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5 June 2020

Speech by Megan Butler, Executive Director of Supervision – Investment, Wholesale and Specialists at the FCA, delivered at PIMFA’s Virtual Festival.

Speaker: Megan Butler, Executive Director of Supervision – Investment, Wholesale and Specialists
Event: PIMFA’s Virtual Festival
Delivered: 4 June 2020
Note: this is the speech as drafted and may differ from the delivered version

Highlights:
In operational terms, advisors and wealth managers responded well to the onset of the coronavirus (Covid-19) crisis.
Whilst acting with speed has been the absolute priority, as the industry adapts to the long-term impact of coronavirus, there is a need to transition from the immediate ‘incident response’ towards focusing on longer-term impacts. In her speech to PIMFA’s members, Megan Butler explores the FCA’s priorities and longer-term expectations for the wealth management and advice industry.
Key areas of focus for the FCA include operational resilience in light of coronavirus, financial resilience (and within that the preservation of client assets and money) and acting with integrity.
On the latter, the FCA has identified some firms which have tried to avoid their liabilities to customers by closing down companies and setting up new ones. These practices are unacceptable, and the FCA will continue to take action against firms conducting such activities.
The FCA, firms and trade bodies face a lot of the same issues, and we need to find opportunities to debate, and to share both good experiences and the things that didn’t work so well. That is why events like these are so important to keep the conversation going, to share observations and best practices, so that we can respond quickly to the issues that arise due to coronavirus faced by both clients and markets.

When I spoke to you last, back in 2017, the big topics on my agenda were culture and the growing influence of financial advice. Whilst those remain highly important topics, I think we can all agree that our perspectives have needed to shift somewhat.

I’d like to discuss with you today the effects of this changing world on the financial sector, taking stock of the industry’s response to coronavirus thus far and how that has shaped our regulatory priorities and response over the coming months.

I would then like to explain what our expectations are of firms during this period, particularly in the wealth and advice space, touching on some recent guidance and other materials we have published. And I’ll end with a look at the capturing lessons learned from coronavirus, and our expectations of firms going forward in the consumer investment sphere – namely with advisors and wealth managers.

Let’s start with where we are right now.

Where we are now and the FCA’s priorities
I think it’s fair to say that, in operational terms, this industry has responded well.

There has been no significant erosion of clients’ access to services, business continuity arrangements appear to be working and “glitches” have been worked through. Overall it feels as if firms are coping and adapting to this new normal.

And the feedback we have received from yourselves and from PIMFA corroborates this.

We expect all firms to have contingency plans to deal with major events and that these plans have been properly tested.
We ourselves have already taken rapid action to respond to the immediate shocks of coronavirus. Alongside HM Treasury and the Bank of England, we have already made a series of interventions, while in parallel delaying other planned regulatory activities so that firms can focus on responding to coronavirus.

You will have all seen that a lot of our work has focused on immediate relief, such as on mortgages and unsecured lending products, and we have also set out further guidance for firms to provide clarity over our expectations. In your sector, you will have seen our Dear CEO letter published on 31 March, which provided further guidance on the 10% devaluation reporting rule for discretionary managers.

We recognise that many in the industry have found this to be quite operationally challenging in the current environment. Of course, as we all know, it is mandated in Markets in Financial Instruments Directive (MiFID) II. Therefore, we have decided to ease the burden on firms by setting out how we intend to supervise against this specific requirement until the end of September, while also considering our consumer protection objective.

Acting with speed has been the absolute priority, but as we adapt to the long-term impact of coronavirus, we have already begun to transition from the immediate ‘incident response’ towards focusing on longer-term impacts and our strategy for tackling these.

Our Business Plan, which we published just last month, sets out the priority areas for our work over the next 1 to 3 years. And I can sum up the 5 key drivers of our response to coronavirus as ensuring:

there is a good level of operational resilience
we understand firms’ financial resilience so that firms can fail in an orderly manner
markets can function enabling price formation and orderly trading activity
customers are treated fairly
customers are aware of the risk of, and protected from, scams
What are our expectations of firms during this time?
Today I would first like to focus on 2 of these drivers, financial and operational resilience, with a focus on what our expectations are.

I think the obvious place for us to start is with operational resilience.

We expect all firms to have contingency plans to deal with major events and that these plans have been properly tested. Our operational resilience consultation paper, published late last year, sets out our proposals for how firms can strengthen their resilience so as to be able to supply their most important services with minimal interruption, even during severe operational events such as coronavirus.

As a reminder, the key messages set out in the consultation paper are:

The proposed requirements and expectations for firms and financial market infrastructure (FMI) to identify their important business services, by considering how disruption to the business services they provide can have impacts beyond their own commercial interests.
That firms must set a tolerance for disruption for each important business service and ensure they can continue to deliver their important business services. They must ensure they are able to remain within their impact tolerances during severe but plausible scenarios.
The requirements to map and test important business services to identify vulnerabilities in their operational resilience and drive change where it is needed.
Alongside the Bank, we are actively reviewing the contingency plans of a wide range of firms. This includes firms’ assessments of operational risks, their ability to continue to operate effectively and the steps they are taking to serve and support their customers.

