Financial Regulations

What Acts did HM Treasury create for financial regulation?

FSMA 2000 and FSA 2012. FSA 2012 created the FCA and PRA, the General Prohibition (S19 FSMA) and Part 4A permission. FSMA 2000 created the FSCS, FOS and UKLA

What do FCA, PRA, FOS, FSCS and UKLA stand for/represent in the UK regulatory structure?

FCA and PRA = the Regulators. FOS = Financial Ombudsman Service (the Ombudsman Service). FSCS = Financial Services Compensation Scheme (the Compensation Scheme). UKLA = UK Listing Authority, linked to the UK Listing Regime. General Prohibition = S19 FSMA and Part 4A permission

How does prudential and conduct regulation apply to dual-regulated vs solo-regulated firms?

Dual-regulated firms (deposit takers, insurers, significant investment firms): PRA does prudential regulation, FCA does conduct regulation. Solo-regulated firms (most investment firms): FCA does both prudential and conduct regulation

How do the Bank of England, HM Treasury and Parliament link into the regulatory structure?

Bank of England links to the PRA (shown as the Prudential Regulation Committee in the Bank of England). HM Treasury and Parliament link to the Financial Policy Committee (FPC), which has powers of direction and recommendation for financial stability. The FCA is shown as the ongoing legal entity of the old FSA

What is the Financial Policy Committee (FPC) responsible for?

Identifying, monitoring and taking action to remove or reduce systemic risk, at the Bank of England. Meets at least four times a year. Responsible for the Bank of England's bi-annual Financial Stability Report (FSR)

What is the FCA's strategic objective?

To ensure that relevant markets function well

What are the FCA's three operational objectives?

Consumer protection - secure an appropriate degree of protection for consumers. Integrity - protecting and enhancing the integrity of the UK financial system. Competition - promoting effective competition in the interests of consumers

What is the PRA's single general statutory objective?

Promoting the safety and soundness of PRA-authorised firms

How does the FCA decide the level of supervisory attention a firm receives?

Firms are assessed based on the risk they present to the FCA's statutory objectives, which determines the degree and level of supervisory attention required

What are the three types of work in the FCA's risk-based supervisory model?

Proactive - pre-emptive identification of harm through review/assessment of firms and portfolios, including business model analysis and reviewing drivers of culture. Reactive - dealing with issues that are emerging or have already happened, to prevent harm growing. Thematic - wider diagnostic or remedy work where there is actual or potential harm across a number of firms

What does FSMA empower the FCA and PRA to do?

Make rules that are legally binding on authorised firms, grant authorisation, supervise authorised persons on an ongoing basis, employ disciplinary measures and sanctions, and generally enforce the regulatory framework

List the FCA's Principles for Businesses

1) Integrity, 2) Skill, care and diligence, 3) Management and control - organise and control affairs responsibly and maintain adequate risk management systems, 4) Financial prudence - maintain adequate financial resources, 5) Market conduct, 6) Customers' interests - treat customers fairly, 7) Communications with clients - clear, fair and not misleading, 8) Conflicts of interest - manage fairly (firm vs customer and customer vs customer), 9) Customer relationships of trust - suitability of advice and discretionary decisions, 10) Clients' assets - provide adequate protection, 11) Relations with regulators - open and co-operative, plus Consumer Duty - deliver good outcomes for retail customers

What does the Consumer Duty initiative comprise?

Principle 12, rules, expected outcomes and formal guidance

What activities does the Consumer Duty apply to?

Consumer credit, retail deposit taking, insurance (not reinsurance), investments (not professional clients), regulated mortgages. Applies to existing and prospective customers, and to wholesale firms where they can impact retail customers

What happens to Principles 6 and 7 when Principle 12 (Consumer Duty) applies?

Principle 6 (Customers' interests) and Principle 7 (Communications with clients) no longer apply to firms in respect of services/products provided to retail customers

What is Fair Treatment of Customers (FTOC) and when does it apply?

Applies where a firm is out of scope of Consumer Duty requirements. Further develops Principle 6. A firm must act honestly, fairly and professionally in accordance with clients' best interests (the client's best interests rule)

What are the six FTOC consumer outcomes?

1) Fair treatment of customers is central to corporate culture, 2) Products/services marketed meet the needs of identified consumer groups, 3) Consumers are given clear information and kept informed, 4) Where advice is given, it is suitable, 5) Products perform as the firm led consumers to expect, 6) Consumers do not face unreasonable post-sales barriers

How do APER and SM&CR apply since March 2016?

