Latest developments in financial services regulation Simon Morris - - PowerPoint PPT Presentation

Latest developments in FS regulation | 20 October 2016

Latest developments in financial services regulation

Simon Morris & David Pygott CMS Cannon Place, London 20 October 2016

Latest developments in FS regulation | 20 October 2016 CMS Cameron McKenna LLP

Agenda

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1. The renewed focus on culture 2. The regulators’ growing expectations of individuals 3. What is getting firms into enforcement? 4. Competition as the new regulatory tool 5. Prudential and conduct drivers for 2016/2017 6. Brexit and the future

Latest developments in FS regulation | 20 October 2016 CMS Cameron McKenna LLP

The renewed focus on culture

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− FCA decided in December 2015 not to proceed with a thematic review into culture in banking… − …is now under new management… − …as is the Treasury… − …but the focus on culture has not gone away − Firms’ culture and governance remains one of FCA’s stated priorities for 2016/2017 − Supervision

• “a central focus”; “will be used to drive our decisions about our thematic projects and

market studies” (extract from FCA Business Plan 2016/2017)

• “Our ambition is for the conduct element of culture: that mindsets and incentives will

shift to make doing the right thing for consumers and the markets the objective that is always considered” (Jonathan Davidson, Director of Supervision, July 2016) − Enforcement

• Part of “a game plan of strategic directions” (Mark Steward, Director of Enforcement

and Market Oversight, April 2016)

• Poor culture and governance continued to be cited as a basis for regulatory action in

Final Notices issued to firms in 2016

Latest developments in FS regulation | 20 October 2016 CMS Cameron McKenna LLP

Culture impacts outcomes

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… I would observe that in the United Kingdom I don’t think we saw a major prudential failure of capital or liquidity which did not have a governance and management story at its heart … Good regulation … is also about creating the conditions for firms to do this right thing in the first place. Let me give three examples of what we are doing in this respect.

• Remuneration & incentives
• Senior management responsibilities
• Supervising governance is inherently a matter of judgement based on

evidence … (Andrew Bailey, PRA Annual report 2015/16)

Latest developments in FS regulation | 20 October 2016 CMS Cameron McKenna LLP

Culture is a catalyst

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The failure of HBOS can ultimately be explained by a combination of factors: − Its Board failed to instil a culture within the firm that balanced risk and return appropriately, and lacked sufficient experience and knowledge of banking. − The result was a flawed and unbalanced strategy and a business model with inherent vulnerabilities … − This approach permitted the firm’s executive management to pursue rapid and uncontrolled growth … The risks involved were either not identified or, where identified, not fully understood by the firm. − There was a failure by the Board and control functions to challenge effectively executive management in pursuing this course or to ensure adequate mitigating actions. … − An overall systemic crisis in which the banks in worse relative positions were extremely vulnerable to failure. HBOS was one such bank.

(Extracts from TSC: Review of the reports into the failure of HBOS, July 2016)

Latest developments in FS regulation | 20 October 2016 CMS Cameron McKenna LLP

Culture is tangible and measurable

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We acknowledge …

• We do not believe that there should be a one-size fits all culture that comes
• ff the shelf … we are not going to prescribe the overall culture.
• Changing culture is very difficult and we know it takes time … because

culture comes from the past … culture is remarkably resilient in the face of attempts to change it; it takes focus, consistency and time to effect change.

But we want …

• … we are making our assessment of culture by looking at the examples
• f behaviours that we come across in supervision and we are looking

closely at what management is doing to shape culture and the direction implied in it …

(Extracts from ‘Getting Culture and Conduct Right’, speech by Jonathan Davidson, Director of Supervision, July 2016)

Latest developments in FS regulation | 20 October 2016 CMS Cameron McKenna LLP

The regulators look for four elements

• 1. Tone from the top … and middle

… are the major determinants of culture an important and regular item for board discussion? But employees are more likely to be influenced by the top trader than the

• Board. If a colleague is successful

despite poor conduct practices it makes positive messages from the top hard to believe … Middle management are critically important to the tone from the top …

