financial services regulation and professional integrity

Knowledge | Skills | Conduct

Financial Services Regulation and Professional Integrity

5 questions

Chapter 8

Further informationThis chapter looks at financial regulations. We will review the powers of the UK and EU regulators. We will then consider the offences of money laundering, insider dealing, market abuse and bribery. The principles behind data protection will then be considered. Finally, we will explore how complaints, breaches and compensation are handled.

This chapter has five questions in the exam.

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The European Commission• The EU civil service• Implements the European Council’s decisions

The European Securities and Markets Authority (ESMA)• Functions in relation to securities trading:

- Improve coordination among regulators- Advise the EU Commission- Implement community legislation

• Main objectives: - Protection of investors- Integrity and transparency of markets- Secure proper functioning of financial markets

1. Financial Services Regulation

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• Markets in Financial Instruments Directive (MiFID)- Harmonised rule book on financial regulations throughout EEA- Recognised multi-lateral trading facilities (MTFs) – alternative exchanges

• MiFID II and MiFIR- Update and tightening of EU rules mostly affecting Sell Side institutions

1. Financial Services RegulationFurther informationMiFID was implemented in the EEA in November 2007. Its purpose was to encourage greater competition and harmonisation within securities markets, and to achieve the recognition of alternative trading venues; MTFs are part of the greater competition drive. The standardisation of rules on best execution is an example of the harmonisation of the conduct of business.

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The Bank of England took over responsibility for regulation from the FSA under a new regulatory structure in April 2013. New institutions:

• Financial Policy Committee (FPC) – macro-prudential supervision

• Prudential Regulatory Authority (PRA) – oversees firm taking on significant risk, e.g. the biggest banks, insurers and deposit takers

• Financial Conduct Authority (FCA) – produces the conduct of business rules for all authorised persons

1. Financial Services RegulationFurther informationThe regulatory structureThe ‘twin peaks’ regulation.

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UK Regulation – FSMA 2000 and FSA 2012

• Statutory objectives of the FCA- Protect consumers- Integrity of the financial system- Maintain competitive markets

• FCA has statutory powers meet is statutory objectives

USA Regulation

• Securities and Exchange Commission


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UK Regulation – General prohibition (S19 FSMA 2000)

‘No person may carry on regulated activity in the UK unless they are an authorised person or an exempt person.’

• Reasons for Authorisation:- Specified investments- Specified activities


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Hints

Customers and clientsThe principles distinguish between a customer and a client:• Customer – retail client and professional client • Client – retail client, professional client and eligible counterparty

Further information

PRA Fundamental RulesFor PRA firms, the Principles of Business are supplemented by the PRA Fundamental Rules. Like the Principles for Businesses for FCA firms, these apply proportionally to the size of the firm and the scope of its activities.1. Integrity2. Skill, care and diligence3. Prudence4. Adequate financial resources5. Effective risk management6. Organisation and control7. Relationship with regulators8. Resolution procedures


Principles for businesses – for an Authorised Person1. Integrity

2. Skill, care and diligence

3. Management and control

4. Financial prudence

5. Market conduct

6. Customers’ interests

7. Communications with clients

8. Conflicts of interest

9. Customers: relationship of trust

10. Clients’ assets

11. Relations with regulators

The Principles for Businesses

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Further information The Certification RegimeThe Certification Regime requires firms to assess, both at the recruitment stage and on an annual basis thereafter, the fitness and propriety of certain employees within the firm who could pose a risk of significant harm to the firm or any of its customers. Such employees include material risk-takers, those performing risk of significant harm functions, and anyone supervising a certified person.


Senior Manager and Certification Regime (SM&CR)

Senior Management

Functions

Certification Functions

Other Conduct Rules staff

Ancillary staff

Pre-approval by regulator Subject to

fit and proper

assessment Subject to

Conduct Rules

Certificate issued by the firm

1. Financial Services RegulationFurther informationThe SM&CR Regime

Senior manager and certification regime

Two distinct categories: Senior Management Functions (SMFs) and Certification Functions (AKA “Significant Harm Functions”).

Fitness and propriety assessed for SMFs by the regulator.

Fitness and propriety assessed for Certification Employees by the firm. Verification sent to the regulator every year.

Code of Conduct governs the conduct of all relevant employees (i.e. excludes ‘ancilliary staff’.)

Further information Applicability of SM&CRThe SM&CR superseded the Approved Persons Regime for all authorised firms, with effect from 9 December 2019.

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Individual Conduct Rules

• Individual (‘First Tier’) Conduct Rules1. You must act with integrity

• A breach would be to deliberately mislead by act or omission

2. You must act with due skill, care and diligence• A breach would be to act without full understanding, without adhering to processes or where

regulatory approval has not been gained

3. You must be open and co-operative with the FCA, the PRA and other regulators• A breach would be a failure to inform the FCA of anything of a nature that it would reasonably

expect to be informed

4. You must pay due regard to the interests of customers and treat them fairly• This effectively extends responsibility for TCF to individuals

5. You must observe proper standards of market conduct• A breach would be a failure to comply with the Code of Market Conduct

The Conduct Rules Further information

The SM&CR Senior Manager Conduct Rules

Second Tier – Senior Manager Conduct Rules

SM1: You must take reasonable steps to ensure that the business of the firm for which you are responsible is controlled effectively.

