UK: Regulatory Reform: Financial Services & Markets Bill

Last Updated: 4 March 1999
The Government issued heavy summer reading in the draft Financial Services and Markets Bill. The Bill sets out the main statutory changes to establish the Financial Services Authority (FSA) as the 'super-regulator' of banking, insurance and investment business in the UK. It affects the scope of financial regulation and provides for new authorisation, marketing and enforcement procedures that will cut across and consolidate existing regimes.

The FSA will take on the responsibilities of nine existing regulators: the SROs, the Insurance Directorate of the DTI, the Building Societies Commission, the Friendly Societies Commission, the Registry of Friendly Societies and the Recognised Professional Bodies. It assumed responsibility for the supervision of banks on 1 June, under the Bank of England Act 1998.

The consultation period is very short (the deadline is 30 October). It is likely that the Bill will be pushed through the next Parliamentary session and the FSA will assume most of its new powers by early 2000. This gives very little time to assess the adequacy of the proposed arrangements.

OVERVIEW

The Bill is mainly in the form of enabling powers and the secondary legislation has not been published. This means that key issues remain unclear, including the scope of regulated business, the regimes for marketing, collective investment schemes and the proposed harmonisation of insolvency arrangements for financial institutions. The scope of regulation may be extended to cover the taking of deposits and the sale of mortgages and general insurance. There are also concerns about the extra-territorial reach of the Bill and whether there will be an overseas persons exemption. We are concerned that the piecemeal and uncoordinated approach taken at the time of the passing of the Financial Services Act 1986 may be repeated.

In addition, the Bill gives unprecedented powers to the FSA to which the proposed Financial Services Tribunal may not be a sufficient counterweight. Nor is it clear whether the move to a single regulator will give rise to the expected cost savings, particularly since the FSA will exercise a wider range of criminal and civil powers than has been previously available to financial regulators.

However, a number of aspects of the Bill are to be welcomed. The FSA will for the first time operate under specified statutory objectives. The Bill aims to provide for unified procedures to cover authorisation, supervision, fitness and properness, the approval of controllers, complaints handling and compensation. The FSA will also have waiver and guidance powers which may be analogous to US no-action letters.

FSA OBJECTIVES

In addition to the specific statutory objectives covering market confidence, public awareness, consumer protection and the reduction of financial crime, the FSA will be obliged to consider criteria including resource efficiency, the desirability of financial innovation and the need to maintain the UK's competitive position. Cost-benefit analysis of new rules and regulations is also required. This is a welcome articulation of the FSA's future role. Together with the proposal to establish an FSA practitioner forum and the publication by the FSA of a paper "Meeting Our Responsibilities" (which sets out the FSA's general regulatory approach), it goes some way towards meeting our concerns that regulation of wholesale business might become too heavy-handed.

However, there are concerns regarding the accountability and transparency of the new system. The FSA's rules will not come under direct Parliamentary scrutiny (unlike delegated legislation) and the FSA tribunal, though managed as part of the Court Service, will only review the FSA's decisions at the appeals stage.

EXTRA-TERRITORIALITY

The territorial scope of UK statutory regulation of financial services is dramatically extended and, although we assume this will be cut back by exemptions in key secondary legislation, the Government has not yet made this clear.

The Bill covers, not only the existing scope under the Financial Services Act 1986 (namely activities carried on in the UK from an office in the UK or on a cross border services basis), but it is extended to cover activities carried on wholly outside the UK by a regulated person, so long as the regulated person has a UK head office. So, for example, the activities of the Singapore branch of a UK regulated person would be deemed to be carried on in the UK and would appear, at least in principle, to be subject to the FSA's conduct of business rules. Nor does the Bill contain a comparable exemption to the existing overseas person exemption under the Financial Services Act 1986. The absence of such an exemption could seriously diminish the attractions of London as a cross-border financial centre.

REGULATED ACTIVITIES AND EXEMPTIONS

So as to cover a whole range of financial activities, the concept of a "regulated activity" is introduced. A regulated activity may relate to "investments", which are defined as "any asset, right or interest" as prescribed by the Treasury. The secondary legislation prescribing these has not yet been published, but it is likely that this will cover activities presently under the Financial Services Act 1986, with possible inclusion of mortgages, the taking of deposits, the sale of pre-paid funeral plans and general insurance at a later date.

Nor does the draft Bill contain a list of exempted activities, but our understanding is that the intention is to retain the existing exemptions (apart from the permitted persons regime).

A regulated person will be required to obtain specific permission from the FSA for each regulated activity it wishes to undertake, and some combinations of regulated activities will be prohibited (such as the existing restrictions on insurance companies doing both long-term and general business). Regulated persons currently authorised as a result of membership of a Recognised Professional Body (such as law firms and accountants) will now require direct FSA authorisation. Fortunately, re-application for membership is not envisaged: authorised persons will be deemed to be authorised ("grandfathered") under the new regime, subject to a general power to require re-application for authorisation.

