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Commercial Question

Double trouble: FCA and PRA take tougher stance on enforcement

updated on 04 February 2014

Question

How are the FCA and the PRA utilising their new enforcement powers almost one year on from their establishment?

Answer

The Financial Services Act 2012 (FS Act) introduced a new regulatory framework for financial services in the United Kingdom. The previous regulator, the Financial Services Authority (FSA), was abolished on 1 April 2013 and there are now two separate regulators - the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA). This fundamental reform of UK financial regulation was prompted by the financial crisis of 2008-09.

The government has described the FCA and the PRA as the United Kingdom's "strengthened regulatory architecture" and it seems that the new regulators have taken a tougher stance on monitoring the financial system than their predecessor. Since their inauguration, these bodies have been more proactive and interventionist. This can be seen in their willingness to impose higher fines, their new 'naming and shaming' strategy and product intervention powers. The new supervisory and enforcement powers that the regulators have been granted, combined with their increasingly interventionist attitude, has resulted in a major overhaul of financial regulation and regulated firms are feeling the force of the 'double trouble' regime.

Background: the twin regulators

The FCA, in its capacity as the new business conduct regulator for the financial services industry in the United Kingdom, regulates approximately 26,000 financial firms and was created with one strategic objective; "to ensure that the markets function well". Its main focus is to protect consumers, promote competition between financial services providers, and maintain the stability and integrity of the financial system. The FCA will intervene when consumers are treated unfairly or when a firm puts at risk the integrity of the market.

The PRA, in its capacity as the micro-prudential regulator, has responsibility for ensuring the effective prudential regulation of the 23,000 firms that manage risks as part of their business strategy. Its main aim is to promote the interests of consumers. To this end, the PRA supervises the activities of banks, building societies, credit unions, insurers and large investment firms.

What kind of behaviour will attract a regulator's attention?

The Financial Services and Markets Act 2000 (Threshold Conditions) Order 2013 recast the old FSA 'threshold conditions' and created four separate sets of threshold conditions for firms governed solely by the FCA, as well as PRA-authorised banks and investment firms, PRA-authorised insurers and conditions for dual-regulated firms. A firm must comply with the relevant conditions in order to be, and remain, authorised as a financial services firm. Examples of threshold conditions include holding adequate resources to meet the regulatory activity undertaken, carrying out effective supervision and conducting business in a prudent manner.

These threshold conditions enable the FCA and the PRA to monitor firms and assess them against objective criteria on a continuous basis. A breach of any of the conditions could lead to enforcement action being taken by a regulator, such as varying or cancelling a firm's regulatory permissions. Additional factors which may exacerbate penalties include activities that cause consumer detriment, undermine public confidence in financial markets, create a risk of financial crime or enable a firm or individual in breach to profit from their misconduct. Also, a firm seen to be uncooperative with the regulators in the case of an actual or suspected breach could exacerbate any penalty imposed.

Supervisory and enforcement powers

During the past year, there has been a significant increase in the use of supervisory and information-gathering powers by the regulator; primarily through Skilled Persons Reports (commonly known as 's.166' in reference to the relevant section of the Financial Services and Markets Act 2000) and thematic reviews. These tools are used by the FCA to obtain an independent view of activities undertaken by a firm which may cause concern or require further investigation. The former focuses on the supervision of individual firms and the latter entails a broader assessment of current or emerging risks in a particular market. The increased use of supervisory powers indicates that the regulator is taking a more preventative, as opposed to reactionary, approach.

However, both the FCA and the PRA also have a multitude of disciplinary and enforcement powers at their disposal which can be utilised if necessary. The justifications for punishment underpinning the use of these powers are deterrence and protection of consumers. The exercise of enforcement powers and the subsequent publication of regulatory non-compliance are intended to deter others from breaching regulations and to deter the party in breach from repeating its misconduct. It also ensures that firms divert more of their resources toward achieving compliance.

Enforcement powers are granted by the Financial Services and Markets Act 2000 (as amended by the FS Act) and include, at the tougher end of the spectrum, prosecuting firms and individuals, withdrawing a firm's authorisation, removing an approved person's approval and suspending firms. Less severe penalties include censuring firms through public statements and seeking injunctions or restitution orders. Currently the most notorious enforcement power in use, which is consistently making the headlines, is the simple fine.

Introducing 'super fines'

Throughout the past year, the trend has been for the FCA to impose increasingly high fines for regulatory breaches. The introduction of these 'super fines' has generated concern among those operating in the financial services industry, primarily due to the unanticipated scale of the penalties.

In 2013 the fines published by the FCA (and its predecessor, the FSA) totalled £474,138,738, which is easily a record. By comparison, the fines imposed by the FSA in 2012 and 2011 were much lower, totalling £311,569,256 and £66,144,839 respectively. Before this, total fines imposed were consistently below £100 million.

