Among the items covered in this month's newsletter are the FCA's ban on mass marketing of speculative mini-bonds, finalised guidance on the FCA's general insurance distribution chain, Q&As on conduct risk during LIBOR transition, and the Investment Association's final report on its responsible investment framework.
Please also take a look at a special Taylor Wessing update on the 5th Money Laundering Directive, which is due to come into force on 10 January 2020.
Payment Services and Systems
Pay.UK unable to progress with CRM fee to fund APP fraud reimbursements
On 15 November 2019, Pay.UK published a document outlining the reasons why it is unable to proceed with a proposal to introduce a Faster Payments Service (FPS) rule requiring a Contingent Reimbursement Model (CRM) fee to reimburse victims of authorised push payment (APP) fraud.
On 26 July 2019, Pay.UK received a change request from UK Finance on behalf of seven FPS Direct Participants, including Barclays, HSBC and RBS. The change request proposed to introduce a requirement into the FPS Rules for Participants to pay a CRM fee, which would be used to fund the reimbursement of 'no-blame' customers as per the assessments outlined within the voluntary CRM Code for Authorised Push Payment Scams.
Following a call for information, Pay.UK has concluded that there is a lack of industry consensus for all FPS Direct Participants to pay a CRM fee and Pay.UK hopes that the industry will work together and take steps to move towards more consistent outcomes for customer protection.
EPC SEPA payment scheme rulebooks enter into force
The European Payments Council (EPC) announced on 18 November 2019 that the following 2019 EPC SEPA payment scheme rulebooks have entered into force:
All four rulebooks entered into force on 17 November 2019 and are applicable until 21 November 2021. The EPC invites stakeholders to submit change requests in relation to the SCT and SDD rulebooks by 31 December 2019.
General financial services regulation
FCA publishes Q&As on conduct risk during LIBOR transition and speech on next steps
On 19 November 2019, the FCA published a statement on conduct risk during LIBOR transition.
During discussions with the industry, firms have asked the FCA questions about its core expectations of firms during the transition away from LIBOR. In response, the FCA has provided a set of Q&As on conduct risk arising from LIBOR transition, outlining the expectation that firms have a strategy during LIBOR transition, and that customers are treated fairly by following the FCA's rules and guidance. The Q&As address various issues, including:
- How firms’ senior managers and boards are expected to understand the risks associated with LIBOR transition and take appropriate action to move to alternative rates ahead of end-2021.
- What a fair replacement rate for LIBOR-linked products or services is when amending existing contracts.
- Whether firms should be offering new products that reference risk-free and other alternative rates rather than LIBOR-linked products.
- How firms must communicate information about LIBOR and alternative investment rates and products to customers in a way that is clear, fair and not misleading.
- How to ensure that a firm acts in the best interests of a client or fund when making investment decisions in relation to LIBOR and RFR-linked products.
All firms that currently rely on LIBOR are encouraged to read and consider the Q&As, which are not exhaustive.
The FCA also published a speech on 21 November 2019 by Edwin Schooling Latter, Director of Markets and Wholesale Policy at the FCA, on the next steps in transition from LIBOR.
In his speech, Mr Schooling Latter outlines the key next steps in reducing the risks from continued use of the LIBOR benchmark, including ending the use of LIBOR in new sterling loans from Q3 2020, and making it standard to quote based on SONIA in sterling swap markets. He also describes how LIBOR could cease or fail the Benchmarks Regulation 'representativeness' test towards the end of 2021, and how robust contractual fall back triggers can protect market participants from risks in both scenarios.
FCA to ban mass marketing of speculative mini-bonds to retail consumers
On 26 November 2019, the FCA published a press release announcing that it will ban the mass marketing of speculative mini-bonds to retail customers in order to prevent consumer harm. The FCA has decided to introduce the restriction without consultation, using its product intervention powers. The restriction will come into force on 1 January 2020 and last for 12 months during which time the FCA will introduce temporary product intervention measures and consult on making permanent rules.
The ban will apply to more complex and opaque arrangements where the funds raised are used to lend to a third party, invest in other companies or purchase or develop properties. Firms that issue speculative illiquid securities, and authorised firms that approve or communicate financial promotions relating to speculative illiquid securities, will be affected, as will firms who conduct regulated activities in relation to these products.