• 2. Formal, tangible practices which

tell people what they need to do to be successful and ensure that the right people are employed and rise to leadership roles Recruitment, compensation and promotion practices …by rewarding staff for performance achieved in line with firm values, remuneration and incentives can reinforce and embed a firm’s desired culture …

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Latest developments in FS regulation | 20 October 2016 CMS Cameron McKenna LLP

• 3. Narratives that circulate in a

firm … the tone of strategies,

business plans and mission statements. The most interesting and accurate are those referred to, repeated and passed

• n the most because they resonate

with the culture of employees. Asking employees to deliver 10% more YOY with 25% less headcount … If employees feel under pressure to deliver against tough targets conduct standards can fall.

• 4. The organisation’s capabilities to

learn a set of behaviours – to have a conversation about the needs of customers requires an ability to relate to a customer and problem solve a solution which is a different competence from the persuasiveness needed to sell a specific product …

(Extracted from same speech by Jonathan Davidson, July 2016)

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Latest developments in FS regulation | 20 October 2016 CMS Cameron McKenna LLP

And another way of looking at it …

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− How quickly does it take for problems to escalate to the right person or group

• f persons for effective decision making or action?

− How many problems linger in the inbox or the draft box or the bottom drawer beyond their easily fixable date? − How difficult is it to fix things once they are detected?

(Speech by Mark Steward: Culture and Governance, 11 November 2015)

Latest developments in FS regulation | 20 October 2016 CMS Cameron McKenna LLP

Growing expectations of individuals (1)

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− Closely linked to the focus on culture − Senior managers regime: where are we now?

• 7 March 2016: senior managers and certification regimes came into force (for

banks, building societies, PRA-designated investment firms, UK branches of foreign banks); full senior insurance managers regime came into force (for insurers)

• 4 May 2016: Bank of England and Financial Services Act 2016 received Royal

Assent; made statutory provision for further extension of scope of senior managers regime (relevant provisions not yet in force)

• 28 September 2016: FCA published ‘6 months on’ review of firms’ implementations;

began further consultations on:

− new guidance regarding enforcement of duty of responsibility − application of conduct rules to all NEDs in banks and insurers − overall responsibility and the Legal function

Latest developments in FS regulation | 20 October 2016 CMS Cameron McKenna LLP

Growing expectations of individuals (2)

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− Growing expectations of Senior Managers (highlights)

• Management responsibilities map
• Individual statements of responsibility
• Duty of responsibility
• Code of Conduct

− Growing expectations of Certification regime staff (highlights)

• Code of Conduct
• Fitness and propriety

Latest developments in FS regulation | 20 October 2016 CMS Cameron McKenna LLP

Growing expectations of individuals (3)

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− FCA CP16/26: enforcement of the duty of responsibility clarified? − FSMA s66A: for a Senior Manager to be sanctioned for a breach of the duty of responsibility, FCA has to prove:

• a contravention of a regulatory requirement by the firm
• that the Senior Manager was responsible for the management of any activities in

relation to which the contravention occurred

• that the Senior Manager did not take such steps as a person in his/her position could

reasonably be expected to take to avoid the contravention occurring or continuing

− New guidance about factors to which FCA will have regard when assessing compliance with the duty of responsibility − Amendments to DEPP proposed

Latest developments in FS regulation | 20 October 2016 CMS Cameron McKenna LLP

Growing expectations of individuals (4)

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− Was the Senior Manager “responsible for the management of any activities in relation to which the contravention occurred”? Factors include:

• Senior Manager’s statement of responsibilities
• BUT also how the firm actually operated / how responsibilities allocated in practice
• Senior Manager’s actual role and responsibilities to be determined by reference to

evidence (such as minutes of meetings, emails, regulatory interviews, telephone recordings and organisational charts)

− Did the Senior Manager take such steps as a person in his/her position could reasonably be expected to take? Factors include:

• His/her role and responsibilities
• Whether or not reasonable care taken and reasonable conclusions reached
• Whether or not legal obligations complied with (eg under Companies Act 2006)
• Nature, scale and complexity of firm’s business
• Knowledge of regulatory concerns which senior manager had (or should have had)
• Whether delegation reasonable
• Whether took reasonable steps to put in place clear reporting lines and policies

Latest developments in FS regulation | 20 October 2016 CMS Cameron McKenna LLP

Growing expectations of individuals (5)

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− No let up likely in regulatory focus on individual accountability − Expectations of individuals will continue to grow as the current regime expands in scope − What next?

