FCA discussion paper on Transforming Culture in Financial Services

The FCA has published a discussion paper [12.03.2018] on Transforming Culture in Financial Services (DP18/2) containing 28 essays from a range of writers including academics, regulators, and industry which are grouped into three themes: (i) Is there a 'right' culture?; (ii) Managing Culture - The role of regulation; and (iii) The role of reward, capabilities and environment in driving behaviours.

Culture the FCA says is "a key root cause" of recent major conduct failings within the industry" so, "given its impact firms' culture is a priority for the FCA". The essays consider "what a good culture may look like, the role of regulation and regulators, how firms might go beyond incentives and how to change behaviour for the better" and the FCA hopes they will trigger discussion on transforming culture at financial services firms.

Although the FCA does not expect firms to respond formally to the DP and states that the essays in the collection do not represent its views, it asks that those with an interest in financial services – industry, boards and shareholders among others - consider the issues and the questions raised by the FCA poses and participate in debate on what constitutes a "healthy culture" and how that can be promoted. The paper also contains what the FCA describes as "actionable insights" (such as use of behavioural science, looking "beyond the role of leadership" to make changes and fostering environments of trust) that may be useful to firms in considering how to make changes. The FCA says it "remains committed to understanding ways to improve culture in financial services" and that it will use the "collection of perspectives" the essays contain "as a springboard to discuss what can be done to put ideas into action." For comment on the FCA's DP18/2 on transforming financial services culture from one of the Pinsent Masons employment law partners, please click here.

FCA's chief executive, Andrew Bailey, speaks on "Transforming culture in financial services"

Andrew Bailey, chief executive of the FCA, spoke at the Transforming culture in financial services conference in London [19.03.18]. Work on culture is "embedded" in FCA supervisors' work and is an "important priority" for them he said. While culture is not "naturally pursued" by making rules it is "influenced by the rules we make and the incentives they create" he said. Bailey discussed a range of areas and in terms of recent developments in incentives for good culture flagged the Senior Managers regime and remuneration requirements for bank senior executives. He singled out the importance of responsibility and accountability so senior managers "take responsibility for the activities under their control. Likewise, they should be accountable for that responsibility." In terms of regulating remuneration at banks he discussed remuneration structure especially concerns around the incentives created by variable remuneration, bonuses and commission which resulted in the UK regulator's 'skin in the game' approach that puts significant parts of variable remuneration at risk, by way of deferral and "so-called 'malus' and 'claw-back'." In relation to culture Bailey says "the lessons I take from these examples are about the power of simple ideas, responsibility, commitment as represented by skin the game, accountability. None of these big ideas is new, in fact quite the opposite. Nor do they require sophisticated tools to apply and monitor. They go with the grain of good incentives, and they act to support the public interest and its objectives. But, they do require effective and consistent implementation. This is where good governance comes in, a strong role for senior management and particularly boards."

Culture is not just about "stopping bad things from happening" Bailey said and identified what he calls "positive culture" as something that "goes right to the heart of what firms and their staff are, what values they represent and the positive ethical customs." He concluded his speech with the four themes in the FCA's DP 18/2 on transforming financial services culture [see above] and sets out some of his views in the answers he suggests. . In Bailey's view there is not a "single 'right' culture" it will depend on circumstances - while observing that "there are certainly cultural characteristics which are highly suggestive of good outcomes". In terms of the role of regulation in relation to culture this is about being able to "create the right incentives and to provide tools to diagnose the key characteristics" Bailey said. it "is not to attempt sweeping rules". Reward is "another influence" in creating incentives for good culture; and on leadership Bailey concludes by saying "in my mind there is no question it plays a crucial role in shaping culture."

FCA Director of Strategy and Competition delivers speech on "Regulating innovation: a global enterprise"

Christopher Woolard, Executive Director of Strategy and Competition has delivered a speech [19.03.2018] at the Innovate Finance 2018 event in The Guildhall, London. Highlights of the speech focus on the prospect of a global sandbox and how it may be used - for example to solve global problems such as money laundering and for reducing the burden of regulatory compliance.