I’m sure you will agree that the proposals laid in our consultation paper on operational resilience are now more relevant than ever.

Alongside the importance of operational resilience, we cannot overlook firms’ financial resilience.
We are proposing that firms identify and document the resources that support their important business services (which we refer to as mapping). Doing so can help firms identify where vulnerabilities may exist in their people, processes and technology and allow them to consider if further investment is required to enable their staff to work from home effectively for a prolonged period, and therefore maintain the availability of their important business services.

So far during the coronavirus pandemic we’ve seen many firms adjust quickly to a very different way of working and, in many cases, they have been able to continue to provide important services to their customers.

However, firms will need to keep their focus on operational resilience as circumstances change, government guidance is updated and, as things return to some form of ‘new normal’, how those changes will affect their resilience and their services.

We understand that many firms face serious practical challenges due to coronavirus, including in their operations dealing with consumer complaints, but welcome firms taking initiatives going beyond usual business practices to support their customers.

Our rules already provide flexibility to firms in many areas and we expect them to use this flexibility to support consumers, bearing in mind customers’ individual circumstances.

Alongside the importance of operational resilience, we cannot overlook firms’ financial resilience.

We are already beginning to see a key impact of coronavirus in its significant downward pressure on many firms’ revenues. We know that any decline in market values will mean there is significant downward pressure on investment management fee incomes. Financial viability concerns already present in some firms will be amplified and otherwise financially sound firms may become vulnerable.

To make sure we have the best possible view of the effect coronavirus is having on firms’ financial resilience, you will be receiving a short, simple coronavirus impact survey on Monday. It is relatively straightforward and quick to fill out – it can even be done on a smartphone – and you have 7 days to fill out and return to us.

The preservation of client assets and money is central to our focus in the wealth management sector.
These financial pressures could give rise to harm to customers if firms cut corners on governance or their systems and controls – for example, increasing the likelihood of financial crime, poor record keeping, market abuse and unsuitable advice and investment decisions. Market volatility could reveal previous mis-selling, increasing complaints and redress.

We are also aware a number of firms provide services to clients that result in firms holding client money and custody assets.

In the current climate, we cannot duck the fact that some of these firms may exit from the market altogether. In these circumstances, it is imperative to minimise any delay in the return of client money and custody assets, and to take action ahead of time to prevent shortfalls in what they should be holding on their clients’ behalf.

To that end, the preservation of client assets and money is central to our focus in the wealth management sector.

Outcomes we are focusing on
We have been clear, both in recent months and in our Business Plan, that a regulatory approach that focuses on outcomes will allow us to be clear at a time when uncertainty, market dynamics, innovation, societal and legislative changes are all transforming the financial landscape.

We want all firms to take consumer and market outcomes into greater account when they design and deliver services. To support this, we will be clearer with firms about the outcomes we expect them to achieve, as well as how we are targeting our own work to achieve them.

The outcomes that we continue to pursue in the wealth management sector are:

As I touched upon earlier, that firms must maintain adequate arrangements to protect client money and custody assets according to our requirements. We are aware that some firms are reporting an increase in client money balances during the coronavirus pandemic. Firms are required to consider the best interests of their clients at all times. Pursuant to this, we expect firms to return balances which are unlikely to be reinvested in the short term. In any case, we are reviewing the financial positions of firms to identify those which are more vulnerable to failure, and to ensure they have appropriate plans in place to wind-down in an orderly way if necessary.
We will assess how the wealth and advice market has reacted to coronavirus, including how service propositions and customer behaviours have changed. But as these changes take hold, we still expect firms to provide suitable advice and discretionary investment decisions.
An outcome that remains unchanged in these changing times is the expectation that firms must act with integrity. This includes charging appropriate fees for services delivered and preventing fraud. We are building on our own current initiatives (such as issuing scam alerts and the Scam Smart website) to make both the public and firms more aware and vigilant.
In this vein, we also still expect firms to prevent financial crime and market abuse through adequate controls and governance.
What we continue to observe
We have seen all too often that historic poor conduct and resulting compensation bills can lead to firm failures, and that this in turn drives increases in the Financial Services Compensation Scheme (FSCS) levy.

And as you know, we regularly review how the FSCS is funded.

It has also come to our attention that a few firms have tried to avoid their liabilities to customers by closing down companies and setting up new ones. We have been very clear that this is unacceptable.
For example, new rules came into effect in April 2019 requiring product providers to contribute around 25% of the compensation costs that fall to the intermediation classes. This was to the direct benefit of PIMFA’s members.

