Enforcement approach
Last year, Nikhil Rathi said that we would begin to see a different type of FCA – one that is more innovative, assertive and adaptive. This message continues in the FCA's recently published Strategy 2022 to 2025 and Business Plan 2022/23.
The FCA positions itself as an outcomes-focused regulator. It says: ‘We are now focusing on results rather than being driven by processes. Our Strategy sets out, for the first time, the outcomes we expect all firms to deliver across our markets’. The Business Plan outlines ‘the key work we will do over the next 12 months to deliver these outcomes, how we will measure progress and also provides examples of our work’. One example of the FCA’s focus on outcomes is, of course, its new Consumer Duty Principle: A firm must act to deliver good outcomes for retail clients. (More on the Consumer Duty below).
The FCA intends to:
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use its full range of tools from competition to policy and from supervision to enforcement to address causes of harm.
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rely more on tools that have an instant effect when there’s immediate harm, rather than launching fuller, longer investigations. In terms of what these tools might be, elsewhere in the Business Plan the FCA refers to tools which help it to make better use of data and help it to act ‘faster and more decisively’, such as RegData, digital listening tools and automated webscraping tools.
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take action against risky firms to send a clear signal to others putting consumers at risk - ‘improve now or you’re next’ – suggesting it will look to make an example of such firms.
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use its enforcement and intervention powers more actively, pushing the boundaries where it needs to.
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act faster and, where it can, prevent harm before it happens, suggesting early action and an increasingly interventionist approach.
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test how far it can go to warn consumers directly when it thinks an authorised firm is misleading consumers about the 'safety' of its products or services.
The use of data plays a key part in helping the FCA become a more effective supervisor and enforcer. The FCA’s Data Strategy will be published in the coming months. It aims to make the FCA more effective by using data to help identify emerging risks, so it can intervene early rather than responding once harm has already happened. The FCA will also be exploring how it can use machine learning and AI for supervisory and enforcement purposes. (It will publish a Discussion Paper on AI later this year). And it will explore the concepts of ethics and bias in algorithms and AI to ensure that all technologies are used in a responsible way that avoids causing harm to consumers.
Where the FCA lacks the regulatory powers to intervene (i.e. regarding activities or firms beyond its regulatory perimeter), it will ‘call out’ its concerns to try to stop serious harm. It gives the example of successfully engaging with the UK Government to combat online consumer harm through proposed new legislation (the Online Safety Bill), following which Google changed their policy so that only FCA-registered firms can advertise financial promotions with them. The FCA says it will continue to engage with other tech platforms who now urgently need to follow through on their commitment to implement similar measures.
Areas of focus
Problem firms: Focus on Threshold Conditions
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There is a focus on firms that do not meet the FCA’s Threshold Conditions. The FCA says it will remove them from the market ‘at pace and at scale’. ‘Threshold Conditions’ are the minimum conditions which a firm is required to satisfy, and must continue to satisfy, to be given and retain permissions.
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The FCA intends to develop an automated approach for identifying simple Threshold Conditions breaches.
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It says it will expand the types of Threshold Conditions breaches it takes action against, including more firms that ‘demonstrate over time that they do not have adequate resources to operate in the interests of consumers and markets without material intervention from the regulator’. In other words, removing firms that consistently don’t meet the FCA’s minimum expectations.
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The FCA proposes to conduct a small number of complex Threshold Conditions test cases to determine whether its aims are supported by current legislation and policy and, where necessary, seek to make changes to support its ambitions.
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In the short term, the FCA will measure whether it is achieving its goal of removing firms that fail to meet the Threshold Conditions by the increase in the number of cancellations or withdrawals over the next three years.
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The FCA aims to increase its resources, with new hires providing extra capacity to drive faster and more targeted action. This is also perhaps in response to a recent increase in staff departures at the FCA due to dissatisfaction with proposed pay reforms.