Woolard describes how the FCA's own "innovation story began in 2014 with the launch of Project Innovate, the purpose of which was – and is - "to help firms tackle regulatory barriers to innovation." The FCA's regulatory sandbox was key in this initiative which he called a 'safe space' where businesses are encouraged to test innovative products and services. As the first regulator to attempt such a project, Woolard said "we had to change perceptions about the role of the regulator" requiring a shift in mindset "from the tradition regulator's standpoint of 'what is the risk?' to asking 'what is the risk of not doing this?'" The answer Woolard explains was that "the risk of not opening up markets to innovation was greater then the risk of taking that leap." The sandbox has been an experiment for both the FCA and the firms using it, which has "really paid off", he said noting that 90% of firms from the first round of applicants for the sandbox "have gone on to market, with many firms finding it easier to get funding as a result of participating." The FCA knows this approach is working, but asked "is it enough?" in view of demand from firms "to operate globally, to grow at real scale and pace". This would require working with other regulators globally "to conduct tests at the same time."

The sandbox has had 30 applications from international firms and supported 11 of them – many of which "are also in other countries' innovation programmes." In addition, the FCA has signed ten cooperation agreements with eight other jurisdictions so as to share market trends, collaborate and refer "innovative firms". Although there is no "joint sandbox programme" currently with other regulators, and "breaking new ground requires an element of risk" Woolard notes, which is "not something...that regulators are generally comfortable with" - the history of Innovate has been just that: "doing things that regulators' historically haven't done", he said. But the right controls must be in place to address the risks – while "bearing in mind the risk of not acting." As part of their "homework" the FCA has invited stakeholders [February 2018] to share their ideas for a global sandbox– read more in our earlier update. The FCA expected respondents to be interested in cross-border testing as a way to drive down expansion costs while accelerating the process but receive, in addition, "really creative suggestions" including for a 'global directory' of "data needs across different countries", a "joint mission statement from participating regulators" and oversight by a college of regulators. In terms of their own thinking the FCA identifies:

  • the need to be "practical" given the enormity of the project ;
  • working with international bodies where possible would be beneficial and potentially to start with those jurisdictions which already have established sandboxes;
  • the model should allow "some room for us to experiment with what works. So we could see a range of sandbox tests." This might comprise a single test in one country to gather data for a range of regulators or "simultaneous testing in more than one country";
  • flexible membership - as not every regulator may be involved in every test though knowledge and learnings should be shared widely; and
  • collaboration is key - "this has to be a joint effort across international regulators, not a UK global sandbox."

Financing growth in innovative firms: government consults on Enterprise Investment Scheme knowledge-intensive fund

HM Treasury has opened its Financing Growth in innovative firms: Enterprise Investment Scheme knowledge intensive fund consultation [13 March 2018]. This contains proposals for a fund structure for investing in innovative, knowledge-intensive companies within the Enterprise Investment Scheme (EIS). The consultation is part of the Patient Capital Review (PCR) that aims to improve access for innovative companies' in the UK to long-term 'patient' financing for growth. The Government sees knowledge-intensive firms as having high growth potential but identified that, as they are "R&D- and capital intensive", they find it hard to obtain capital to "scale up". Accordingly HM Treasury consulted on Financing Growth in Innovative Firms [August 2017] that looked at how to improve capital flows to such companies, including via the EIS, Seed Enterprise Investment Scheme (SEIS), and Venture Capital Trusts (VCTs). The EIS and VCT schemes are being "significantly expanded for knowledge-intensive companies" HM Treasury says The current consultation includes a chapter on the possible EIS Fund structure and the constraints within which it would operate. It asks respondents to clarify in particular to Government which incentives they recommend, as not all those outlined in the chapter will be provided. Responses are to be submitted by 5pm on 11 May 2018. Contains public sector information licensed under the Open Government Licence v3.0.

FCA updates webpage on closet trackers, closed constrained funds and improving disclosure to investors

The FCA has updated its webpage on closet trackers and closet constrained funds [14.03.2018] On this page the FCA says that "Clear, fair and not misleading promotional material and investment objectives are a priority for us" and identifies that asset managers have a "duty to their investors" to make sure that their products are clear, fair and not misleading. So fund managers are to "communicate fund investment objectives and policies clearly, including changes to these, even if only clarifying existing disclosures" in order for investors to have "clear information and the best possible understanding of the funds". In addition "improved disclosures" (such as about benchmarks) can help investors compare funds when they are looking to invest or are reviewing their investments.