Naturally, we need to evaluate the effect of the coronavirus pandemic on FSCS costs, and we are working jointly with the Prudential Regulation Authority (PRA) and the FSCS to better forecast what the impact might be to ensure we are in a position to respond if and when needed.

I think it is fair to say that whilst we as an industry will work together to get through, and manage the effects of, coronavirus – as the regulator we will take action where we see bad practices.

It has also come to our attention that a few firms have tried to avoid their liabilities to customers by closing down companies and setting up new ones. A process we call phoenixing.

We have been very clear that this is unacceptable.

We made a statement to this effect back in December 2018 and have remained utterly clear about this ever since. So, it is disappointing that we continue to identify this practice in some parts of the industry.

We have also caught firms pre-emptively setting up new entities and applying for authorisation before complaints and liabilities at their existing entities have crystallised. This is a practice that we call lifeboating.

We have also prevented firms attempting to achieve the same outcome by acquiring control of an existing authorised firm to transfer the assets into or by putting forward individuals with a ‘clean’ regulatory history to front their new operation in the hope that they will get through the authorisation gateway undetected.

A recent, and particularly egregious, development is the practice of advisers leaving financial advice firms that have run up liabilities to customers through providing poor advice – often in the pension transfer space – only to re-emerge directly, or via associates, in claims management firms to pursue claims against the advice that they themselves have given.

Our message is very clear: these practices are completely unacceptable and totally out of line with being fit and proper, a requirement on all authorised persons. You should of course be thinking about this as you are hiring people as certified individuals.

If you are considering this course of caution, be aware that we will be on to you and we will use all the regulatory tools available to us to stamp it out. If you have outstanding liabilities to customers, you should not expect to be allowed back into the regulatory perimeter.

Another area of significant intervention for us is in the defined benefit transfer market. You will have seen on 7 April, we published extensive guidance for firms on pensions and retirement income.

In that publication, we also set out detailed guidance on how firms could give consumers pension information without giving ‘advice’ and guidance on our expectation of advisers giving defined benefit pension transfer advice. In this guidance, we set out how firms can and should support consumers that seek to access to their pension savings during the current disruption.

The future of regulation
I want to finish with some remarks about the future of regulation.

The financial services industry continues to evolve, with the emergence of new products and services and mechanisms for delivering them, alongside changing consumer needs and attitudes.

Use of technology and data, which have been core to the industry for decades, have become ever more central to how financial services are designed and offered, with innovation increasingly bringing new ideas and products to customers over the internet.

And the UK’s position in Europe has fundamentally changed, the macro-economic landscape has evolved and HM Government has initiated discussions about the regulatory framework in the UK, after a decade of post-crisis regulation.

Against this backdrop we at the FCA have started to consider what the future of regulation might look like. Regulators need to be agile during times of change; now is the right time to take that step and consider our approach further.

In a more outcomes-based approach, we start from the perspective of end users of financial services. We consider their needs and vulnerabilities and identify what a well-functioning market looks like in line with our strategic objective. And then we use the full range of powers and tools available to us to achieve the desired outcomes.

Rules will remain important. But we know that the number and complexity of rules in the Handbook can make it hard for firms to interpret our expectations and the outcomes we want to see achieved and this is an area we’ll continue to think about.

Our current regulatory framework is based on a combination of the Principles, other high-level rules and, where necessary, detailed rules and guidance. However, there is a strong case for taking a step back and assessing whether the regulatory framework is delivering against more than just rules, but rather against ultimate outcomes for users of financial services.

And that is what we are now doing.

We will capture the lessons from this emergency about delivering quickly…and ensure that unacceptable firms and individuals are stopped and removed from the regulated sector as quickly as possible.
An example of this is the interpretation of the inducements rules (COBS 2.3 and 2.3A).

These rules aim to remove incentives for firms to act in a way that conflicts with their duty to act honestly, fairly and professionally in the best interests of their clients, but were not drafted with the intention of applying to the provision of mental-health counselling service.

Given the current climate, some firms want to make mental health counselling services available to advisers in other firms (a non-monetary benefit).

One interpretation is that this is altruistic and unconnected to the provision of an investment or insurance service or product to a client, another interpretation is that such services are an ‘inducement’, but one that does not impair compliance with the firm’s duty to act in the best interests of the client.

In either case, it would be reasonable for firms to determine that they can both provide and accept such mental-health counselling services.

We will capture the lessons from this emergency about delivering quickly. But we also need to look at our entire system, from the data and intelligence we collect, how we decide which firms and individuals to allow to operate and how we supervise them, to how we ensure that unacceptable firms and individuals are stopped and removed from the regulated sector as quickly as possible.

Conclusion
So, I am grateful to have chance to speak to today, it is only by having a strong communication between industry and regulators that we can achieve the outcomes we wish to see.

Taken from the FCA Website – https://www.fca.org.uk/news/speeches/fca-response-covid-19-and-expectations-2020

By David Petty

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