United Kingdom

Author: | Published: 9 Jul 2001
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The main regulatory bodies and their powers

The main regulator of deposit-takers is the Financial Services Authority (FSA) and of broker-dealers and other banking-related financial services institutions the Securities & Futures Authority (SFA).

The latest pronouncement from HM Treasury on the date upon which the FSA will assume its powers under the Financial Services & Markets Act (FSMA) and act as the sole regulator of the UK financial services industry is "not later than November 30 2001". On this date, commonly known as N2, the FSMA should come into force and the FSA assumes its considerable regulatory powers under that Act.

Implications of the new legislation and associated regulatory developments

The FSMA gives the FSA wide-ranging powers which will enable it to assert its influence as the sole regulator of banking and other financial businesses in the UK. The FSMA sets out the regulatory framework, and much of this is fleshed out in statutory instruments which have been issued in draft form (covering, for example, the financial promotion regime and the rules setting out which activities require firms to be authorized) and in rules to be published by the FSA (notably those governing prudential supervision and Conduct of Business Rules). In total there is something in excess of 2,500 pages of new regulations which banks will need to take into account by the end of the year. The key changes which will be introduced by the FSMA and which will influence the operation of the FSA are as follows:

Accountability and objectives

The FSMA sets up the FSA as a statutory regulator. This may not seem as though it is a particularly key change. Previously, banks complied with the rules of the Bank of England or the SFA, and now they will comply with the rules of the FSA. However, the FSA's statutory footing indicates a key shift in the emphasis and tone of regulation, which will be more apparent to banks than any other regulated entity. This is because the last vestiges of self-regulation and the traditional approach of the Bank of England will disappear. No longer will firms be dealing with the regulator of their own industry, notwithstanding any attempt to build in practitioner involvement in consultation groups. Banks will soon discover that, in fact, they are dealing with the "man from the Ministry", not the industry. It is clear that the less formal banking regulation model will move closer to the more rigid and role-based securities regulation model. In particular, the FSA is required to report to HM Treasury annually on a discharge of its statutory functions, which are:

  • to maintain confidence in the financial system;
  • to promote public understanding of the financial system;
  • to secure appropriate levels of consumer protection; and
  • to bring about a reduction in financial crimes.

The wording of this final objective is very significant for banks. It indicates clearly that the government thinks that there is too much financial crime which goes unpunished. The wording does not say, as it might if the government were satisfied with the present position, that the aim is to "preserve low levels of financial crime".

The territorial scope of the new regime is largely unchanged. To require authorization, the regulated activity must be carried on in the UK. Exclusions continue to apply to overseas persons as set out in the Regulated Activities Order which are broadly similar to those which already exist. However, the overseas person exclusion for securities and derivatives does not apply to deposit-taking, and it must be hoped that the FSA will take a similar view to that of the Bank of England and issue guidance clarifying that deposits are accepted, and hence business is carried on, in the place where the currency settles.

Approved persons

The FSMA retains, and to some extent strengthens, the rules governing the regulation of, and the conduct of, individuals. From N2, persons will need to become approved:

  • if they are in a management role which is such that they can exercise influence on the conduct of a firm's affairs;
  • if they deal with customers; or
  • if they deal with the property of customers.

One of the key concerns of the regulators following the collapse of Barings Bank was to ensure that senior management could properly be held accountable for their actions. Ensuring that senior management are held responsible for the conduct of firms is now a statutory duty of the FSA. The FSA has also issued separate Principles for Business and for Approved Persons, which is a sign that the FSA intends to hold registered individuals at banks accountable to a greater extent than has previously been the case. The better defined individual responsibilities are, the easier the FSA will find it to hold individuals to account. In particular, when considered along with the statutory responsibility to reduce financial crime, and its increased prosecution powers (see below), it is clear that the FSA intends to hold individuals within banks to account for their actions to a greater extent than has previously been the case. Considering that the FSA has the power to levy unlimited fines or expel from the industry persons who are guilty of gross misconduct (a failure to comply with a statement of principle or being knowingly concerned in the contravention of a requirement placed upon a firm) it is easy to see why senior management responsibility and the approved persons regime are of such concern to the UK banking industry.

