FREE CHAPTER from ‘City Limits: FCA Compliance for Financial Businesses’ by James Brilliant

CHAPTER ONE

FCA AUTHORISATION AND APPROVAL

1.1 The General Prohibition

Businesses wishing to conduct regulated activities in the UK must take heed of the so-called “general prohibition”, which is laid down in FSMA s. 19(1) and underpins the UK’s financial regulatory system:

The general prohibition
“No person may carry on a regulated activity in the United Kingdom, or purport to do so, unless he is – an authorised person; or an exempt person.”

Contravention of the general prohibition is a criminal offence under FSMA s. 23(1).

1.1.1 Regulated activities

Regulated activities” are prescribed in FSMA RAO, and comprise various specified activities when carried on by way of business.1 Some activities are caught only when carried on in relation to certain “specified investments” (also as prescribed in FSMA RAO), and others when carried on in relation to property of any kind.

Exempt persons” include, notably, unauthorised firms operating as appointed representatives under the contractual responsibility of an authorised principal within FSMA s. 39, as well as the relatively narrow classes of persons covered by the Financial Services and Markets Act 2000 (Exemption) Order 2001. Unless exempt, any financial business wishing to conduct regulated activities in the UK is required to be authorised.

Detailed guidance on the scope of specified activities, specified investments and exemptions, as well as territoriality and the “by way of business” element, is contained in PERG (especially PERG 2 (Authorisation and regulated activities) and PERG 8 (Financial promotion and related activities)).

1.1.2 Investment firms and MiFID

MiFID is an EU directive that, together with connected EU legislative instruments,2 sets harmonised EU-wide rules and guidance that apply to investment intermediaries and trading venues. MiFID took effect on 3 January 2018 and built upon the regulatory framework introduced in November 2007 by its predecessor, MiFID I.

The rules and guidance prescribed by the MiFID framework govern organisational, conduct and operational aspects of firms’ businesses, including senior management arrangements, systems and controls, conduct of business, and pre- and post-trade transparency.

MiFID provisions are implemented and enforced at a local level: that is, by the competent authorities of each EU member state. In the UK, the FCA is a designated competent authority for implementing and enforcing MiFID,3 and it has incorporated or reflected most MiFID-derived rules and guidance directly in the FCA Handbook.4

Certain regulated activities in relation to certain specified investments under FSMA RAO constitute “investment services and activities” in relation to “financial instruments” under MiFID Annex I, and therefore must be conducted in compliance with MiFID-derived requirements. Firms carrying on such business are referred to as “investment firms”; many also come within the scope of other types of firm, such as “MiFID investment firm” and “common platform firm” (each as defined in the FCA Handbook Glossary).

PERG 13 contains guidance on the scope of MiFID, including “permission maps”5 indicating how FSMA RAO business corresponds to MiFID business. For ease of reference, set out in the table below are the types of business potentially in scope:

FSMA RAO business potentially in scope of MiFID Business required to be regulated under MiFID
Regulated activities Advising on investments (except P2P agreements) Arranging (bringing about) deals in investments Bidding in emissions auctions Dealing in investments as agent Dealing in investments as principal Making arrangement with a view to transactions in investments Managing investments Operating a multilateral trading facility (“MTF”) Operating an organised trading facility (“OTF”) Investment services and activities Reception and transmission of orders in relation to one or more financial instruments Execution of orders on behalf of clients Dealing on own account Portfolio management Investment advice Underwriting of financial instruments and/or placing of financial instruments on a firm commitment basis Placing of financial instruments without a firm commitment basis Operation of an MTF Operation of an OTF
Specified investments alternative debenture binary bet certificate representing certain securities commodity future commodity option and option on a commodity future contract for differences (excluding a spread bet, a rolling spot forex contract and a binary bet) debenture emission allowances future (excluding a commodity future and a rolling spot forex contract) government and public security option (excluding a commodity option and option on a commodity future) rolling spot forex contract share spread bet unit warrant Financial instruments Transferable securities Money-market instruments Units in collective investment undertakings Options, futures, swaps, forward rate agreements and any other derivative contracts relating to securities, currencies, interest rates or yields, emission allowances or other derivatives instruments, financial indices or financial measures which may be settled physically or in cash Options, futures, swaps, forwards and any other derivative contracts relating to commodities that must be settled in cash or may be settled in cash at the option of one of the parties other than by reason of default or other termination event;



