Financial services, regulation and ethics

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Regulatory obligations for firms

Threshold Conditions (COND)

The threshold conditions are the minimum conditions that firms must satisfy at all times if they are to retain their ‘Part 4A permission’, allowing them to conduct investment business in the UK.

The conditions are:

Location of offices: If the person concerned is a body corporate constituted under the law of any part of the UK, its head office and its registered office must be in the UK (‘person’ can mean company, partnership or individual)

Effective supervision : A person must be capable of being effectively supervised by the FCA, having regard to all circumstance. If the person concerned has close links with another person (‘the close link’), the FCA must be satisfied that those links are not likely to prevent the effective supervision of that person by the FCA. Where the close link is subject to laws or regulations of another territory that is not an EEA state, the foreign provision or any deficiency in their enforcement cannot prevent the FCA’s effective supervision of the person

Appropriate resources: The resources of the person concerned must, in the FCA’s opinion, be adequate for the regulated activities they carry out. The FCA may take into account the membership of any group to which the person belongs and the effect that membership may have on the provisions they make and which they and other group members make in respect of liabilities

Suitability: The person concerned must satisfy the FCA that they are a ‘fit and proper’ person in relation to all the circumstances, including their connection with any person, the nature of any regulated activity that they carry on or seek to carry on, and the need to ensure that their affairs are conducted soundly and prudently

Business model: A person’s strategy for doing business must be suitable for the regulated activities they seek to carry out. The matters determining whether this condition is satisfied include whether the model is compatible with the affairs being conducted in a sound and prudent manner, the interests of consumers and the integrity of the UK financial system. This condition was added in 2013

Further conditions apply to a person who has their head office outside of the EEA and appears to the FCA to be seeking to carry on a regulated activity relating to insurance business.

Principles for Businesses (PRIN)

The FCA Principles for Businesses are a general statement of fundamental obligations of all authorised firms in the regulatory system.

Senior Management Arrangements, Systems and Controls (SYSC)

The senior management of authorised businesses must have an adequate structure of systems and controls for the business. The partners, directors and senior managers need to understand their responsibilities, which should be formally documented.

Senior management arrangements (SYSC 2): Each firm should appoint individuals to be personally responsible for ‘senior management functions’ within the firm.  The records should show who is responsible for what function, although overall responsibility lies with the firm’s chief executive or equivalent person

Systems and controls (SYSC 3): A firm should have systems and controls ‘appropriate to its business’ - that is, according to its size and nature and the risks associated with it.  Systems must be reviewed regularly to ensure they continue to remain appropriate 

They should cover such areas as:

Reporting lines and how responsibilities are delegated

The compliance function

The assessment of the risks facing th...

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Remuneration code (SYSC 19A)

All FCA authorised banks, building societies and Capital Adequacy Directive (CAD) firms within the provisions of the remuneration code. Affected firms must establish, implement and maintain remuneration policies, procedures and practices that are consistent with and promote effective risk management.

The code includes twelve Remuneration Principles which, in summary, require firms to:

Have in place good governance structures regarding remuneration policy approval

Operate fair remuneration structures which take account of future risks and the quality of business undertaken, with bonus payments being based on long term performance

Avoid an over-reliance on performance related pay as opposed to standard salaries

Consider deferring a significant proportion of bonuses so that they are paid over a period of time and thus reducing the risk of high-risk practices

The twelve principles are:

Risk management and risk tolerance

Supporting business strategy, objectives, values and the long-term interests of the firm

Avoiding conflicts of interest

Governance

Control functions

Remuneration and capital

Exception government intervention

Profit-based measurement and risk adjustment

Pension policy

Personal investment strategies

Non-compliance with the remuneration code

Remuneration structures

Additional Risk Controls (SYSC 21)

This chapter mostly applies to banks and insurers included in the FTSE 100 index.

References (SYSC 22)

This chapter concerns the obligations that apply to firms concerning references for employees.

Senior Managers and Certification Regime (SYSC 23 - 27)

These chapters concern the rules of the Senior Managers and Certification Regime (SM&CR), including classification, allocation of prescribed responsibilities, responsibilities maps, handover procedures, overall and local responsibility, certification regime.

Financial Stability and Market Confidence (FINMAR)

This sourcebook contains provisions relating to financial stability, market confidence and short selling. The first part covers the FCA’s power for gathering financial stability information, requiring an individual to provide information or documentation. 

The second part sets out the rules and provides guidance in relation to short selling. Short selling regulations are intended to stop or limit short selling of financial instruments if the price falls significantly during one single day’s trading. The FCA will step in to prevent markets becoming disorderly if there are violent movements in price, there are unsubstantiated rumours or false information circulating, or if there are suspicions of improper trading.