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It terms of targeted action, it seeks to adapt its response to the circumstances it faces, targeting the requirements it imposes on firms so they match the risks they pose. For example, requiring firms to stop specific activities or taking on new business.
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It aims to act earlier and more assertively to prevent harm and intervene before problems become systemic.
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And it will readily make use of its formal powers to reduce and prevent harm, accepting a higher risk of legal challenge.
Redress: More from firms, less from the Financial Services Compensation Scheme (FSCS)
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By acting earlier and more assertively, and intervening before problems become systemic, the FCA hopes to stabilise and then reduce the FSCS.
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It aims to make the redress framework fairer by seeing more consumers get redress from the firm that owes them money.
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It seeks to identify potential problems earlier and, where appropriate, carry out redress exercises with firms, so they quickly remedy harm. For example, intervening where consumers are complaining and it is more efficient and effective for the firm to resolve these complaints without them having to be referred to the Financial Ombudsman Service.
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The FCA intends to enable more consumers who have suffered harm to have access to fair redress before firms fail. Relatedly, the FCA is focused on improving firms’ financial resilience so they can cover a larger proportion of their redress liabilities. The regulator recognises, however that it does not run a ‘zero failure regime’ so firms may fail owing consumers redress, and in some cases the FSCS may be called upon. That said, this should only be seen as ‘a fund of last resort’.
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When firms fail, the FCA says it will be more assertive with its powers to start insolvency processes when necessary to mitigate harm..
Appointed Representatives (AR): More assertive supervision of high-risk principals
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While the AR regime has benefits, including encouraging effective competition and providing market access, evidence shows that principals’ oversight of ARs is not always effective. Principals generate more complaints and supervisory cases than other directly authorised firms. The FCA says that the potential for consumer harm from ARs is too high, and that consumers are at risk of being misled, mis-sold and under-protected when things go wrong. As such, the FCA aims to take more assertive supervision of high-risk principals, including greater use of regulatory tools and enforcement action.
Financial crime: A system-wide response
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The FCA says it will be more proactive in its supervision. Where it detects harm or UK-wide financial crime vulnerabilities, it will share intelligence with its partners – in the UK and internationally - to drive a system-wide response.
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Over the next two years, it says it will focus additional efforts on two types of fraud: investment fraud (via its Consumer Investments Strategy) and authorised push payment fraud. These efforts will go over and above its existing work to stop and prevent fraud.
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It aims to undertake a small number of assessments of firms’ anti-fraud systems and controls to understand and evaluate how they are protecting consumers from fraud.
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And it aims to put greater resource into its intelligence gathering and expanding its analytics to better spot and track potentially fraudulent activity, and to reduce the average amount of money lost due to scams.
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The FCA says it will enhance its capabilities to identify, alert and request that platforms take down unauthorised financial promotions, associated websites and social media accounts.
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More generally, it states that it will continue to use its enforcement powers to disrupt, pursue and sanction those committing financial crime, fraudsters and their enablers.
Crypto: Risks for consumers, firms and market integrity
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Cryptoassets are increasingly being adopted and incorporated into existing financial services. In March 2022, the FCA published a statement reminding authorised firms of their existing obligations where they are interacting with, or exposed to, cryptoasset services. Firms remain responsible for assessing the risks to their business and consumers. The FCA says it will continue to assess that firms are adequately taking account of cryptoasset risks and making it clear to consumers when they are interacting with unregulated services.
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It adds that it will continue to supervise cryptoasset firms’ compliance with the Money Laundering Regulations (MLRs). The FCA will rapidly intervene where firms risk being used as conduits for illegal activity, or where firms pose harm to consumers or market integrity (for example operating without registration, perpetrating fraud or engaging in high-risk activities).
Market abuse: Greater ability to detect
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Over the next two years, the FCA intends to improve its ability to detect market abuse, through a significant upgrade in its market surveillance systems, which will enable it to keep pace with evolving market abuse techniques. This will include moving its market monitoring capability closer to real time and improving its data capabilities so that, in the future, it can better monitor a broader range of asset classes.
