On 18 September 2015, the FCA published two guides that set out its new approach to the supervision of firms. Previously, the FCA used four categories (C1 – C4) for its conduct classification of firms. This has now changed with firms being classified as either fixed portfolio or flexible portfolio. Whilst the majority of firms will be classified as flexible portfolio and supervised through a combination of market-based thematic work and programmes of communication, engagement and education, a small population will be classified as fixed portfolio and be allocated a named individual FCA supervisor and be proactively supervised.
Notwithstanding whether a firm is classified as flexible portfolio or fixed portfolio the FCA’s supervisory approach is built on ten principles:
- Ensuring fair outcomes for consumers and markets. This is a dual consideration that runs through all the FCA’s work. The FCA will assess issues according to their impact on both consumers and market integrity.
- Being forward-looking and pre-emptive, identifying potential risks and taking action before they have a serious impact.
- Being focused on the big issues and causes of problems. The FCA concentrates resources on issues that may have a significant impact on its objectives.
- Taking a judgement-based approach, with the emphasis on achieving the right outcomes.
- Ensuring firms act in the right spirit, which means they consider the impact of their actions on consumers and markets rather than just complying with the letter of the law.
- Examining business models and culture, and the impact they have on consumer and market outcomes. The FCA is interested in how a firm makes its money, as this can drive potential risks.
- An emphasis on individual accountability, ensuring senior management understand that they are personally responsible for their actions – and that it holds them to account when things go wrong.
- Being robust when things go wrong, making sure that problems are fixed, consumers are protected and compensated, and poor behaviour is rectified along with its root causes.
- Communicating openly with industry, firms and consumers to gain a deeper understanding of the issues they face.
- Having a joined-up approach, making sure firms get consistent messages from the FCA.
Both guides contain some common messages from the FCA. These include:
- The FCA aims to protect consumers and ensure market integrity by examining the areas that have an impact on them. This means looking at far more than systems and controls and compliance with the Handbook.
- Whilst wanting firms to be commercially successful the FCA believes that this should not come at the expense of customers getting products and services that meet their needs. The FCA will ask about the detail of a firm’s strategy and business plan, and expect it to be able to show it how it assesses and mitigates the risks these generate.
- The FCA is putting a particular emphasis on understanding the culture within a firm - the way it conducts its business, what it expects of its staff, its attitude towards its customers.
- A firm’s business processes, from product development to complaints handling, should be designed to give customers what they need and meet their expectations.
- In relation to systems and controls the FCA would expect a firm to have in particular effective, independent controls – usually in the compliance, risk and internal audit functions – that provide challenge to business units and assurance to senior management and the board that the group is operating as it should.
- Senior management and the board should be able to explain clearly the conduct risks in their strategies, and the FCA will pay close attention to the way consumer and market-focused values are implemented.
Three pillar supervision model for fixed portfolio firms
Pillar 1 proactive supervision generally covers a 12 to 36 month cycle and will involve firm meetings, review of management information, an annual strategy meeting and other proactive firm work. Deep dive(s) assessments that look at how a firm’s business operates in practice may also be scheduled as part of the supervision strategy. In relation to business model and strategy analysis (BMSAs) the FCA will pay particular attention where it sees common indicators of heightened risk such as strategies that depend on cross-selling. For all fixed portfolio firms the FCA will conduct periodic analysis, normally across a peer group of firms sharing similar business models or activity. Peer group BMSAs for wholesale firms focuses primarily on business lines. Also, cross-border services and activities are as relevant to FCA assessments of wholesale firms as individual legal entities.
A firm evaluation (a summary of the FCA’s view of a firm or group based on all the information it has about it) is undertaken in a cycle ranging from 1 to 3 years depending on the scale of the firm/group’s activities and the FCA’s assessment of risk. Key messages from the firm evaluation are given in a letter to the board of directors. The FCA aims to discuss its view with the board and its senior management and will usually attend a board meeting. Interim reviews of the firm evaluation are carried out during the supervisory cycle.
Pillar 2 event-driven, reactive supervision is discussed below as is Pillar 3 issues and product supervision.
Three pillar supervision model for flexible portfolio firms
Pillar 1 proactive supervision does not apply to flexible portfolio firms.
Pillar 2 event-driven, reactive supervision has a pre-emptive focus, aiming to identify and prevent consumer detriment and threats to market integrity before they happen. Risks and problems can be discovered through a number of sources, including information from the firm as well as data analysis. The FCA’s focus is on addressing the most important issues that affect its objectives. It expects firms to fix the root causes of problems as well as the symptoms. It expects firms to have a comprehensive and credible plan of action to mitigate risks.
Pillar 3 issues and products supervision. The FCA’s work under this pillar is fundamental to its approach to identifying and mitigating risks across multiple firms or whole sectors. Through sector analysis the FCA identifies common emerging risks, new products and other issues that it examines through a range of activities including thematic reviews. The FCA’s findings from this work are communicated to the industry and firms are expected to consider and act as necessary on the findings.
Firms that are prudentially regulated by the FCA fall into four prudential categories: P1, P2, P3 and P4. Like the conduct categories, the prudential categories determine the intensity of the prudential supervision of the firm. The prudential classification is:
- P1 firms and groups are those whose failure could cause significant, lasting damage to the market place, consumers and client assets, due to their size and market impact.
- P2 firms and groups are those whose failure would have less impact than P1 firms, but would nevertheless damage markets or consumers and client assets.
- P3 firms and groups are those whose failure, even if disorderly, is unlikely to have a significant market impact. They have the lowest intensity of prudential supervision.
- P4 firms are those with special circumstances – for example, firms in administration – for which bespoke arrangements may be necessary.
For P1 and P2 firms the FCA carries out a comprehensive capital and liquidity analysis and a risk management capability assessment.
The FCA Handbook sets out minimum financial resources requirements (FRR) for all firms and this is the starting point for any prudential supervisory review. The scope and nature of an FRR is:
- P1 firms have a capital and (if applicable) liquidity assessment every two years.
- P2 firms have a capital and (if applicable) liquidity assessment every three to four years.
The FCA does not usually carry out prudential assessments for P3 firms nor does it proactively review or challenge how these firms calculate and meet their FRR. P3 firms are monitored by the FCA in two ways. First, reactively using an alerts-based system that allows the FCA to identify and deal with firms that have breached their prudential requirements. Second, through targeted cross-firm work assessing whether firms in a peer group are meeting the FRR.
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