The measures, which will involve more substantial costs to the regulated community, are the establishment of the consumer finance education body and money guidance service, the new consumer redress mechanisms, and the transfer of the costs of funding the exercise of the special resolution regime powers to Financial Services Compensation Scheme levy payers. The Bill also gave the FSA new objectives, duties and a range of new powers, in terms of rule-making, supervision and enforcement. In some cases the effect of these will extend beyond the regulated community.
The FS Bill will deliver significant reforms which are designed to: strengthen financial regulation, including improving prudential regulation and supervision; improve corporate governance and remuneration practices; and give consumers greater rights and information.
The FS Bill also gives the FSA new objectives and duties and extends its powers in various ways, mainly through amendments to the Financial Services and Markets Act 2000 (FSMA).
Key Provisions in the FS Bill
Objectives of the FSA – the new financial stability objective
Under FSMA, the FSA currently has four regulatory objectives. These are: maintaining confidence in the financial system; promoting public understanding of the financial system; securing the appropriate degree of protection for consumers, and reducing financial crime.
The FS Bill gives the FSA a new financial stability objective to contribute to the protection and enhancement of the stability of the UK financial system. In considering this objective, the FSA must have regard to:
• the economic and fiscal consequences for the UK of instability of the UK financial system;
• the effects (if any) on the growth of the UK economy of any regulatory action taken tomeet the financial stability objective; and
• the impact (if any) on the stability of the UK financial system of events or circumstances outside the UK (as well as in the UK).
In consultation with the Treasury, the FSA must determine and review its strategy in relation to the financial stability objective.
The FS Bill also gives the FSA a broad power to require certain persons to provide specified information or produce specified documents in the context of its new financial stability objective. The types of person to whom this requirement applies include:
• a person who has a legal or beneficial interest in any of the assets of a relevant investment fund;
• a person who is responsible for the management of a relevant investment fund;
• a person who provides any service to an authorised firm (only if the FSA considers that the service or any failure to provide the service poses, or would be likely to pose, a serious threat to the stability of the financial system);
• a person prescribed by order made by the Treasury; and
• a person who is connected with the above persons.
A “relevant investment fund” is defined for these purposes as an investment fund whose assets consist of or include financial instruments which are traded in the UK or were issued by a body incorporated in the UK.
The FSA will also be able to exercise the power to require information at the request of an overseas regulator in order to support the stability of the financial system operating in the country or territory of that regulator.
Meeting the FSA’s regulatory objectives
The FS Bill enables the FSA to exercise its rule-making, permission varying and intervention powers for the purpose of meeting any of its regulatory objectives. Currently, it can only exercise these powers in order to meet its consumer protection regulatory objective.
Remuneration of executives
(a) Executives’ remuneration reports
The FS Bill gives the Treasury the power to make regulations for authorised firms to prepare, approve and disclose remuneration reports covering their executives, officers, employees and consultants (and those of their corporate group). The regulations may provide for such reports to be filed with the Registrar of Companies or the FSA, and for the FSA to publish any reports filed with it. The Treasury has power to create offences in relation to remuneration reports equivalent to those under the Companies Act 2006 in relation to directors’ remuneration reports, with comparable penalties.
This will provide a mechanism to implement the final recommendations of the Walker Review which extend current disclosure to include banded disclosure of the remuneration of high-end non-board executives. Interestingly, during the debate on the FS Bill’s second reading, the Chancellor stated that the Government intends to go further than Sir David Walker has suggested. It plans to consult on regulations for narrower disclosure bands than he proposed, starting with salary packages below the £1 million threshold.
(b) FSA rules about remuneration
The FS Bill will also impose a duty on the FSA to make rules requiring all authorised firms to operate a remuneration policy which is consistent with the effective management of risks and the FSB’s Implementation Standards for Principles for Sound Compensation Practices. (The term “remuneration policy” is widely defined to cover a policy about the remuneration not only of officers and employees but also “other persons” of a description specified in FSA’s rules.)