APPOINTED REPRESENTATIVES AND EMPLOYEES

The growing regulatory focus on the role of key individuals and, in particular, senior executive officers is reflected in the new regime. Existing arrangements for appointed representatives and the appointment of key employees of regulated persons will be strengthened by prior FSA consent procedures. Individuals who breach the FSA's rules may be subject to the sanctions currently applied by SROs, including fines. The FSA's current power to disqualify individuals from employment in the industry will be extended to all financial sectors. The FSA will be issuing for consultation statements of principle and codes of practice to apply to senior management. Senior management, in particular that of banks, building societies and insurers, are likely to find the new regime more onerous. It is also likely that there will be increasing interest in the scope of insurance cover to help individuals with the growing possibility of regulatory proceedings.

In addition to statements of principle for senior management, the FSA has issued draft principles for firms (Consultation Paper 13, September 1998) which make the firms themselves responsible for ensuring that their senior managers are fit and proper in their roles. These principles include a requirement for firms to apportion responsibilities among their senior managers and directors in such a way that their individual responsibilities are clear, and the business and affairs of the firm are adequately monitored and controlled at senior management and board level.

A regulated person will, in future, require direct authorisation to market the products of another regulated person (rather than becoming its appointed representative). This will mean than banks and building societies, which currently can operate as appointed representatives of other providers of life insurance and investment products, will be directly regulated for these activities.

MARKETING

A tougher consolidated framework for financial promotion will replace the existing advertising and cold-calling regime. Marketing restrictions may be extended to cover various forms of promotional communications, including conversations which are not face-to-face and which do not necessarily involve cold-calling, so as to cover internet marketing. Beyond this, the absence of key secondary legislation means that it is difficult to gauge how the new regime will operate: as presently worded the Bill would prevent an unauthorised individual from suggesting to a relative that it might be time to sell her BT shares.

The new legislation, as it stands, would make breach of the cold-calling regime a criminal offence for the first time. We await with interest further details on the new regime and exemptions.

COLLECTIVE INVESTMENT SCHEMES

The regulatory regime for collective investment schemes is to remain broadly as at present. However, there will be new powers to enable the formation of a wider range of OEICS, so as to cover not only funds in securities but also funds investing in other assets such as derivatives and money market instruments. Unauthorised OEICs, namely pooled un-authorised open-ended investment companies to be known as 'PUNCs', will also be allowed (but not marketed to the public), on which there will be separate consultation in the autumn. Why the Treasury has chosen to leave the industry with the advertising challenge of products named 'PUNCs' and 'OEICs' remains a mystery.

There is good news in that the restrictions on the activities of a manager of an authorised unit trust scheme under section 83 of the Financial Services Act 1986 will be lifted (although the FSA will retain power to impose any restrictions required by EC law, or which are appropriate for other reasons).

BANKS AND BUILDING SOCIETIES

The shift of responsibility for banking supervision from the Bank of England to the FSA has already taken place (as of 1 June) under the Bank of England Act 1998, but building societies will continue to be formally regulated by the Building Societies Commission until the new legislation is in force.

The FSA has confirmed that deposit taking and general insurance business will not be subject to detailed conduct of business rules, and that it plans to proceed only as a prudential supervisor. The FSA has also allayed fears that the new principles for firms may indirectly mean an extension of conduct of business regulation to deposit taking or general insurance. It has confirmed that it has no plans to extend the scope of regulation at the moment. However, as at present, if any firm falls significantly short of the standards set by the principles, the FSA may see this as a matter of prudential concern.

INSURANCE AND LLOYD'S

The scope of insurance regulation potentially will include all contracts of insurance and contracts to transfer underwriting capacity. This means that the FSA will be able to become the regulator of general insurance if the latest moves towards a self-regulatory regime do not succeed.

In addition, the FSA will have extensive intervention and authorisation powers over Lloyd's, which may increase compliance costs for those in the Lloyd's markets. Managing Agents and Members' Agents will be subject to FSA authorisation. However, members of Lloyd's (both corporate and individual) will not be subject to authorisation (although the FSA will have this power in reserve).

Although at first it was assumed that the provisions of the Insurance Companies Act 1982 would be repealed and consolidated in the Bill, this now seems not to be the case. The Government has said that no major changes to the existing scope of regulation are likely but the wide, 'enabling' nature of the powers laid down in the Bill leaves it with maximum flexibility. The FSA has also indicated that the regulatory regimes for insurance companies and friendly societies will be reviewed.

ENFORCEMENT, MARKET ABUSE AND FINANCIAL CRIME

At least on paper, the FSA will be one of the most powerful bodies of its kind anywhere in the world. It will have disciplinary powers against regulated persons and specified employees, as well as powers to fine, to make restitution/compensation orders, to issue public reprimands and to order individual disqualifications from the industry. It will have extensive powers of investigation, including powers of compulsory questioning. It will also have the power to require regulated persons to commission an external auditor's or actuary's report on any aspect of their business (this power currently applies only in relation to banks).