The ban comes as a result of the FCA raising significant concerns with widespread marketing of these products, particularly online, despite them being high risk and difficult for most retail investors to understand. Such promotions are said to contain limited explanations of risks and fees or costs involved, and may include misleading information suggesting these products are more secure or less risky than is the case. As such, the FCA considers that it gives rise to a significant risk of consumer harm.
The FCA has also published guidance on approving the financial promotions of unauthorised persons. The regulator is particularly concerned about the promotion of unlisted debt securities or 'mini-bonds' above, although the principles outlined in the guidance are applicable to approving financial promotions in other sectors.
Banking and insurance
PRA publishes Dear CEO letter on reliability of regulatory returns
On 1 November 2019, the PRA published a Dear CEO letter (dated 31 October 2019) on the reliability of regulatory returns. The letter sets out the PRA's expectations for firms to be able to respond promptly to a request from it to:
- Demonstrate how the design and operation of the governance, controls and other processes deliver regulatory reporting of appropriate quality. Firms should also be able to provide details of the key interpretations and judgements made relating to regulatory returns and the governance processes used to validate these.
- Provide the PRA with details of any material regulatory reporting errors identified, together with an explanation of the actions taken to remediate them.
Firms are reminded that the production and integrity of a firm's financial information and its regulatory reporting is a prescribed responsibility. The PRA therefore expects firms to take any necessary action to ensure the integrity of its returns, such as undertaking regular, comprehensive reviews of the effectiveness of the governance, controls and other processes to ensure they are fit for purpose. Firms should also carry out deep dives that look at the accuracy of the returns themselves.
As part of the PRA's ongoing focus on the integrity of regulatory reporting, it also intends to commission reports from skilled persons under section 166 of the Financial Services and Markets Act 2000. Such reviews may involve:
- A 'reasonable assurance' opinion on whether the return reviewed has been properly prepared.
- A review of the relevant governance, controls and other processes.
- The gathering of information that will enable the PRA to review the key interpretations applied in preparing the return.
The main focus of these reviews will be on larger firms and the PRA will let firms know if it decides to commission a skilled person review.
FCA publishes finalised guidance on the general insurance distribution chain
On 19 November 2019, the FCA published its final guidance on the general insurance (GI) distribution chain for insurance product manufacturers and distributors. The guidance gives further clarity on the FCA's expectations of firms in the GI and pure protection sector, particularly on how firms should consider the value that the product and distribution arrangements present to the customer.
The guidance follows previous work done by the FCA into product value in GI. During 2017 and 2018, the FCA conducted diagnostic work on GI distribution chains, which found a number of harms to customers from failures in product design, oversight and distribution. At the same time, the Insurance Distribution Directive was introduced which brought in new rules on product design, oversight, governance and distribution. The FCA then consulted on proposed non-handbook guidance in April 2019, which found that most respondents supported the proposed guidance although some raised concerns on specific expectations.
The final guidance largely implements the guidance as consulted on, although some amendments and additions have been made based on the feedback received. Among other things, the FCA has:
- Clarified the scope to make clear that the guidance applies to the distribution of all GI products, including pure protection products launched on or after 1 October 2019.
- Clarified how the guidance on value links to existing handbook rules.
- Explained that value includes a range of factors, including price and quality.
- Amended the guidance for manufacturer firms on their oversight of distribution agreements.
Alongside the FCA's work on overall product value, it also conducted a separate market study into how GI firms charged their customers for home and motor insurance. Further details can be found in our November newsletter.
PRA publishes Dear CEO letter on areas of focus for general insurance firms
On 5 November 2019, Gareth Truran, acting director of insurance supervision at the PRA, sent a letter to CEOs of PRA-regulated general insurance firms setting out the PRA's priorities for the general insurance sector, along with some feedback from its recent supervision activity.
The letter outlines several areas of focus, including:
- Reserving adequacy and associated governance and control, particularly in light of emerging risk developments including the US.
- The extent to which firms are demonstrating discipline in underwriting strategies remediation activity and controls, notwithstanding recent rate rises in some speciality lines.
- Emerging risk trends and experience in firms’ exposure management practices, including both natural catastrophe and man‐made accumulations.