Market abuse and criminal offences

The existing criminal regime relating to financial misconduct is not often prosecuted, and rarely successfully prosecuted. The new regime retains the old criminal offences but, crucially, gives the FSA the power to prosecute both the old criminal offences and a new market abuse regime which is civil in nature. It will therefore be much easier for individuals to be held to account for potential market abuses than had previously been the case.

Market abuse is defined as behaviour likely to be regarded by a regular user of the particular market as a failure to observe the standard of behaviour expected of a person in that position in relation to that market. The behaviour itself must be:

  • based on information not generally available to market users but which a regular user would be likely to regard as relevant in determining the terms on which transactions should be effected. This is insider dealing as seen by the man on the street who happens to be a stockbroker. Information will be considered generally available if it has been disclosed through an accepted channel for dissemination of market information, is contained in records which are open to public inspection, or has otherwise been made public (in each case, even if this happens abroad);
  • likely to give a regular market user a false or misleading impression of the supply of, or demand for, or price of, or value of, an investment. This restriction is aimed at preventing artificial transactions, or the dissemination of false information; and
  • such that a regular market user would be likely to regard the behaviour as distorting, or being likely to distort, the market in that investment. This is aimed at preventing abusive squeezes, where a market user has a significant influence over supply, or attempts to position the price of particular securities or indices.

The market abuse regime has been the key concern for many banks in planning for N2. Banks will need to train a significant number of staff as to what might constitute market abuse to ensure that staff understand the situations in which they might be acting in contravention of the FSA's Code of Market Conduct. Given the FSA's new powers and approach, there is unlikely to be leeway or forgiveness for banks who do not take seriously or act effectively in implementing new procedures in relation to the market abuse regime.

The FSA only needs to "prove" that market abuse has occurred to the civil, not criminal, standard. The Code contains certain "safe harbour" defences which mirror those contained in the City Code on Takeovers and Mergers. The code itself is not conclusive or exhaustive, and for this reason there is no template to enable firms to train their staff in how to comply with the new code. Banks will need to take into account their own operating methods in order to tailor their new procedures. Banks are unlikely to retrain staff effectively in this area without using carefully selected real-life examples.

The FSA rules and guidance

A benefit for banks faced with the new regime is that there will at least now be a single rule book covering their activities. The key issue will be to ensure that banks' activities are in compliance with the new rules because there will be no general grace period under which banks can operate using the old rules. The new Conduct of Business Rules, which run to several hundred pages, will prove to be a particular challenge. Banks will face changes to rules:

  • where, for consistency, the FSA has been forced to adopt one or the other of two previously existing regulatory approaches;
  • where change is required to reflect the FSA's new statutory background and power (for example, the Code of Market Conduct);
  • where new elements of regulation have been introduced, such as market abuse and the Inter-Professional Conduct rules (see below); and
  • where attempting to redraft sections for consistency or clarity has actually led to minor amendments to the rules which may or may not have been intended. This category is particularly difficult to spot.

Inter-professional conduct

N2 will see the end of the Section 43 regime, which excluded from the detailed conduct rules of the various regulators transactions between fellow market participants that fell within certain criteria. The FSA has published a paper on inter-professional conduct which sets out the replacement regime to ensure that regulation does not become unduly burdensome in relation to transactions between parties who do not need detailed regulatory protection. The limited rules which will govern transactions between fellow professionals, are almost unchanged from the previously published consultation paper in May 2000. However, a number of developments in the February 2001 paper are worthy of note:

  • the rules relating to inter-professional conduct will be applied to overseas transactions which are booked through a UK office. The FSA considers such transactions to be undertaken in the UK and therefore that the inter-professional conduct rules should apply. Previously, firms had not generally considered that booking trades through the UK had automatically meant that they would need to comply with the terms of the previous regime and its Grey Paper rules;
  • at present, Section 43 dealers are not subject to a training and competence regime. This position will be maintained for two years following N2, but from that date training and competence requirements will apply. This is one area where banks may consider making further representations to the FSA to explain the training provided to those conducting Section 43 business and to discuss whether there is a necessity for regulation in this area given the FSA's Principle 3, which requires firms to take reasonable care to organize and control their affairs responsibly and effectively.

