Mike Kennedy Compliance Auditor Policy Team

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22/04/23 1PFS Regional Conferences – March 2011PFS Regional Conferences – March 2011


22/04/23 2PFS Regional Conferences – March 2011

Mike Kennedy

• Compliance Auditor

• Policy Team



Gap-Fill Session

Financial Services Regulation and Ethics



Objectives – Part 1

• To better understand the FSA’s responsibilities in the regulation of financial services

• To consider ways of operating more effectively in the current regulated environment



Areas to cover – Part 1• The Financial Services Authority– Background– Functions– Statutory objectives

• Financial stability and prudential regulation• FSA Supervision and powers• Authorisation and Controlled Functions• Principles for Business• Approved Persons Statements of Principles & Code

of Practice



FSA - Background

• Independent non-government body• Company limited by guarantee • Financed by the firms it regulates• Accountable to Parliament via the Treasury• Created under Financial Services and Markets Act

2000 (FSMA)



FSA - Functions

• Authorisation

• Enforcement

• Supervision

• Rule making



FSA - FunctionsAdditional functions under;

• Building Societies Act 1986• Friendly Societies Acts (1974 & 1992)• Proceeds of Crime Act 2002• Unfair Terms in Consumer Contracts Regulations 1999• Distance Marketing Regulations 2004



FSA – Statutory Objectives

• Market confidence– maintaining confidence in the financial system

• Financial Stability– contribute towards protecting & enhancing UK financial

stability

(Public awareness– Promote public understanding of the financial system)



FSA – Statutory Objectives

• Consumer protection– securing the appropriate degree of protection for

consumers

• Reduction of financial crime– reducing the extent to which it is possible for a business to

be used for a purpose connected with financial crime



FSA – Principles of Good Regulation

• Efficiency and economy• Role of management• Proportionality• Innovation• International character• Competition• Public awareness



FSA – Financial Stability

• Financial Services Act 2010 – new FSA Objective– Contribute towards protecting & enhancing UK financial

stability• Required to co-operate with the Treasury, Bank of

England and other bodies to achieve this• Part of the wider objectives of the International

Financial Stability Board (FSB)



FSA – Prudential Regulation

• Firms must maintain adequate systems and controls to ensure adequate risk management systems (Principle 3)

• Firms are required to maintain adequate financial resources (Principle 4)



FSA – Prudential RegulationCapital Adequacy• Required levels differ depending on the activities– GENPRU/ IPRU(Inv)/MIPRU/BIPRU

• Expenditure Based Requirement• PII Excess / Exclusions• Firms must maintain required capital at all times• Consider liquidity and stress testing



FSA - Supervision• The FSA adopts a risk based approach• Firms are risk assessed in terms of;– Impact– Probability

• ARROW II (Advanced Risk-Responsive Operating FrameWork)– ARROW Firms Approach– ARROW Themes Approach



FSA - Supervision• Accounts and Auditor Statements• Business Volumes• Sources of Business• Complaints• Other relevant returns• Mystery shopping



FSA - Powers

• The FSA has powers over regulated firms and individuals

And

• Unregulated firms and individuals e.g. Market abuse, money laundering and unauthorised activity



FSA - PowersThe FSA has the power to;

• require firms to provide information and documents• require firms to provide reports by skilled persons• appoint investigators to carry out general

investigations into firms



FSA - Powers• appoint investigators to carry out investigations into

specific matters

• require information and appoint investigators to in support of overseas regulators

• appoint investigators to carry out investigations into collective investment schemes



FSA - Powers

• Monitoring and supervision• Prohibit individuals from carrying out functions• Financial penalties• Public censure• Criminal prosecution• Removal of permissions



FSA - Authorisation

• To undertake regulated activities a person must be;

– Authorised; or– Exempt



FSA - AuthorisationAuthorised Firms• New Firms apply for Part IV Permissions – must go through a rigorous application process

• Existing firms may need to apply for permissions relating to new areas / activities

• Change of legal status – involves a new application



FSA - AuthorisationExempt Firms

• Appointed Representatives

• Professional Firms which are members of DPB

• Others e.g. Bank of England, European Central Bank and local governments



FSA – Controlled Functions

• Authorised Person – the business that carries on regulated activities

• Approved Person – the individual who has been approved to carry on one or more controlled functions within the business



FSA – Controlled FunctionsRequired for any person who;• Is able to exert significant influence over the firm’s

affairs in relation to regulated activity• Deals with clients in connection with regulated

activities • Deals with the property of clients in connection

with a regulated activity



FSA – Controlled FunctionsCover two categories• Significant Influence Functions– Governing functions– Required functions– Systems and controls functions– Significant management functions