APER (Approved Persons Regime) only applies to a limited number of individuals, such as Appointed Representatives. SM&CR applies to all authorised firms except those limited individuals

What powers does FSMA give the FCA/PRA over approved persons, and what are the two groups of controlled functions?

FSMA gives the FCA and PRA powers/obligations over approved persons, who perform controlled functions. Two groups: Significant influence functions (individuals exercising influence on a firm's affairs, e.g. directors, CEOs), Customer dealing functions (customer-facing individuals)

What does the Senior Managers and Certification Regime (SM&CR) consist of?

Senior Managers Regime (SMR), Certification Regime (CR) and Conduct Rules

What does the Senior Managers Regime (SMR) require?

Applies to individuals performing Senior Management Functions (SMFs), effectively replaces significant influence functions. Senior managers must be pre-approved by regulators, certified fit and proper by the firm, subject to the Conduct Rules, and Form A must be completed

What does the Certification Regime require?

Applies to roles posing a significant risk of harm to the firm/customers, and customer-facing roles subject to qualification requirements. Individuals must be certified fit and proper by the firm annually and are subject to the Conduct Rules

Who do the six Conduct Rules apply to?

All relevant employees, excluding ancillary staff such as cleaners and catering staff

List the six Conduct Rules

Rule 1 - act with integrity. Rule 2 - act with due skill, care and diligence. Rule 3 - be open and cooperative with the FCA, PRA and other regulators. Rule 4 - pay due regard to the interests of customers and treat them fairly. Rule 5 - observe proper standards of market conduct. Rule 6 - act to deliver good outcomes for retail customers

Who do the four additional Senior Manager Conduct Rules apply to?

Only individuals performing Senior Management Functions (SMFs)

List the four Senior Manager Conduct Rules (SC1-SC4)

SC1 - take reasonable steps to ensure the business you are responsible for is controlled effectively. SC2 - take reasonable steps to ensure the business complies with relevant regulatory requirements/standards. SC3 - take reasonable steps to ensure delegation is to an appropriate person and oversee it effectively. SC4 - disclose appropriately any information the FCA/PRA would reasonably expect notice of

What factors is a Senior Management Function individual assessed on under the Fit and Proper Test?

Honesty, integrity and reputation. Competence and capability. Financial soundness

What do FSMA s56 and s59 provide regarding fitness and controlled functions?

s56 - allows the FCA to issue Prohibition Orders against individuals who are not fit and proper. s59 - states no person may perform a controlled function unless approved by the appropriate regulator

When can a private person sue a firm under FSMA s71 and FSA s138D?

s71 - where a prohibited individual carries out a function, or an unapproved person performs a controlled function. s138D - if losses are suffered as a result of the firm breaching an FCA rule

What does the Training and Competence Sourcebook require before undertaking specified activities?

Firms must not allow employees to carry on or undertake a specified activity, other than an overseeing activity, unless they have passed each module of an appropriate examination

What exemptions exist from examination requirements?

Individuals with three years of up-to-date relevant experience outside the UK may be exempt from exams, but not the regulatory module. The 30-day rule applies to overseas individuals spending less than 30 days a year in the UK

What must firms consider when reviewing employee competence regularly?

The individual's technical knowledge and its application, the individual's skills and expertise, changes in the market and to products, legislation and regulation

What does GENPRU set and what is the CRD?

The General Prudential Sourcebook (GENPRU) sets high-level standards, principles and capital adequacy requirements for firms subject to the Capital Requirements Directive (CRD)

What are the three pillars of the Capital Requirements Directive (CRD)?

Pillar 1 - minimum capital requirements for credit, market and operational risks. Pillar 2 - firms and supervisors decide whether additional capital should be held for risks not covered in Pillar 1. Pillar 3 - disclosure of information about risks, capital and risk management to improve market discipline

What are the three tiers of capital?

Core Tier One - permanent share capital, reserves and externally verified interim profits. Tier Two - long-term subordinated debt and revaluation reserves. Tier Three - short-term subordinated debt and interim trading book profit and loss

What is MIFIDPRU and IPRU-INV?

MIFIDPRU (Prudential Sourcebook for UK MiFID Investment Firms) introduced new prudential requirements effective 1 January 2022, applying to UK-regulated firms subject to MiFID. IPRU-INV (Interim Prudential Sourcebook for Investment Businesses) contains capital adequacy rules for investment firms not subject to CRD/CRR and not subject to MIFIDPRU

What is MiFID and what happened to it?

The Markets in Financial Instruments Directive, an EU directive allowing firms authorised in one member state to provide financial services in another, subject to restrictions. Repealed and replaced by MiFID II in 2018. The term MiFID is often used to mean the whole framework, covering MiFID and MiFIR

What is MiFIR?