Options, futures, swaps, and any other derivative contract relating to commodities that can be physically settled provided that they are traded on a regulated market, a MTF, or an OTF, except for wholesale energy products traded on an OTF that must be physically settled; Options, futures, swaps, forwards and any other derivative contracts relating to commodities, that can be physically settled not otherwise mentioned in [MiFID Annex I Section C(6)] and not being for commercial purposes, which have the characteristics of other derivative financial instruments Derivative instruments for the transfer of credit risk Financial contracts for differences



Options, futures, swaps, forward rate agreements and any other derivative contracts relating to climatic variables, freight rates or inflation rates or other official economic statistics that must be settled in cash or may be settled in cash at the option of one of the parties other than by reason of default or other termination event, as well as any other derivative contracts relating to assets, rights, obligations, indices and measures not otherwise mentioned in [MiFID Annex I Section C], which have the characteristics of other derivative financial instruments, having regard to whether, inter alia, they are traded on a regulated market, OTF, or an MTF Emission allowances consisting of any units recognised for compliance with the requirements of Directive 2003/87/EC (Emissions Trading Scheme)

1.1.3 MiFID optional exemption firms

A subcategory of investment firms, referred to as “MiFID optional exemption firms”, is created by MiFID art. 3(1). Such firms are entitled to certain minor derogations from the MiFID regime, and include many independent financial advisers and similar advisory businesses.

Investment firms are MiFID optional exemption firms to the extent that they (in summary):

MiFID optional exemption firms (summary)
are not allowed to hold client funds or client securities and which for that reason are not allowed at any time to place themselves in debit with their clients; are not allowed to provide any investment service except the reception and transmission of orders in transferable securities and units in collective investment undertakings and/or the provision of investment advice in relation to such financial instruments; and in the course of providing that service, are allowed to transmit orders only to (in summary) duly authorised investment firms or credit institutions (or branches of third-country equivalents), UCITS or UCITS managers, or EU-listed investment companies with fixed capital.

MiFID optional exemption firms in the UK are entitled to treat various MiFID-derived “systems and controls” rules as guidance only or, in some cases, to disapply them entirely. Further details are set out at M2G 2.7.1G.

There is also a dispensation from the strict application of the telephone taping requirements which is available to UK MiFID optional exemption firms that provide services solely or mainly to retail clients – see 4.4.2.

Note, however, that the FCA is obliged under MiFID to ensure that requirements “at least analogous to” the rest of the MiFID-derived “systems and controls” rules – plus the bulk of authorisation, ongoing supervision and conduct of business provisions – are applied to MiFID optional exemption firms as they are to other investment firms.6 Thus there are significant limits, in principle, on the scope of exemptions that the FCA could create for independent financial advisers and other MiFID optional exemption firms.

MiFID optional exemption firms may not operate in any other EU member state through a branch or services passport.7


1.2 Becoming Authorised

UK-based firms requiring authorisation must apply to the FCA or PRA for regulatory permission, which is governed by Part 4A of FSMA and consequently known as “Part 4A permission”.8

The majority of firms must apply to the FCA (rather than the PRA) for Part 4A permission – these firms are the focus of this book. PRA Part 4A permission must be sought by banks, building societies, credit unions, insurers and designated major investment firms.9

Firms applying to the FCA for Part 4A permission must do so in such manner as the FCA may direct.10 The application procedure is detailed on the “Authorisation: what’s involved” webpage in the “Firms” section of the FCA website, and involves using the FCA’s Connect online system. An application fee is payable; the amount varies by complexity, but, by way of indication, for most financial advisers, mortgage brokers and general insurance intermediaries it is £1,500.

