FREE CHAPTER from ‘City Limits: FCA Compliance for Financial Businesses – 2nd Edition’ by James Brilliant

CHAPTER ONE – INTRODUCTION

1.1   About this Book

This book is about compliance with the rules, guidance and directions of the UK’s Financial Conduct Authority (“FCA“). It aims to highlight the financial regulatory topics likely to be of greatest relevance to the bulk of UK financial businesses and to present key requirements in a way that is accessible for anyone who is tasked with advising on or overseeing compliance with those requirements.

The archetypal “financial business” contemplated in this book is a UK-headquartered, FCA solo-regulated “investment firm” which carries on certain advisory, intermediary, execution or portfolio management activities as further described in §3.ii.1. Consideration is also given to “alternative investment fund managers” (§3.ii.2) and “credit firms” (§3.ii.3). Other types of financial business are likely to be subject to many of the same, or similar, high-level requirements, but supplemented by specific legislation or specialist regimes which are beyond the scope of this book.

Terms defined in the FCA Handbook Glossary have the same meanings in this book. For some of those terms, summaries of the definitions are given in this book for convenience; those summaries are subject to the full definitions as given in the FCA Handbook Glossary. A list of abbreviations used in this book is set out in §(2).

All publications referenced are published by the FCA unless otherwise specified. These include webpages and “documents” (such as Dear CEO Letters, templates and notes), where the year of publication given is the “last updated” year if applicable. Other types of FCA publication include Consultation Paper (“CP“), Discussion Paper (“DP“), Finalised Guidance (“FG“), Feedback Statement (“FS“), Policy Statement (“PS“) and Thematic Review (“TR“), where, in each case, the first two digits of the reference number are the publication year.

Information in this book is intended to represent law and practice as at 1 January 2022.

1.2   The FCA: From Big Bang to Twin Peaks

The UK’s financial regulatory framework exists to protect society from the devastating harm that can be done to personal, corporate and public finances by the unscrupulous, incompetent or unfair behaviour of those providing financial services or participating in the financial markets.

A classic hallmark of any regulatory framework is superintendence by an executive branch agency, whose purpose is traditionally perceived as being to issue rules and guidance, impose licensing regimes and ongoing operating conditions, and intervene and penalise in cases of non-compliance. This layer of administration is subordinated to the ultimate jurisdiction of the courts to adjudicate in case of dispute or criminal proceedings.

In the case of financial services in the UK, the conduct regulator for all 58,000 or so firms within the sector is the FCA. For over 95% of those firms (more than 56,000 “solo-regulated” firms), the FCA is responsible also for authorisation and prudential supervision. The remaining firms are the larger, “dual-regulated”, institutions – banks, building societies, credit unions, insurers and designated investment firms – which, while still conduct-regulated by the FCA, are authorised and prudentially regulated by the Prudential Regulation Authority (“PRA“). The PRA is a subsidiary of the Bank of England, and its relationship with the FCA is governed by a Memorandum of Understanding which notes that the two authorities “have separate and independent mandates, which are set out in statute, reflecting the UK’s ‘Twin Peaks’ micro-regulatory system“.1 It is FCA rather than PRA authorisation and regulation that are the subject of this book.

The FCA in its current form has existed since 2013, but its origins as an independent statutory financial regulator can be traced back to the 1980s. Under Margaret Thatcher’s Conservative government, various restrictive practices in the UK financial markets were rapidly abolished, enabling domestic and global players to scale up their operations in the City during what came to be called the “Big Bang”. To encourage such investment, the Government sought to promote confidence in the UK financial system and established the Securities and Investments Board (“SIB“) under the Financial Services Act 1986 (which commenced in 1988).

The main role of the SIB initially was to oversee the five self-regulatory organisations (“SROs“) in existence at that time, which covered futures broking and dealing, financial intermediation, investment management, life assurance broking and securities broking. The SROs represented the culmination of a 700-year-old tradition of statutory self-regulation in the City that stretched back to 1285, when the Court of Aldermen was first authorised by a statute of Edward I to license brokers and prosecute unlicensed brokers.

Several financial scandals in the 1990s spelled the end for the SROs altogether. Widespread mis-selling of various personal savings plans, as well as misconduct at the Maxwell company pension funds and Barings Bank, fuelled criticism that the system of SROs was not delivering adequate standards of investor protection or supervision, was confusing for investors, lacked accountability, was unsuited to a new reality where the distinctions between different types of financial institution and their products were increasingly blurred, and was not structured appropriately to regulate multinational firms effectively.2

In response, Tony Blair’s incoming Labour administration changed the SIB’s name to the Financial Services Authority (“FSA“) and then gradually set about transforming the FSA into a unitary conduct and prudential regulator constituted under the Financial Services and Markets Act 2000 (“FSMA“). The transition was formally completed in 2001 with the commencement of FSMA.