A regulation that came into effect alongside MiFID II, following a review of MiFID and as a response to the 2007-2008 global financial crisis. As a regulation, EU member states were not required to transpose it into national law

What does the UK prefix denote in relation to UK MiFID?

The onshored version of the European Union's MiFID II framework

What are the Competition and Markets Authority's (CMA) aims?

Make markets work well for consumers (in and out of the UK), businesses and the economy, and ensure healthy competition between UK companies

List the CMA's priorities

Investigating mergers that could restrict competition, conducting market studies/investigations, investigating breaches of anti-competitive agreement/dominant position prohibitions, bringing criminal proceedings for the cartel offence, enforcing consumer protection legislation, cooperating with sector regulators and considering regulatory references/appeals, providing information/advice on competition and consumer law, and providing advice, reporting and monitoring on government subsidies

What is the Pensions Regulator (TPR) and what are its roles?

The UK regulator of work-based pension schemes. Protects the UK's workplace pensions, ensures scheme members' rights are safeguarded, and monitors employers, trustees, pension specialists and business advisers

What does the General Prohibition state and where is regulated activity defined?

No person may carry on a regulated activity in the UK unless authorised or exempt. Regulated activity is defined in the Regulated Activities Order 2001, consisting of specified investments and specified activities

What are the penalties for unauthorised investment business?

A criminal offence, with a maximum penalty of two years' imprisonment and/or an unlimited fine. Civil remedies also apply - contracts are enforceable by the injured party (the investor) but unenforceable by the offending person (the firm)

List the specified investments

Deposits, electronic money, rights under contracts of insurance, shares, debentures (instruments creating/acknowledging indebtedness), government and public securities, warrants (entitlements to investments), certificates representing securities, units in a collective investment scheme (AUT, OEIC, ICVC), rights under stakeholder/personal pension schemes, options (securities, currencies, precious metals, futures), futures for investment or speculation, contracts for differences (CFDs), Lloyds syndicate capacity and membership, funeral plans, home finance transactions (mortgage contracts, home reversion plans, home purchase plans, sale and rent-back where at least 40% of the property is retained for occupation), greenhouse gas emissions allowances, credit and consumer hire agreements, alternative finance investment bonds and alternative debentures (Sharia-compliant bonds/sukuk)

What is excluded from specified investments?

Property deals, currency deals, National Savings and Investments (NS&I) products

List the specified activities

Accepting deposits, issuing electronic money, effecting/administering/performing contracts of insurance, dealing in investments as principal or agent, arranging deals in investments, advising on investments, arranging or advising on home finance transactions, operating a multilateral trading facility (MTF), operating an organised trading facility (OTF), bidding in emission auctions, managing investments, safeguarding and administering investments, sending dematerialised instructions, establishing/operating/winding up a collective investment scheme or UCITS, establishing or operating a pension scheme, Lloyds market activities, entering a funeral plan contract, activities relating to consumer credit and credit reference services, the setting of benchmarks, advising on home or land finance transactions

What activities are excluded from being regulated activities?

Dealing as principal where there is an absence of holding out (not acting as a market maker), media such as newspapers, TV, radio and information providers (unless a subscription tip sheet), trustees, nominees and personal representatives, employee share schemes

List examples of exemptions from authorisation requirements

Appointed representatives, recognised investment exchanges (RIEs) and recognised clearing houses (RCHs), FSMA Exemption Order 2001, supranational bodies and central banks (such as the Bank of England and the IMF), syndicate members of Lloyds of London, members of the professions through designated professional bodies (DPBs)

How do members of the professions obtain exemption, and which professions are covered?

They apply to their designated professional bodies (DPBs) rather than the FCA or PRA for permission to carry out incidental regulated activities. Professions include accountants, solicitors, actuaries, chartered surveyors and licensed conveyancers

What is the authorisation application process?

The firm submits an application pack to the PRA and/or FCA (FCA-only for FCA-only regulated firms). Dual-regulated firms make a single application to the PRA but require FCA consent

What do authorisation application packs require?

Core details, controllers, business plan, disclosure of significant events, approved person forms, checklist and declaration

What are threshold conditions?

The minimum standards for being, and remaining, authorised

List the threshold conditions

Legal status (acceptable legal form), location of offices (registered office in the UK), business conducted in a prudent manner (appropriate financial and non-financial resources), effective supervision including close links (no impediment to effective supervision), suitability (fit and proper), business model (suitable business strategy), appointment of claims representatives (for motor insurers only)

What is COBS and its purpose?

