Topic 2 - The Prudential Regulation, and Financial Conduct Authority

PRA is concerned with the financial arrangement of a business, and whether or not financial affairs are arranged in such a way as to not threaten the operation of the business. 

FPC looks at the economy in broad terms to address any risks that might happen on a large scale.

FCA is responsible for the conduct regulation of all firms not covered by the PRA (some are dual regulated like banks, building scoieties, credit unions, insurers etc. 

The PRA has the power to veto any decisions made by the FCA that may threaten financial stability. 

Any companies acting in regulated activities must be authorised under the regulated activities order. Any deposit taking, insurance, managing, operating, advising, lending, counseling is regulated. Permission is listed in the PART iv PERMISSION.

Two key categories of investment - Securities (shares, debentures, gilts) & contractually based investments (life policies, pensions, options & futures)

The PRA focuses on the harm firms can cause to the stability of the financial system. 

Firms must have: 
LIQUIDITY
RISK MANAGEMENT
PRUDENT CONDUCT
BE FIT AND PROPER
ABLE TO BE SUPERVISED 

The three key areas of prudential control are:

CAPITAL ADEQUACY -  banks own funds, not from shareholders or investors.
LIQUIDITY - The speed at which cash can be acquired (through borrowing or selling assets)
SOLVENCY - the banks own funds (short term assets) in relation to it's longer term assets (loans to customers)  

Banks own 'capital base' must be sufficient to not place deposits at risk, whereas shareholders are expected to take risks. 

Minimum capital is decided by SOLVENCY RATIO - own funds as a percentage of the risk-adjusted value of its assets. (defined by SCR - Solvency Capital Requirement)

EU SOLVENCY DIRECTIVES & key legislation for insurers
Solvency 2 is current and adopted by all EU member states. Protects policyholders interests. 
Its main aims are to Reduce the risk of a company being unable to meet its claims and reduce losses of claims not paid in full, establish a disclosure system for early problem identification and promote confidence in the stability of insurance sector. 

It is met through 3 pillars. 1. capital requirements, 2. governance & risk management requirements, 3. disclosure & transparency rules.

Insurers required to submit an ORSA - own risk & solvency assessment 

The requirements of Solvency 2 became effective Jan 2016

The ease and speed at which an asset can be converted into cash without significant loss of capital value to meet demands for cash outflows.

LIQUIDITY RISK is the risk that although solvent, does not have sufficient resources to meet obligations if they fall due.

Asset Liquidity: A firm's assets can be sold for cash, reach maturity date, and provide security from borrowing. Asset Concentrations, where lots of receipts from assets occurring at the same time should be avoided.   

Liability Liquidity: Banks must avoid the situation where a single factor could result in significant claims at once - liability concentration. Wide-spread maturity dates is a way to achieve this. 

Senior Managers Regime 2016 - personally accountable for specific aspects of a business. FCA/ PRA define certain senior management duties. The regulators personally vet those who apply for a senior management role. 

Senior managers must be equipped for their role effectively. 

All managers are subject to a code of conduct, and if found guilty of leading the business to fail - maximum sentence 7 years/ unlimited fine.

Firms should have whistleblowing procedures in place for employees to report inappropriate behaviours or circumstance. These procedures should help not hinder.

All aspects of a financial services institution should be kept under review to ensure investments are being handled safely. This can be carried out by individuals, groups, auditors, trustees, compliance officers etc. 

The regulatory regime of the PRA is based on 8 fundamental rules, measuring the likelihood of a risk event occurring and the impact if it did. 

1. Conduct business with integrity
2. Conduct business with skill, care, and diligence
3. Act in a prudent manner
4. Maintain adequate financial resources
5. Effective risk strategy & management systems
6. Deal with regulators in an open & cooperative way
7. Prepare for conflict resolution 

The PRA supervisory approach is as follows:

1. Judgement based approach - Are the firms safe and sound? Able to meet thresholds?
2. Forward-looking approach - Assess current and future risks. 
3. Focused approach - Looking into firms those pose the biggest risk of stability to financial system

Responsible for regulating the conduct of retail financial services. It has one strategic objective: To make relevant markets work well.

This is delivered through three operation objectives:

1. To facilitate efficiency and choice in the market for financial services. 
2. To secure an appropriate degree of protection for consumers. 
3. To protect and enhance the integrity of the UK financial system 

The FCA is directly accountable to HM Treasury & Parliament. 

In order to deliver good market conduct, the FCA looks at behaviour that damages trust in the integrity of the financial markets. 

1. Focus on wholesale conduct to enhance trust and confidence in these markets.

2. Trust in the integrity of markets where poor behaviour leads to the detriment of customers. 

3. Preventing market abuse by policing and tackling criminal and civil abuse

The FCA achieves this through: 

PRODUCT GOVERNANCE & INTERVENTION - Scrutiny of products sold, the FCA has the power to ban products that pose an unacceptable risk to consumers. 