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When it finds market abuse, it says it will take decisive action. The FCA will use the full range of its supervisory and enforcement tools, including criminal and civil sanctions where appropriate, to pursue offenders and deter future wrongdoers.
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Two key areas of focus will be: (i) ensuring accurate and timely disclosures by firms and issuers of securities; and (ii) firms' systems and controls around market abuse.
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The FCA will measure its progress in this area by the increase in the number of interventions it makes, although it states that in the longer term, it is ‘still considering the best way to measure market abuse and misconduct enforcement cases and outcomes’.
Operational resilience: Focus on Critical Third Parties (CTPs)
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With the Bank of England and the Prudential Regulation Authority, the FCA aims to publish a discussion paper on CTPs in 2022 which will propose an oversight regime to set resilience standards, a testing approach, and enforcement powers for CTPs, most likely driven partly by the increasing use of cloud services providers in the financial services sector. The FCA intends to use responses to the discussion paper to inform a consultation in 2023.
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From 31 March 2022 to 31 March 2025, the FCA says it will assess how able firms are to remain within their impact tolerances (i.e. the maximum tolerable amount of disruption to an important business service) ahead of the 31 March 2025 deadline, from which point they will need to show they can remain within their impact tolerances.
Consumer protection: Making the Consumer Duty an ‘integral part of [the FCA’s] regulatory approach and mindset’
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The FCA proposes to publish the policy statement and final rules relating to the new Consumer Duty by 31 July 2022, with firms having until April 2023 to implement the Duty. The FCA aims to embed the new Consumer Duty in its approach to supervision and enforcement, so it will increasingly focus on the outcomes which consumers experience. For example, it will focus not only on checking whether firms comply with disclosure rules but also on whether consumers understand the products they buy. The FCA would expect to see evidence of this.
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It says it will continue to use its regulatory toolkit, including its powers to enforce consumer protection legislation – e.g. Consumer Rights Act 2015, Consumer Protection Unfair Trading Regulations 2008 - to address harm where it sees poor practice.
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It aims to intervene swiftly and assertively against authorised firms issuing non-complaint financial promotions and against unauthorised firms conducting activity that could lead to mis-selling and financial losses.
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To ensure consumers are empowered to take decisions in their best interest, the FCA says it will undertake robust investigations informed by behavioural economics to test digital consumer journeys – understanding how consumers access information and make decisions about digital financial products and services, and ensuring consumers are empowered to take decisions in their best interest.
ESG: Enforcement action on the horizon?
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The FCA is developing metrics to measure the incidence of (i) misleading marketing of ESG products; and (ii) the increase in quality and quantity of climate-related disclosures.
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It proposes to monitor firms and take enforcement action as needed on how firms manage the impacts, risks and opportunities from ESG issues, including how they ensure customers are treated fairly. It says it will develop new interventions as necessary.
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It aims to embed ESG across its organisation so that more of its staff are empowered to take action. It says it will identify where firm practices do not meet its expectations (e.g. greenwashing) and intervene swiftly to protect consumers. In the past the asset management sector has been ‘called out’ by the FCA for falling below its expectations in this space (see ‘Dear Chair’ Letter in July 2021). If this sector hasn’t improved, it may be in the FCA’s line of fire.
Next steps
In its bid to become more innovative, assertive and adaptive, the FCA has set itself an ambitious programme, covering a wide range of areas. Time will tell whether the FCA delivers on its promises – and whether we see enforcement action by the regulator as outlined above. Firms should visit areas of their business which touch on the areas of focus highlighted by the FCA to ensure all necessary regulatory rules and standards are being met.
Our financial services investigations and enforcement team have a wealth of experience in advising financial services clients on all areas of contentious regulatory work, so please get in touch if you wish to discuss anything in this article or otherwise.
Authored by Claire Lipworth and Daniela Vella.