- Understanding UK retail general insurers' responses to the FCA's pricing practices review.
- Ensuring firms develop and maintain a culture where staff feel able to speak up and raise concerns, with effective mechanisms in place to support them in doing so.
Firms are encouraged to assess these points and consider whether the issues raised are relevant to them. Further, the PRA expects a discussion of the letter at board level in order to identify actions that a firm believes should be taken.
Asset management and investments
Investment Association updates principles of remuneration for 2020
On 1 November 2019, the IA published an updated Principles of Remuneration (the Principles). In accompanying the Principles, a letter was sent to chairs of remuneration committees of FTSE 350 companies highlighting key aspects of the Principles that its members have identified as areas of focus for the forthcoming AMG season.
The letter highlights that, in order to reduce complexity in remuneration structures, investor shareholders should consider using alternative remuneration structures if aligned to the company strategy. It is also suggested that remuneration committees should introduce discretion into their incentive schemes, allowing them to limit the vesting outcomes if a specific monetary value is exceeded. Other key areas of focus include:
- Approach on pensions: Members expect remuneration committees to set out a credible action plan to reduce the pension contributions of incumbent directors to the majority of the workforce level by the end of 2022.
- Shareholding requirements and post-employment shareholding requirements: During the forthcoming AGM season, shareholders will expect to see post-employment shareholding requirements included in all new policy approvals (which were introduced in the 2018 Principles).
- Pay for performance: To justify support for remuneration pay-outs, IA members request that strategic and personal targets relating to and outcomes are disclosed separately.
Investment Association publishes final report on responsible investment framework
On 18 November 2019, the Investment Association (IA) published its final report on its responsible investment framework that aims to categorise, and provide standard definitions for, the different components of responsible investment. Firms are encouraged to adopt the framework to help bring clarity and consistency to investors on the approaches they take to responsible investment.
The report is intended to provide context, guidance and uses for the framework as well as outline next steps and raise outstanding questions. In particular, the report:
- Sets out the key issue on a lack of common language and framework with which to define and categorise different responsible investment approaches carried out by investment managers.
- Gives an overview of the industry-wide consultation that the IA carried out at the start of 2019.
- Provides more detail on the responsible investment framework, including industry response to the consultation and the framework's subsequent development and intended uses.
The glossary sets out the meaning of "stewardship", "ESG integration", "exclusions" and "sustainability focus" along with examples. These are intended to provide consensus on widely adopted terminology, rather than create a set standard.
A related press release explains that from 2020, IA members will be asked to identify which funds should be classified as having responsible investment characteristics to help bring further clarify to the market.
FCA statement on SEC decision to extend no-action relief relating to MiFID II inducements and research
On 8 November 2019, the FCA published a statement on the US Securities and Exchange Commission's (US SEC) announcement to extend no-action relief relating to the Markets in Financial Instruments Directive II (MiFID II) inducements and research provisions.
In the announcement, the US SEC said it would extend the SEC staff 'no action letter', which addresses the potential conflict between US regulation and MiFID II. The existing relief was due to expire on 3 July 2020.
In welcoming the decision, the FCA stated that during the remainder of the current period and the extended period of the no-action relief, US broker-dealers may receive payments for unbundled research from firms subject to MiFID II or equivalent rules of EU member states without being considered an investment adviser under US law. This will also apply to UK firms in the event of EU withdrawal before or during the extended period.
The FCA will carry out further work in 12-24 months' time to assess firms' ongoing compliance with its rules and developments in the market for research.
Financial crime
NCA revised guidance on SAR glossary codes and reporting routes
On 11 November 2019, the National Crime Agency (NCA) published a revised version of its guidance on the use of Suspicious Activity Report (SAR) glossary codes and reporting routes.
The updated guidance includes new codes for SARs where the value of suspected money laundering falls below £3,000 and where the firm is unaware of any existing law enforcement interest at the time of reporting. The guidance replaces all previous glossary codes publications.
The guidance highlights that the use of glossary codes is considered good practice, and that they are crucial in enabling the UK Financial Intelligence Unit (UKFIU) and wider law enforcement to conduct analysis to identify money laundering trends. The guidance also explains that the SARs regime is not a route to report crime or matters relating to immediate risks to others. Instead, the SARs regime is for reporting knowledge or suspicions of money laundering, or beliefs or suspicions relating to terrorist financing. Other key points include:
- When submitting a SAR, the relevant glossary code should be included in the 'Reason for Suspicion' text space.