This single-regulator set-up lasted a little more than a decade. Its most serious challenges came during the 2008 global financial crisis, which brought to the fore a perceived “regulatory underlap” whereby “no single institution has the responsibility, authority or powers to monitor the system as a whole, identify potentially destabilising trends, and respond to them with concerted action“.3

Thus in 2013 the FSA was renamed and recast as the FCA; the more systemically important part of its micro-prudential supervisory remit was hived off to the PRA while other organs of the Bank of England received newly-created macro-prudential responsibilities and certain other supervisory functions. This restructuring was achieved formally by amending FSMA through the Financial Services Act 2012.

Notable organisational reforms of the FCA since 2013 include: taking over responsibility for regulating the consumer credit industry from the Office of Fair Trading in 2014; establishing the Payment Systems Regulator as a subsidiary in 2015; and, since 2017, phasing out the term “UK Listing Authority” to refer to the FCA’s primary market functions of monitoring market disclosures, reviewing and approving prospectuses and operating the UK listing regime.

The FCA is a creature of statute whose genetic code has lengthened considerably over time. When it was the SIB, its specifications were contained in six concise paragraphs in Schedule 7 to the Financial Services Act 1986. Today’s regulator, by contrast, is endowed with a wide set of mandates and powers rooted in a catalogue of “general functions”, “general duties”, “strategic and operational objectives”, “regulatory principles” (also referred to by the FCA as the “principles of good regulation”) and other similar strictures laid out in the opening 20 sections of FSMA and a further 27 paragraphs in Schedule 1ZA.4

This expansion has driven a broadening in the overall aim of the FCA, which is (in its own words) to “add public value by improving how financial markets operate, to benefit individuals, businesses and the UK economy“.5

Consistent with this, the FCA has moved beyond simply fulfilling a rule-making mandate, towards occupying a position from which it seeks to influence the behaviour of firms through a range of techniques including nudges and thought leadership. As its Chief Executive said in 2018: “In the traditional world of regulation, rules act as prescriptive statements that forbid, require or permit some action or outcome… The problem is that in practice a set of rules tends to underdetermine what needs to be done… So, to the verbs of forbidding, requiring and permitting, I would add enabling, encouraging and incentivising as important tasks of the regulator“.6

These incremental shifts in both remit and supervisory tone are nowhere more evident than on the FCA’s website, which today carries essays, speeches, blogs and podcasts that go beyond the confines of conduct in financial intermediation, and respond to deeper questions about environmental sustainability, social purpose, diversity and inclusion, artificial intelligence and the ethical use of big data. The FCA is clear in its ambitions to play a type of active – even activist – role in trying to shape public policy that came less naturally to its predecessors. This is the stance of a regulator that keenly feels the weight of its responsibilities for an industry that employs over 2.2 million people in the UK and contributes £65.6bn in tax each year – and whose failure can, as the FCA Chair observed in 2018 when reflecting on the tenth anniversary of the Lehman collapse, lead to “tragedies of individual loss: loss of employment, loss of savings, loss of mental or physical health and, in some cases, loss of life“.7

1.3   The FCA Handbook

The FCA’s “general functions” under FSMA include formulating rules, codes, guidance and general policy and principles,8 and its powers to do so are contained in Part 9A.

The FCA makes its rules by “rule-making instrument”, all of which are reproduced in the FCA’s Handbook of rules and guidance (“FCA Handbook“) which is freely available online. Technically the definitive versions of the FCA rules are the original instruments themselves.9

In the FCA Handbook, the rules are marked “R”. Other legislative provisions include evidential provisions (“E”), guidance (“G”), directions (“D”), principles (“P”) and descriptions of conduct (“C”). There are also excerpts and copy-outs from UK legislation which are marked with “UK” or a UK flag.

The provisions of the FCA Handbook are organised primarily in 50 “modules” which are thematically grouped together in nine “blocks”.10 Constructed on an epic scale, just three of the more prominent modules – SUP, SYSC and COBS – alone occupy more than 2,800 pages. To complicate matters further, a labyrinthine network of cross-references and densely-defined technical terms runs through the whole corpus.

The size and complexity of the FCA Handbook are the result of two main structural factors.

Firstly, the FCA Handbook caters to the needs of myriad kinds of financial businesses differentiated by various criteria such as regulated activity, client type, financial resources, group structure and so on. The FCA Handbook Glossary has entries for around 130 different varieties of firm, from “AIFM” to “venture capital firm”. FCA provisions often need to have the firms in scope spelled out at great length, meaning that firms effectively must chisel out a tailored version of the FCA Handbook in order to isolate the provisions that apply to them specifically.

