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TCC regulatory update: the year so far

Chris Hamblin, Editor, London, 21 March 2017

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In this, the first monthly regulatory round-up by TCC Group, the regulatory consultancy that specialises in 'transforming culture and conduct,' we evaluate the first year in the life of of the Senior Managers and Certification Regime, the Financial Conduct Authority's vision for 'conduct' regulation, 'best execution' and other things, and proposals for initial public offerings and open-ended funds investing in illiquid assets.

The regulator’s viewpoint: 'developing the approach'

Mary Starks, the director of competition at the FCA, delivered a speech on 10th March that looked at ways in which the regulator is continuing to approach its duties through uncertain times.

Political changes such as 'Brexit' and the pension reforms, and indeed short periods of personal vulnerability, can affect the ways in which consumers make decisions and this can have significant effects on the wider economy. The question of how consumers respond to uncertainty is linked to wider questions about the role of the FCA, its priorities, and how it ought to settle on the right approach to regulation in times of uncertainty. 'The Mission,' which the FCA published in November 2016, helps to explain its interpretation of its objectives and the way it chooses its priorities.

In particular, 'the Mission' has helped to clarify the FCA’s competition remit, which is not always well understood. If competition in a market is to be effective, the FCA knows that it has to do more than keep prices low or break up dominant firms – it also has to ensure that firms are competing effectively on the multiple fronts of service, quality and price to offer consumers with better choice and value for money. The FCA is there to support a healthy competitive process and encourage it, rather than prescribe it, by removing barriers to competition and anti-competitive behaviour. Depending on the circumstance, this can involve the FCA becoming actively involved to facilitate competition (as in Project Innovate, an initiative it began in 2014 to provide innovators with regulatory support) or stepping back to allow market forces to operate.

The FCA’s asset management market study is a significant piece of work that will, hopefully, further the regulator's aim to make the industry more competitive. With the study's interim findings published in November, the FCA is now in the process of reviewing responses to its consultative process which ended on 20th February. The UK's asset management industry is the second largest in the world, so if the FCA ensures that the market works effectively, its efforts might have a noticeable effect on the lives of millions of people. The study has revealed the limited nature of price competition for retail actively managed funds and a need for greater openness about costs.

The Senior Managers and Certification Regime, one year on

A year has now passed since the Senior Managers and Certification Regime (SM&CR) began on 7th March 2016 with the aim of encouraging regulated firms to concentrate on culture and governance and making individuals more accountable than ever before. The new regime came into being as a result of recommendations by the Parliamentary Commission on Banking Standards (PCBS) for the improvement of standards in financial services.

Although firms have been making steady progress towards the adoption of a culture of individual accountability, they still have more work to do. The FCA continues to work with firms to ensure that the responsibilities of senior managers are allocated properly and understood clearly.

On 7th March 2017, the rules that govern regulatory references for senior managers and staff under the Certification Regime came into force. The SM&CR will also be extended so that all elements of the regime apply to insurers. The FCA expects to consult interested parties about its plans to widen the regime to the rest of the financial services industry in the second quarter of 2017, with implementation beginning in 2018.

Investment managers failing to implement effective oversight of 'best execution'

The FCA has outlined its findings from supervisory work, looking at how investment managers ensure the best execution possible for their customers' orders. This follows the publication of a thematic review on the subject and the recent asset management market study.

The regulator has found that firms have still not addressed many of the poor practices outlined in the thematic review, particularly in the following areas.

  • Best execution monitoring in fixed income was of a lower standard than in equity trading.
  • Senior managers were not giving compliance staff enough permission to challenge their front offices about execution quality.
  • Compliance staff often lacked the necessary access to the data used by their firms' dealing teams.
  • In many cases, data used across the organisation was inconsistent and therefore could not evidence any improvement to their execution process.

However, the FCA says that there were instances of good practice at some firms, in particular where 'best execution' was considered as a high-level trading strategy and not just by the dealing teams. Other examples of good practice included effective governance processes that challenged the overall costs of execution. In addition, these firms had management information (MI) that allowed them to view equity execution costs accurately.

Efficiency and effectiveness: the FCA’s approach to primary markets

Christopher Woolard, the executive director of strategy and competition at the FCA, delivered a speech this month about the FCA’s policy towards primary markets and its proposals to amend the initial public offering (IPO) process.

The speech touched on the part that primary markets play in the economy, how the FCA supports the operation of primary markets as it pursues its objectives and how some measures that it is proposing can ensure that the markets of the UK will remain strong. The financial sector must have a clear and robust regulatory regime that is constantly adapting to market developments and associated risks. A key aim of the FCA's is to assure wholesale markets remain efficient, effective and open for business.

The importance of primary markets

The FCA is responsible for ensuring that primary markets play a vital part in supporting the wider economy, and for bringing together investors who wish to pursue investment opportunities, and issuers, who require funds to finance their business.

The wholesale financial sector has a number of responsibilities, including; financing UK and international businesses and governments; determining the cost and credit for consumers and small businesses; setting commodity prices; providing investment opportunities; aiding domestic and international trade; and making a direct contribution to the UK economy.