These rules are relevant to any entity to whom EU short selling regulation applies, even if they are not regulated by the FCA, and are in place to promote the FCA’s objectives of ‘protecting consumers’ and ‘enhancing financial integrity’. 

Training and Competence (TC)

Training and competence requirements ensure that certain individuals achieve appropriate qualifications, demonstrate competence, and undertake continuous professional development (CPD).

The rules apply to those who give advice (investment advisers, mortgage advisers and general insurance advisers), and to their supervisors. They also apply to overseers (line managers in life assurance companies in departments that deal with new business and claims).

Explain what is meant by the ‘threshold conditions’.

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Capital adequacy

All firms regulated by the FCA must maintain sufficient resources to cover the risks that arise from the way they carry out their business.  Although all firms must meet a general rule requirement, there are additional requirements for different types of firms.

Large organisations (e.g. banks and insurance companies) are subject to rigorous monitoring of their financial resources, with many being subject to the Investment Firms Prudential Regime (IFPR) now that the UK has left the EU. The rules in the new MIFIDPRU handbook require firms to undertake detailed risk assessments and stress testing scenarios to establish the level of resources they need to maintain.  This does not currently apply to most IFA businesses, though they are still subject to a variety of financial tests tha...

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Cover a proportion of any guarantees provided to clients

MiFID firms, such as those with portfolio management permissions holding client money in excess of £1.2bn, have a minimum capital requirement of £75,000 plus 25% of fixed overheads.

Exempt MiFID firms, such as small investment firms, have a base capital requirement of £20,000, and a variable requirement of 5% of income.

MIPRU

MIPRU sets out the professional indemnity insurance and capital resource requirements for home finance providers and intermediaries and general insurance intermediaries.

IPRU-INV

Within this section are the professional indemnity insurance and capital resources requirements for investment firms. It is sub-divided into securities firms, investment management firms and personal investment firms.

What are firms subject to the Capital Requirements Directive (CRD) required to do?

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Regulatory rules for investment advice (COBS)

Most of the rules which affect the day-to-day operations are contained in the Conduct of Business Rules (COBS).

Purpose of the COBS rules (COBS 1)

The purpose is to provide detailed guidance on how staff and representatives of regulated businesses should deal with customers. It incorporates the MiFID requirements and introduces a principles-based regime for regulated firms.

The rules apply to all regulated life and pensions and investment businesses and the investment activities of banks and building societies. Many rules only apply to specific regulated activities, while others cover how regulated firms should carry out activities which are unregulated.

COBS obligations (COBS 2)

Inducements: Firms must take reasonable steps to ensure that they do not offer, give, solicit or accept an inducement or place business in any way likely to conflict with any duty owed to customers.

For packaged products (life and pension policies, OEICs and unit trusts), commission overrides are forbidden, and legacy commission can only be paid to the intermediary responsible for the sale (unless they have passed the right to the commission to a third party, another firm has given advice on investments to the same customer after the sale in question, or it relates to a direct offer advertisement to a customer of the firm). The rules seek to ban many indirect benefits and ‘under the table’ payments and services.

The goods and services guidelines cover four areas:

Selling: Product literature without intermediary's name can be supplied, product promotion to enhance customer service is permitted and intermediary seminars can be attended by provider staff for genuine business purposes

Gifts/extras: A provider can give specific advice on its products; IT hardware can be given as part of a software project only; gifts and hospitality of ‘reasonable value’ are permitted; providers can run seminars for intermediaries but cannot pay expenses and providers can pay 'reasonable fees’ to intermediaries who participate in market research

Communications: A provider can pay reasonable travelling expenses and accommodation costs of an intermediary visiting a UK office, a provider can supply pre-paid envelopes for communicating with it, plus a freephone link if these are available to intermediaries generally.

Training: Training facilities can be supplied (with or without charge) if the provider makes them generally available for intermediaries and the provider can pay or contribute to any reasonable travelling or accommodation expenses of the intermediary for this training

To satisfy the ‘client best interests’ rule, the provider of benefits will make the benefits generally available to intermediaries.  All records of benefits given to an intermediary must be kept for five years.

Regulatory rules for non-investment insurance advice (ICOBS)

Advising on general insurance products became regulated under the FCA on

14 January 2005, with all firms having to reapply to the FCA for authorisation. ‘General insurance’ includes motor, pet and home insurance, for example. The rules also cover some protection products, namely those with no investment element, such as pure life assurance, critical illness insurance, income protection insurance and private medical insurance.

General standards

The Insurance: Conduct of Business Sourcebook (ICOBS) brought into force on 6 January 2008 reflects the more principles-based focus and risk-based approach the FCA is trying to establish. It replaced many of the old rules of the General Insurance Standards Council (GISC) with high-level guidance, with different rules for different product types.