• Customer functions



FSA – Controlled FunctionsMost common• CF1 Director – not necessarily companies house!• CF2 Non-executive Director• CF3 Chief Executive• CF4 Partner• CF10 Compliance Oversight• CF11 Money Laundering Reporting Officer• CF30 Customer (investment business)• Responsible for Insurance Mediation



FSA – Controlled FunctionsSome changes taking place from May 2011• CF00 – Parent Entity Significant Influence

• CF2 (a-e) - Non-executive Director • CF13 – Finance• CF14 – Risk• CF15 – Internal Audit



FSA – Principles for Business1. Integrity– A firm must conduct its business with integrity

2. Skill, care and diligence– A firm must conduct its business with due skill, care and

diligence3. Management and control– A firm must take reasonable care to organise and control

its affairs responsibly and effectively, with adequate risk management systems



FSA – Principles for Business4. Financial prudence– A firm must maintain adequate financial resources

5. Market conduct– A firm must observe proper standards of market conduct

6. Customer’s interests– A firm must pay due regard to the interests of its clients

and treat them fairly



FSA – Principles for Business7. Communications with clients– A firm must pay due regard to the information needs of

its clients, and communicate information to them in a way which is clear, fair and not misleading

8. Conflicts of interest– A firm must manage conflicts of interest fairly, both

between itself and its clients and between a client and another client

9. Customers: relationships of trust– A firm must take reasonable care to ensure the suitability

of its advice and discretionary decisions for any client who is entitled to rely on its judgment



FSA – Principles for Business

10. Clients’ assets– A firm must arrange adequate protection for clients’

assets when it is responsible for them11. Relations with regulators– A firm must deal with its regulators in an open and

cooperative way, and must disclose to the FSA appropriately anything relating to the firm of which the FSA would reasonably expect notice



Approved Persons – Fit & Proper

• Honesty, integrity and reputation

• Competence and capability

• Financial soundness



Principles for approved persons

• Principles 1 – 4 : all approved persons

• Principles 5 – 7 : significant influence functions



Code of PracticePrinciple 1 - Act with integrity• Misleading a client, the firm (or its auditors) or the FSA• Carrying out unsuitable transactions• Not disclosing a material issue or error when knowing it to

be wrong• Falsifying documents, qualifications or employment records• Preparing false trading records• Misusing assets or confidential information of a client or the

firm• Failing to disclose a conflict of interest



Code of Practice

Principle 2 - Act with due skill care and diligenceFailing to;• Explain investment risks or product charges• Providing inaccurate information• Recommending / transacting unsuitable transactions• Advising on transactions when the risk to client or firm are

not understood• Control or segregate client assets• Disclose a conflict of interest• To cease a controlled function when not competent to act



Code of Practice

Principle 3 - Observe proper standards of market conduct

• Whether the requirements of the Code of Market Conduct, relevant market codes or exchange rules have been followed



Code of Practice

Principle 4 - Deal with the FSA and other regulators in an open and cooperative way and disclose appropriately any information of which the FSA would reasonably expect notice

Failure to;• report promptly in line with the firm’s internal procedures

(or direct to the FSA), information which could reasonably be assumed to be of material interest to the FSA.

• without reason to attend an interview or answer questions put by a regulator

• supply a regulator with documents or information when requested to do so



Code of PracticePrinciple 5 - Take reasonable steps to ensure that the

business of the firm for which he is responsible is organised so that it can be controlled effectively

Failure to ensure; • Each area of business is clearly assigned to particular

individual(s)• Responsibilities apportioned properly and recorded• Reporting lines/accountability clear to all staff• Authorisation levels and job descriptions• Suitability of individuals – unsatisfactory performance• Record keeping



Code of Practice

Principle 6 - Exercise due skill, care and diligenceFailure to ensure;• Reasonable steps to inform himself about the affairs of the

business• Expansion of business without assessing potential risks• Appropriate knowledge about the business – sufficient

understanding of risks• Responsibilities on delegation

– Disregarding an issue once delegated– Failing to require adequate reports following delegation– Accepting implausible/unsatisfactory explanations without testing

veracity



Code of PracticePrinciple 7 - Take reasonable steps to ensure that the

business of the firm for which he is responsible complies with the relevant requirements and standards of the regulatory system

Failure to:• implement (personally or through compliance) adequate

systems• monitor (personally or through compliance) compliance with

regulatory requirements• adequately inform himself about the reason why significant

breaches (suspected/actual) may have arisen• ensure that reasonable independent recommendations

(threesixty) are implemented in a timely manner



FSA Structural change

• Financial Services Authority – RIP

• Prudential Regulation Authority (PRA)– Responsible for Prudential supervision

• Financial Policy Committee (FPC)– Responsible for macroeconomic and financial stability issues

• Financial Conduct Authority (FCA) – Responsible for conduct of business

• Consumer Financial Education Body (CFEB)– Responsible for role out of national roll out of Money Guidance Service



Thank You

Any Questions?



