November 2012 Update

13th November 2012

Proactive and Online regulatory reviews
FSA are conducting regional Proactive Regulatory Reviews (PRR) with firms across the country. During 2012, FSA have already met with firms based in the North West and South West of England. The next region to receive PRR is West Midlands and invites will be issued to firms shortly.

Firms based within the regions mentioned above who have yet to receive an invite for a regulatory review, have been selected to receive their review using an online regulatory review system that is currently being developed. FSA plan to launch the Online Tool towards the end of 2012/beginning of 2013 and will communicate more detail closer to the planned launch date.

FSA will be in touch with your firm during the next few months in order to provide more specific information in relation to the firm’s online regulatory review.

Business Risk Awareness Workshops are being run on a regional basis in conjunction with the PRR. Scotland/Northern Ireland is the next scheduled region with workshops scheduled for November.

More information about Business Risk Awareness Workshops are available via the FSA’s website.

FSCS funding review model
The regulator has published proposals on how the Financial Services Compensation Scheme (FSCS) is funded. FSA have published a web page that sets out their proposals and where they are not changing our approach.

Many small and medium sized firms (specifically with retail permissions) have been hit by the dramatically increased FSCS levy this year that is likely to continue to rise if financial firms fail and the FSCS have to step into the breach. I think in the past year, the volume and value of claims coming to FSCS has exceeded their previous assumptions. The increase has partly been driven by on-going costs for high profile failures such as Keydata Investment Services Ltd, Wills & Co, CF Arch Cru and MF Global. FSCS has met more claims than previously predicted with a higher average compensation payment than earlier claims. But remember, FSCS fees are divided into classes so firms are not necessary subsidising the failures of investment firms. Well, at least that’s the theory!

For more information on the FSCS and how its funded and the tariff classes, take a look at:


Client Money

The Financial Services Authority has issued a Paper that proposes a number of changes to the client money regime for firms that undertake investment business.

In addition to some changes required by the European Markets Infrastructure Regulation (EMIR), the FSA proposes changes that could lead to a radical shift in how firms protect client money. The FSA also seeks comment on some wider issues in relation to its fundamental review of the client assets regime with the aim of producing better results in the insolvency of an investment firm. The paper can be found here:

Note: This document is important reading for firms with client money permission.

Failings in the Investment Firms Interact with Clients Highlighted
A recent review has led to FSA publishing several key areas of concern particularly the inability of firms to demonstrate that client portfolios were suitable.

FSA have become aware that in some firms there is an inability to demonstrate suitability because of:
• an absence of basic know-your-customer (KYC) information;
• out-of-date KYC information;
• inadequate risk-profiling;
• some firms not implementing MiFID client classification requirements;
• the lack of a record of clients’ financial situation (assets, source and extent of income, financial commitments); and,
• the failure to obtain sufficient (or any) information on client knowledge, experience and objectives.

Further problems included:
• inconsistencies between portfolios and the client’s attitude to risk; and
• inconsistencies between portfolios and the client’s investment objective, investment horizon and/or agreed mandate.

These are areas that investment firms would be well advised to review.

Remuneration Practices
FSA published a Consultation Paper on remuneration reporting requirements for BIPRU firms. The changes proposed are largely the result of legislative requirements; these include the Capital Requirements (Amendment) Regulations 2012, which came into force in April, and the amendments to the Capital Requirements Directive (CRD3).

FSA are consulting on two topics:

• The Remuneration Benchmarking Information report – Significant banks, building societies and investment firms, that have total assets of £50bn or greater, will be required to submit information on the structure of remuneration for its group;
• The High Earners Report – banks, building societies and investment firms, excluding solo limited licence and limited activity firms, will be required to submit data on all employees in the group (excluding subsidiaries and branches established outside the EEA) earning €1m or more.

Although focused on larger investment managers the paper has relevance to investment firms across the sector.