• 9 January 2017: current FCA ‘6 months in’ consultations close
• March 2017 (firms currently in scope):

− required to have certified as ‘fit and proper’ staff covered by Certification regime − final rules on regulatory references implemented − Code of Conduct comes into force for remaining staff (unless on ‘excluded’ list, e.g. switchboard operators, vending machine staff)

• 2017/2018: consultation expected on extension of scope of senior managers regime

to all FCA-regulated firms

• 2018: regime expected to come into force for all FCA-regulated firms
• [????]: pursuit by regulators of first disciplinary cases against Senior Managers

under the new regime; challenges in the Upper Tribunal likely

Latest developments in FS regulation | 20 October 2016 CMS Cameron McKenna LLP

What is getting firms into enforcement?

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Some themes: − Controls against financial crime, in particular anti-money laundering controls, controls against bribery, corruption and fraud − Controls against market abuse − Principle 11 issues / failures to be open and cooperative with regulators − Client assets / CASS issues − TCF issues Some other areas of contention: − Issues emerging as firms with interim consumer credit permissions seek full permissions − Forbearance and fair treatment of borrowers in financial difficulty

Latest developments in FS regulation | 20 October 2016 CMS Cameron McKenna LLP

Competition as the new regulatory tool

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Latest developments in FS regulation | 20 October 2016 CMS Cameron McKenna LLP

What the FCA means by “competition”

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Competition in the commercial world means firms striving to win customers, with innovative firms bringing ideas to market, successful firms thriving, and unsuccessful ones making an exit. When markets are competitive, consumers will be offered variety and choice, with firms striving to win custom on the basis of service, quality, price and

• innovation. In such circumstances, consumers can feel confident in exercising

choice and competition is strengthened. Our long-term goal is to help solve the long-standing problems of competition and consumer choice in financial services … Competition is not an alternative to regulation. Proportionate regulation is a pre-requisite for competition in financial services to thrive. Consumers need to know they can trust the firms they buy from and that they are appropriately protected when something goes wrong ...

(FCA Competition Report 2013-16, July 2016)

Latest developments in FS regulation | 20 October 2016 CMS Cameron McKenna LLP

What the FCA has done to date?

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− launched four new market studies on investment and corporate banking, asset management, the mortgage sector and the use of big data in the general insurance sector − published one interim report on credit cards − started to trial competition remedies in two sectors: retirement

• utcomes and general insurance add-ons

− implemented competition remedies in two markets, cash savings and general insurance add-ons − extended the Innovation Hub remit and set out plans for implementing a ‘regulatory sandbox’ − launched first Competition Act investigation − and also commenced widespread collusion reviews

Latest developments in FS regulation | 20 October 2016 CMS Cameron McKenna LLP

Common themes from the competition reviews

Behavioural economics

• ‘We know better than the client’
• Value for money

Warning signs

• Concentration
• Profitability
• Stasis
• Low engagement
• Incumbency advantage

Issues

• Over-complexity of non-advice
• Secondary products
• Barriers of intermediation

− Consultants − Platforms

• Provider purchased services

Remedial tools

• Incentives to shop around/switch
• Incentives to protect vulnerable

customers

• Price cap
• Limiting add-ons
• Clarity of information
• Price framing

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Latest developments in FS regulation | 20 October 2016 CMS Cameron McKenna LLP

The PRA’s view

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The PRA’s secondary competition objective

• Only applies when advancing a primary objective.