Wholesale-only deposit-takers

In April 2001, the FSA published a Consultation Paper (number 88) which drew attention to a proposal to create a new category of wholesale-only deposit-takers. The intention is to create a very light regulatory regime to cover such institutions, in particular because elsewhere in the European Economic Area banks can utilize exemptions to lower the regulatory scrutiny to which they are subject if they only accept deposits from wholesale counterparties.

The precise definition of a wholesale counterparty is one of the matters which is up for consultation. However, there is logic to the FSA's starting position, which is that the definition should be restricted to entities which are not covered by the Deposit Protection Scheme. This will be a very clear divide, in that either customers would be worthy of protection (and would therefore fall within the ambit of the scheme) or would not (and therefore, institutions which only dealt with such depositors could operate with a reduced regulatory regime).

Supervision and monitoring of banks

The approach of regulators to supervising banking and financial services institutions has always been systematic. For example, SRO's have visited firms on a rota basis every few years in order to carry out a broad compliance review of their activities.

The FSA has expressly said that the previous system of routine monitoring will be given a considerably reduced role. Banks can still expect to be visited by a regulator on a basis which will be determined by a combination of the perceived risk posed by problems within an institution and the likelihood of such a risk occurring. However, monitoring will in general be far more focused than had previously been the case. Regulators will try to identify market developments and potential issues before they develop (as happened with the Pensions Review) into full blown crisis. For example, the FSA has suggested that, had it received its powers under the FSMA at an earlier date, it would have carried out focused reviews on use of the internet (especially by online banks) and the sales of mortgage endowments because these were either new areas of business which posed a potential risk or areas whereby market developments had made it clear that there was a potential risk posed by a particular business practice. Therefore, monitoring of banks will, in the near future, be more thematic than systematic. To some extent, banks should be comforted by this increasingly focused approach. the FSA will be open to persuasion by institutions who use internal risk models that they should be given a lower regulatory focus. However, the FSA will clearly concentrate its approach on industries or entities who do not appear to be taking its new powers seriously enough.

Discipline and enforcement

The FSA's disciplinary powers are applicable to contraventions of requirements imposed by the FSMA. In practice, this means breaches of the FSA's rules and principles. Much attention has been paid to the precise scope of the FSA's rules. From the point of view of banks, it may be more important to consider the regulator's approach to those rules. This is because the approach will be very different from that previously undertaken by the Bank of England. It is clear from the statutory principle to reduce financial crime, the increased emphasis on senior management responsibility shown by its inclusion as a statutory objective, and the introduction of the Principles for Approved Persons and the Market Abuse regime in particular, that the FSA intends to take disciplinary action against banks and individuals working at them more frequently than had previously been the case. Whether the FSA turns out to be a no-tolerance or a low-tolerance regulator remains to be seen, but no one expects it to be a particularly tolerant regulator.

Steps to be taken by banks in light of N2

2001 will be remembered as a year in which banks undertook extensive reviews of their existing procedures and worked against very tight timescales in attempting to draft, and train staff in the use of, new procedures and client documentation to take into account the FSA's new requirements and rules. N2 will be the most important date as far as banking regulation is concerned since the introduction of the Banking Act itself. Banks will need to undertake wholesale reviews in relation to market abuse and the inter-professional code and monitor to ensure that staff have properly understood the new procedures. Institutions which do not do so will face a regulator which is unlikely to be tolerant of lapses caused by a lack of planning for, or investment in training relating to, N2.

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