The Treasury is given the power, after consulting the FSA, to direct it to consider whether certain authorised firms’ remuneration policies comply with the FSA’s rules. If the FSA considers that a remuneration policy is not compliant, it may take such steps as it considers appropriate to deal with the failure, including requiring the policy to be revised.
The FSA’s new rules may:
• prohibit persons from being remunerated in a specified way;
• provide that any provision of an agreement that contravenes such a prohibition is void; and
• provide for the recovery of any payment made, or other property transferred, under a void provision.
By requiring the FSA to make remuneration rules, the FS Bill gives a clearer basis for the FSA’s Remuneration Code which applies at present only to 26 large banks and broker dealers and came into force in a rather half-baked form on 1 January 2010. It will also extend regulation of remuneration to a much larger number of authorised firms. However, the FS Bill will have no retrospective effect on existing remuneration contracts: thus remuneration provisions in agreements made before any new FSA rules on remuneration will not be affected.
Recovery and resolution plans
The FS Bill imposes a duty on the FSA to make rules requiring authorised firms to prepare and keep up-to-date recovery and resolution plans (RRPs), more commonly, but rather misleadingly, known as “living wills”. This requirement can apply to all authorised firms, or the FSA can exercise discretion over which authorised firms are required to produce an RRP, by specifying the firms to which the rules apply. This will allow for gradual implementation, focusing on the largest, most complex and systemically important firms to begin with. It is also important to note that the FSA’s rules must apply to authorised firms in relation to whom any power under Part 1 of the Banking Act 2009 (the Special Resolution Regime) is exercisable.
The FSA’s rules must be made in consultation with the Treasury and the Bank of England. The FSA must also have regard to any international standards about documents with a similar purpose to RRPs when making its rules.
Recovery plans: a recovery plan aims to reduce the likelihood of failure of an authorised firm by setting out what the authorised firm would do in, or prior to it becoming subject to, stressed circumstances that would affect the ability of the authorised firm to carry on all or a significant part of its business. A recovery plan might include actions such as restructuring or the scaling back or sale of certain businesses or assets.
Resolution plans: a resolution plan is a plan covering both action to be taken in the event of failure of any part of an authorised firm’s business occurring, and action to be taken by the firm where failure is likely. This would include action to be taken by the relevant authorities to resolve the authorised firm. A resolution plan may require a firm to identify obstacles to the application of possible resolution tools by the authorities or to the carrying out of the functions of an insolvency official in the event of the authorised firm’s failure and to set out what action may be required to facilitate the application of those tools or carrying out of those functions. This could include provisions to ensure that a data room can be set up quickly and effectively. It could also mean information about the simplification of legal structures ahead of a resolution being triggered.
The FSA is required to consider whether each RRP complies with its rules and to take steps to deal with any failure to comply, including requiring the RRP to be revised.
General rules about RRPs may, in particular, impose a requirement on authorised persons to collect and keep up-to-date certain information. Where the FSA considers that an authorised firm has failed to comply with this requirement, it may require that firm to appoint a skilled person to collect or update the information in question.
The FS Bill also gives the FSA additional enforcement powers relating to the collection of information relating to RRPs.
The FS Bill provides the FSA with a new power to make rules to prohibit, or require disclosure of short selling and inserts a new Part 8A into FSMA whichprovides that:
• the FSA may make rules banning short selling in relation to certain financial instruments by prohibiting persons from engaging in this practice; and
• the FSA may make rules requiring the disclosure of information relating to short selling in relation to specified financial instruments. These rules may apply in relation to short selling engaged in before the rules are made where the resulting short position is still open when the rules are made.
Both sets of short selling rules will apply to all persons, whether authorised by the FSA or not. The rules may apply to short selling wholly outside the UK by persons outside the UK, but only in so far as the rules relate to UK financial instruments. They may be targeted at a particular form of financial instrument issued by a specified company.
The definition of short selling for the purposes of the short selling rules includes any case in which a person sells a financial instrument which that person does not own, and will make a profit if the price of that instrument falls before the person has to buy the instrument to deliver it to the buyer or to return to the lender (where the sale was settled with borrowed financial instruments). It also includes any case in which a person enters into a transaction in a different financial instrument to the shorted instrument (whether the first-mentioned financial instrument was in existence before the transaction, or was created as a result of the transaction), where the effect of the transaction entered into is that that person will make a profit if there is a fall in value in the shorted instrument.