The ICOBS handbook introduces three product categories:

General insurance products

Pure protection (term assurance, income protection, critical illness)

Payment protection insurance (PPI).

All categories are subject to one set of rules, but there are additional rules for pure protection and PPI policies as they are deemed to be more complex and thus to require a more complex sales process.

The handbook is divided into nine chapters:

ICOBS 1 – Application

ICOBS 2 – General matters

ICOBS 3 – Distance communications

ICOBS 4 – Information about the firm, its services and remuneration

ICOBS 5 – Identifying client needs and advising

ICOBS 6 – Product information

ICOBS 6A – Product specific rules

ICOBS 7 – Cancellation

ICOBS 8 – Claims handling

Under ICOBS, insurers and intermediaries require authorisation to carry out regulated activities and insurers must ensure that the intermediaries they deal with are authorised. The rules separate consumers and commercial customers and vary according to whether the sale is made with or without advice. They apply to new business and the nor...

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Banning the sale of products containing toxic combinations of characteristics that put borrowers at risk

Banning arrears charges when a borrower is already repaying and ensuring firms do not profit from those in arrears

Requiring all mortgage lenders to be personally accountable to the regulator and calling for the regulator’s scope to be extended to buy-to-let arrangements and all lending secured on a home

These changes came into force on 26 April 2014.

The new rules apply to new borrowers and existing borrowers, but lenders are required to ensure that existing borrowers are not ‘trapped’ by the new requirements. They can apply transitional provisions where a borrower already had a mortgage before the new rules came in and now wants to move or remortgage. This effectively relaxes some elements of the affordability assessment, provided that the existing borrower is not borrowing further funds.

Mortgage Credit Directive (MCD)

The Mortgage Credit Directive (MCD) was implemented on 21 March 2016, resulting in amendments being made to MCOB rules.

One of the main changes introduced by the MCD is that first and second charges are treated equally in respect of regulation, so from 21 March 2016, second charge lending came under MCOB instead of the Consumer Credit sourcebook. To undertake second charge mortgage business, lenders, administrators and brokers must be authorised and hold the correct permissions from the FCA – previously there were no qualification requirements to advise on or arrange second charge mortgages.

Other changes brought about by the MCD are:

The regulation by the FCA of firms carrying out consumer buy-to-let (CBTL) activity, as defined in the Government’s legislative framework

The requirement to provide a binding mortgage offer and seven-day (minimum) reflection period

The requirement to give an adequate explanation of a product’s essential features, which must include:

- Pre-contract information

- Essential features of the product

- Potential impact on the consumer (including the consequence of default)

The manner and extent of the explanation can vary depending on the circumstances of the sale. Firms need to establish how an adequate explanation is provided by them for both advised and execution-only sales.

Firms are expected to issue a European Standardised Information Sheet (ESIS). This is a mandatory product disclosure document that replaced the key facts illustration (KFI).

Firms that are paid commission must tell consumers that they have the right to ask for information on the commission paid by different lenders, and firms must ensure they are able to respond adequately to such a request.

Mortgage advisers’ renumeration cannot be linked to sales

Second charge mortgage business - The FCA rules do not require firms to broaden their scope of service to include second charges as well as first, but those firms that do offer both need to take these different products into account when giving advice. If an existing mortgage-holder wishes to borrow more, firms must make the customer aware that other forms of borrowing are available that may also meet their needs. For example, if a customer is considering a second charge mortgage, firms must make the customer aware that it might be possible to obtain a further advance. However, firms are not required to provide advice on the suitability of alternatives if they are not within their scope of service.

The FCA rules for second charge mortgages, including regulated loans taken out before 21 March 2016, are tailored to the risks that occur with secured lending. For instance, the vast majority of sales require advice, with lenders expected to carry out detailed affordability assessments, as well as dealing with customers who experience payment difficulty in a way that considers their individual circumstances.

Advice must be given if there is interactive dialogue between the firm and the customer during the sale (or if debt consolidation, equity release, right to buy or sale and rent back is the main purpose of the loan). Firms must recommend a product (or products) deemed as suitable for the customer based on an assessment of their needs and circumstances. If there is no suitable product, firms cannot recommend the product that is ‘least worst’. However, firms do not have to recommend a single most suitable product.

  In choosing the most appropriate product, firms must consider whether it is appropriate for a customer to:

Have stability of mortgage payments

Take out a mortgage with a specific term

Make early repayments

  Establishing and demonstrating affordability is the responsibility of the lender, even though advisers/intermediaries will consider and discuss a lender’s eligibility criteria with their client.

Qualifications - The FCA requires mortgage advisers to obtain a relevant Level 3 qualification.

