FCA’s future approach to retail consumers

In April 2017, the FCA published their Mission which explained the process for setting regulatory priorities and how they regulate to deliver good outcomes for a wide range of users of financial services and intervene in the relevant markets. The publication of Mission Statement marked the FCA’s desire to be more transparent about the way they work and it also explained how they hold themselves to account while carrying out their statutory obligations.

They have now released, in November 2017, an Approach paper setting out their vision for well-functioning markets for consumers. They have outlined the following key indicators which they believe demonstrate the existence of the conditions they want to see when competition is working well in consumers’ interests.

  • Consumers are enabled to buy the products and services they need because the environment in which they are sold is clear, fair and not misleading with a good choice architecture.
  • High-quality, good value products and services that meet consumers’ needs.
  • Inclusion – where everyone is able to access the financial products they need and the needs of vulnerable consumers are taken into account.
  • Protection – consumers are appropriately protected from harm.

The FCA have noted certain constraints that firms face in delivering the desired outcomes for consumers. These typically arise from some consumers’ low levels of financial capability, financial resilience or level of confidence in managing their money and finances, coupled with behavioural biases. While acknowledging the general principle that consumers should take responsibility for their choices and decisions, the FCA have cautioned firms to be aware of the very real factors that might limit consumers’ ability to do so. Accordingly, the FCA expect firms to make decisions for customers based on real world consumer behaviours and not to exploit biases. They also expect firms to exercise extra care where consumers may be vulnerable, reminding firms of their regulatory obligations as set out by the FCA from time to time.

The FCA also pointed out that whereas the Principle of ‘treating customers fairly’ applied to all firms and the FCA Handbook requires firms to act in the best interests of their clients, a number of stakeholders have identified a potential need for FCA to introduce a new Duty of Care that firms must apply in their dealings with customers. This would impose an obligation for firms to exercise reasonable skill and care in the provision of services to consumers. The FCA confirmed that they would undertake a thorough and detailed consideration of the issue against the impact on the Handbook as a whole. They believe that it is best done following the UK’s withdrawal from the European Union once the relevant parts of the European legislation have been incorporated into UK law.

They propose to publish in due course a Discussion Paper to explore the Duty of Care issue as part of the broader exercise of reviewing the FCA Handbook.


Stress Testing the UK banking system and increase in counter-cyclical capital buffer

The Bank of England (the Bank) published in November, the results of the stress testing carried out for the UK banking sector in 2017.

The 2017 annual cyclical scenario (ACS) was calibrated to reflect the March 2017 assessment of risks.  At that time, the Financial Policy Committee (FPC) concluded that domestic credit risks were at a standard level overall, while global vulnerabilities were elevated and had increased somewhat over the past year.  Reflecting these risks, in the ACS test scenario considered was as below:

  • World GDP falls by 2.4%.
  • UK GDP falls by 4.7%.
  • UK unemployment rises to 9.5%.
  • UK residential property prices fall by 33%.
  • UK commercial real estate prices fall by 40%.
  • UK Bank Rate rises and peaks at 4%.
  • The sterling exchange rate index falls by 27%.

The economic stress scenario in the test was more severe than what was experienced during the last global financial crisis. The Bank was pleased that significant improvements in asset quality since the crisis meant that the loss rate on banks’ loans in the stress test remained the same as in the financial crisis.

The review showed that, for the first time since the Bank launched its stress tests in 2014, no bank needs to strengthen its capital position as a result of the stress scenarios tested. The 2017 stress test shows the UK banking system is resilient to deep simultaneous recessions in the UK and global economies, significant falls in asset prices and a separate stress of misconduct costs. Conduct related stress test has been introduced by the Bank from last year.

The UK banks had, in aggregate, a Tier 1 leverage ratio of 5.4% and a Tier 1 risk‑weighted capital ratio of 16.4%.  The aggregate common equity Tier 1 (CET1) ratio was 13.4%, which is three times stronger than ten years ago.  After applying the severe losses in the test scenario, the participating banks would, in aggregate, have a Tier 1 leverage ratio of 4.3%, a CET1 capital ratio of 8.3% and a Tier 1 capital ratio of 10.3%.  IN the opinion of the Bank, the UK banking sector would be able to continue to supply the credit the real economy could demand even in a very severe stress.

In the test, banks could incur losses of around £50 billion in the first two years of the stress. This scale of loss, relative to their assets, would have wiped out the common equity capital base of the UK banking system in 2007. However, the stress test showed that these losses can now be absorbed within the buffers of capital the banks have on top of their minimum requirements.

