On 19 June 2019, the FCA published their first ever report on the FCA’s regulatory perimeter. The purpose of the report is to provide some clarity on what is acknowledged as being a complex patchwork of UK and EU law, and to provide some guidance to both consumers and regulated firms about how the FCA’s regulatory perimeter works in practice. It is intended that this will be an annual report series by the FCA.
On 02 August 2019, the House of Commons Treasury Committee (the Committee) released their report in response to the FCA’s first annual report on the FCA’s regulatory perimeter (see Treasury Committee Response section below for an overview of key points).
FCA First Annual Report
Scope and Purpose
The scope of the report is limited to FCA regulated firms (or dual regulated firms in respect of their FCA regulated activity). PRA regulated activity is not considered in this report.
The examples set out in the paper and drawn out below are reflective of some of the FCA’s current hot topics.
We note in addition that there is a brief suggestion in the report that the complex state of the regulatory perimeter might be simplified in a post-Brexit environment, however no further details are provided in the report.
There are three stated reasons for publishing this report:
- Firms operating on the edge of the perimeter have recently caused serious harm to consumers. This damages public trust.
- Technology has increased the speed of change in financial services markets. The perimeter is now being tested more often due to innovative products and changes to firms’ service delivery models.
- The FCA perimeter is complex and the future of regulation should be made clearer in order to determine the UK financial services framework after Brexit.
How far does the FCA’s role extend?
The FCA’s remit is rooted in the authorisation and supervision of firms engaged in regulated activities that require authorisation to be granted under FSMA 2000 RAO. However, its perimeter is also defined by the its role in respect of:
- acting as the UK’s listing authority
- the Market Abuse Regime
- the Payment Services Regulations
- the Money Laundering Regulations 2017, and
- the Senior Manager & Certification Regime.
Key issues raised in the report
Consumer confusion around how the perimeter works
- It is not always obvious to consumers that financial services firms that they are using may be providing services, some of which may be regulated (and so carry a higher level of consumer protection), but some of which are not (and so do not carry the same protections).
- For example, a consumer could receive a personal recommendation (investment advice) on a regulated financial product (FSCS protection should be available), and later take a separate recommendation from the same service provider to use their savings for a buy-to-let investment (this is a non-regulated financial product therefore, FSCS or Financial Ombudsman Service may not be available).
- Outcome: The FCA is likely to try and make potential issues around regulated and non-regulated activity clearer to consumers, and seek to reduce the complexity around how different types of service are regulated. They are currently reviewing the Retail Distribution Review and the Financial Advice Market Review (which includes measures to clarify the boundary). Other actions to clarify understanding of the perimeter include:
- continuing to update PERG
- publishing this annual report
- supervisory discussions with firms
- continuing to take enforcement action and publish details of the cases to mark lines in the sand
- working to develop an online disclosure system to make consumer protections clearer
Impact of firm activity outside the FCA perimeter
- Particularly relevant in the securitisation space, the FCA flags an issue in the report around firms which purchase mortgage books under structured agreements. This means that those firms do not then have to be authorised for their lending activity. The FCA is concerned that they cannot provide the same level of protection to consumers using these unregulated firms as compared to regulated mortgage lenders.
- Mini-Bonds are also raised as problematic due to the fact they fall outside of the regulatory perimeter, but may still be made available to consumers despite their high-risk nature. The recent collapse of London Capital & Finance (LC&F) is cited as a case in point.
- Outcome: The FCA are:
- Consulting on changes to their rules around access to and switching between regulated and unregulated mortgage lenders to make this more affordable for consumers.
- Following the LC&F scandal, the FCA requested a Treasury investigation into the FCA’s actions approach and policies in that case. The Treasury have announced a wider review of the issues the investigation raises, including the current regulatory arrangements for the issue of mini-bonds and other non-transferable securities.
Impact of technology on financial services
- The rapid pace of change due to technology is causing markets to evolve swiftly and business models to change. The FCA is concerned because:
- Firms now routinely deliver services digitally, which means faster access to the consumer market. This means that financial promotions and consumer protections are harder to monitor and take action against when required.
- These challenges are exacerbated when firms are conducting business online and acting on a cross-border basis. There is a risk of firms exploiting the potential for regulatory arbitrage.
- The intangible nature of cryptoassets presents challenges to the regulatory perimeter as they have variable characteristics and can be used for different functions. It is therefore harder to classify them within established regulatory frameworks and the FCA perimeter.
- As tech companies enter the financial services space, there is increased risk around market power and these firms not having the required knowledge, expertise, systems and controls, or regulatory supervision in place, even though they are technologically able to offer financial services.