The Conduct of Business Sourcebook, which sets out the FCA conduct rules that apply to firms carrying on investment business and related regulated activities. Designed to ensure firms deal with clients clearly, fairly and appropriately

What key areas does COBS cover?

Client categorisation, client agreements and information, financial promotions and communications, advising and selling standards, suitability and appropriateness, product disclosure, cancellation rights, conflicts of interest, inducements and research, best execution/dealing/managing, client and transaction reporting, client assets and client money under CASS

How does the level of COBS protection vary by client category?

Retail clients normally receive the highest level of protection. Professional clients receive fewer protections because they are treated as having relevant knowledge and experience. Eligible counterparties receive the lowest level of protection

What is a durable medium?

A medium that enables a client to store information addressed personally to them in a way that is accessible for future reference for an adequate period. Paper is a durable medium, electronic communication can be a durable medium if the client can store and reproduce the information unchanged

When can information be provided to a client via a website as a durable medium?

The client has consented to receiving information in that form, the firm notifies the client electronically of the website address and location, the information is up to date, and remains accessible for as long as the client may reasonably need it

What are the three client categories, and must firms categorise clients before providing services?

Firms must categorise clients before providing services. The three categories are: Retail client, Professional client, Eligible counterparty

How is a retail client defined and what protection do they receive?

Clients who are not professional clients or eligible counterparties. They receive the greatest level of protection under COBS

What are professional clients and what are the two types?

Considered to have the experience, knowledge and expertise to make their own investment decisions and assess risks. Two types: Per se professional clients, Elective professional clients

List examples of per se professional clients

Firms authorised or regulated to operate in financial markets, large undertakings meeting relevant size tests, national and regional governments, public bodies that manage public debt, central banks, international and supranational institutions, other institutional investors whose main activity is investment in financial instruments

How does a client become an elective professional client?

The client chooses to be treated as professional and is accepted by the firm as such. The firm must carry out an adequate assessment of the client's expertise, experience and knowledge. The qualitative test asks whether the client can make investment decisions and understand the risks. For MiFID business, the client must also satisfy quantitative criteria

What quantitative criteria can apply for elective professional status in MiFID business?

Sufficient transactions of significant size over the relevant period, a financial instrument portfolio of sufficient size, relevant professional experience in the financial sector

What must happen before a client is treated as an elective professional client?

The client must be warned in writing of the protections and investor compensation rights they may lose, and must state in writing that they wish to be treated as a professional client

What are eligible counterparties, and can they request different treatment?

Generally sophisticated market participants dealing in eligible counterparty business. They may request treatment as professional or retail clients to obtain a higher level of protection. Firms may also opt clients down into a more protective category

When must firms review a client's categorisation?

When they become aware that the client no longer satisfies the conditions for their category

What must firms provide clients before providing services (client agreements/information)?

Appropriate information in good time, enabling the client to understand the nature and risks of the service and investment being offered

What can client information cover?

The firm and its services, the firm's regulatory status, financial instruments and proposed investment strategies, execution venues, costs and associated charges, safeguarding of client assets, conflicts of interest

What is a client agreement and when is it required?

Sets out the essential rights and obligations of the firm and client. Generally required before providing relevant services to retail clients and professional clients. Must be retained in accordance with record-keeping requirements, and clients informed of material changes to information already provided

What is a financial promotion and how must it be communicated?

An invitation or inducement to engage in investment activity. Must generally be communicated or approved by an authorised person unless an exemption applies

What is the fair, clear and not misleading rule for communications?

Communications and financial promotions must be fair, clear and not misleading (written and spoken where relevant), presented to be understood by the average member of the target group, with important information/statements/warnings not disguised, diminished or obscured, and a financial promotion should be clearly identifiable as a promotion

What are the categories of financial promotions?

Real-time (e.g. telephone calls, face-to-face conversations) vs Non-real-time (e.g. letters, emails, websites, advertisements). Solicited (following an express client request) vs Unsolicited. Direct-offer financial promotions, where the client is invited to enter into an agreement and told how to respond

What rules apply to past performance information in financial promotions?

Should not be the most prominent feature of a communication, must be fair and normally cover an appropriate period, and is not a reliable indicator of future results. Simulated past and future performance information are subject to additional controls and warnings

What other requirements apply to financial promotions?

Must include appropriate risk warnings where required. Firms must have systems and controls for approving, reviewing and withdrawing promotions where necessary. Records of financial promotions must be retained for the applicable period

When does suitability apply and what must a firm do first?

When a firm makes a personal recommendation or manages investments. The firm must obtain the necessary information about the client before recommending or managing investments

What does the suitability assessment consider?

