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22/04/23 1PFS Regional Conferences – March 2011PFS Regional Conferences – March 2011
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Mike Kennedy
• Compliance Auditor
• Policy Team
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22/04/23 3PFS Regional Conferences – March 2011
Gap-Fill Session
Financial Services Regulation and Ethics
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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
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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
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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)
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FSA - Functions
• Authorisation
• Enforcement
• Supervision
• Rule making
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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
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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)
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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
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FSA – Principles of Good Regulation
• Efficiency and economy• Role of management• Proportionality• Innovation• International character• Competition• Public awareness
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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)
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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)
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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
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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
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FSA - Supervision• Accounts and Auditor Statements• Business Volumes• Sources of Business• Complaints• Other relevant returns• Mystery shopping
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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
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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
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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
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FSA - Powers
• Monitoring and supervision• Prohibit individuals from carrying out functions• Financial penalties• Public censure• Criminal prosecution• Removal of permissions
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FSA - Authorisation
• To undertake regulated activities a person must be;
– Authorised; or– Exempt
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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
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FSA - AuthorisationExempt Firms
• Appointed Representatives
• Professional Firms which are members of DPB
• Others e.g. Bank of England, European Central Bank and local governments
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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
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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
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FSA – Controlled FunctionsCover two categories• Significant Influence Functions– Governing functions– Required functions– Systems and controls functions– Significant management functions
• Customer functions
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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
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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
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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
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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
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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
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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
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Approved Persons – Fit & Proper
• Honesty, integrity and reputation
• Competence and capability
• Financial soundness
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Principles for approved persons
• Principles 1 – 4 : all approved persons
• Principles 5 – 7 : significant influence functions
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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
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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
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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
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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
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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
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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
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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
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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
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Thank You
Any Questions?
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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
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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
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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
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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
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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’
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Ethics and CultureBehaviour is likely to be influenced by;
• Leadership• Strategy• Decisions• Incentives• Controls• Deterrence (the threat of sanctions)
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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
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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”
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Outcomes Focused Regulation FSA’s previous approach to regulation;
• Principles based• ‘Light touch’• Reactive
Tendency was almost to wait for something to go wrong!
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Outcomes Focused Regulation The FSA’s new approach to regulation;
• Proactive
• Outcome based
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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
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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
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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
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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
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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
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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
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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
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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
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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
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22/04/23 63PFS Regional Conferences – March 2011
Thank You
Any Questions?
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