- Outcome: The FCA are:
- Considering how to adapt the financial promotions regime for the digital age and developing automated tools to detect online activity which poses a risk to the FCA’s objectives.
- Involved in international initiatives to align approaches to regulator issues which can affect the perimeter.
- Publishing a final guidance report on updates to PERG related to cryptoassets (due this summer). A consultation is also due later in 2019 on a potential ban on the sale to retail consumers of products (eg derivatives) referencing some cryptoassets that fall outside of the regulatory perimeter.
- Publishing a call for input on the Open Finance initiative later this year which will consider how the principles of Open Banking (eg data sharing) can be applied more widely across the financial services sector.
Consumer confidence and the future of UK regulation
- The FCA perimeter (and issues around the perimeter) are to be made clearer to consumers.
- However, the FCA are not seeking to create a “zero-failure regime” and acknowledge that resources and enforcement cases must be focussed on matters inside the perimeter – the FCA apply a higher test before responding to information about unregulated activities.
- Where appropriate, the FCA aims to identify unregulated activity which they consider should fall within the perimeter, and will make recommendations to Government and Parliament.
- The FCA will seek further alignment between regulated activities and coverage of the Financial Ombudsman and the FSCS.
- The FCA aims to be forward-looking and successfully adapt to technological change.
- An update on progress in this regard will be provided in the 2020 FCA perimeter report.
Treasury Committee Response
The report makes a number of recommendations with a focus on three areas of questioning:
- the speed at which the FCA can come to conclusions (timeliness)
- the information the FCA discloses about its work and decisions (transparency), and
- how the FCA deals with issues beyond the perimeter of regulation (terrain).
- Concerns about the perimeter and its complexity have featured in the Committee’s previous work. The Committee agrees that the perimeter can be confusing for consumers of financial services.
- The Committee recommends that where regulated financial institutions undertake unregulated activity, the regulatory system should ensure that clear and explicit warnings are provided at that point, with the potential consequences of the lack of regulatory cover clearly explained. There would be sanctions for firms that fail to do so.
FCA’s powers at the perimeter
- The FCA’s powers to act beyond the perimeter are currently limited. The Committee believes that the regulatory system as currently set up does not provide the FCA with the necessary remit to actively monitor or intervene outside of the perimeter (which also has an effect on how the FCA directs its resources).
- Following the collapse of London Capital & Finance (LC&F) (related to investments outside of the regulatory perimeter) and the FCA’s request for a Treasury investigation, the Treasury announced a wider review of the issues the LC&F investigation raises, including (i) the regulatory arrangements for the issue of mini-bonds (and other non-transferable securities), and (ii) the Financial Promotions regime which governs the marketing of such products.
- The Committee also re-raises in this report the fact that it has previously recommended changes to the scope of perimeter in a report on SME Finance arguing:
“Experience has shown that the justification for leaving commercial lending outside the regulatory perimeter is feeble, and it is unclear whether this issue was subject to sufficient public debate when the regulatory perimeter was established.”
- The Committee recommends that the FCA be given the formal power, and necessary remit to be able to formally and publicly recommend to the Treasury changes to the perimeter of regulation, where that would enhance its ability to meet its objectives, in particular to prevent consumer harm (setting out any costs of doing so). Replies from the Treasury would also be publicly disclosed, providing greater transparency and focus.
- In reference to the Committee’s inquiry and report into Crypto-assets, the Committee considers in its recommendation that the FCA must not in future be constrained, or feel constrained, from providing warnings on financial products that may cause consumer detriment.
- The Committee adds that this power should be written into the relevant primary legislation, and include any necessary powers needed to fulfil that remit.
Potentially greater information gathering powers
- The Committee believes that the FCA needs greater information gathering powers to better assess the risks to consumers at, and beyond, the perimeter.
- The Committee recommends that the FCA should be given the power to order additional information from unregulated entities to help meet its objectives, and proposes that the Treasury undertake research on this point, including canvassing the FCA’s views. However, the FCA would not be able to take action against unregulated business unless they were, for example, carrying on a regulated activities without a license.
Role of the Treasury
- The Treasury is currently considering the wider scope of financial regulation. It is suggested that the Treasury should also report annually on the work it will do to monitor the perimeter of regulation, in response to the FCA’s annual report.
Impact of Brexit
- The Committee does not consider that the recommendations it makes in this report should be held back in anticipation of Brexit. It considers that they should be brought forward by the Treasury as soon as possible.
This document (and any information accessed through links in this document) is provided for information purposes only and does not constitute legal advice. Professional legal advice should be obtained before taking or refraining from any action as a result of the contents of this document.