The FPC has increased the system‑wide UK countercyclical capital buffer rate, which applies to all banks, from 0.5% to 1%.  This has been decided by the losses banks made on their UK credit assets in the stress test.

Capital buffers for individual banks (‘PRA buffers’) will be set by the Prudential Regulation Committee (PRC) in light of the stress‑test results.  PRA buffers will in part reflect the judgement made by the FPC and PRC in September 2017 that, following recent rapid growth, the loss rate on consumer credit in the first three years of the scenario would be 20%.


FCA review of Compliance function in banking

The FCA have published, in November 2017, the findings of their review into the evolving nature of compliance function in banking. Their review indicates that the compliance function is moving toward a pure, independent second line of defence risk function with a higher profile within firms. The FCA found that compliance representatives have been added to boards and governance committees and reporting lines of the function have been elevated in a number of banks.

The FCA observed that firms were seeking to clarify the shifting boundaries of the first and second lines of defence to help define the responsibilities of the compliance function, with regard, for instance, to financial crime. They expect such organisational change to continue in the coming years. While the mandates of compliance function remain relatively static, they are still considering how best to define their responsibilities as a second Line of Defence (LoD) function. The FCA are of the view that, in defining their responsibilities, compliance functions may benefit from considering how they interact with other second LoD functions such as Legal and Risk, and the third LoD, i.e. Internal Audit. Within the function itself, Compliance needs to ensure it is adequately balancing its role as advisor to the front line with its role of providing challenge to the management.

The FCA have said that most regulated firms and heads of compliance may find the contents of this paper helpful in developing their departments.


ESMA report on requirements of Compliance Function under MiFID

The European Securities and Markets Authority (ESMA) has reviewed and set out the need for adequately resourced compliance function to ensure compliance with the requirements of the Markets in Financial Instruments Directive (MiFID).

The compliance function is a key source of information for supervisors on the firm’s compliance with MiFID requirements. The compliance function is responsible for identifying, assessing, advising, monitoring and reporting on the risk that a firm fails to comply with its obligations under MiFID and the respective national laws, as well as the related standards set out by ESMA and the National Competent Authorities (NCAs). For this reason, ESMA decided to perform a peer review on the Guidelines on certain aspects of the MiFID compliance function requirements. The peer review aims at enhancing supervisory convergence in the application of the Guidelines and helping NCAs to enhance their supervisory approach towards the compliance function.

NCAs are expected to check that the compliance function at supervised investment firms performs compliance risk assessments as part of its risk-based approach and the function ensures the monitoring of the compliance obligations of firms in addition to performing its advisory and reporting obligations.

The ESMA’s Assessment Group (AG) has found a high-level of compliance with the Guidelines among NCAs, it has also found quite some diversity in the supervisory approaches applied by NCAs. For each of the guidelines in the scope of this peer review, certain NCAs applied a more robust process than others relating to certain aspects of the guidelines. AG’s country visits to review MiFID compliance standards were informative in that they provided AG with more detail on the particular approach of a NCA. For instance, one NCA focused on the licensing of the compliance officer and frequent interactions with this officer as a key point of contact for the NCA. It is also worth noting that for many NCAs the compliance function was generally not the main objective of a supervisory review but an ancillary target of supervision of firms’ obligations under MiFID.


FATF publishes updated guidance on financial inclusion

The Financial Action Task Force (FATF) have published a paper, in November 2017, to update its guidance on financial inclusion. The guidance relates to the application of measures that enable more individuals and businesses, especially low-income, unserved and underserved groups, to access and use regulated financial services.

FATF standards require financial institutions to apply appropriate customer due diligence (CDD) measures as part of their obligations to comply with the Anti-Money Laundering (AML) framework. However, FATF is also aware that applying an overly cautious, non risk-based approach to AML safeguards when providing financial services (both at the on-boarding stage or in the context of ongoing relationships) can have the unintended consequence of excluding legitimate consumers and businesses from the regulated financial system. To address this concern, in February 2013, FATF adopted Guidance on AML/CFT Measures and Financial Inclusion, updating the guidance it first provided in 2011.

The objective of the latest paper is to encourage countries to implement the FATF Recommendations and the risk-based approach in a way that responds to the need to bring the financially excluded into the regulated financial sector, while at the same time maintaining effective safeguards and controls against money laundering risks. It focuses on initiatives to support access to and use of basic financial services and products for low income, unserved or underserved natural persons/individuals, which are generally limited purpose or restricted use products or services. Those products and services may (1) be exempted from some AML controls based on proven low risks; (2) benefit from a simplified due diligence (SDD) regime, based on evidence of lower risks; or (3) be submitted to standard CDD supported by the use of new or alternative forms of identity documentation, including digital solutions.