FINANCIAL PROMOTIONS - Banning misleading adverts and promotions that don't help consumers make reliable and informed choices. 

PUBLICISING ENFORCEMENT ACTION - The FCA can publicly announce when action has been taken, and details of unacceptable behaviour. Consumers wil know what action is being taken on their behalf. 

Promoting competition so customers can have a range of options, and make informed choices. 

From April 2015 FCA has more powers to enforce restrictions detailed in Competition Act 1998. It can also carry out market studies and investigation under Enterprise Act 2002. 

It will want to promote competitive markets where firms compete on services; prices being aligned with the cost of production and distribution; innovation & product development. 

The FCA and CMA (Competition & Markets Authority) have the same powers so are concurrent regulators. 

FCA STRESSES OUTCOMES RATHER THAN MEANS. Businesses can develop their own culture where they seek to achieve the FCA outcomes. 

11 principles for businesses

1. Integrity 
2. Skill, care & diligence 
3. Management & control- must organise & control affairs responsibly.
4. Financial prudence - maintain adequate financial resources.
5. Market Conduct - observe proper standards.
6. Customers Interests - Pay due regard to customer interest and treat them fairly 
7. Communications with clients- Clear, fair and not misleading
8. Conflicts of interests - must manage conflict of interest fairly. 
9. Customers relationship of trust - must keep customers trust and give accurate advice.
10. Clients assets - must arrange adequate protection for clients assets. 
11. Relations with regulators - must be open and cooperative with regulators.

An individual must be 'Fit and Proper' to undertake controlled functions (FSMA 2000)

HONESTY, INTEGRITY & REPUTATION - Criminal record, known contravention of FCA, complaints, insolvency, dismissal from a position of trust etc. 

COMPETENCE OR CAPABILITY - Must meet training and competence requirements.

FINANCIAL SOUNDNESS - Current financial position, any previous bankruptcy.  

A firm must be able to show consistently that the fair treatment of customers is at the heart of their business.

Fairness is Flexible & Dynamic and can vary with individual circumstance. 
Fairness must be at the center of all business practice: product design, sales, marketing, advice, selling, administration, post sale activities. 

This should lead to expected company behavior: Considering specific target markets, ensuring communications are clear, honoring promises, getting rid of root causes of complaints, high-quality advice, clear literature. This responsibility is down to the senior managers of a firm. 

There are 6 outcomes customers can expect if treated fairly: 
1. Confident in the firm's commitment to them, 2. products meet their needs, 3. given clear information, 4. advice given is customer specific, 5. products perform as expected, 6. no unreasonable barriers when complaining or leaving. 

Firms must demonstrate to FCA how their culture & strategies deliver fair treatment - eliminating 'conduct-risk'. 

Supervisory work focused on firms that failure would have the biggest impact. It studies market sectors and uses that information to investigate areas where competition isn't working well. 

IMPACT CATEGORIES: 
Fixed Portfolio Firms  - those with a large number of retail customers where failure poses substantial risk. 
Flexible Portfolio Firms - represent the vast majority and are supervised by market work, communication, engagement & education. They pose low risk. 

FCA supervision has 10 principles:
1. Ensure fair outcomes for consumer & markets, 2. Be preemptive and forward looking, 3.focus on root causes of big threat problems, 4. judgment approach focused on outcomes, 5.ensure firms act in the right spirit, 6. examine business models & culture impact, 7.individual accountability emphasis, 8. acting in a robust manner when things go wrong, 9. communicating with regulators openly, 10. joined approach so messages are consistent. 

MARKET ABUSE - insider dealing, unlawful disclosure of inside information, market manipulation. 
MONEY LAUNDERING - legislation must be met: Proceeds of Crime Act 2002, Terrorism Act 2000 and Money Laundering Regulations 2012

If rules have been broken (falsifying, contravening, crime participation) The FCA can undertake a general investigation - looking at the business as a whole, or a specific investigation - looking at a particular person.

The FCA can demand that ANY person they believe to be related to the incident provide information or, in the case of a specific investigation, answer questions. 

If an investigation finds rules broken, the FCA can take the following steps:

VARIATION OF FIRMS PERMISSIONS - Removal of business permitted activities or scope of a particular activity. 
WITHDRAWAL OF APPROVAL - Removal of personal approval to carry out permitted functions. 
INJUNCTION - Prevention of person benefitting from actions that contravened regulation. 
RESTITUTION - Forfeit of any benefit from the action to the FCA
REDRESS - Making good any losses
DISCIPLINARY ACTION - warnings, statements, penalties, compensation order, criminal charges. 
ENHANCED SUPERVISION - Reviews, accountable future conduct, using other tools to watch firms more closely. 

For a dual-regulated firm, the FCA will consult PRA to decide in a joint approach or single approach is best.