And the PRA considers … − Does the proposal reduce incentives for suppliers to compete? Significantly raises cost of production for some suppliers relative to others => Suppliers compete to offer a choice of products/services. − Could the proposal limit the ability of suppliers to compete? Softens pricing rivalry as a result of information on supplier outputs, prices, sales or costs being shared => Suppliers compete to offer a choice of products/services. − Could the proposal limit the choices and information available to customers? Reduces mobility of customers between suppliers => Informed customers get products/services at suitable price − Could the proposal limit the number or range of suppliers? => Establishes an authorisation process as Effective entry, expansion and exit possible PRA: Annual Competition Report (July 2016)

Latest developments in FS regulation | 20 October 2016 CMS Cameron McKenna LLP

Prudential and conduct drivers for 2016/17

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Latest developments in FS regulation | 20 October 2016 CMS Cameron McKenna LLP

The FCA

− Areas requiring priority focus − Areas failing to work well − Addressing problems of the past

• Delivering redress

− Improving standards The five key conduct questions

1. What proactive steps do you take as a firm to identify the conduct risks inherent within your business? 2. How do you encourage the individuals who work in front, middle, back office, control and support functions to feel and be responsible for managing the conduct

• f their business?

3. What support does the firm put in place to enable those who work for it to improve the conduct of their business or function? 4. How does the Board gain oversight of the conduct of business within their

• rganisation?

5. Has the firm assessed whether there are any other activities that it undertakes that could undermine strategies put in place to improve conduct?

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Latest developments in FS regulation | 20 October 2016 CMS Cameron McKenna LLP

The FCA

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Multiple thematic reviews conducted during 2015/2016. These included:

− A review into firms’ oversight and controls in relation to financial benchmarks. This thematic review was carried out between August 2014 and June 2015 to get an early assessment of the extent to which firms had learnt the lessons from previous failures around benchmark activities and taken appropriate action in response. − A review of suitability of retail investment portfolios provided by wealth management and private banking firms including examples of good and poor practice to help firms better understand the standards expected of them. − A report was published in March 2016 setting out findings from a thematic review of the fair treatment of long-standing customers in life insurance. The review used a sample of 11 firms with around £153bn held in closed-book products for around 9.4m customers … − A follow-up review of mobile phone insurance after FCA had previously identified a number of practices within the mobile phone insurance market that were leading to poor

• utcomes for consumers. In its 2015 review, FCA found that some firms had improved

their practices, with evidence that customers were now consistently receiving fair

• utcomes …

Latest developments in FS regulation | 20 October 2016 CMS Cameron McKenna LLP

The areas of focus

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− Governance

• Mapping and managing risk

− Vulnerable customers

• A wide construct

− Clarity of information

• Marketing & disclosure

− Fair treatment

• Extends beyond contractual promises

− Individual responsibility

Latest developments in FS regulation | 20 October 2016 CMS Cameron McKenna LLP

The PRA

The PRA’s key business aim – Continue to develop and implement the forward-looking judgement-based supervisory regime

• Capital
• Liquidity
• BRRD
• Management accountability
• Operational resilience

Tea at the Bank of England

• Drivers of capital
• Regulatory risks
• What steps taken to address

concerns

• Use of ICAAP
• How handle liquidity risks
• Board action over liquidity stress
• Operational risk scenarios
• Operation of governance
• Working of risk function

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Latest developments in FS regulation | 20 October 2016 CMS Cameron McKenna LLP

Brexit & the future

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Latest developments in FS regulation | 20 October 2016 CMS Cameron McKenna LLP

The developing UK stance

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− “Brexit means Brexit” − Article 50 to be triggered by March 2017 − “Hard Brexit” vs “soft Brexit”

• Controls on who comes to Britain from Europe; but
• A positive outcome for those who trade goods and services?

− Conundrum

• Free access
• No free movement
• Limited financial contribution

− And the EU says …

• Britain “cannot keep the nice things about membership” – D V-C
• EU summit Sept 16th Bratislava … but await F & D elections Q3 2017

Latest developments in FS regulation | 20 October 2016 CMS Cameron McKenna LLP

The role of the UK Parliament

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Triggering Art 50

The [EU] treaties were not enacted and do not form part of our domestic law. They were given effect in domestic law by the 1972 Act. The exercise of our treaty rights under Article 50 will have no effect in itself in our domestic law. To complete the process of disengagement, it will be necessary to repeal the 1972 Act. But the exercise of our rights under Article 50 is a matter for the royal prerogative, since it affects the position in international law and not in domestic law. Lord Millett

Role of the devolved UK administrations?