Objectives – Part 2

• To provide an overview of what the FSA means by outcomes focused regulation and how it aims to use this to promote ethical and fair outcomes

• To encourage firms to consider ways of dealing with outcomes focused regulation



Areas to cover – Part 2

• Ethics and culture

• ‘Outcomes Focused Regulation’

• Evidence of the FSA’s new approach

• What firms can do to operate effectively under this new approach



Ethics and Culture

• EthicsA system or code of morals of a particular person, religion,

group, profession, etc.

• CultureA set of shared attitudes, values, goals, and practices that

characterizes an institution, organization or group



Ethics and Culture

• It is not for the FSA to define a firm’s ethics or culture

• “A firm’s culture plays an important role in influencing the actions and decisions taken by individuals within firms and in shaping a firm’s attitudes towards it’s clients”

– Hector Sants



Ethics and Culture

Firm’s need to• Understand their own culture

• Understand the potential risks posed by the wrong culture

• Implement a positive culture which facilitates ‘right behaviours’



Ethics and CultureBehaviour is likely to be influenced by;

• Leadership• Strategy• Decisions• Incentives• Controls• Deterrence (the threat of sanctions)



Ethics and Culture

• Not for the FSA to define a firm’s ethics and culture

• FSA will however look to focus on any unacceptable culture - resulting in poor behaviours



Ethics and Culture

• FSA’s view – there is a gap between what senior management in firms claim to believe and do, and what actually happens

– Firms are not always ‘practising what they preach’• “Don’t tell me – show me”



Outcomes Focused Regulation FSA’s previous approach to regulation;

• Principles based• ‘Light touch’• Reactive

Tendency was almost to wait for something to go wrong!



Outcomes Focused Regulation The FSA’s new approach to regulation;

• Proactive

• Outcome based



Outcomes Focused Regulation

Focus is now on• Improving long-term efficiency and fairness of the

market

• Delivering intensive supervision

• Securing redress and compensation and achieving deterrence by enforcement action against firms and individuals



Outcomes Focused Regulation Under this new approach the FSA will;

• ‘take a view’ and judge firm’s decisions based on the firm’s business model and other analysis

• Intervene much earlier to prevent customer detriment

• Test outcomes through increased use of mystery shopping, on-site visits, thematic reviews



Evidence of the FSA’s new approach• More stringent authorisation process – for firms

and individuals

• Particularly for Significant Influence Functions – in some cases the FSA will interview

• Remuneration Code – initially focused on banks and larger institutions but now likely to be expanded to other firms



Evidence of the FSA’s new approach• Increased focus on role of senior management– Make up of the board / senior management team– Influence from within a ‘parent entity’– Role of non-executives– Ability of senior management team to demonstrate

competence re risk management, regulation and the business model of the firm

• Increasing focus on T&C



Evidence of the FSA’s new approach

• TCF – now incorporated into normal supervisory / arrow process

• On-site visits focus on ‘what really happens’– Likely to talk to a range of people and not just senior management

and compliance

• Increasing number of Skilled Persons Reports requested and enforcement cases against firms and individuals



What can firms do?

• Firms need to define their own culture – What does good look like?

• Firms need to have a positive culture – which facilitates the ‘right behaviours’

• These then need to be driven by senior management and understood by all – lead from the top and by example



What can firms do?• Staff must be adequately trained (T&C) – applies to

all staff – advisers, support and management

• When recruiting – bear in mind the culture and outcomes required– Have defined standards, knowledge & skills– Can the individual evidence good behaviours?

• Have defined outcomes which can be measured– Appropriate Management Information– KPIs – links to T&C



What can firms do?• TCF – “firms should demonstrate to themselves that

they deliver fair outcomes to clients”– Management Information

• Senior Mgt teams as a whole – must challenge – ask difficult questions – play devils advocate– Must review relevant Management Information, KPIs etc

and act on this where appropriate

• Big Risk – a firm only finds out that issues exist when the FSA find them during a review



Summary• The FSA’s focus has clearly shifted with more

emphasis on outcomes

• Firms need to ensure they have a positive culture which facilitates the right behaviours and is understood by all staff

• Senior management need to;– lead by example– Have appropriate MI to demonstrate TCF– Actively monitor and challenge where necessary



Thank You

Any Questions?

Mike Kennedy Compliance Auditor Policy Team

Documents

Transcript of Mike Kennedy Compliance Auditor Policy Team