The definition of “relevant financial instrument” means that the FSA may make rules regulating short selling in relation to financial instruments admitted to trading in EEA markets, or which have any other connection to EEA markets which may be specified in the rules, as well as financial instruments admitted to trading in the UK.
Where a financial instrument is admitted to trading both on a UK or EEA market and markets elsewhere in the world, the FSA may make short selling rules in relation to that instrument on any or all of the markets on which it is admitted to trading. The same applies where related financial instruments are admitted respectively to trading on an EEA market and a market elsewhere in the world. An instrument will be related for these purposes if the price or value of one instrument depends on the price or value of the other.
The FS Bill enables the FSA to make short selling rules without prior consultation if it considers that it is necessary to do so in order to maintain confidence in the UK financial system or protect the stability of the UK financial system. Initially these emergency short selling rules may last for no more than three months. However, the FSA is given power to direct that emergency restrictions can extend these rules for a further three months provided that it still considers them to be necessary.
The FS Bill also gives the FSA power to require the production of information or documents in order to ascertain whether there has been a breach of any short selling rules.
The FSA may impose an unlimited fine on any person if it is satisfied that the person has contravened any part of the short selling rules or an information requirement. The FSA may alternatively decide to publish a censure to this effect.
There is a four-year time limit on the FSA’s ability to take such enforcement action against a person, unless, before the end of the four-year period, the FSA has given a warning notice to the person concerned. The four-year period begins with the first day that the FSA knew that a person contravened any provision of the short selling rules or the information requirement. For this purpose the FSA is to be treated as ‘knowing of a contravention’ if it has information from which the contravention can reasonably be inferred.
FSA disciplinary powers
The FS Billgives the FSA a range of new disciplinary powers to punish regulatory breaches. Although the FSA can effectively suspend (through the variation process) the permission of an authorised firm to carry on regulated activities in the context of its supervisory work, it is not able to impose a suspension as an enforcement sanction to punish regulatory misconduct.
Under the new provision, the FSA will have the power to suspend, limit or otherwise restrict an authorised firm’s permission for up to 12 months where it considers that that firm has contravened a relevant regulatory requirement. Relevant regulatory requirement for these purposes means a requirement imposed under FSMA or by any directly applicable regulation made under the Markets in Financial Instruments Directive (MiFID).
The FSA will be able to impose a penalty and cancel a firm’s authorisation
The FSA is currently prohibited from imposing a penalty on an authorised firm and withdrawing that firm’s authorisation for the same contravention. The FS Bill removes that prohibition and so enables the FSA to stop an authorised firm from continuing to carry on all regulated activities at the same time as imposing a financial penalty on that firm.
The FSA will be able to impose penalties for performance of controlled functions without approval
Under FSMA, authorised firms are required to take reasonable care to ensure that no person performs a controlled function (under an arrangement entered into by the firm or its contractor) in relation to the carrying on by the authorised firm of a regulated activity, without that person having obtained FSA approval to do so. However, the FSA does not currently have any power to penalise a person performing a controlled function without FSA approval.
Under the FS Bill, the FSA will be able to impose a financial penalty on a person if it is satisfied that that person has performed a controlled function without approval. It may not, however, impose any penalty if there are reasonable grounds for it to be satisfied that the person did not know and could not reasonably be expected to have known that they were performing a controlled function without approval.
The FSA is not allowed to impose a penalty under this power after the end of the limitation period that is the period of four years beginning with the first day on which the FSA knew that the person concerned had performed a controlled function without approval.
The FSA will be able to suspend or impose restrictions on an approved person who is guilty of misconduct
Section 66 of FSMA sets out the FSA’s present disciplinary powers in respect of misconduct by approved persons. The FS Bill adds to the current sanctions (financial penalty and public statement of misconduct) that the FSA can impose for misconduct by enabling the FSA to suspend an approved person from carrying on certain functions, and/or impose restrictions on that person’s performance of certain functions, for a maximum period of two years.
