Mike Kennedy Compliance Auditor Policy Team

2. Mike Kennedy • Compliance Auditor • Policy Team

3. Gap-Fill Session Financial Services Regulation and Ethics

4. Objectives – Part 1 • To better understand the FSA’s responsibilities in the regulation of financial services • To consider ways of operating more effectively in the current regulated environment

5. Areas to cover – Part 1 • The Financial Services Authority • Background • Functions • Statutory objectives • Financial stability and prudential regulation • FSA Supervision and powers • Authorisation and Controlled Functions • Principles for Business • Approved Persons Statements of Principles & Code of Practice

6. FSA - Background • Independent non-government body • Company limited by guarantee • Financed by the firms it regulates • Accountable to Parliament via the Treasury • Created under Financial Services and Markets Act 2000 (FSMA)

7. FSA - Functions • Authorisation • Enforcement • Supervision • Rule making

8. FSA - Functions Additional functions under; • Building Societies Act 1986 • Friendly Societies Acts (1974 & 1992) • Proceeds of Crime Act 2002 • Unfair Terms in Consumer Contracts Regulations 1999 • Distance Marketing Regulations 2004

9. FSA – Statutory Objectives • Market confidence • maintaining confidence in the financial system • Financial Stability • contribute towards protecting & enhancing UK financial stability (Public awareness • Promote public understanding of the financial system)

10. FSA – Statutory Objectives • Consumer protection • securing the appropriate degree of protection for consumers • Reduction of financial crime • reducing the extent to which it is possible for a business to be used for a purpose connected with financial crime

11. FSA – Principles of Good Regulation • Efficiency and economy • Role of management • Proportionality • Innovation • International character • Competition • Public awareness

12. FSA – Financial Stability • Financial Services Act 2010 – new FSA Objective • Contribute towards protecting & enhancing UK financial stability • Required to co-operate with the Treasury, Bank of England and other bodies to achieve this • Part of the wider objectives of the International Financial Stability Board (FSB)

13. FSA – Prudential Regulation • Firms must maintain adequate systems and controls to ensure adequate risk management systems (Principle 3) • Firms are required to maintain adequate financial resources (Principle 4)

14. FSA – Prudential Regulation Capital Adequacy • Required levels differ depending on the activities • GENPRU/ IPRU(Inv)/MIPRU/BIPRU • Expenditure Based Requirement • PII Excess / Exclusions • Firms must maintain required capital at all times • Consider liquidity and stress testing

15. FSA - Supervision • The FSA adopts a risk based approach • Firms are risk assessed in terms of; • Impact • Probability • ARROW II (Advanced Risk-Responsive Operating FrameWork) • ARROW Firms Approach • ARROW Themes Approach

16. FSA - Supervision • Accounts and Auditor Statements • Business Volumes • Sources of Business • Complaints • Other relevant returns • Mystery shopping

17. FSA - Powers • The FSA has powers over regulated firms and individuals And • Unregulated firms and individuals e.g. Market abuse, money laundering and unauthorised activity

18. FSA - Powers The FSA has the power to; • require firms to provide information and documents • require firms to provide reports by skilled persons • appoint investigators to carry out general investigations into firms

19. FSA - Powers • appoint investigators to carry out investigations into specific matters • require information and appoint investigators to in support of overseas regulators • appoint investigators to carry out investigations into collective investment schemes

20. FSA - Powers • Monitoring and supervision • Prohibit individuals from carrying out functions • Financial penalties • Public censure • Criminal prosecution • Removal of permissions

21. FSA - Authorisation • To undertake regulated activities a person must be; • Authorised; or • Exempt

22. FSA - Authorisation Authorised Firms • New Firms apply for Part IV Permissions • must go through a rigorous application process • Existing firms may need to apply for permissions relating to new areas / activities • Change of legal status – involves a new application

23. FSA - Authorisation Exempt Firms • Appointed Representatives • Professional Firms which are members of DPB • Others e.g. Bank of England, European Central Bank and local governments

24. FSA – Controlled Functions • Authorised Person – the business that carries on regulated activities • Approved Person – the individual who has been approved to carry on one or more controlled functions within the business

25. FSA – Controlled Functions Required for any person who; • Is able to exert significant influence over the firm’s affairs in relation to regulated activity • Deals with clients in connection with regulated activities • Deals with the property of clients in connection with a regulated activity

26. FSA – Controlled Functions Cover two categories • Significant Influence Functions • Governing functions • Required functions • Systems and controls functions • Significant management functions • Customer functions

27. FSA – Controlled Functions Most common • CF1 Director – not necessarily companies house! • CF2 Non-executive Director • CF3 Chief Executive • CF4 Partner • CF10 Compliance Oversight • CF11 Money Laundering Reporting Officer • CF30 Customer (investment business) • Responsible for Insurance Mediation

28. FSA – Controlled Functions Some changes taking place from May 2011 • CF00 – Parent Entity Significant Influence • CF2 (a-e) - Non-executive Director • CF13 – Finance • CF14 – Risk • CF15 – Internal Audit

29. FSA – Principles for Business • Integrity • A firm must conduct its business with integrity • Skill, care and diligence • A firm must conduct its business with due skill, care and diligence • Management and control • A firm must take reasonable care to organise and control its affairs responsibly and effectively, with adequate risk management systems

