This week in regulation


The Speed Read

This week's regulatory highlights:

  • [Speech] Assessing the value of financial advice
  • FCA reveals next round of successful firms in its regulatory sandbox
  • [Speech] Effective global regulation in capital markets
  • FCA fines firm £4m for misleading customers
  • Further success in reducing pension funds’ costs and charges
  • [Speech] Using artificial intelligence to keep criminal funds out of the financial system
  • CP17/39: Quarterly Consultation Paper No. 19

[Speech] Assessing the value of financial advice

Megan Butler, the FCA’s Director of Supervision – Investment, Wholesale and Specialists, delivered a speech outlining the FCA’s key areas of concern and subsequent activity in the advice and investment management market.

With the widening number of options and choices available to consumers, the role of financial advice has never been so important. However, with disengagement also widespread, communicating the value of advice continues to be essential.

Overall suitability is on the up, which means the FCA is focusing on increasingly smaller and less visible instances of poor performance. Their work is therefore currently concentrated on:

  • DB Transfers – poor advice can impact large numbers of clients and impact the public’s trust in financial services, leading to heightened interest from the FCA and subsequent increased activity in this area. Following supervision work, the FCA has found levels of unsuitable advice relating to DB Transfers to be higher than they would like. As a result, the FCA will be widening its DB Transfers work. The main issues are:
    • Failure to obtain enough information about client needs and personal circumstances;
    • Failing to consider the clients’ needs alongside objectives;
    • Inadequate assessment of the risk clients are willing and able to make;
    • Many issues relating to poor business models.
  • High risk investments – both unregulated introducer firms and SIPP operators’ risk from pension scams are at the centre of the FCA’s focus on high risk investments. The regulator is using increasingly sophisticated data analytics to detect high risk firms and manage poor advice. The FCA is also working closely with a number of agencies to deal with pension related scams and fraud.
  • Whistleblowing – although whistleblowing disclosures are on the increase in the financial advice sector, cases are scarce compared to other sectors. Butler offered assurance to all that the regulator treats whistleblowing with the utmost confidence and records the information securely.
  • MiFID II – there are two key areas of focus for advice firms:
    • MIFID II product governance introduces stricter controls around the need for firms to assess their target markets to ensure board-level accountability and ensure products are working as intended. As a result, there will need to be greater sharing of information between distributors and product manufactures, which should be underpinned by contractual provisions for the exchange of data.
    • Costs and disclosure requirements are enhanced under MiFID II and although the FCA isn’t going to prescribe a standardised format for disclosures either at the point of sale or post sale, it is engaging with industry-led proposals for templates.


FCA reveals next round of successful firms in its regulatory sandbox

Eighteen FinTech and RegTech firms have successfully begun testing their solutions through the FCA’s Sandbox live market environment. Set up as a protected environment to help firms test innovative products, services and business models, these eighteen firms represent a third cohort of companies within the Sandbox, which has seen almost 70 firms test their innovations to date.

Included in this cohort’s innovations are Barclay’s RegTech proposition that tracks updates to FCA handbook regulations and aligns them to the firm’s internal policies, Nationwide’s automation solution which provides digital savings guidance and investment advice, and Yoti, which lets users create a biometric digital identity that can be shared with financial institutions for use in KYC verification.

The FCA is now accepting applications to be part of the 4th cohort of the sandbox, which is open until 31st January 2018.


[Speech] Effective global regulation in capital markets

Megan Butler, the FCA’s Director of Supervision – Investment, Wholesale and Specialists, delivered another speech last week, this time focusing on cyber security.

The FCA is looking to contain escalating cyber threat by sharing intelligence and expertise with UK financial and enforcement authorities and collaborating with international counterparts in Europe, the USA and further afield. The rise of machine learning and artificial intelligence brings with it the potential for an increased risk of cyber-attacks in the form of ransomware and malware.

The regulator has this risk on its radar and is of the view that some cyber-attacks will be successful, however, it expects firms to make the FCA aware of cyber breaches as soon as they know that something has happened. It currently suspects that breaches are going underreported, so Butler reiterates its expectations:

  • Report material cyber breaches in real time;
  • If you’re not sure if you need to tell the FCA, do so anyway;
  • Put in place good cyber security: know what data you hold, manage the risk and have a process for responding to a cyber-attack.

To help firms, the FCA is collaborating with organisations across the financial services sector to assess cyber capabilities and develop best practices.

Money laundering through the capital markets is viewed as a significant emerging risk. The FCA lauds effective AML controls throughout capital markets as essential for ensuring the UK financial system is hostile for money launderers. Its focus on AML controls has developed from a past record of poor controls in capital markets and is therefore an area of focus and concern for the FCA going forward.