- It is acceptable to have a SAR with several codes.
- If there is doubt as to which code applies, always work on the basis that it is better to include one than not.
- It is possible that a code does not match the set of circumstances, in which case "no codes apply" can be populated into the 'Reason for Suspicion' text space.
FCA and PRA self-assessment questionnaire on cyber resilience
On 21 November 2019, the FCA published a self-assessment questionnaire (CQUEST) to help firms understand their cyber resilience capability at a high level.
The questionnaire was designed by both the FCA and PRA, and consists of multiple-choice questions, such as:
- Are risks to cyber security effectively managed?
- How is user access to data via systems reviewed?
- Does a formally documented cyber security strategy exist and who is it approved by within the organisation?
The answers will provide the FCA/PRA and firms with an overview of their cyber resilience capabilities, while also highlighting areas for improvement.
Enforcement and investigations
FCA fines Henderson Investment Funds £1.9m for overcharging investors
On 20 November 2019, the FCA published a final notice (dated 18 November 2019) fining Henderson Investment Funds Limited (HIFL) £1,867,900 for failing to treat fairly retail investors in its Henderson Japan Enhanced Equity and the Henderson North American Enhanced Equity funds. The FCA found that HIFL had breached Principle 3 and Principle 6 of the FCA's Principles for Businesses.
HIFL breached Principle 6 between November 2011 and August 2016 by failing to ensure that it paid due regard to the interests of the retail investors in the two funds. In November 2011, a decision was taken by Henderson Global Investors (HGI) to reduce the level of active management that was being applied to the Japan and North American funds. The subsequent treatment retail investors received from HIFL was then substantially different from its institutional investors, in that:
- HGI informed institutional investors of the change and offered to manage the two funds for those investors without charge.
- The investment strategy was not communicated to retail investors, and HIFL continued to charge these investors the same level of fees as it had prior to the decision being made.
As a result, over 4,500 retail investors were charged £1,784,465 more than if they had been invested in a passive fund.
HIFL also breached Principle 3 between November 2011 and March 2017 by failing to exercise adequate oversight over the November 2011 decision made by HGI, since there was no requirement for the issues to be considered by any governing committee, nor was Henderson's Compliance function consulted before the decisions were made. Principle 3 was also breached as there was no governance or risk management systems or effective ongoing monitoring of the performance of the Japan and North American funds to determine whether they were continuing to meet investment objectives.
HIFL agreed to resolve the matter and qualified for a 30% discount.
PRA fines Citigroup £44m for regulatory reporting governance and controls failings
On 26 November 2019, the PRA issued a press release and final notice imposing a combined penalty on Citigroup Global Markets Limited (CGML), Citibank N.A. London branch (CBNA London) and Citibank Europe Plc UK branch (CEP UK) (Citi) of £43.9 million for failings in relation to their internal controls and governance arrangements in relation to compliance with PRA regulatory reporting requirements.
Between 19 June 2014 and 31 December 2018, Citi's UK regulatory reporting framework was not designed, implemented and operating effectively. As a result, they failed to submit complete and accurate regulatory returns to the PRA. The failings persisted over a significant period of time, which led to errors in the firms' returns, including six substantive matters which had a material or potentially material impact on the returns. Consequently, the returns submitted were unreliable and provided the PRA with an inaccurate picture of the firms' capital and liquidity position.
The PRA's investigation also identified that:
- Citi failed to allocate adequate human resources to ensure its liquidity returns were complete and accurate.
- Much of Citi's documentation was inadequate given its size, complexity and systemic importance.
As a result, CGML and CBNA London breached the PRA Branch Return Rule, and all three firms breached Rule 6.1 of the Notifications Part of the PRA Rulebook.
Citi agreed to resolve the matter and qualified for a 30% discount.
FS trivia
Which of the following is not a control band under the change in control regime as it applies to dual-regulated firms?
The answer to last month's question is systems and controls. Systems and controls roles are included in the Significant Management Certification Function. See pages 11-13 of the FCA's Policy Statement PS19/20.