30. FSA – Principles for Business • Financial prudence • A firm must maintain adequate financial resources • Market conduct • A firm must observe proper standards of market conduct • Customer’s interests • A firm must pay due regard to the interests of its clients and treat them fairly

31. FSA – Principles for Business • Communications with clients • A firm must 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 • Conflicts of interest • A firm must manage conflicts of interest fairly, both between itself and its clients and between a client and another client • Customers: relationships of trust • A firm must take reasonable care to ensure the suitability of its advice and discretionary decisions for any client who is entitled to rely on its judgment

32. FSA – Principles for Business • Clients’ assets • A firm must arrange adequate protection for clients’ assets when it is responsible for them • Relations with regulators • A firm must deal with its regulators in an open and cooperative way, and must disclose to the FSA appropriately anything relating to the firm of which the FSA would reasonably expect notice

33. Approved Persons – Fit & Proper • Honesty, integrity and reputation • Competence and capability • Financial soundness

34. Principles for approved persons • Principles 1 – 4 : all approved persons • Principles 5 – 7 : significant influence functions

35. Code of Practice Principle 1 - Act with integrity • Misleading a client, the firm (or its auditors) or the FSA • Carrying out unsuitable transactions • Not disclosing a material issue or error when knowing it to be wrong • Falsifying documents, qualifications or employment records • Preparing false trading records • Misusing assets or confidential information of a client or the firm • Failing to disclose a conflict of interest

36. Code of Practice Principle 2 - Act with due skill care and diligence Failing to; • Explain investment risks or product charges • Providing inaccurate information • Recommending / transacting unsuitable transactions • Advising on transactions when the risk to client or firm are not understood • Control or segregate client assets • Disclose a conflict of interest • To cease a controlled function when not competent to act

37. Code of Practice Principle 3 - Observe proper standards of market conduct • Whether the requirements of the Code of Market Conduct, relevant market codes or exchange rules have been followed

38. Code of Practice Principle 4 - Deal with the FSA and other regulators in an open and cooperative way and disclose appropriately any information of which the FSA would reasonably expect notice Failure to; • report promptly in line with the firm’s internal procedures (or direct to the FSA), information which could reasonably be assumed to be of material interest to the FSA. • without reason to attend an interview or answer questions put by a regulator • supply a regulator with documents or information when requested to do so

39. Code of Practice Principle 5 - Take reasonable steps to ensure that the business of the firm for which he is responsible is organised so that it can be controlled effectively Failure to ensure; • Each area of business is clearly assigned to particular individual(s) • Responsibilities apportioned properly and recorded • Reporting lines/accountability clear to all staff • Authorisation levels and job descriptions • Suitability of individuals – unsatisfactory performance • Record keeping

40. Code of Practice Principle 6 - Exercise due skill, care and diligence Failure to ensure; • Reasonable steps to inform himself about the affairs of the business • Expansion of business without assessing potential risks • Appropriate knowledge about the business – sufficient understanding of risks • Responsibilities on delegation • Disregarding an issue once delegated • Failing to require adequate reports following delegation • Accepting implausible/unsatisfactory explanations without testing veracity

41. Code of Practice Principle 7 - Take reasonable steps to ensure that the business of the firm for which he is responsible complies with the relevant requirements and standards of the regulatory system Failure to: • implement (personally or through compliance) adequate systems • monitor (personally or through compliance) compliance with regulatory requirements • adequately inform himself about the reason why significant breaches (suspected/actual) may have arisen • ensure that reasonable independent recommendations (threesixty) are implemented in a timely manner

42. FSA Structural change • Financial Services Authority – RIP • Prudential Regulation Authority (PRA) • Responsible for Prudential supervision • Financial Policy Committee (FPC) • Responsible for macroeconomic and financial stability issues • Financial Conduct Authority (FCA) • Responsible for conduct of business • Consumer Financial Education Body (CFEB) • Responsible for role out of national roll out of Money Guidance Service

43. Thank You Any Questions?

44. Objectives – Part 2 • To provide an overview of what the FSA means by outcomes focused regulation and how it aims to use this to promote ethical and fair outcomes • To encourage firms to consider ways of dealing with outcomes focused regulation

45. Areas to cover – Part 2 • Ethics and culture • ‘Outcomes Focused Regulation’ • Evidence of the FSA’s new approach • What firms can do to operate effectively under this new approach

46. Ethics and Culture • Ethics A system or code of morals of a particular person, religion, group, profession, etc. • Culture A set of shared attitudes, values, goals, and practices that characterizes an institution, organization or group

47. Ethics and Culture • It is not for the FSA to define a firm’s ethics or culture • “A firm’s culture plays an important role in influencing the actions and decisions taken by individuals within firms and in shaping a firm’s attitudes towards it’s clients” • Hector Sants

48. Ethics and Culture Firm’s need to • Understand their own culture • Understand the potential risks posed by the wrong culture • Implement a positive culture which facilitates ‘right behaviours’

49. Ethics and Culture Behaviour is likely to be influenced by; • Leadership • Strategy • Decisions • Incentives • Controls • Deterrence (the threat of sanctions)

50. Ethics and Culture • Not for the FSA to define a firm’s ethics and culture • FSA will however look to focus on any unacceptable culture - resulting in poor behaviours