Principal Functions of the Financial Conduct Authority - Chapter 3 Flashcards
Explain the work of the FCA?
1) Authorises UK firms to carry on regulated activities. It shares this function with the PRA for banks, insurance companies and large investment firms.
2) Publishes rules and principles that those firms must follow (the FCA Handbook).
3) Authorises individuals to perform certain controlled functions within firms. This function is performed by the PRA for certain significant influence functions in banks, insurance companies and large investment firms
4) Maintains a public register of all FCA authorised firms and approved persons and others under S347. It also keeps a register of known, unauthorised persons overseas
many of whom are boiler room operators.
5) Takes action against unauthorised persons by seeking restitution orders under Section 382. It can also apply for a winding up order under S367.
6) Can impose prohibition orders under Section 56 that persons may no longer carry out investment activities, or it may ban them for a fixed period, require that they work under supervision, or prohibit them from exercising significant influence in the activities of an
authorized firm.
7) Vets “suspicious” advertisements which promise returns that are too good to be true
and issues general warnings to the public about “risky” investments and boiler room operators.
In April 2007 it warned that the sub-prime mortgage problems in the USA were likely to spread to the UK - which they did, the following September – leading to a run on Northern Rock.
What are the FCA’s regulatory objectives?
The FCA’s strategic objective is to ensure that the financial markets and the markets for regulated financial services (including those provided by exempt persons) function well.
It must perform its duties in a manner which is compatible with this strategic objective and which advances one or more of the following operational objectives:
Consumer protection objective: securing an appropriate degree of protection for consumers;
Integrity objective: protecting and enhancing the integrity of the UK financial system;
Competition objective: promoting effective competition in the interests of consumers in the markets for regulated financial services (including services provided by Recognised Investment Exchanges).
FSMA, sections 1M to 1R provide that in carrying out its objectives the FCA must establish and consult a Consumer Panel and a number of Practitioner Panels made up of representatives from the financial services industry (e.g. the Practitioner Panel, the Smaller
Business Practitioner Panel, and the Markets Practitioner Panel).
Give more detail on the FCAs regulatory objectives and how they reach them?
1) Consumer Protection is provided by the overall work undertaken by the FCA and in particular by making rules, authorising, and monitoring firms in the financial services industry, taking action against unauthorised firms, vetting suspicious advertisements, banning people from working within the industry, or requiring them to work under supervision.
2) Under the integrity objective the FCA is tasked with protecting and enhancing the integrity of the UK financial system in terms of:
its soundness, stability and resilience;
its not being used for a purpose connected with financial crime;
its not being affected by behaviour that amounts to market abuse;
the orderly operation of financial markets;
the transparency of price formation in those markets.
The FCA meets its integrity objective through a combination of prudential supervision of non-PRA regulated firms, monitoring anti-money laundering rules, investigating and prosecuting
cases of insider dealing and market abuse, issuing conduct of business rules and regulating the operation of financial markets.
3) The competition objective was introduced by the Financial Services Act 2012. In pursuing this objective, the FCA may have regard to:
the needs of different consumers and their information needs;
the ease with which consumers can access the relevant services;
the ease with which they can change the person they obtain those services from;
the ease with which new entrants can enter the market;
how far competition is encouraging innovation.
How do the FCA tackle crime?
Through its Enforcement and Financial Crime Division. It deals principally with boiler room operators, money laundering, identity theft and fraud.
In August 2008 a computer purchased on eBay for £35 was found to contain the account details of 1m customers of Royal Bank of Scotland, and its subsidiary Natwest Bank. These details had apparently not been removed by the banks’ external archivist.
In the first half of 2008, seventeen mortgage brokers were banned for submitting fraudulent
applications, and twenty-four others were under investigation.
What are Boiler Room Operators?
They are crooks - high pressure salespeople urging people to buy shares (on some non existent stock exchange).
Boiler room operating is invariably connected with money laundering because innocent members of the public are relieved of their money which then starts its new life by being placed in the financial system.
Most boiler room operators are based outside the UK so the FCA can do nothing about them.
