their business models. The FCA requires firms to document their strategy for doing business, and this strategy must be suitable for the regulated activities. There should also be a focus on the interests of consumers, the integrity of the UK financial system and the need for the firm’s business to be conducted in a sound and prudent manner. These areas of focus directly relate to the regulators’ objectives, which place high importance on protecting both consumers and the UK financial system.

For many firms, updating the business model has not previously been a habitual action. Now it must be. The business model must become a dynamic, current document, clearly explaining how the firm can run its affairs according to the regulatory rules and within the scope of its permission.

The business model should then flow through to the Internal Capital Adequacy Assessment Process (ICAAP), which must itself be regularly updated to reflect developments in the business model, such as any plans for expansion. The review of the business model could also have repercussions for the Threshold Condition concerning appropriate resources. All firms must maintain both financial and non-financial resources that are adequate to the nature and scale of their business and the risks that could threaten business continuity, and must ensure that management’s skills and experience are appropriate.

The need for the review and updating of documentation is a key theme in any overview of the impact of the new regulatory system. All documentation linked to regulatory compliance is affected. This includes, alongside the business model and ICAAP, all corporate governance policies, compliance manuals, compliance monitoring programs, group structures, staff organisation charts and reporting lines. The list is extensive and the time taken to complete all such reviews and updating of documentation should not be underestimated.

Completing this work as soon as possible – though it inevitably takes substantial time – is particularly important given the new regulators’ approach to supervision – much more intrusive than that of the FSA. Although firms have been categorised in relation to both conduct and prudential supervision, with the higher categories receiving the most intense contact with regulators, low category firms will not be allowed to slip under the radar. The FCA, for example, will be running onsite reviews, sending out questionnaires to collect data, conducting market surveys on firms, and completing thematic reviews on specific topics. All firms will be affected, large and small.

Some firms are already feeling the effects of the new regulatory impetus, particularly those in the top categories for conduct supervision, which from May until December 2013 are being moved into the new Firm Systematic Framework. These firms will experience reviews on a one- to two-year cycle.

All firms should, however, be assured that the regulator will be in touch, if not now, then at a definite point in future. Under the old regime, a low risk firm could have no contact with the FSA for many years. Under the new regime, even firms in the lowest risk category for conduct supervision will be subject to at least a four-year cycle of review. The regulators’ resources are being increased accordingly.

Alongside their increased resources, the regulators also have impressive powers. A key development is the new power of both the FCA and PRA to make directions imposing requirements on certain unregulated parent undertakings that control and exert influence over authorised firms. It may come as a shock to some parent entities based overseas that these UK-based regulatory organisations can request information and give directions – but they can. They could conceivably even complete onsite visits should they choose to do so.

The substantial potential impact of the regulators’ powers is also reflected in the FCA’s ability to make immediate temporary interventions to address issues arising from financial products or services considered detrimental to the interests of consumers or competition. It could, for example, prevent the launch of a product, require certain product features to be included or require the payment of compensation. The FCA can also require firms to withdraw or amend a misleading financial promotion, and to announce that it has done so.

Firms should also make sure they fully understand the implications of the power acquired by the FCA and PRA to conduct investigations of firms or individuals relating to enforcement action. For example, the FCA and PRA can require a firm to appoint a skilled person to produce a report under section 166 and 166A of the Financial Services and Markets Act. The regulators also now have the power to appoint a skilled person directly – recovering the associated costs from the firm concerned. Firms should take note: the new regulators are committed to bringing more enforcement cases and applying tough penalties, holding senior managers accountable for their actions, pursuing criminal prosecutions and obtaining compensation for consumers. Reputational risks need to be considered, not least because both regulators can now publish at an early stage a warning notice issued to a firm in relation to enforcement actions.

As a final call to action, firms must ensure that the new Statements of Principles contained in both regulators’ handbooks (applying to any individual performing a controlled function) are translated into a material code of conduct. The regulators expect the principles to be embedded in all firms systems and procedures, to create a strong compliance culture. Ethical considerations should be part of daily activity, not matters for occasional review.

Lorraine Bay is a partner and Giovanni Giro is compliance manager at Moore Stephens LLP. Ms Bay can be contacted on +44 (0)20 7334 9191 or by email: lorraine.bay@moorestephens.com.

Lorraine Bay and Giovanni Giro

Moore Stephens LLP