In the last quarter of 2013, the FCA imposed two of its highest ever fines. The heaviest fines were imposed for misconduct relating to the London Interbank Offered Rate (LIBOR). Of particular note are the fines for £105,000,000 imposed on Rabobank on 29 October 2013 and the £137,610,000 fine given to JP Morgan Chase Bank for serious failings relating to its Chief Investment Office's 'London Whale' trades on 18 September 2013.

There has been a 20-fold increase in the level of fines imposed over the past five years. However, it is of note that the actual number of fines imposed by the FCA in 2013 was 42, which represents a decrease of 12 from 2012 and 14 from 2011. It has been argued that this is due to the super-fines and LIBOR cases taking up the bulk of the FCA's resources.

Evidently the regulators are taking their enforcement powers more seriously and are imposing more severe penalties than in the past to deter firms from breaching regulations. Indeed, the recent fine of £1.876 million imposed on JLT Specialty Limited, one of London's largest insurance brokers, for failing to have in place appropriate checks and controls to guard against the risk of bribery or corruption, illustrates that it is no longer sufficient for a company to have a policy on paper, but fail to execute it in practice. The risk of a fine is now a far greater threat and will be at the forefront of a firm's concerns when determining its risk management strategies. High fines focus firms' attention and resources on achieving compliance.

Shoot first, think later

The FCA announced in October 2013 that it will exercise new powers of disclosure to publish information about proposed disciplinary actions through warning notice statements, naming regulated firms and individuals who work at regulated firms, before deciding whether or not it will take action against them. A warning notice statement will contain a summary of facts contributing to the regulator's concerns. This is a significant change, as previously the regulator could only publish such information once it had decided to take action. The 'naming and shaming' strategy is in aid of consumer protection, public trust and transparency; however, it has caused considerable industry concern.

This move has been controversial and has even been branded a "publicity stunt" to change perceptions of the regulators' strength. It has been argued that it is unfair and unjust to name companies and, more particularly, individuals publically without evidence of misconduct having been heard, plus it is unnecessary to do so before a decision on their culpability has been made. A premature and unfounded announcement could be highly prejudicial and damaging to a firm or an individual. However, the FCA maintains that the details of each case will be considered specifically and the person under investigation will be consulted before publication, so the unfairness of publication can be judged. It remains to be seen how the new power will be used and the impact that it will have in practice.

Product intervention rules

The new product intervention rules were introduced so that the regulator can monitor and intervene quickly in the design of financial products for consumers, if necessary. These powers will be utilised when there is a danger of a product being sold to the wrong people, when a product is inherently flawed or when a non-essential feature of a product is causing serious problems for consumers. There are two courses of action open to the FCA in such a scenario. It can either create temporary product intervention rules with immediate effect, or make rules relating to the unenforceability of contracts that are in breach of its product intervention rules. In practice, the rules imposed by the FCA may request that a firm change certain product features, make amendments to its promotional materials, or prohibit the sale of a particular product and prevent a product launch. This is the clearest example of the regulators' new interventionist stance.

Super complainants

In December 2013 the government announced the appointment of four financial services 'super complainants'. This new procedure is a crucial step in the regulator's mission to "tackle bad practice" because the market will be independently and rigorously monitored. The chosen consumer representative bodies (Consumer Council Northern Ireland, Citizens Advice, The Federation of Small Businesses and Which?) will be empowered to raise complaints with the FCA if they feel there are particular features of a financial services market that pose a risk of damage to consumer interests. They are to judge whether markets are failing UK consumers as a whole. Following a complaint, the FCA can invoke its enforcement powers to tackle any underlying issues identified. This is another - more robust - example of the voice of consumers and small businesses being prioritised. It also increases the number of scenarios in which the regulator can invoke its enforcement powers.

Conclusion

There has been a fundamental overhaul in financial regulation, both in terms of the actual institutions overseeing the system and in the attitude of the regulators who are now far more interventionist. The FCA and the PRA are becoming more proactive in their monitoring of financial markets and the signs are that this trend will continue.

On the positive side, this should raise the standard of financial services products across the board and provide greater protection for consumers. The changes encourage a new culture of transparency, cooperation and accountability.

However, firms will have to improve their internal processes and develop a greater awareness of their procedures to avoid future problems. It is insufficient to keep enforcement at bay by merely having a policy in place without implementing it, or to hope that no penalty will be imposed. As the financial secretary to the Treasury, Sajid Javid, highlighted: “The government is determined to create a financial services sector that serves the needs of customers, rather than the other way round.” In support of this vision, the regulators are ready to play hard ball.

Ashleigh Reid is a first-year trainee at Clyde & Co's London office.