Secondly, multiple legislative rivers and tributaries drain into the basin of UK financial services regulation. These include:

  • measures promulgated by the FCA using its statutory powers;
  • legal and regulatory obligations that are contained in UK acts of Parliament and statutory instruments;
  • a large body of onshored regulations originating in EU regulations which were formerly directly applicable in the UK by virtue of its membership of the EU, and becoming part of UK domestic law as soon as the Brexit implementation period ended at 11pm on 31 December 2020;11
  • non-legislative material produced by the EU and still considered relevant in principle by the FCA notwithstanding the UK’s withdrawal from the EU;12 and
  • case law that includes judicial interpretation of statutory and regulatory provisions.

Rules may sometimes be time-limited, or temporary provisions may allow firms to choose which of two or more regimes to follow. For example, to help firms adapt to new requirements following Brexit, the FCA was empowered to make certain “transitional directions” which, as made, generally apply until 31 March 2022 and allow firms to continue to comply with pre-existing requirements in specified areas until then.13 Meanwhile, during the ongoing Covid-19 pandemic, forbearance and other temporary changes in regulatory expectations have routinely been communicated at short notice through the FCA website and not reflected in the FCA Handbook at all (see §(v)).

The overall result is that a firm using the FCA Handbook to construct a compliance programme must be sensitive to the many technical definitions, cross-references, exceptions, redundancies and other subtleties which pervade its provisions. The FCA acknowledges that, for many firms, it may take “significant effort to navigate and interpret our Handbook, necessitating expenditure and reliance on external professional services“, and that implementing rules in a manual way creates, specifically, “the risk of different interpretations and inconsistent reporting“.14

If Euclid once counselled Ptolemy I that there was no royal road to geometry, he might have said the same for FCA compliance. The FCA has signalled a desire for such a road to be built, and is sponsoring work programmes under its “RegTech” banner to harness “technology that drives efficiencies by closing the gap between intention and interpretation” and possibly achieve “a more interactive FCA Handbook better tailored to the firm’s permissions [that] could make compliance and reporting requirements clearer“.15 In the meantime, it is hoped that this book might prove a useful navigational aid for those plotting a course through the UK financial regulatory landscape.

James Brilliant
January 2022

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1 “Memorandum of Understanding: Between the Financial Conduct Authority and the Bank of England (exercising its prudential regulation functions)” (FCA and PRA, 2019).

2 C. Blair, “Financial Services and Markets Bill [Bill 121 of 1998-99]” (Research Paper 99/68) (House of Commons Library, 1999).

3 “A new approach to financial regulation: judgement, focus and stability” (HM Treasury, 2010).

4 The FCA’s “strategic objective” is ensuring that the relevant markets function well, and its “operational objectives” are the “consumer protection objective”, the “integrity objective” and the “competition objective” (FSMA s. 1B(2), (3)). The “principles of good regulation” come under the headings of “efficiency and economy”, “proportionality”, sustainable growth”, “consumer responsibility”, “senior management responsibility”, “recognising the differences in the businesses carried on by different regulated persons”, “openness and disclosure” and “transparency” (FSMA s. 3B(1); “Principles of good regulation” (webpage, 2016)).

5 “Our Mission 2017 – How we regulate financial services” (document, 2017).

6 A. Bailey, “The role of regulation in encouraging good culture” (speech, Investment Association Culture Conference, Mansion House, London, 06/11/2018).

7 C. Randell, “Ten years after Lehman: how accountants can make finance safer” (speech, ICAEW Canary Wharf Members’ Club, 06/09/2018).

8 FSMA s. 1B(6).

9 “Reader’s Guide: An introduction to the Handbook” (document, 2021).

10 The nine blocks are: High Level Standards; Prudential Standards; Business Standards; Regulatory Processes; Redress; Specialist sourcebooks; Listing, Prospectus and Disclosure; Handbook Guides; and Regulatory Guides.

11 European Union (Withdrawal) Act 2018 ss. 1A, 3. The onshoring process for EU regulations typically involved introducing domestic “amending” regulations at the same time “to prevent, remedy or mitigate (a) any failure of retained EU law to operate effectively, or (b) any other deficiency in retained EU law, arising from the withdrawal of the United Kingdom from the EU” (s. 8). For example, the effective onshoring of MiFIR and MiFID Org Reg was enabled by the Markets in Financial Instruments (Amendment) (EU Exit) Regulations 2018, which amended the retained EU regulations by replacing references to EU legislation and institutions with their UK equivalents.

12 “Brexit: our approach to EU non-legislative materials” (document, 2020).

13 Financial Services and Markets Act 2000 (Amendment) (EU Exit) Regulations 2019 r. 198(1); “Onshoring and the Temporary Transitional Power” (webpage, 2020).

14 “Digital Regulatory Reporting – Feedback Statement on Call for Input” (FS18/2).

15 “Call for input on supporting the development and adopters of RegTech” (FS16/4).