Learning Material Sample

Financial services, regulation and ethics

9. The FCA's use of principles and outcomes based regulation to promote ethical and fair outcomes

Learning outcome 9: Understand the FCA’s use of principles and outcomes based regulation to promote ethical and fair outcomes.

In this chapter we examine how the FCA...

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... outcomes in their dealings with them.
The FCA has 11 general statements, known as the Principles for Businesses , which set out the obligations on all the authorised firms under the regulatory system. They are high level standards that are designed to apply even when there are no stated rules or procedures for a given situation. All authorised firms must comply with and be ready, willing and organised to abide by the principles at all times. In the event of a conflict between the FCA rules and the Principles, the Principles take precedence.

The FCA operates on set principles that authorised firms must follow within their businesses.

A firm that does not follow these principles may be subject to disciplinary action.

The FCA Principles for Businesses state that a firm must:

Conduct its business with integrity

Conduct its business with due skill, care and diligence

Take reasonable care to organise and control its affairs responsibly and effectively, with adequate risk management systems

Maintain adequate fi...

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...s, where supervisors are supported by sector analysis and high quality technical advice from specialists in prudential and conduct risk. The supervisor’s role should be to act on a firm-specific basis as an integrator of risk information and as the focal point for the analysis of the risk posed by the firm’s business model, assessing both prudential and conduct information.

For example, in the mortgage market, the regulator needs to identify both the funding risks and the risk caused by the products and sales practices. In the case of payment protection insurance, the way to identify mis-selling practices before they become widespread is through the business model analysis - the inspection-based approach only detects mis-selling after it has occurred.

This integrated supervisory approach underpins Intensive Supervision and the Supervisory Enhancement Programme (SEP).

Explain the purpose of the FCA’s Principles for Businesses.

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Culture

The FCA believes that there are six key drivers which influence the culture of a firm. These are:

Leadership

Strategy

Decision making and challenge

Controls

Recruitment and training and competence

Reward.

These factors will have a strong influence on the behaviours of management and staff and ultimately on the consumers.

Leadership

The tone of an organisation is set by the leadership provided at all levels which, in turn, drives the behaviours of staff and impacts the quality of decisions that are made. Strategy sets the direction and priorities of the business and the focus for management control, which includes management information (MI). This is essential to satisfy management that the firm is delivering fair outcomes for consumers. The approach taken by a firm towards performance management and reward drives the behaviour of staff and ...

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...adequate direction or monitoring from senior management.

Method of delivery not suitable for importance of message: For example, different areas of the business receive different training and interpretations of the main messages.

Outcomes inconsistent with strategy: For example, process adopted not consistent with the overall TCF strategy adopted.

Failure to identify TCF risks and take action: For example, concerns abut the skills and competence of some advisers being ignored and no remedial action being considered.

Corporate governance

Governance, risk management and compliance (GRC) operate to communicate the company’s values, collect relevant information and connect risk to compliance and ethical issues on a principles-based approach.

List the six key drivers which the FCA believes influence the culture of a firm.

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In addition to the Principles for Businesses, the FCA has Statements of Principle and Code of Practice for Approved Persons which apply to those individuals carrying out controlled functions and therefore require individual authorisation. These are also founded on ethics.

The Statements of Principle for Approved Persons applies only to the extent that a person is performing a controlled function for which approval has been sought and granted. All approved persons are subject to Principles 1-4, while only those carrying out ‘significant influence functions’ are subject to the additional Principles 5-7.

Principles 1 – 4 apply to all approved persons

1. Integrity : An approved person must act with integrity in carrying out their controlled function.

2. Skill, Care and Diligence: An approved person must act with due skill, care and diligence in carrying out their controlled function.

3. Market Conduct: An approved person must observe proper standards of market conduct in carrying out their controlled function.

4. Open and co-operative: An approved person must deal with the FCA and other regulators in an open and co-operative way and must disclose any information which the FCA would reasonably expect notice.