The FS Bill also extends the limitation period within which the FSA must take disciplinary action against an approved person from two to four years.
The Financial Services Compensation Scheme (FSCS) Changes
FSCS contributions to costs of special resolution regime
Under section 214B of FSMA (inserted by the Banking Act 2009) the Treasury may require the FSCS to contribute to the costs incurred in applying the stabilisation powers of the special resolution regime to a bank that is failing.
The FS Bill provides that the Treasury may include interest costs in the calculation of expenses incurred in connection with the use of the stabilisation power. It also provides for the maximum amount which the FSCS may be required to contribute. This is limited to the notional net expenditure (which is the amount that the FSCS would have paid in the hypothetical scenario where the stabilisation power had not been exercised and the bank had entered insolvency proceedings) minus the actual net expenditure (that is any actual payments the FSCS has made in respect of the resolution, net of any recoveries made).
Power to require the FSCS manager to act in relation to other schemes
The FS Bill enables the Treasury to require the manager of the FSCS to make payments on behalf of another compensation scheme (or a government or other authority) that pays compensation in respect of institutions that provide financial services, including institutions that are not authorised financial services firms. (The purpose of the provision is to allow the FSCS to act as an agent to deliver compensation to UK customers of financial firms based overseas with a view to improving depositor protection.)
The FSCS manager will be entitled to decline to act (after notifying the Treasury) on a variety of grounds, including:
• where it is not satisfied that it will be able to obtain the necessary information, advice or assistance from the scheme’s administrator;
• where it is not satisfied that funding is being provided to meet the expenditure that it will incur in acting on behalf of the relevant scheme manager;
• where the manager of the relevant scheme has not given an undertaking not to bring proceedings against the FSCS manager; or
• where there are no arrangements for the reimbursement of expenses arising out of claims brought against the FSCS manager by third parties.
The FS Bill also enables the FSA to make rules in connection with the FSCS manager acting as a paying agent on behalf of relevant schemes. This includes conferring power on the FSCS manager to impose levies to cover its expenses. However, if the FSA does impose such a power, the FSCS manager may only exercise it if it has tried and failed to obtain reimbursement of its expenses elsewhere.
The Asset Protection Scheme
The FS Bill gives HM Treasury the power to require information or documents from participants or proposed participants in the asset protection scheme or related schemes, which the Treasury designated as corresponding to, or connected with, the asset protection scheme. The Treasury will be able to enforce the requirements by way of an injunction, or in Scotland, by way of an order for specific performance.
Implementation of the Legislation
On 9 April 2010, the Financial Services Act 2010 was published and the FSA also published a statement relating to the Act together with a related new webpage.
In both the statement and the webpage, the FSA outlined the main changes to its objectives, powers and duties resulting from the new Act.
Different parts of the new Act will take effect at different times. The parts that come into effect immediately include the financial stability objective and the duty to create a consumer financial education body. Parts that come into force two months after the Act was passed include the power to make rules on short-selling and the enforcement powers. A number of provisions will take effect, however only after a commencement order is made by HM Government.
Despite the Government’s initial confidence that the FS Bill would complete its Parliamentary scrutiny before the end of the current session, the decision to call a General Election on 6 May 2010 meant that the Bill entered the “wash up” process which sees bills rushed through shortly before the dissolution of parliament prior to a General Election.
Whilst many of the reforms brought about by the FS Bill are relatively uncontroversial, the Government removed some of its more contentious provisions in order to increase the Bill’s likelihood of survival. Clearly, it was necessary to get the FS Bill through before the General Election, in the knowledge that the opposition parties plan significant changes to the entire financial supervisory structure. In particular, the Government conceded the removal of provisions relating to:
• the proposed Council for Financial Stability which would have been responsible for reviewing matters affecting the stability of the UK financial system;
• the proposed FSA duty to promote international regulation and supervision; and
• the proposed measures allowing the courts to authorise collective proceedings for financial services claims.
Certainly, given the significance of the FS Bill’s implications and the importance of its stated aims, it is a shame that it did not receive the full and further debate and clarification that it deserved.