Financial services, regulation and ethics

In this chapter, we examine how the ...

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...utcomes in their dealings with them.

The FCA has 12 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 financial resource...

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...t supervision of firms, 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 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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...f message: For example, different areas of the business receive different training and interpretations of the main messages.

Outcomes inconsistent with strategy: For example, processes adopted are not consistent with the overall strategy adopted for ensuring the fair treatment of customers.

Failure to identify the risks that prevent the fair treatment of customers 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 the Code of Conduct (COCON), and the Statements of Principle and Code of Practice for Approved Persons (APER)  These are also founded on ethics and are indicators or good conduct and best practice.

Code of Conduct (COCON)

The conduct rules contained within COCON apply to nearly every employee in firms subject to the SM&CR regime (most financial firms). This includes those who have oversight responsibilities for staff and all those who are customer-facing. Some rules apply to everyone and some only apply to senior managers, and the rules are intended to improve individual accountability and awareness of conduct issues across firms.

Employees are expected to understand their responsibilities under the conduct rules, and any breach that results in disciplinary action must be reported to the FCA.

The individual conduct rules are:

Rule 1 - You must act with integrity

Rule 2 - You must act with due skill, care and diligence

Rule 3 - You must be open and cooperative with the FCA and PRA and other regulators

Rule 4 - You must pay due regard to the interests of customers and treat them fairly

Rule 5 - You must observe proper standards of market conduct

Rule 6 – You must act to deliver good outcomes for retail customers

Examples of poor practice that would demonstrate non-adherence to the individual conduct rules might include:

Rule 1 (integrity) -  making recommendations that cannot be properly justified, misusing the assets of a client, destroying documents relevant to an  FCA investigation, misleading providers about the status of a client (creditworthiness or health for example), or misleading clients or the regulators

Rule 2 (skill, care and diligence) - failing to explain investment risks to a client, failing to secure a client’s assets, failing to disclose charges or surrender penalties to a client, or making recommendations for products without understanding the risks involved

Rule 3 (open and cooperative with regulators) - failing to answer questions of the regulator, or provide the regulator with information when questioned, failing to supply requested documents or failing to attend a meeting or interview the regulator

Rule 4 (interest and fair treatment of customers) - failure to provide accurate information to a client, providing a product that is different from the one applied for, failing to resolve mistakes when identified, failing to provide clear terms for a product or service to a client, or recommending a product with no grounds for considering it suitable.

Rule 5 (market conduct) - manipulating a benchmark or market

R...

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...ts must be borne in mind at all times when carrying out duties and any neglect or deliberate ignoring could result in disciplinary action by the FCA. This could result in financial penalties, the loss of the individual’s job and the end of any prospect of future employment in the industry. If a firm believes that a senior manager, certified individual or an approved person is no longer ‘fit and proper’ it must take appropriate action and immediately inform the FCA.

Conflicts of interest

The senior management of firms need to be fully involved in conflict identification and its management, taking a broad view of the risks posed to the business. The responsibility must be designated to accountable individuals and there must be controls in place which are regularly reviewed.

It is often the case that firms view conflicts of interest only in relation to the area of remuneration. However, it can be far wider than this and senior management are responsible for ensuring that the broad range of possible conflicts that their firm could be exposed to is monitored and conflicts addressed.  A formal conflicts policy should be put in place and regularly reviewed, with formal procedures for dealing with the conflicts identified.

The FCA expects firms to take a critical view of how conflicts will affect the fair treatment of clients and respond in a manner consistent with the Fair Treatment of Customers initiative. Clear guidance should be in place to assist staff to recognise potential conflicts, including how and in when issues should be escalated to senior management.

Conflicts of interest mitigation

Some conflicts policies start by attempting to define what a conflict is, but consideration must be given to whether this may be too narrow or too wide. An alternative and perhaps better approach is to give a general definition, with an analysis of how this may apply in common business situations. It may be beneficial to have a high-level framework with subsequent manuals for different business areas.

All staff at a firm of intermediaries should be aware of conflicts and should be responsible for conflicts arising from their own conduct.  In smaller intermediary firms there may not be an internal audit (IA) function and, where this is the case, a method of insuring that risks arising from conflicts have not arisen is to have internal and consistent checking of files by an individual not involved in the placement of business.

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.