Financial Services Regulation Notes

What Are Regulations?

  • Definition: Regulations are "rules or directives made and maintained by an authority."
  • Purpose: They exist to mitigate the potential economic and social effects of financial instability and to protect retail consumers.

Quote: Lord Turner of Ecchinswell (FSA, 2005): Regulation is necessary to maintain efficient, orderly, and fair markets, and to protect consumers.

Purpose of Regulations in Financial Services

  • The financial services industry involves risk; regulations serve to protect the public from potential financial losses due to misconduct.
  • Main objectives include:
    1. Fairness & Efficiency: Maintain fairness, efficiency, competitiveness, transparency, and orderliness in financial markets.
    2. Public Understanding: Promote public understanding of how financial services operate.
    3. Consumer Protection: Protect consumers investing in or holding financial products.
    4. Minimize Crime: Reduce crime and misconduct within the industry.
    5. Systemic Risk Reduction: Lower systemic risks that might affect the financial system.
    6. Market Stability: Assist in maintaining financial stability through appropriate regulatory measures.

Development of Financial Services Regulations

  1. Initial Market Development - Self-Regulation:

    • Early market participants created their own rules and agreed on standards for behavior.
    • Example: Stock exchanges setting rules for member conduct.

  2. Regulatory Bodies Formation:

    • Need for formalized rules as self-regulation proved inadequate.
    • Examples include the Financial Services Authority (FSA) now replaced by the FCA.

  3. Global Market Development:

    • Crises like the collapse of Barings Bank and the 2008 Financial Crisis prompted international cooperation among regulators (e.g., Anti-money laundering rules).

Financial Services Regulations in the UK

  • Financial Services and Markets Act 2000 (FSMA):
    • Simplified previous legislation and established the FSA as the principal regulatory body.
    • Following the financial crisis of 2008, UK regulations were strengthened to ensure comprehensive oversight.
  • Key Institutions Established:
    • Financial Policy Committee (FPC): Located in the Bank of England, tasked with maintaining overall financial system stability.
    • Prudential Regulation Authority (PRA): Regulates 'significant' firms, emphasizing safety and soundness to enhance financial stability.
    • Financial Conduct Authority (FCA): Established in 2013; focuses on consumer protection and ensuring industry integrity.

Role of the Financial Conduct Authority (FCA)

  • Formation: Established alongside PRA and FPC in 2013, replacing the FSA.
  • Oversight: Operates under the supervision of HM Treasury.
  • Key Responsibilities:
    1. Supervises investment exchanges and monitors compliance with regulations (e.g., Market Abuse Directive).
    2. Investigates and prosecutes instances of insider dealing.
    3. Oversees Financial Ombudsman Service (FOS).
    4. Sets standards of conduct in retail and wholesale markets for around 26,000 firms.
    5. Promotes competition in financial markets for the benefit of consumers.

FCA - Authorisation and Approved Persons

  • Firm Authorisation:
    • It’s an offence for firms to provide services in the UK without FCA authorization.
    • Dual regulation is applicable for some firms under both FCA for conduct and PRA for prudential considerations.
  • Fit and Proper Test:
    • The FCA assesses whether individuals in key roles (approved persons) possess honesty, integrity, reputation, competence, and financial soundness.

Controlled Functions and Consumer Protection

  • Controlled Functions: Include key roles like management and customer interaction; classified into groups such as Governing Functions, Significant Management Functions, and Required Functions (compliance oversight).
  • Treating Customers Fairly (TCF):
    • The FCA emphasizes a conduct risk approach focusing on how firms treat their customers post-crisis.
    • Objectives: Ensure fair treatment of consumers is embedded in firms' cultures and operations; six TCF outcomes to be met:
    1. Consumers are confident in dealing with firms focused on fair treatment.
    2. Products meet the needs of targeted consumer groups.
    3. Clear information is provided to consumers throughout the sales process.
    4. Products perform as expected based on provided advice and information.
    5. Consumers do not face unreasonable post-sale obstacles to change providers or make claims.
    6. Firms implement consumer-focused practices in their operations.