Following their Meeting Investors' Expectations thematic review in 2016, the FCA found most funds they reviewed were "in line with their stated strategy", some "were not being clear with their investors" - in particular closet trackers and closet constrained funds. The FCA has continued with this work and by the end of 2017 had reviewed 84 funds which potentially were closet trackers or closet constrained funds. The FCA continues to assess such funds to ensure they are managed "appropriately" and make "adequate disclosures". While 20 of these funds explained how investors' money was managed adequately the FCA says it is working with 42 of the other 64 funds and 22 funds have "already made improvements". Frequently the required changes to disclosures were clarification rather than material but overall £34m in compensation has already been paid out to funds and investors.

FCA updates Quarterly Consultation Paper No 20 by publishing addendum

The FCA published an Addendum [12.03.2018] to CP18/6, its Quarterly Consultation Paper No 20, on the removal of appointed representatives annual reporting requirements described in chapter 3, but which was omitted from the legal instrument's amendments to SUP. "Any responses to the consultation paper should be made on the basis that this text is included" in the legal instrument the FCA says.

As the policy intention in chapter 3 of the Quarterly Consultation Paper has not changed, the FCA is not providing an extended consultation period for this chapter. Read more in our earlier update here.


European Commission proposes package of CMU measures

The European Commission has published a communication [12.03.18] "Completing the Capital Markets Union by 2019 – time to accelerate delivery" presenting a number of additional Capital Markets Union ("CMU") proposals. These include proposals to increase the cross-border investment funds market through amendments to the existing directives; to stimulate the EU's covered bond market; and to give investors more clarity when carrying on cross-border securities transactions and assignments of claims.

The proposals for investment funds include a new Regulation and Directive, amending the AIFMD and UCITS Directive, which are aimed at improving transparency, removing unduly complicated requirements and harmonising divergent EU rules to encourage cross-border distribution by making it easier, faster and cheaper - whilst ensuring consumer protection. Among the amendments are a ban on Member States from imposing requirements on UCITS to have a physical presence to market in a Member State, although local facilities are required (for example for subscriptions, redemptions and payments) but fund managers would be permitted to use electronic or other distance communication methods to do so. To remove various national inconsistencies a "precise time frame" will be introduced for specified communications by competent authorities - such as where a UCITS would no longer comply with the directive on making a proposed change, or when ceasing marketing an AIF or UCITS into a Member State. The proposed Directive would harmonise the process for investment funds to exit national markets and would allow AIFMs to carry out pre-marketing activities, such as testing investment ideas or their strategy, with professional investors. However, AIFMs will not be allowed to market an existing AIF in a Member State without a notification to the competent authority.

The Commission has also proposed new rules relevant to cross-border securities transactions. Where a creditor transfers the right to claim a debt to another party cross-border, the Commission proposes that in a dispute over ownership of the claim the law of the assignor's "habitual residence" will apply, irrespective of which Member State's courts examine the case. There are proposals for exemptions from this general rule for "claims derived from financial instruments" and "cash on the account of a credit institution". The Commission has also adopted a Communication clarifying which country's law will apply in cross-border securities transactions when identifying the owner of the security.

Commission Vice-President Valdis Dombrovskis also delivered a speech on the proposals [12.03.2018], highlighting the increasing importance of speeding up the CMU process in light of Brexit, so the various parts of CMU are in place by mid-2019 when the UK exits the EU. He stated that the CMU strategy has three components: "allowing all investors to take full advantage of the single market for capital with new EU-wide labels and passports for financial products" (which includes the newly announced EU authorisation for crowdfunding platforms); "to remove barriers to deeper capital markets through clearer and simpler rules for businesses"; and by "achieving more consistent supervision of EU capital markets, to maintain the protection of investors and financial stability".

Dombrovskis identified that markets for investment funds "are still mostly national", stating that: "the share of UCITS funds that are marketed in more than three countries is low - only 37%. And for alternative funds it is very low - only 3%." The Commission hopes that by removing regulatory barriers (such as Member States' marketing requirements, regulatory fees, administrative and notification requirements) it will encourage more cross-border fund distribution and "boost the cross-border market for investment funds", by making it easier for investment funds to market their funds across the EU "without compromising on investor protection." The proposals on assignment of claims aim to provide "legal certainty on who owns a claim" which, Dombrovskis argues, will "promote cross-border investment and access to credit, while preventing systemic risks." For more on the CMU and cross-border fund distribution, read here.