Explain which types of mortgage contracts are regulated by the FCA.

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Decision procedure and penalties (DEPP)

The FCA can be reactive or proactive in its approach.

Enforcement : The FCA has teams of enforcement officers who can investigate problems or suspicions about firms. They can:

Make visits to premises with or without giving notice

Demand access to documents and other records and take away copies

Obtain warrants to enter premises and take documents by force if necessary

Disciplinary action : The FCA can take several types of disciplinary actions against firms and individuals including:

Making public announcements

Levying fines

Setting conditions on future business

Obtaining a court injunction

Ordering compensation to customers

Withdrawing authorisation

Prohibiting individual...

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Disciplining firms and approved persons

Varying a firm’s permission to conduct certain regulated activities

Matters relating to market abuse

Withdrawing individual approval

Making prohibition orders banning individuals from employment relating to specific or all regulated activities

The Upper Tribunal is part of HM Courts & Tribunals Service, an executive agency of the Ministry of Justice. Following an appeal, it can uphold the FCA’s decision or overrule it.  An aggrieved individual can appeal against the decision to the Court of Appeal but only on a matter of law.

What information must be provided to an individual who is subject to an investigation by the FCA’s enforcement officers?

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(DISP) Dispute resolution: Complaints

This includes procedures a firm must have in place to handle complaints made by its customers, and the rules that apply to firms subject to the Financial Ombudsman Scheme (FOS).

CONRED

This part of the handbook relates to consumer redress, requiring firms to investigate whether it has f...

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Who can complain to the Complaints Commissioner about the actions or inactions of the FCA?

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The Specialist Sourcebooks contained within section 6 of the Handbook contain the requirements for individual business sectors. These are the requirements for:

Collective Investment Schemes (COLL)

Credit Unions (CREDS)

Consumer Credit (CONC)

Investment Funds (requirements for those covered by AIFMD (FUND)

Professional Firms (PROF)

Regulated Covered Bonds (RCB)

Recognised Investment Exchanges and Recognised Clearing Houses (REC)

Listing, Prospectus and Disclosure

Contains the United Kingdom Listing rules. These are in:

Listing Rules (LR)

Prospectus Rules (PR)

Disclosure Rules and Transparency Rules (DTR), the UK listing disclosure rules

Product Disclosure (DISC) (additional rules following the FCA’s amendments to the PRIIPs rules)

Handbook Guides

This sectio...

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‘The MiFID 2 Onshoring Guide’ (M2G) – Contains two guides that deal with post-Brexit onshoring of MiFID II – one dealing with trading venues and data-reporting service providers, and one dealing with senior management arrangements and systems and controls obligations

Unfair Contract and Consumer Notices Regulatory Guide (UNFCOG)

Collective Investment Scheme Information Guide (COLLG)

What information is provided by the sourcebooks contained in section 6 of the FCA handbook?

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Consumer Credit Act 1974

The Consumer Credit Act 1974 regulates the provision of any form of credit or advice on repaying debt provided by individuals or corporate bodies and applies to both the actual lenders and intermediaries. Firms who may find themselves advising a client to repay their mortgage out of, say, an inheritance, is covered by the Consumer Credit Acts and need a credit license. The 1974 Act related mainly to credit agreements not exceeding £25,000.

Certain bodies could apply for exemption against the Act if they dealt in loans secured on land, and building societies are specifically exempt.

Since 1 April 2014, it is the FCA who will issue licences to those applying for authority to give credit or advice on loans.  Carrying on credit business without a licence is a criminal offence.  The FCA can revoke licences where it is dissatisfied with the lisencee’s conduct.

Some of the main provisions of the Consumer Credit Act are:

The true Annual Percentage Rate (APR) must be quoted on advertisements and quotations

Customers must receive one copy of the loan agreement for their records

The contents of the loan agreement are regulated

There must be a cooling off period giving consumers ...

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A term deemed to be unfair under the new Act is not binding, although consumers can choose to rely on it if they wish, and the new rules cover not just policy schedules, but also renewal notices and promotions.

The role of the FCA

By agreement with the CMA, the FCA is responsible for considering, within the terms of the regulations, the fairness of standard terms in financial contracts issued by FCA authorised firms or appointed representatives of firms that undertake any regulated activity. This includes:

Mortgages

General insurance

Bank, building society and credit union savings accounts

Life assurance

Pensions

Investments

Long-term savings

If the FCA feels that the CMA is better placed to deal with the issue, it will pass the case to them to decide whether action is required and if so what it should be.

Which body is the principal enforcer of the Consumer Rights Act 2015?

Answer: The Competition and Markets Authority (CMA) the principal enforcer of the Consumer Rights Act 2015

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