Trends in the FCA’s use of ‘hard’ and ‘soft’ powers


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By: Polly JamesIn this short video, Polly James, a senior associate in our Financial Services Regulation team, discusses the trends in the FCA’s use of ‘hard’ and ‘soft’ powers, including:• the FCA’s increasing use of supervisory powers as part of its early intervention strategy;• the jurisdictional land grab underway by the FCA; and• key recommendations of the recent HMT Enforcement Process ReviewOur Financial Regulatory Group launched its fifth annual Emerging Themes in Financial Regulation publication this month, which looks are the regulatory changes that are affecting the UK financial services industry in 2015.Hello, The introduction of the new regulatory regime in April 2013 brought with it a definite blurring of the boundaries between the FCA supervisory powers, their so called soft powers and its important powers or hard powers with the increasingly broadening draconian supervisory powers the FCA has obtained it has become really clear to us over the past year that the FCA is keen to do as much as it possible can to achieve its objectives using its soft powers rather than enforcement powers as a part of its so called early intervention strategy. So I was at a conference at the end of last year where the FCA said, rather staggeringly, that 95% of what it does is now using its soft powers so the vast majority of what the FCA is doing these days is without any recourse at all to its former statutory powers and I find that extraordinary and the FCA has also started using the term recently “hard soft powers” to relate to some of the more draconian supervisory powers. I think that’s quite telling about the way that things are going. So why are things moving that way? Well, there are many advantages to regulators of using supervisory rather than enforcement powers to achieve their objectives. Its quick, it costs a lot less resource than instructing the enforcement division to get involved. Its private for now, although there are suggestions that in the future some firms may have their supervisory outcomes published for other firms to learn from. And finally, there are because of their relatively informal nature and much less likely to have firms getting their external lawyers involved where the regulators are wanting to use their supervisory powers in relation to them. Contrast that then to the position where you are using your enforcement powers as a regulator. Clearly that is when you get your fines, that’s where you get your public outcomes and your deterrence factor. And you do clearly need those but you don’t need them every time and would certainly not in circumstances where you can levy over a billion pounds worth of fines in the course of a single morning as the FCA did in relation to Forex. So it is clear to me that we will see the regulators increasingly using their soft powers to achieve the objectives that they want to achieve.Now I have a theory for you as to the real reason why the FCA is so keen to use its soft powers rather than its enforcement powers at the moment. I think it is because they are panicking a bit because they suddenly seem to think at the FCA that they are responsible for regulating everything that FCA authorised firms do both in this country and in other jurisdictions. Why do I say that? Because of my reading of what the FCA has been doing recently, so in the last year we have seen the FCA bring enforcement action against a variety of banks in relation to their spot effects trading which we know is not a regulated activity. Now the statutory notices are quite vague about the jurisdictional basis for doing this but it seems to me that it must be as follows: first that there has been a breach of Principle 3, so systems and controls and risk management systems; secondly, where there is a prudential context the FCA Handbooks says that Principle 3 applies in relation to unregulated activities and in relation to activities outside the United Kingdom. The FCA Handbooks says that prudential context covers any context when a firm may be failing to meet its threshold conditions and since April 2013 there has been one particular extremely broad and vague threshold condition that effectively says that a firm must behave properly. Now, we have also seen the FCA use this combination of arguments in an insurance enforcement case last year where the FCA fined an insurer in respect of activities carried out outside the UK by its branch officers and again in that case the FCA use the Principle 3 plus prudential context argument. So, I question whether its actually the FCA’s place to bring enforcement action for conduct breaches outside the UK. Under the framework set up by the European single market directives prudential regulation is clearly a matter reserved to the home state regulator but conduct regulation is for the regulators in host states. So I do question that but I do believe that until someone challenges the FCA on this they will continue to use this combination of Principle 3 and the prudential context really as the joker in the pack to bring enforcement action against firms in whatever way they want to do. And given that most regulatory breaches could probably be characterised as a Principle 3 breach and in a prudential context as defined I see this as a real worry. Finally, but also importantly the process for the FCA exercising its enforcement powers is set to change over the coming year. Back in May last year George Osborne committed a review of the fairness and effectiveness of the regulatory enforcement process and following that a report was published just before Christmas which contained a number of recommendations. Now, some of these recommendations I think are very good and will improve things for firms in enforcement a lot, for example, there will be must better communication between the enforcement lawyers and the fair minded investigation, more frequent communication, there should be advanced notice now to the firm of the beginning of the Stage 1 28 day settlement window which I think firms will find extremely helpful. They are also recommending that higher level engagement by the regulator should happen in the context of settlement negotiations and so far I think so good. But there is one recommendation in here which I think is really bad and that’s that the Stage 2 and Stage 3 settlement discounts should be scrapped altogether effectively narrowing the executive settlement window to 28 days. Now our experience is that firms are already at a very significant disadvantage compared to the FCA in executive settlement discussions. The FCA has a massively better bargaining position because it knows the values to firms over 30% discount on the proposed fine and it uses that again rather like a trump card to just say that they will walk away from it were a particular difficult point arises and that leaves the firm at a very significant disadvantage. Now if Stage 2 and Stage 3 settlement discounts are scrapped I think that they playing field is going to be skewed even further in favour of the FCA. At present, if a firm doesn’t manage to reach executive settlement within 28 days of receiving a draft warning notice it loses the chance of a 30% discount from the proposed fine but it retains the chance of settling for a 20% discount. Now if you take that away suddenly the position is that at the end of the 28 day period you move from having a chance of a 30% discount to having absolutely nothing at all. This cannot be fair and it’s not clear to me at the moment when the FCA is going to consult on implementing this recommendation. I have been asking them whether they will, but if they do consult then I thoroughly intend to get in touch with as many of you as are interested to coordinate a response against the implementation to this recommendation.So to sum up, what to expect in 2015? I think an increasingly intrusive approach by your regulatory supervisors mirroring the increase in the intrusiveness we have already seen in the past year do bear in mind these very broad and draconian powers that they have when dealing with them they are not to be regarded as being on the home team anymore. Secondly, I think we will see more enforcement cases which will see more enforcement cases which involve conduct outside the UK and possibly cases which involve unregulated activities as well. Be aware of that and ask yourself whether the conduct of your branch operations stands up to FCA scrutiny. Thirdly, its significant changes to the enforcement process, do look out for a consultation paper from the FCA on that, please get in touch with us if you would like to join with us in lobbying against the proposed changes to the executive settlement procedure.Thank you

In this short video, Polly James, a senior associate in our Financial Services Regulation team, discusses the trends in the FCA’s use of ‘hard’ and ‘soft’ powers, including:

  • the FCA’s increasing use of supervisory powers as part of its early intervention strategy;
  • the jurisdictional land grab underway by the FCA; and
  • key recommendations of the recent HMT Enforcement Process Review

Our Financial Regulatory Group launched its fifth annual Emerging Themes in Financial Regulation publication this month, which looks are the regulatory changes that are affecting the UK financial services industry in 2015.

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