Commission's finance and sustainability Action Plan

The European Commission has announced its Action Plan [08.03.2018] for a financial system that "supports the EU's climate and sustainable development agenda." The Commission intends its Action Plan will "boost the role of finance in achieving a well-performing economy that delivers on environmental and social goals as well". This Action Plan: Financing Sustainable Growth is both part of the Capital Markets Union's (CMU) and one of the "key steps" towards the implementation of the Paris Agreement and the EU's sustainable development agenda.

The EU's strategy, the Commission notes in it press release, is "inspired by" the final report of the High-Level Expert Group on sustainable finance (read more here and in our earlier briefing here). Key features of the Commission's resulting Action Plan include to:

  • establish a sustainable finance "language" by way of an "EU classification system – or taxonomy - to define what is sustainable and identify areas where sustainable investment can make the biggest impact";
  • create "EU labels for green financial products" based on the EU's classification system, to help investors identify investments that are compliant with green or low-carbon criteria;
  • clarify "the duty of asset managers and institutional investors to take sustainability into account in the investment process and enhance disclosure requirements";
  • require insurance and investment firms advise clients based on their sustainability preferences;
  • incorporate sustainability in prudential requirements, given the importance of banks and insurance companies in supplying external finance to the European economy; and
  • enhance "transparency in corporate reporting" – to do so the Commission proposes revising non-financial information guidelines in view of the Financial Stability Board's Task Force on Climate-related Financial Disclosures (TCFD).

The Commission's Action Plan: Financing Sustainable Growth sets out action points on the key features above. In relation to the clarification of institutional investors' and asset managers' duties the Commission proposes that a legislative proposal will be tabled (subject to the results of its impact assessment) that will "(i) explicitly require institutional investors and asset managers to integrate sustainability considerations in the investment decision-making process and (ii) increase transparency towards end-investors on how they integrate such sustainability factors in their investment decisions, in particular as concerns their exposure to sustainability risks."


FCA publishes survey for EEA inbound passported firms prior to Brexit

The FCA issued a statement on EU withdrawal [20.12.17] in which it referred to HM Treasury's announcement that the UK Government would, if necessary, legislate to provide a "temporary permission scheme for EEA firms and funds passporting into the UK". This would mean such firms and funds could carry on business "within the scope of their permission", mitigating "risks associated with a sudden loss of permission". In particular this would enable them to continue to perform under their existing contracts and carry on with and enter into new business. The FCA has launched a survey for inbound EEA passported firms [09.03.2018] about such a temporary permission scheme that could be set up for them while they apply for full authorisation in the UK.

The FCA's "expectation is that firms and funds that would be solo-regulated in the UK by the FCA would need to notify [it] before the UK exits the European Union of their desire to benefit from the regime." They anticipate a "relatively simple" process and that a notification system would be in place prior to the UK's exit from the EU. The FCA confirms "notification will not require the submission of an application for authorisation in the UK prior to exit day". The FCA is asking relevant firms and fund managers to complete their short online survey, which includes questions on contact details, the directive/s under with firms are passporting and about firms' intentions for accessing the UK market after the UK's exit from the EU. The survey will assist the FCA design the scheme and enable them to communicate with interested firms about the scheme and the authorisation process. The page links to the Prudential Regulation Authority's website where the PRA has previously provided its own proposals relevant to dual-regulated firms, EEA credit institutions and insurers. The FCA reminds firms that they will need their Reference Number from the Financial Services Register to complete its survey which closes on May 11 2018. The FCA will provide more information on the proposals in due course.

UK will guarantee financial services firms in Gibraltar the access they now have to UK markets until 2020

The UK Government "will guarantee Gibraltar financial services firms' access to UK markets as now until 2020." according to a UK Government Statement [08.03.18]. However prior to that date, the Statement says, the UK Government intends to work closely with the Gibraltar Government "to design a replacement framework to endure beyond 2020 similarly based on shared, high standards of regulation, and enforcement of this regulation and underpinned by modern arrangements for information-sharing, transparency and regulatory co-operation." Contains public sector information licensed under the Open Government Licence v3.0.

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For comment on the FCA's DP18/2 on transforming financial services culture from one of the Pinsent Masons employment law partners, please click here.

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