In determining an application for Part 4A permission, the FCA must at a minimum ensure that the applicant will satisfy the “threshold conditions” which are specified in Schedule 6 to FSMA and COND, and organised under the following headings: “location of offices”; “effective supervision”; “appropriate resources”; “suitability”; and “business model”.11 This duty does not detract from the FCA’s overall ability to take such steps as it considers necessary to advance its operational objectives.12 There is further colour in the FCA’s Mission Paper.13

The FCA must determine the application within 6 months of receiving the completed application, or within 12 months of receiving an incomplete application.14

Once authorised, firms are entered into the Financial Services Register, which is freely accessible online.

1.3 Approval of Persons Performing Controlled Functions for an Authorised Firm

An FCA-authorised firm must take reasonable care to ensure that each person who “performs a controlled function under an arrangement entered into by [that firm] in relation to the carrying on by [that firm] of a regulated activity” is approved by the FCA (an “approved person”).15

Note that significant changes to the approved persons regime are in the pipeline. The senior managers and certification regime (“SMCR)”, already in place for PRA-authorised firms, will be extended to virtually all FCA-authorised firms from 9 December 2019.

Among the changes introduced by SMCR, only staff performing “FCA-designated senior management functions” (as defined in the FCA Handbook Glossary) continue to require prior FCA approval;16 other staff within the approved persons regime, to the extent that they perform “FCA certification functions” (as defined in the FCA Handbook Glossary) become subject instead to certification by the firm itself.17


1.3.1 Controlled functions

Controlled functions” (designated “CF”) are specified in SUP 10A.4, of which the following would often be relevant for a firm:

“FCA significant-influence functions”
FCA governing functions” CF1 (Director function) (for a company) or CF4 (Partner function) (for a partnership) CF3 (Chief executive function) “FCA required functions” CF10 (Compliance oversight function) CF10a (CASS operational oversight function)18 CF11 (Money laundering reporting function)
Non “FCA significant-influence functions”
FCA customer-dealing function” CF30 (Customer function)

The requirement to be an approved person captures (most notably) individuals who are employed or otherwise contractually engaged by the authorised firm – for example, the firm’s directors, CEO, head of compliance, and many client-facing staff. In the case of CF4 (Partner function), it is not uncommon for an approved person to be a corporate entity rather than an individual.

1.3.2 Applications and notifications in respect of approved persons

An application for approval to perform a controlled function is submitted by a firm in respect of the person in question.

When a firm first becomes authorised, an initial person or group of persons will need to be granted approved by the FCA at the same time. Thereafter, as persons start to perform controlled functions for the firm, or transfer from one controlled function to another, the firm must apply to the FCA accordingly.

The FCA may grant an application for approval only if it is satisfied that the candidate is fit and proper.19 In assessing fitness and propriety, the FCA regards the most important considerations to be the candidate’s (i) honesty, integrity and reputation, (ii) competence and capability, and (iii) financial soundness.20 Guidance on relevant criteria is set out in FIT 2.

Notifications (as opposed to applications) must be submitted to the FCA for withdrawals of applications once submitted (but prior to decision), changes to approved persons details,21 and cessations of controlled functions.22

Applications and notifications must usually be submitted and managed using the FCA’s Connect online system. Note, however, that the Connect system forms stipulate that a permanent copy, signed both by an authorised signature of the firm and by the candidate, must be retained for an appropriate period for inspection at the FCA’s request. When preparing the forms, it may be helpful to consult the templates and further guidance located at SUP 10A.12-14, 16 and 17.

Once approved, a person must keep the firm informed of certain changes in order for the firm to be able to comply with its obligations to submit ad hoc notification to the FCA – see 2.3. An approved person also must comply with the FCA’s Statements of Principle for Approved Persons – see 3.2.