FSA Moves to Deal with Poorly Designed Incentive Schemes

Martin Wheatley, director-designate of the FCA gave a speech a few days ago where he stated that he wanted to make it his personal mission to bring about an end to an incentive schemes in firms that do not lend themselves to customers being treated fairly and in some cases encourage firms to mis-sell. A recent review in this area by the regulator found failings that included:
• Most incentive schemes were likely to drive people to mis-sell and these risks were not being properly managed;
• Firms failing to identify how incentive schemes might encourage staff to mis-sell, suggesting they had not properly thought about the risks or simply turned a blind eye to them;
• Firms failing to understand their own incentive schemes because they were so complex, therefore making it harder to control them;
• Firms relying too much on routine monitoring of staff rather than taking account of the specific features of their incentive schemes;
• Sales managers with clear conflicts of interests, such as a responsibility to manage the conduct of sales staff whilst themselves able to earn a bonus if their team made more sales; and
• Firms not doing enough to control the risk of mis-selling in face-to-face situations.

Firms would do well to review their incentive and remuneration schemes in the light of these points. To be more specific FSA expect firms to:
• properly consider if their incentive schemes increase the risk of mis-selling and, if so, how;
• review whether their governance and controls are adequate;
• take action to address any inadequacies – this might involve changing their governance and/or controls, and/or changing their schemes;
• where risks cannot be mitigated, take action to change their schemes; and
• where a recurring problem is identified, investigate, take action and pay redress where consumers have suffered detriment.

FSA CII Presentation
Two lectures at the Chartered Insurance Institute in the last month looked at the impact of changing regulation on the insurance industry:

Julian Adams (insurance division director, Financial Services Authority) looked to that launch of the FCA and PRA next year and hopes the two regulators will make forward-looking judgement calls. He argued that the FSA’s old approach of simply basing supervision on backward looking returns, based on data which bears little resemblance to actual markets will not suffice in the 21st century.

He also anticipated a trend towards a greater focus on identifying the key risks that individual firms are exposed to along with an ever-growing focus on ensuring that firms’ solvency positions remain healthy.

He also observed that over recent years there has been a development of a regulatory framework which has moved first from one of self regulation onto a statutory basis and then secondly moved from being national in its characteristics to one which is increasingly shaped by international (EU) standards.

In contrast Stephen Lewis (chief executive officer, Zurich Insurance Company) cut straight to the chase, outlining what we must aim for:

• Balance regulation with innovation
• Proportionate regulation and proper assessment of systematic risk
• Two-way consultation
• Treating Customers Fairly
• Policyholder Protection
• Shared commitment to rebuild confidence in the financial system

And what we want to avoid at all cost:

• Overly-prescriptive and stifling regulation which is harmful to both the consumer and productivity
• Twin peaks (dual PRA and FCA regulation) should not = duplicated regulation
• Transparency works… but only if it is meaningful
• Thick rulebooks add quality over quantity

Review of Client Money Rules for Insurance Intermediaries
When FSA began regulating general insurance intermediaries seven years ago, including how they hold client money the promised to review the client money rules at some point. They have. FSA have now conducted a review of the applicable client money rules, in particular whether enhancements can be made to the regime itself or to the detailed rules.

These are significant proposals that include changes to how often client money calculations and reconciliations are done and FSA is proposing that firms have to allocate a specific approved person with responsibility for client money oversight.

Read more about these proposals a take the opportunity to respond to FSA’s request for feedback here:

Journey to the FCA
FSA released a key document called Journey to the FCA this month. Which sets out the vision for the Financial Conduct Authority, highlights new powers the FCA will have and talks about the steps that will be taken to ensure firms continue to meet FCA’s standards, as well as what will happen to firms that do not meet the standards.

The document is important reading for those responsible for compliance and approved persons. A copy is available here. I will produce and circulate a document looking at some of the action points that come out of this piece. The regulator is currently soliciting views on specific elements of the new regulatory environment – now is the time for firms like to have their say and play a role in shaping the regulation that will govern our activities for the foreseeable future. FCA are already saying the will put more responsibility on providers to ensure that products only reach the customers they were designed for. They will also have tougher powers to ban misleading financial promotions. FCA are exploring the possibility of a product pre-approval scheme and are indicating their intention to publish details of situations where they have intervened, with a firm, for example on a financial promotion – which certainly raises the reputational risk stakes if firms get regulatory issues wrong.