The range and depth of data the regulator will get from MiFID II reporting requirements will enable it to better monitor the market and identify market abuse earlier. Given the potentially onerous requirements of MiFID II transaction reporting this will bring, Butler assures firms that the regulator will take a proportionate and sensible approach to the introduction of MiFID II (i.e. no enforcement action against firms for not meeting requirements immediately as long as there is evidence that sufficient steps have been taken to meet the obligations and there are plans to fully comply as soon as possible).


FCA fines firm £4m for misleading customers

Inadequate systems and controls and a failure to provide fair, clear and not misleading information about ‘independent status’ have been stated as the reasons for a large insurance broker being hit with a whopping £4m fine.

At the core of the firm’s failings was a culture that placed an increase in business for the parent company over the interests of customers, compromising the firm’s independent status. The firm’s brokers did not disclose the relationship, nor effectively manage the conflict of interest, leading to customers being misled into believing they were purchasing from a broker with an unbiased search of the market.


Further success in reducing pension funds’ costs and charges

Workplace pension funds’ costs and charges have reduced due to joint intervention by the FCA, DWP and Independent Governance Committees (IGCs) and trustees, says the FCA.  In a bid to improve value for money for those in workplace pension schemes, the joint group conducted a review and required remedial actions to costs and charges from providers offering poor value schemes and overly high costs (i.e. costs over 1%).

Some high costs and charges remain (£0.9bn out of £25.8bn assets under management) falling into the two categories:

  • A change in the IGC’s position on whether initially accepted high costs (due to the delivery of valuable benefits) has led to further discussions being required between providers and the IGC before a conclusion can be made.
  • Some remedial actions will not be delivered until next year.


[Speech] Using artificial intelligence to keep criminal funds out of the financial system

Rob Grupetta, Head of the Financial Crime Department at the FCA last week delivered a speech on the use of technology to combat financial crime.

As technology capability develops, the industry is more frequently questioning whether this can be harnessed to detect suspicious behaviour. For example, could machine learning and artificial intelligence detect suspicious transactions or detect when predetermined thresholds have been exceeded in real time? Grupetta says that data analytics and machine learning have been heralded as having the greatest potential to improve transaction monitoring. Anti-impersonation checks driven by artificial intelligence also look promising.

For the regulator, concerns arise from the increased use of machine learning based on the systems’ effectiveness to spot suspicious activities. Machine learning is likely to change transaction monitoring processes and practices significantly and, with change, comes risk. Interpretability and auditability, for example, pose a risk to the integrity of the information provided by machine learning systems which means regulators may feel less comfortable with systems’ effectiveness. 

The FCA’s expectations around the use of new technology

  • Responsible innovation – the FCA is encouraged that some firms are developing codes of ethics around data science and stresses that new technology should be implemented with appropriate testing, governance and management.
  • Trialling and replacing systems – the FCA would be happy for older systems to be decommissioned should they prove to be less effective than newer systems following a period of trialling.
  • Complementing human judgement – the FCA sees machine learning sitting alongside humans rather than replacing them in order to refine and improve the predictability of technology and to act as a facilitator to human decisions and judgements.

Non-technological challenges facing use of machine learning for anti-money laundering

  • Data quality – lack of cooperation between banks and the police force can mean data is patchy and unreliable. This is being improved by the Joint Money Laundering Intelligence Taskforce.
  • Data sharing – the sharing of data across institutions, enabled by the recent Criminal Finances Act, will improve the quality of intelligence and provide information that can be used by authorities.

Technology has the potential to enhance the financial crime detection capabilities of firms but it will need to be implemented in conjunction with human judgement. The regulator recognises it will need to evolve to understand forthcoming technology and techniques that become available.


CP17/39: Quarterly Consultation Paper No. 19

The quarterly consultation paper sets out minor proposed miscellaneous amendments to the FCA handbook that the FCA wishes to gain feedback on. This quarter, the FCA is consulting on changes to:

  • The DEPP, due to a change in the governance structure;
  • The meaning of Premium Listing Principle 6 in LR and where diversity reporting may be located under corporate governance reporting requirements in DTR;
  • DISP relating to access to the FOS for PEPs, and referrals to TPO;
  • The Glossary definition of fee-paying payment service provider;
  • FEES 5 Annex 1R to collect the general levy for the FOS from RAISPs;
  • EG, which will ensure full implementation of the Insurance Distribution Directive (IDD);
  • Guidance notes on the completion of the Annual Financial Crime Report (REP-CRIM) to reflect changes in the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (MLRs);
  • Regulatory reporting requirements.

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