7.1 - The General Prohibition

General Prohibition and Regulated Activities

Introduction

This section covers the Financial Conduct Authority (FCA) and Prudential Regulation Authority (PRA) authorization of firms and individuals, focusing on regulated activities and the general prohibition as defined under the Financial Services and Markets Act 2000 (FSMA).

General Prohibition

The general prohibition is detailed in Section 19 of FSMA 2000, stating that no person may carry on a regulated activity in the UK unless authorized or exempt.

Deconstruction of the Law
  • No Person: Refers to a legal person, typically a firm, which is a legal entity with its own separate legal existence. This includes firms, companies, trusts, charities, individuals, and partnerships.
  • Authorized or Exempt: Firms must be authorized or exempt to carry out regulated activities. Unauthorized activity is illegal.
Consequences of Breaching the General Prohibition

A breach of the general prohibition constitutes both a criminal and civil offense.

  • Criminal Offense: May result in a maximum penalty of two years in prison and/or an unlimited fine upon conviction in the Crown Court.
  • Civil Offense: The person or firm can be sued for damages by victims, and contracts are unenforceable by the breaching firm.

Regulated Activities

Regulated activities are defined by the Regulated Activities Order 2001 (RAO), which is an adjunct to FSMA 2000. The RAO lists specified activities and specified investments.

Components of a Regulated Activity

A regulated activity requires both a specified activity and a specified investment.

  • Specified Activity: E.g., dealing in investments.
  • Specified Investment: E.g., shares.

Combining dealing, a specified activity, with shares, a specified investment, constitutes dealing in shares, which is a regulated activity.

Authorization for Regulated Activities

Firms become authorized by seeking Part 4A permission from the FCA or PRA. The regulators assess applications based on threshold conditions.

Specified Investments

A summary of specified investments is provided, categorized into MiFID (Markets in Financial Instruments Directive) investments and non-MiFID investments.

MiFID Business vs. Regulated Activities

MiFID business is a subset of regulated activities, involving MiFID activities and MiFID investments. Dealing in shares can be both a specified activity and a MiFID activity.

Importance of MiFID Designation
  • Compliance with MiFID Regulations: Activities classified as MiFID business must comply with MiFID regulations.
  • Passporting Rights: Within the EEA, firms authorized for MiFID business can passport their authorization into other EEA member states. (Note: British firms lost passporting rights due to Brexit).
List of Specified Investments (Examples)
  • Derivatives: Options, futures, contracts for differences (CFDs), and emission allowances.
  • Equities: Shares, deposit receipts, warrants.
  • Fixed Income Securities/Debt Instruments: Bonds, gilts, loan stock, debentures, treasury bills, commercial paper.
  • Units in Collective Investment Schemes (CIS): Funds.
Non-MiFID Investments (Examples)
  • Lloyd’s Syndicate
  • Insurance Contracts: General and life insurance.
  • Funeral Plan Contracts: Small life assurance policies for prepaying funeral expenses.
  • Pensions
  • Regulated Mortgages
  • Home Finance Activities
  • Deposits and Electronic Money: Retail banking products.
  • Rights to Specified Investments: Repos, loans, forms of credit, benchmarks (e.g., SONIA, IBOR).

Specified Activities

The list of specified activities is also divided into MiFID activities and non-MiFID activities.

MiFID Activities (Examples)
  • Dealing in Investments: Acting as a principal, e.g., a dealer or market maker.
  • Arranging Deals in Investments: Acting as a broker (agent) trading in the name of a client.
  • Managing Investments: E.g., private wealth manager managing assets for a client.
  • Advising on Investments: E.g., independent financial advisor giving financial advice.
  • Operating Multilateral Trading Facilities (MTFs) or Organized Trading Facilities (OTFs): Securities trading platforms.
Non-MiFID Activities (Examples)
  • Safeguarding and Administering Investments: Acting as a custodian.
  • Sending Dematerialized Instructions: Electronic money transfer instructions via services like Crest.
  • Lloyd’s Activities: Insurance industry-related activities.
  • Mortgages: Provision, administration, advising, and arranging regulated mortgages.
  • Home Finance Activities
  • Managing Dormant Account Funds
  • Accepting Deposits by Way of Business and Issuing Electronic Money: Retail banking activities.
  • Providing Credit Reference or Credit Information Services: E.g., Fitch Ratings.
  • Activities Related to Funds or Pension Schemes: Setting up, operating, or winding up collective investment schemes or pension schemes.
  • Agreeing to Carry on Most Regulated Activities

Excluded Activities

Certain activities are excluded from regulation, allowing individuals or firms to perform them without authorization or exemption.