In the near future, we can also expect consumer credit regulation to fall under that FCA. Worth being aware of the following practical points:

• approved persons already registered with the FSA will not need to reapply to become regulated by the FCA and PRA. We will be automatically transferred to the appropriate regulator (the FCA) at Day One.
• Gabriel and ONA, the online systems for reporting regulatory data, and applications and notifications respectively, will continue to be used.
• Firm reference numbers and individual reference numbers will remain the same.
• There will be only one Register for all firms, as there is now. It will be accessed via the FCA and the PRA websites.
• Applications made to the FSA but not completed by Day One will not need to be re-submitted. They will be transferred to the appropriate regulator automatically.

FSA’s Financial Crime Thematic Work
News is FSA’s next round of thematic reviews will focus on:
1. Money laundering, terrorist financing and sanctions risks in trade finance; and
2. Anti-money laundering and anti-bribery and corruption systems and controls in asset management firms.

FSA will be talking to a selection of their regulated firms on their arrangements regarding these topics over the coming months and expect to publish both reports by Q3 2013.

Risks to customers from financial incentives
FSA have published a guidance consultation on risks to customers from financial incentives, which applies to all firms in retail financial services with staff who are part of an incentive scheme and deal directly with retail customer transactions.

This paper gives examples of how financial incentive schemes can be a key driver of mis-selling and how firms are not adequately managing these risks.

There is specific information to help smaller firms consider how the guidance will apply to them. This can be found on pages 19 and 26.

Data Protection Officer conference 2013
The ICO's next annual Data Protection Officer conference will be held in Manchester on Tuesday 5 March 2013. More details on the Information Commissioner’s Website .

2gether Consulting chaired a 2-day conference this week on the regulatory requirements relating to outsourcing in the financial services sector. There were 16 speakers involved and presentations included: Outsourcing Evolution in Financial Services, and Regulatory Expectations in Meeting Outsourcing Requirements and there was also discussion on other external standards that impact outsourcing deals including DPA and a new ISO standard of relevance to the area. There was extensive discussion of SYSC 8 that sets out senior management responsibilities in an outsourced agreement. There were also specific presentations on outsourcing contracts as well as an analysis of best practice in the negotiation and procurement of outsourcing deals in the financial services sector. Please let me know if you require further details on any of the above topics and I will pass on a copy of my notes from the event.

Anti-bribery and corruption systems and controls in investment firms
In March 2012 FSA published a report on how firms are managing the bribery and corruption risk in their business. FSA found that, although some had started work to identify and assess their bribery and corruption risks and factor them into their controls, including policies, procedures and training and monitoring programmes, most had more work to do.
In particular:

• most firms had not properly taken account of our rules covering bribery and corruption, either before the implementation of the Bribery Act 2010 or after;
• nearly half the firms in the sample did not have an adequate risk assessment;
• management information was poor, making it difficult for FSA to see how firms’ senior management could provide effective oversight;
• only two firms had either started or carried out specific internal audits on the topic;
• there were significant weaknesses in firms’ dealings with third parties used to win or retain business; and
• many firms had recently tightened up their gifts, hospitality and expenses policies, but few had processes to ensure gifts and expenses in relation to particular clients/ projects were reasonable.
On the positive side; FSA were pleased to see, that most firms used senior committees to drive the Anti-bribery and corruption (ABC) agenda, and generally there was an appropriate level of senior management involvement in decision-making about new third-party relationships or transactions.

Overall, the report concluded that the sector has been too slow and reactive in identifying, assessing and managing their bribery and corruption risk. In particular, the introduction of the Bribery Act and FSA’s visits were the main triggers for many firms in our sample to review, or consider for the first time, their approach to ABC.

Martin Wheatley speech on the future of conduct regulation
Martin delivered the keynote speech at the Association of British Insurer's Future of Conduct Regulation Conference. He set out how conduct regulation will be changing and how the new regulator will seek to get a fair deal for consumers – some of the material in this speech is covered in the ‘Journey to FCA’ document above.

Focus on Complaints Data – Ever Wonder What Happens to Your RMAR Data?
The total overall number of complaints increased by 59% to 3,577,599 in the first half of 2012.

The increase was driven by a rise in the volume of complaints about ‘general insurance and pure protection’ that increased by 99% to 2,541,430. Most notably within this product group were the number of complaints about payment protection insurance (PPI) which rose by 129% to 2,232,294 making up 62% of total complaints.