1.3.3 Exemptions for temporary arrangements

For the FCA significant-influence functions, a firm may appoint an individual – without requiring FCA approval – to provide temporary cover for an approved person whose absence is temporary or reasonably unforeseen (e.g., holidays or emergencies). The appointment must be for less than 12 weeks in a consecutive 12-month period.23

There is no relief of the same kind for the customer-dealing function. However, for the customer-dealing function,24 FCA approval is not required for an individual who is based overseas and who, in a 12-month period, spends no more than 30 days in the United Kingdom. Such an individual must be appropriately supervised by a CF30-approved person.25

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1Circumstances in which persons are, or are not, to be regarded as “carrying on regulated activities by way of business” are defined in the Financial Services and Markets Act 2000 (Carrying on Regulated Activities by Way of Business) Order 2001.

2The other EU legislative instruments connected to MiFID comprise:

  • MiFIR, which, like MiFID, is a “Level 1” framework act;
  • Level 2” delegated and implementing acts, including: MiFID Org Regulation; MiFID Delegated Directive; and multiple Commission Delegated Regulations setting regulatory technical standards and Commission Implementing Regulations setting implementing technical standards;
  • Level 3” guidance and recommendation documents issued by ESMA, an EU financial regulatory agency; and
  • Level 4” reports issued by ESMA regarding the implementation and enforcement of MiFID by member states.

3Financial Services and Markets Act 2000 (Markets in Financial Instruments) Regulations 2017 r. 3(1).

4Technically, provisions in EU directives have “direct effect”, which means that they must be transposed by member states into national law or regulation, and only when transposed are they binding on firms. EU regulations, on the other hand, are “directly applicable”, which means that they are immediately binding upon firms without requiring transposition (although MiFID-derived EU regulations are often reproduced or summarised in the FCA Handbook for ease of reference). See Treaty on the Functioning of the European Union art. 288.

5PERG 13 Annex 2.

6MiFID art. 3(2).

7MiFID art. 3(3).

8FSMA s. 55A.

9Financial Services and Markets Act 2000 (PRA-regulated Activities) Order 2013.

10FSMA s. 55U(4)(a).

11FSMA s. 55B(3).

12FSMA s. 55V(4). The FCA’s “operational objectives” are defined in FSMA s. 1B(3) as the “consumer protection objective”, the “integrity objective” and the “competition objective”, as defined in FSMA ss. 1C, 1D and 1E, respectively.

13“FCA Mission: Our Approach to Authorisation” (FCA, December 2017) (https://www.fca.org.uk/publication/corporate/our-approach-authorisation.pdf).

14FSMA s. 55V(1), (2).

15FSMA s. 59(1).

16FSMA s. 59(6A); SUP 10C.

17FSMA ss. 63E, 63F; SYSC 27. Further guidance is set out in “The Senior Managers and Certification Regime: Guide for FCA solo-regulated firms” (FCA,
July 2018) (https://www.fca.org.uk/publication/policy/guide-for-fca-solo-regulated-firms.pdf).

18Only for “CASS large firms” and “CASS medium firms”, as defined at CASS 1A.2.7R. These categories are relevant only for firms which (essentially) hold £1 million or more of client money, or £10 million or more of safe custody assets, in a calendar year.

19FSMA s. 60(1).

20FIT 1.3.1BG.

21Most notably: change in personal details; change in arrangements; and change in fitness and propriety information.

22Must be submitted no more than a month before the effective date of cessation; if submitted after the effective date of cessation, a reason must be given for that delay (even though there is a deadline of ten business days under SUP 10A.14.8R(1)).

23SUP 10A.5.6R, 7G; SUP 10A Annex 1 Q.2.

24Except: giving advice or performing related activities in connection with pension transfers, pensions conversions or pension opt-outs for retail clients; and giving advice to a person to become, or continue or cease to be, a member of a particular Lloyd’s syndicate.

25SUP 10A.10.8R.