Due to the increased prevalence of boiler rooms, in October 2006 the FSA and the ICSA
Registrars group drafted a Warning Notice which registrars could pass on to shareholders
with any statutory mail or a dividend warrant. The notice explains how boiler rooms operate
and says that anyone who receives an unsolicited invitation should:
1.) Ask for the caller’s name.
2.) The name of the firm he works for.
3.) Check whether it is an authorised firm.
4.) Be very wary
5.) Report all suspicions to the FCA with any details that you have gathered.
What are Ponzi Schemes?
Ponzi schemes, also known as pyramids, are named after Charles Ponzi, who, in 1921 promised American investors that he could achieve returns of 40% per annum by speculating in stamps and foreign currency markets.
Operators of such schemes pay themselves substantial fees, and commonly steal the funds entrusted to them. Such schemes inevitably collapse because they use money raised from new investors to pay the promised returns to earlier investors.
A Ponzi scheme had operated in the UK in the 1980s when Peter Clowes had promised investors yields in the gilt edged market that were persistently above the returns being achieved by other fund managers. Investors suffered losses of £100m.
Detail the FCA/PRA Principles?
The principles are that a firm must:
1. Conduct its business with integrity [FCA / PRA]. Integrity can be shown in part by adopting a whistle-blowing culture.
2. Conduct its business with due skill, care and diligence [FCA / PRA]. In order to do this, a firm must constantly review and monitor its own internal standards and give
proper training to its staff.
3. Take reasonable care to organise and control its affairs responsibly and effectively, with adequate risk management systems [FCA / PRA].
In order to comply with this, a firm must have regard to record keeping, compliance, and staff supervision requirements, maintain an adequate risk management
system and regularly monitor and check that its internal structures are functioning properly. There should also be a clear apportionment of responsibilities among senior managers. The FCA and PRA sourcebooks impose a variety of record-keeping requirements and retention periods. These are usually found in one of the annexes.
An effective whistle-blowing system should be part of a good risk management system.
The consequences of not having an adequate risk management system can be seen in the demise of Barings Bank in 1995 where a trader was able to hide losses of £800m because he was responsible for undertaking the trades and recording their settlement which was done fictitiously. The credit crunch and banking crisis in 2008-
2009 demonstrated a worldwide failure of risk management system with the banking industry.
4. Maintain adequate financial resources [FCA / PRA]. Firms must have adequate finances to honour their investment commitments.
5. Observe proper standards of market conduct [FCA]. Firms must act in accordance with current rules and codes particularly in relation to Market Abuse and Money Laundering.
6. Pay due regard to the interests of its customers and treat them fairly [FCA].
7. Pay due regard to the information needs of its clients, and communicate information to them in a way which is clear, fair and not misleading [FCA]. In order to comply with this they must give all information necessary for the client to make an informed decision and communicate in clear English.
How should you segregate a clients’ money and assets
- The money must be paid into a separate account with an approved bank, and the bank must agree not to seize the money if the firm becomes insolvent or goes into liquidation.
- Money must be paid into the account within one working day of receipt.
- If the client agreement letter is silent on the point, then interest must be paid on the money.
- The firm must either open separate accounts for each client, or open an omnibus account with designations for each client.
- Where an omnibus account is opened no client can become overdrawn as this would be unfair to the other clients.
In additional to regulating authorised firms the FCA/PRA also directly regulate individuals in those firms who carry out controlled functions. Which functions are these?
- Significant influence functions, including both executive and non-executive directors, partners, compliance officers and MLROs and various other roles.
- Customer dealing functions – for people who deal directly with clients or have custody of clients’ assets
The PRA (rather than the FCA) approves individuals for most significant influence functions in dual regulated firms. The FCA approves all other controlled functions. The approval process requires the firm to make an application for approval on behalf of the individual. The onus is on the firm to provide sufficient information on the Application Form (Form A) to prove that the candidate is a fit and proper person. For certain high profile positions (e.g. CEO of a bank), the regulators may invite the candidate for an interview.
Explain how the SYSC (Senior Management, Systems and Controls sourcebook provide firms must hire competent staff.
Assessing competence
It is up to firms to decide what methods they want to use to assess their employee’s competence. The FCA defines competence as having the skills, knowledge and expertise needed to discharge the responsibilities of an employee’s role.