The client's knowledge and experience in the relevant investment field, financial situation including ability to bear losses, investment objectives, and risk tolerance

What must a firm do if it lacks the necessary suitability information, and what else applies to suitability?

It must not make a personal recommendation or take a decision to trade for the client. Suitability reports are required for retail clients in relevant advised transactions, explaining why the recommendation is suitable. Firms must consider costs/complexity of products. Switching or churning can cause harm where excessive/unnecessary transactions generate fees or commission without client benefit

When does appropriateness apply and what must the firm assess?

Applies to certain non-advised investment services. The firm assesses whether the client has the necessary knowledge and experience to understand the risks involved

What must a firm do if a product isn't appropriate, or if there's insufficient information to assess appropriateness?

If not appropriate, the firm must warn the client. If the client does not provide enough information, the firm must warn the client that it cannot determine whether the service or product is appropriate

When can execution-only exemptions from the appropriateness test be available?

The service relates to non-complex financial instruments, is provided at the initiative of the client, the client is clearly informed the firm is not required to assess appropriateness, and the firm complies with conflicts of interest rules

What is the purpose of product disclosure rules?

To ensure clients understand the product before investing. Firms must provide appropriate information on the nature and risks of investments, which should be accurate, balanced and understandable, and given in good time before the client is bound by the transaction

What are the key product disclosure documents?

KIID for UCITS funds, KFD for packaged products, KID for PRIIPs

What is the difference between independent and restricted advice?

Independent advice requires a broad and fair analysis of the relevant market. Restricted advice does not meet the independent standard because it is limited by product, provider or another restriction

What are cancellation rights and how long are the cancellation periods?

Allow certain clients to withdraw from specified contracts within a defined period. Generally 14 days for many investment products, and 30 days for life and pension products

What must firms provide about cancellation rights, and what if they fail to do so?

Firms must provide clients with information about cancellation rights where those rights apply. Failure to provide cancellation information may extend the cancellation period

What must firms identify regarding conflicts of interest, and where can conflicts arise?

Circumstances that may give rise to conflicts of interest involving a material risk of damage to clients. Conflicts may arise between the firm and a client, between one client and another, and between employees and clients

List examples of conflicts of interest

The firm is likely to make a financial gain at the expense of a client, the firm has an interest in the outcome of a service that differs from the client's interest, the firm has a financial or other incentive to favour one client over another, the firm receives an inducement from a third party in relation to a service provided to a client

What must firms do to manage conflicts of interest, and when must they disclose a conflict?

Maintain and operate an effective conflicts of interest policy, with organisational and administrative arrangements designed to prevent conflicts adversely affecting clients. If arrangements are not sufficient, the firm must disclose the conflict before undertaking business. Disclosure is a backstop and should not be relied on instead of effective conflict management

What do inducement rules restrict, and what is the core duty involved?

Restrict fees, commissions and non-monetary benefits paid or received by firms. A firm must not pay or accept inducements that impair its duty to act honestly, fairly and professionally in accordance with the client's best interests

What must permitted inducements do, and what about minor non-monetary benefits?

Must be designed to enhance the quality of the service to the client, not impair the firm's duty, and be disclosed where required. Minor non-monetary benefits may be permitted where reasonable, proportionate and unlikely to impair the firm's duty. The rules are designed to reduce bias in advice and investment services

How can investment research create conflicts, and how should it generally be paid for?

Where research is received as a benefit linked to trading or execution services. Research should generally be paid for from the firm's own resources or through permitted research payment arrangements

What are research payment accounts and research budgets?

Research payment accounts may be used where relevant rules and controls are satisfied. Research budgets should be set and assessed independently from transaction volumes, to separate the cost of research from execution and reduce inducement risk

What must firms do when dealing and managing for clients?

Act honestly, fairly and professionally in the best interests of clients, and take sufficient steps to obtain the best possible result for clients when executing orders (best execution)

List the best execution factors

Price, costs, speed, likelihood of execution, likelihood of settlement, size, nature of the order, any other relevant consideration

For retail clients, how is the best possible result generally determined?

By total consideration, meaning price plus costs

What must firms establish regarding order execution?

Establish and implement an order execution policy, give clients appropriate information about it, and obtain prior consent to it where required

What are the requirements for executing and handling client orders?

Executed promptly, fairly and accurately. Comparable client orders must be carried out sequentially unless order characteristics or market conditions make this impracticable. Firms must inform retail clients of material difficulty in carrying out orders promptly once aware of it

When is aggregation of client orders permitted, and what governs allocation?

Only where unlikely to work overall to the disadvantage of any client whose order is aggregated. Allocation following aggregation must be fair and in accordance with the firm's order allocation policy