In addition, the Bill introduces a new civil regime for market abuse backed by a power to impose unlimited fines on regulated and unregulated persons. The draft Code on Market Abuse will provide evidential weight of breaches of the statutory provisions. One of our main concerns in relation to the Code is the lack of clarity as to the types of activities covered and the overlap with the provisions of the existing criminal and civil regimes. (See our earlier Briefing on Market Abuse (FSA Consultation Paper 10) on our internet site ( Click Contact Link ) under the Practice Area heading Financial Services.)

The FSA will also have power to bring criminal prosecutions for insider dealing under the Criminal Justice Act 1993, for misleading statements and practices in relation to designated investments (similar to section 47 of the Financial Services Act) and for breaches of the money laundering regulations. Before imposing a fine or ordering restitution, a warning notice will be issued with the opportunity to make representations. There appears to be no right to a formal hearing until the appeals stage before the Financial Services Appeals Tribunal. The Tribunal will be managed independently as part of the Lord Chancellor's department and will include market practitioners.

One of the statutory objectives of the FSA is the reduction of financial crime. This is defined as including any offence involving (a) fraud or dishonesty; (b) misconduct in, or misuse of information relating to, a financial market; or (c) handling the proceeds of crime. There is no need for the "financial crime" to have taken place in the UK, so long as it would be classified as an offence had it taken place in the UK. It is not clear whether the "financial crime" objective will cover not only the existing criminal offences (insider dealing, market manipulation under section 47 of the Financial Services Act and money laundering) but also the new civil offence of market abuse.

The FSA will publish a further paper on the exercise of its enforcement powers which may allay some of our concerns regarding, in particular, the compliance problems in apparently overlapping criminal, civil and regulatory regimes. There are also concerns that decisions taken under the new regime could be subject to challenge under Article 6 of the European Convention on Human Rights (due to come into effect at around the same time as the new financial regulatory regime) on the basis that they take insufficient account of the right to a fair trial.

MONEY LAUNDERING

The Bill also gives the FSA wide rule-making powers in relation to money laundering, as well as powers to bring criminal prosecutions under the existing regulations. This heralds a probable shift away from the consensual 'guidelines' approach taken by the Money Laundering Steering Group and towards a more prescriptive regime.

CHINESE WALLS

The Bill, in its final form, is intended to include a provision which will remove current uncertainty regarding the effectiveness of Chinese Walls as a defence in civil actions for breach of fiduciary duty. In the meantime, however, a recent case has highlighted the difficulties which arise in this area (Bolkiah v KPMG (a firm), September 1998).

LISTING

The London Stock Exchange will remain the listing authority, but the Bill makes it easier for this to be transferred to the FSA if felt necessary (in particular, if it is felt that the LSE thereby has an unfair competitive advantage over other exchanges). At present, the sanction for breach of the listing rules is de-listing; the Bill will supplement this with a power to fine.

SINGLE OMBUDSMAN SCHEME

The various ombudsman schemes will be merged into a single statutory Financial Services Ombudsman scheme with the power to bind regulated persons (but not the consumer). This will replace, in particular, the voluntary nature of some existing ombudsman arrangements, as in relation to the Insurance Ombudsman and the Banking Ombudsman. The maximum amount payable under the scheme has not been determined. Although there may be benefits from the consumer point of view in the establishment of a single scheme, the move to a statutory system and the imminent incorporation of the European Convention on Human Rights could result in added formality and cost implications.

SINGLE COMPENSATION SCHEME

The various compensation schemes will similarly be merged into a single statutory scheme, replacing existing arrangements. The FSA has said that it does not intend to introduce cross contribution between different financial sectors, in which case there may be no overall increase in levels of payment by each sector as a result of the merger. Separately, however, the implementation of the Investor Compensation Directive may result in increased cost exposure for UK ISD firms.

EXCHANGES AND CLEARING HOUSES

The FSA will have powers of direction over Recognised Investment Exchanges and Clearing Houses. New flexibility will be introduced to amend recognition criteria. The Bill will also allow for recognition of clearing houses which do not provide clearing facilities to RIEs. The power to recognise overseas investment exchanges and clearing houses will be transferred from the Treasury to the FSA. RIEs and RCHs will also be provided with statutory immunity from civil action.

INSOLVENCY/WINDING UP

The Bill will introduce a common approach to winding up across all sectors of the financial industry. Regulations have also been issued to extend the insolvency protections under Part VII of the Companies Act 1989 to the clearing of over-the-counter business by RIEs and RCHs.

EC TREATY RIGHTS

There will be a single passport for regulated persons in relation to their European Economic Area business to replace the existing separate passports. In addition, the Bill extends the concept of automatic authorisation under the single passport directives to non-passported activities carried on by EEA financial institutions. The intention is to facilitate further the concept of home State responsibility in the context of the single market. For example, a German commodities dealer (not covered by the Investment Services Directive) could nonetheless make a notification to the FSA and be subject solely to prudential regulation by its home German regulator, without being subject to local UK authorisation, so long as relevant provisions of German law are deemed to be equivalent to those in the UK.

This note is intended to provide general information about some recent and anticipated developments which may be of interest. It is not intended to be comprehensive nor to provide any specific legal advice and should not be acted or relied upon as doing so. Professional advice appropriate to the specific situation should always be obtained.

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