Examples of Excluded Activities
  • Newspapers and Other Media: Journalists writing about listed companies (treated as incidental advice).
    • Note: Tip sheets (stock picking tips sold to investors) are regulated.
  • Providing Information to Others: Firms like Bloomberg or Reuters selling market information.
  • Unpaid Trustees: Nominees, executives, etc., carrying out activities without commercial gain.
  • **Employee Share Schemes
  • Group or Joint Enterprises: Services provided within a group of companies where there are no external clients.
  • Absence of Holding Out: Not presenting or implying that one is regulated.
    • Dealing as principal and end user without offering services to others.
    • Primary market sales or buybacks, e.g., IPO-based activities.
    • Derivatives Used for Risk Management Purposes: Hedging by companies in the real economy, e.g., a bakery using wheat futures to manage price risk.

Exempt Persons

Exempt persons can carry out regulated activities without breaching the general prohibition.

List of Exempt Persons (Examples)
  • Other Exempted Bodies: Central banks, government bodies/agencies, supranational agencies (e.g., EU, UN).
  • Appointed Representatives (Tied Agents): Companies or individuals contracted to an authorized firm to carry out regulated activities in the authorized firm’s name. The authorized firm is responsible for their actions.
  • Lloyd’s Syndicate Members: Clients of insurance brokers joining syndicates managed by the broker.
  • Members of Designated Professional Bodies: Chartered accountants, surveyors, conveyancers, actuaries, and lawyers providing services incidental to their primary, non-regulated activities.
  • Recognized Investment Exchanges: London Stock Exchange.
  • Recognized Clearing Houses: London Clearing House.

Authorization Process

If a person is not exempt and wishes to carry out regulated activities, they must be authorized.

Relevant Regulations and Guidance
  • Perimeter Guidance Manual (PERG): Provides guidance on whether authorization is needed. Offers guidance and regulatory codes (G), but it is not legally binding.
  • Supervision Manual (SUP): Sets out the FCA's and PRA's powers to grant, vary, or withdraw permission for firms to carry out regulated activities.
Application for Part 4A Authorization

A firm applies using a specific form, and the regulator assesses the application against threshold conditions.

Threshold Conditions

Minimum requirements a firm must meet to gain and maintain Part 4A permission. Continued compliance is essential to retain authorization.

Assessment of Threshold Conditions
  • Solo Regulated Firms (FCA Firms): Assessed against five threshold conditions by the FCA.
  • Dual Regulated Firms: Firms carrying out activities like deposit-taking or insurance services, regulated by both FCA and PRA.
    • PRA assesses legal status and financial resources.
    • FCA assesses non-financial resources.
    • Both regulators jointly assess effective supervision and suitability.
Specific Threshold Conditions
  • Legal Status: Dual-regulated firms must be UK-registered companies.
  • Location of Offices: Registered office must be in the UK, with most activities conducted from there.
  • Effective Supervision: Internal controls must ensure the board and senior managers can control business and financial risks. Determination of the ultimate beneficial owner of the firm.
  • Resources: Financial resources (capitalization) assessed by the PRA under “prudent conduct.” Non-financial resources (compliance and risk management functions) assessed by the FCA.
  • Suitability Assessment: Determination of collective fitness and propriety.
  • Business Model: Viability and sustainability of the firm’s business model assessed by the FCA.

Passporting (Post-Brexit)

  • Before Brexit, firms authorized in the UK or EEA could passport their authorization into other countries within those regions.
  • Post-Brexit, this passporting is no longer possible unless new agreements are negotiated.