Principles 5 – 7 apply to those individuals holding a significant influence function (in addition to principles 1 – 4)

5. Organisation and control : An approved person performing a significant influence function must take reasonable steps to ensure that the business of the firm for which they are responsible in their controlled function is organised so that it can be controlled effectively.

6. Skill, Care and Diligence in managing: An approved person performing a significant influence function must exercise due skill, care and diligence in managing the business for which they are responsible in their controlled function.

7. Compliance: An approved person performing a significant influence function must take reasonable steps to ensure that the business of the firm for which they are responsible in their controlled function complies with the regulatory requirements of that business.

The Code of Practice for Approved Persons is issued for the purpose of helping to determine whether or not an approved person’s conduct complies with a Principle. The Code sets out descriptions of conduct which, in the opinion of the FCA, do not comply with the relevant Statements of Principle.

Some examples:

Under Principle 1: Integrity , an example of conduct that does not comply with the first Statement of Principle would be deliberately recommending an investment that the adviser is unable to justify, i.e. that is inappropriate for the client’s circumstances.

Under Principle 2: Skill, care and diligence , an example of conduct that does not comply with the third Statement of Principle would be deliberately failing to disclose the existence of a conflict of interest.

In determining whether or not the particular conduct of an approved person within their controlled function has complied with the Statements of Principle, the following are factors are taken int...

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...h-level rules (set out in COCON) that apply directly to nearly all staff (apart from ancillary staff, e.g. catering staff). Firms must ensure that staff who are subject to the rules are aware of them and how they apply to their jobs. The Conduct Rules apply to Senior Managers and staff in the Certification Regime from March 2016, and to everyone else from March 2017.

Regime for branches of foreign banks

The FCA rules apply the same principles to branches of foreign banks, but tailor them to account for the different governance structures in branches (notably that the ultimate board will likely reside overseas). For branches of European banks, the rules also recognise the split of responsibilities between the FCA as the ‘host state regulator’, and the European ‘home state regulator’, as set out in EU law. The final rules for branches apply the certification and conduct rules to individuals where they are performing activities from the UK establishment.

Remuneration

The FCA have made changes to the Remuneration Code to encourage more effective risk management and better align individual decision-making with good standards of conduct.

Whistleblowing

New rules to promote a culture where people can speak up took effect from September 2016. These rules apply to deposit-takers (meaning banks, building societies and credit unions) with assets over £250m, Solvency II insurers and PRA-designated investment firms.

In October 2015, HM Treasury announced that it plans to extend the Senior Managers & Certification Regime to all FSMA-authorised firms. This will include all firms regulated by the FCA. HM Treasury introduced a Bill to Parliament on the extension of the regime and implementation is likely to be in 2018. The Bank of England and Financial Services Act 2016 duly received Royal Assent in May 2016 and the changes mentioned will follow in due course.

Senior Insurance Managers Regime (SIMR)

Also with effect from 7 March 2016, the FCA and PRA introduced changes aimed at increasing individual accountability within the insurance sector.

Changes to the Approved Persons Regime for Solvency II firms take into account:

Requirements in Solvency II on the governance of firms and the fitness and propriety of key function holders

Provisions in the Financial Services (Banking Reform) Act 2013 that apply to insurers

 Changes that the PRA is making to its approval regime for these firms (‘Senior Insurance Managers Regime’ or ‘SIMR’).

In December 2015, the FCA published rules for UK insurance firms that fall outside the Solvency II Directive, which are known as ‘non directive firms’ or ‘NDFs’ and apply to:

Insurers and reinsurers

Insurance special purpose vehicles (ISPVs)

The Society of Lloyd’s

Managing agents

UK branches of third-country firms and European Economic Area (EEA) firms

Approved persons within those firms.

Give three examples of records that will be checked under the FCA’s ‘fit and proper test’ in relation to honesty, integrity and reputation.

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This revision test (opens in a new window) has 6 questions and t...

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... time 4.5 hours

7 standard multiple choice questions in the R01 exam.

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