Latest developments in FS regulation | 20 October 2016 CMS Cameron McKenna LLP

Ratifying agreements

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UK Parliament has a statutory role in ratifying any withdrawal and other agreements provided they are subject to the usual procedure:

A treaty may not be ratified unless the Minister responsible has:

• Laid a copy before Parliament;
• Published it;
• Allowed a period of 21 sitting days during which either House may resolve

that the treaty should not be ratified … Constitutional Reform and Governance Act 2010

An act of the UK Parliament is required to approve any treaty which seeks to amend or replace TEU or TFEU.

European Union Referendum Act 2011

Latest developments in FS regulation | 20 October 2016 CMS Cameron McKenna LLP

Changing legislation

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The challenge

“the size of the task could overwhelm Parliament’s capacity to exercise effective legislative control” … “unravelling 40 years of an entrenched constitutional position” is the “largest legal, legislative and bureaucratic project in British history except for a world war” ...

An emerging (domestic) legislative strategy

• “Great Repeal Bill” to feature in next Queen’s Speech
• BUT how much will it actually repeal?
• Provision to repeal European Communities Act 1972
• Provision to enact EU law generally to preserve the status quo (as at when)?
• Changes may be needed anyway to SIs already made under the European

Communities Act 1972 and/or other ‘parent’ acts

• Effect of ECJ judgements post-Brexit on former EU laws adopted in UK at Brexit?
• Future “bonfire of the regulations”?

Latest developments in FS regulation | 20 October 2016 CMS Cameron McKenna LLP

Parliamentary oversight

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− The scrutiny work that lies ahead will be detailed, complex and

• technical. MPs already struggle to effectively scrutinise financial and

delegated legislation and this will add to the burden … − In the Commons a regular ministerial question time may well be demanded, debates about the way ahead will be a regular feature and the urgent question is likely to be a key tool as backbenchers try to hold ministers to account … − A stand-alone select committee or a joint committee of both Houses may be required to monitor the negotiations and decision-making, although existing departmental select committees will want to oversee their own particular departmental policy area …

Ruth Fox Hansard Society

Latest developments in FS regulation | 20 October 2016 CMS Cameron McKenna LLP

3rd state models

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Six models

• Norway – access in return for recognising four freedoms & contribution.

− Pay but no say − Copy out EU laws

• Switzerland – 120+ agreements, only 1 on FS. EU does not favour this

approach.

• Canada – free trade – mainly goods and slow to achieve
• Turkey – customs union for goods only
• Liechtenstein – largely agricultural
• WTO – goods tariffs alone

Latest developments in FS regulation | 20 October 2016 CMS Cameron McKenna LLP

Financial Regulation – passporting rights

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Best Case Worst Case

• Extended withdrawal period
• Continued ability to provide

financial services in the EU from UK entities through a special deal for UK

• Withdrawal in 2018 without negotiated

solution

• UK firms no longer able to provide any

financial services (including sales, trading and advisory activity) in the EEA without locally authorised subsidiary/branch

Base Case

• Withdrawal in 2018 with negotiated

solution

• Piecemeal equivalence over time,

resulting in continued ability to provide some financial services from UK entities under one/more EU regulatory frameworks

Higher probability Lower probability

Latest developments in FS regulation | 20 October 2016 CMS Cameron McKenna LLP

Balancing the arguments …

− Will retain some influence

• Basel
• G20

− UK needed for the 4th Freedom − UK non-banking experience − Sidelined on ESFS − Uncertainty

• Precipitate response

− Equivalence

• But there are exceptions
• No automatic passporting
• Take an average Deutsche AG
• Renegotiate each change
• UCITS disapplied => AIFMD

− No concessions offered

• Or likely to be

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Latest developments in FS regulation | 20 October 2016 CMS Cameron McKenna LLP 35

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