Making the connection between wholesale and consumers

The FCA believes that markets work well when they are transparent, efficient, fair and able to provide various benefits to consumers, shareholders and members of staff. It places particular importance on consistency and good market integrity when talking about markets working well for consumers.

It is the FCA’s responsibility to promote a healthy environment to enable wholesale markets to succeed. One of its key priorities is to address the link between wholesale and retail markets, emphasising areas such as competition, integrity and the consequences of poor conduct for consumers.

Proposals for IPO reform

For primary markets to function properly the IPO process must operate effectively. The FCA has identified areas for improvement in the process, such as the availability of information within the book-running syndicate. It has published a consultation paper on the subject.

The FCA has also published two additional papers that aim to improve the effectiveness and efficiency of the financial sector, including a discussion paper about how the needs of issuers and investors can be satisfied by changes to the UK’s primary markets, and a consultation paper which interprets the changes made to some of the key areas of the UK's Listing Rules.

FCA and Practitioner Panel launch new joint survey for 2017

In response to feedback from the financial services industry, the FCA and the Practitioner Panel will be joining forces to conduct a single industry survey for 2017, with the aim of making it quicker and easier for firms to respond.

The survey is intended to help the respective institutions better understand the issues affecting firms and how they can improve. Issues raised in previous surveys include the need for more accessible and transparent regulation and a clearer explanation of the FCA’s competition objective. As a result of these responses, changes have been made to the FCA’s website and handbook.

Good regulation of 'conduct'

John Griffith Jones, the FCA's chairman, recently delivered a speech on what good regulation looks like, with particular reference to financial conduct regulation and how it can be improved further in the light of the direction of travel since the financial crisis.

He looked at the five key factors that he believes contribute to the success of 'conduct.'

  • Government policy. Policy is the concern of the elected government and regulation works most effectively when it supports the social and economic policies that the Government sets. In cases where the main political parties agree about the direction of policy, the regulator can be forthright when it intervenes in the financial markets. In times when policy objectives compete, typically with a change of the party in power, the FCA is able to exert influence, although it is crucial for it to remain as independent as possible from the Government when it is discharging its duties.
  • Strategic objectives and perimeters. It is vital for the FCA to remain clear about its broad strategic objectives and keep them specific enough to allow people to apply them to real situations as they arise. In addition, it is hard for the Government and for the regulators themselves to set the perimeters of the FCA’s regulatory authority in the face of continually developing technology. The FCA is dealing with this by continuing to embrace and monitor the development of financial software through Project Innovate and by eventually completing its 'mission' statement, which will state its overriding objectives very clearly and go into specific details.
  • Risk tolerance. This largely represents the balance between the enforcement of rules and a recognition that infringements will always happen in a less-than-perfect industry. The FCA takes a two-pronged approach, distinguishing between ex ante regulation (identifying and reacting to potential issues in the early stages of development to minimise any potential harm) and ex post regulation (implementing a system of safety nets such as the Financial Services Compensation Scheme to deal with failures that have occurred).
  • Operational excellence. The FCA wants to create a regime that aligns firms' self-interest with regulatory objectives. As financial conduct is as much to do with human behaviour as it is about processes, it accepts that there is a high degree of subjectivity in what it does, and a corresponding risk that it might perform poorly. The FCA is aware that it has to understand psychology and behavioural economics to do its job. At a 'micro' level, when it is making everyday, specific decisions, it can certainly use technology to help it exercise of good judgement, but it knows that the former can never replace the latter.
  • Measurement and transparency. The National Audit Office has set out some concepts for the measurement of regulatory success or failure. There are three main principles of economy, efficiency and effectiveness that can be measured as inputs, outputs and outcomes. In the case of conduct, it is not really possible for an auditor to evaluate effectiveness, particularly when he is trying to measure misconduct that has never taken place because the regulator has prevented it. However, surveys, reported complaints and suspicious activity levels help to give the FCA a good idea of how well or badly its regulatory regime is doing.

The current regulatory regime, unlike previous regimes, places 'conduct' regulation in the spotlight but there is still some way to go before the FCA can satisfy itself that all the areas outlined above are working as they ought to be.

FCA opens discussions on the regulatory approach to open-ended funds investing in illiquid assets

The FCA has published a discussion paper that asks interested parties to comment on the practice of investing in illiquid assets through open-ended funds. Illiquid assets may include land and buildings, infrastructure and unlisted securities. Investment in illiquid assets might yield good returns in the medium-to-long-terms and can also help a HNWI diversity his portfolio risk. However, it can be difficult for managers to calculate the daily price of a fund if that fund invests in illiquid assets whose prices are calculated less frequently. This is particularly problematic if an event in the market causes a decrease in price which is not reflected fully in fund valuations, or there is a sudden increase in redemption demand. The FCA wishes to review the current regulatory approach to open-ended funds that invest in illiquid assets in order to avoid these kinds of liquidity management issues and provide more market stability.

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