Back to overview

Commercial Question

Pressing the reset button for financial services

updated on 18 June 2013


How will regulation in the financial services industry change following the dissolution of the Financial Services Authority (FSA) and the introduction of the Financial Conduct Authority (FCA)?


Martin Wheatley, chief executive of the newly-formed FCA, stated in a recent speech entitled 'The human face of regulation’ that, in order to rebuild confidence in the financial services industry and to allow consumers to access the right products, "we need to press the reset button for the industry". In order to clarify precisely what this will involve and form a better idea of how the FCA approach may differ from that of the FSA, we must consider the scope of the FCA's new powers and the way in which its representatives plan to exercise them.

The new regime

Under the United Kingdom's new regulatory regime, the FSA has been divided into two newly formed bodies - the Prudential Regulation Authority (PRA) and the FCA. The PRA (a subsidiary of the Bank of England) is responsible for prudential regulation of deposit takers, insurers and certain investment firms. The FCA is the new financial services regulator that will regulate the conduct of all firms that were, prior to its dissolution, regulated by the FSA. In addition, the FCA is responsible for the regulation of conduct in the United Kingdom's retail and wholesale markets, supervision of the trading system that supports those markets and the prudential regulation of firms that are not regulated by the PRA. The FCA's single strategic objective is to protect and enhance confidence in the UK financial system.

Consumer-focused regulation

There is little debate that the most recent financial crisis was in large part due to ineffective financial regulation and there is even less debate that there still exists a huge amount of distrust among UK consumers in relation to banks and other financial institutions. The FCA aims to rectify this and, in its business plan for 2013-14, it talks of a need to take a proactive - not reactive - approach to consumer protection. The FCA plans to address issues before they adversely affect the consumer and this is reflected in the enforcement action that the FCA has so far taken. At the time of writing, the vast majority of published FCA Final Notices relate to a failure to put systems in place that effectively manage risk and protect consumers. It is hoped that this proactive approach will cut FCA costs in the long term.

Clive Adamson, director of supervision at the FCA, has spoken of a need to change the culture within financial services firms that see customers as people from whom to maximise profit, rather than people whose needs and interests need to be considered. The FCA plans to implement this culture change by: encouraging senior staff members to set positive examples to more junior staff; ensuring more ethical business practices across firms; and managing employee performance effectively, with appropriate development opportunities and rewards. This is admirable and efforts do need to be made to avoid another LIBOR or PPI scandal, but there is an acceptance by the FCA that such a culture change will take years to implement and, despite some guidance, it is still not clear exactly how the FCA will implement this without stopping financial services firms from running their businesses in a way that maximises profit.

Clarity for the consumer

The FCA has criticised firms for misleading consumers in the past with lengthy documents that consumers are unlikely to ever read in what has been described as an "overly legalistic compliance culture within firms" by Adamson, who has also stated that firms currently believe that disclosure at the point of sale fully absolves them of responsibility for the actual value provided by a product or service. Wheatley has said that "the new FCA won’t be afraid to shine a light on the murkier psychological enticements and entrapments that exist in financial services", instead urging firms to guide consumers toward the best and most suitable products.

The FCA aims to reduce the potential risk of harm to consumers caused by misleading promotions and has been handed a new power to ban financial promotions and publish the reasons for the ban. It will be carrying out reviews of financial promotions across all industries to ensure that consumers are being provided with information that is fair, clear and not misleading. As a result of its product intervention rules which came into effect on 1 April, the FCA has the power to restrict product sales before consultation when it identifies a significant risk to consumers. This will allow the FCA to restrict the use of certain product features, require that products are not promoted to some or all types of customers, or even stop products from being sold altogether. Instances in which the FCA may exercise these powers include where a product is in serious danger of being sold to the wrong consumers or where a product is inherently flawed.

Financial crime

The FCA's 'Approach to Regulation' paper states that the FCA will adopt a risk-based approach to financial crime, focusing its resources on firms that are particularly exposed to the risk of financial crime. It will focus on protecting consumers as victims of financial crime and the use of firms as conduits for such crime, rather than the protection of firms as victims themselves. The FCA's head of enforcement and financial crime, Tracy McDermott, has said that "the FCA will continue to focus on high-risk customers and business", much like the FSA before it.

In the FCA's business plan, emphasis was placed on preventing and punishing market abuse. In the next year, the FCA will focus on taking strong enforcement action to deter future misconduct.  There will be a focus on wholesale conduct by the FCA, "ensuring that participants act with integrity at the start of the investment chain". The FCA will have the same powers that the FSA had to impose penalties for market abuse and will, in addition, have the power to bring criminal prosecutions for market manipulation and insider dealing (other than in Scotland).

There will also be a new approach to the supervision of trading platforms. In its business plan, the FCA has set out how it will build on its thematic work on transaction reporting to identify misconduct. The aim is to ensure that firms are aware of - and comply with - their reporting obligations. The FCA states that it will take action where necessary to ensure that firms comply as transaction reporting enables the FCA to identity risks more quickly and respond to minimise any potential harm to consumers.

Consumer credit

Following on from the dissolution of the FSA, the OFT will cease to exist on 1 April 2014. This will mean that responsibility for consumer credit regulation will pass from the OFT to the FCA, with potentially significant consequences for firms carrying on consumer credit businesses. The government's long-term objective is to move as much of the Consumer Credit Act 1974 (CCA) as possible into a new rulebook, which is set to be published in April 2014.

Only about 15% of the CCA is to be repealed by April 2014, which will comfort consumer credit businesses. However, importantly, many of the CCA's criminal sanctions are to be repealed in order to allow the FCA greater disciplinary powers than the OFT has ever had, which it hopes will prove more of a deterrence to consumer credit businesses. It is anticipated that the FCA will prove a far tougher regulator than the OFT and will be more willing to exercise its powers where it deems action to be necessary.

The FCA will also put in place a new authorisation process for firms conducting regulated consumer credit business, with full authorisation to be required from 1 April 2016 (interim authorisation processes will be established in the meantime). Firms will need to satisfy certain "threshold conditions" in relation to matters such as suitability and legal status in order to be granted authorisation. Firms perceived to be at lower risk will not need to satisfy the same strict thresholds that will be required of larger firms. Individuals who are to take up key positions within consumer credit businesses will need to satisfy the FCA, through an adapted version of the FSA's 'Approved persons' regime that they can satisfy a "fit and proper" person test and then perform their controlled function in accordance with standards set by the FCA.

A new era for financial regulation?

Sceptics will argue that the messages coming from the FCA bear many similarities to the stricter and more interventionist regulation promised by the FSA following the credit crunch. Indeed, the board of the FCA is largely made up of previous FSA employees and the FCA Handbook is similar to that of its predecessor. However, there seems little doubt that the FCA, with increased powers and a wider range of firms and individuals to regulate, will take strong action to ensure that firms have systems in place which effectively protect consumers and manage risk, and clamp down on firms and individuals who fail in their compliance obligations. There is hope that such measures will effect a cultural and behavioural change in firms that will prioritise the interests and needs of consumers in their decision making, something which can hopefully be balanced with the simple business need for these firms to maximise profit.

James Hillman is a second-seat trainee at Irwin Mitchell.