This includes achieving a good standard of ethical behaviour. It is not simply a question of having obtained the right appropriate qualification and/or reading the Statements of Principle for Approved Persons (APER) where this is required.
Maintaining competence
Firms are required to assess the competence of their employees on a regular basis, as well as continue to assess employees’ training needs.
Firms must not only consider changes in the marketplace and in products, regulation and legislation, but also consider the skills, expertise, technical knowledge and behaviour of their employee, and their ability to apply these in practice.
There are specific continuing professional development (CPD) requirements for firms undertaking retail investment activities.
Firms should ensure appropriate training is provided so that their employees remain competent. They will also need to monitor and assess regularly the effectiveness of the training, to ensure it is meeting its objectives.
Record keeping
Firms should keep records on anything that relates to the firm complying with the TC Sourcebook. They need to keep appropriate records relating to staff recruitment, training, assessment of competence, supervision of staff and details of appropriate qualifications for any activity within the scope of TC.
For MiFID business, these records must be kept for at least 5 years after an individual has stopped carrying on an activity within the scope of TC, for non-MiFID business it is 3 years after stopping the activity and for a pension transfer specialist the records must be kept indefinitely.
Practical application
When recruiting an individual to work with private clients (essentially retail investors), the firm must consider the individual’s knowledge and skills for the job and must ascertain any details about previous work experience and training.
Who are Appointed Representatives?
S39 Appointed representatives of authorised persons are exempt (don’t need to get authorisation) in relation to business carried out as such a representative.
The principal is liable for the acts of the representative, who is an agent, only in relation to investment business that the representative is authorised to conduct.
Section 39 is clear that appointed representatives are only given exempt status in relation to the business they carry out as such a representative because their employer (usually a life assurance company) is liable for what they do within the scope of their agency.
Authorised must carry out checks on their tied agents (can only work for one person)
A person who is not ‘tied’ for example independent financial advisers can give advice on a wide variety of products. IFAs are not exempt and must be authorised by the FCA. Sanders Report 2002 says that such people must be paid a flat rate not commission or they are not allowed to call themselves IFAs.
Tied agents can sell products of up to six providers. Most banks and building societies are tied agents of insurance companies.
Article 23 of MiFID requires the FCA to maintain the names of all tied agents on its public register.
List some regulated activities?
These are prescribed in FSMA as:
Dealing in investments as principal (eg market makers)
Dealing in investments as agent (e.g. a trustee)
Arranging deals in investments (brokers and registrars)
Managing investments (fund managers, banks)
Advising on investments (financial advisers)
Safegaurding and administering investments (custodians)
Deposit taking
Issuing electronic money
mortgage broking
Merely generic advice is not advising on investments so explaining the difference between a share and life insurance policy is not regulated.
How are investments defined in the FSMA?
shares of stock in the share capital of a company Debentures, loan stock, bonds Depositary receipts unit trusts options to acquire or dispose of property insurance contracts deposits loans (including mortgages) contracts for hire of goods
The purpose of the act is to distinguish between physical and intangible investments. Houses, jewellery, antiques, vintage cars are not regulated by the act, but vendors may call them investments.
A covered warrant is a gamblers market which allows the purchaser to buy share at todays price up to six months in the future. so you may pay 30p for a share and after six monte price rises to 300p you will make a profit. You must first sign a risk notice.
Briefly explain American Depositary receipts
In the US they are not allowed to deal in shares in foreign countries (e.g. UK) but can buy depositary receipts.
Americans want a stake in British shares so will appoint a nominee co which holds the shares usually in London in ‘share certificates’. Against those shares it will issue American Depositary receipts (ADRs) so they can trade in these receipts.
What does the Financial Services Compensation Scheme do?
All EU member states are required to establish a compensation scheme to which all authorised firms must belong.
The FSCS is designed to protect investors who lose money when an authorised firm goes into liquidation. It is funded by the financial services industry.
The maximum claim for deposits held in banks is 85,000 per individual or joint holder (so never have more than this in one account!)
investments and home finance 50,000
Insurance and business advice, 90% of the claim or 100% of the claim with no upper limit for compulsory insurance.