SM2: You must take reasonable steps to ensure that the business of the firm for which you are responsible complies with the relevant requirements and standards of the regulatory system.

SM3: You must take reasonable steps to ensure that any delegation of your responsibilities is to an appropriate person and that you oversee the discharge of the delegated responsibility effectively.

SM4: You must disclose appropriately any information of which the FCA or PRA would reasonably expect notice.

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Conduct Risk – Treating customers fairly (TCF)• TCF is an outcomes-based regime focusing mainly on retail products. It has six

consumer outcomes:- Outcome 1: Fair treatment of customers is central to the corporate culture of all firms- Outcome 2: Products and services meet the needs of identified consumer groups and

are targeted accordingly- Outcome 3: Consumers are provided with clear information before, during and after

the point of sale- Outcome 4: Any advice is suitable and takes account of their circumstances- Outcome 5: Products and services perform as firms have led consumers to expect- Outcome 6: Consumers do not face unreasonable post-sale barriers imposed by firms

to change product, switch provider, submit a claim or make a complaint

• FCA provides case studies on their website• Firm must have management information (MI) arrangement to monitor

effectiveness

1. Financial Services RegulationKeeping on target

Which of the following is not a principle according to the treating customers fairly initiative?A. Customers can be confident that a trade has been executed at the best

possible priceB. Customers do not face unreasonable post-sale barriers to change

product or providerC. Customers are provided with products and services that perform as they

have been led to expectD. When customers receive advice, it should be suitable for them

Hints

Conduct riskThe successor to principles-based and outcomes focused regulation. The process aims to improve industry behaviour without the need for prescriptive rules.Firms may adopt a conduct risk policy.

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Money laundering – the three stages

2. Financial Crime

1. Placement:

Proceeds of any crime areplaced into a bank or buildingsociety.

Fraud

Drug sales

Robbery

Bank Fund Manager

Business

Property

2. Layering:

A cheque is drawn on thebank and used to buydifferent investments tocover the audit trail.

3. Integration:

The money appearsas a legitimate sourceof income.

PaySigned

Further informationCriminal Finances Act 2017Amends the Proceeds of Crime Act (POCA) to make further provision for the forfeiture of assets and additional powers for the sharing of information in connection with terrorist property.

Answer to question on the previous slideAnswer A. A financial services firm is an authorised person. Some of its employees are approved persons.

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Money laundering – the legislation

• The Money Laundering Regulations 2017- Internal controls

• Risk-based• Money Laundering Reporting Officer (MLRO)

- Education and training – at least every two years- Identification procedures – customer due diligence (CDD)

• Enhanced for high-risk clients, services or countries- Politically exposed person

• Simplified on a case-by-case basis

- Reporting suspicions• Employee to MLRO• MLRO to National Crime Agency

- Record keeping• 5 years

2. Financial CrimeFurther informationSuitable evidence: IndividualsExamples of proof of identity include a passport or driving license. Evidence of address is also required, e.g. a utility bill or entry on the electoral roll. A passport is not evidence of address.

Politically exposed person (PEP) is a term that describes a person who has been entrusted with a prominent public function, or an individual who is closely related to such a person

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Further informationSuspicionA reluctance of a client to provide necessary documents or continual patterns of unusual trading should be considered suspicious. Suspicious Activity Reports (SAR) are used to inform the authorities of suspicion.

Suspicious Activity Report (SAR) and the National Crime Agency (NCA)The law enforcement agency to which suspicions of money laundering must be reported by a firm’s Money Laundering Reporting Officer (MLRO).


The Proceeds of Crime Act 2002

General offences

• Concealing

• Arrangements (assisting)

• Acquiring and/or possessing

• Knowingly prejudicing an investigation (five years and/or unlimited fine)

Regulated sector offences

• Failure to report (five years and/or unlimited fine)

• Tipping off (two years and/or unlimited fine)

2. Financial Crime

14 years and/or

unlimited fine

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Bribery Act 2010 – the legislation• Applies where individuals are expected to act in:

- Good faith

- Impartially

- Not abusing a position of trust

• Covers public and corporate officials

• The main provisions – it is an offence:- To offer, promise or give advantage

- To request, agree to accept or accept advantage

- For a company to fail to have appropriate procedures to avoid bribery• E.g. training of staff, and must monitor and review these on an ongoing basis

• Appropriate procedures are risk-based

• Failure to comply with the act (ten-year prison sentence)

2. Financial Crime

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Other areas of financial crime

• Identity fraud- Example forged or stolen identity documents

• Identity theft- Misappropriation of a persons identity

• Cybercrime- Advanced cybercrime (or high-tech crime) – sophisticated attacks against computer

hard and soft ware- Cyber-enabled crime – internet crimes against children, financial and terrorist crimes

2. Financial Crime

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Insider dealing offences• Dealing on…• Encouraging others to deal on…• Disclosure of…

Price affected securities• Shares, depositary receipts and warrants• Bonds – government and corporate• Futures, options and contracts for difference (of securities)

Insider dealing – penalties• Seven years in jail and an unlimited fine

3. Insider Dealing (Part V Criminal Justice Act 1993)

Inside information

Specific or preciseFrom an inside source

Price sensitive

Further informationInsiders can be primary or secondary.Primary insider: someone who has acquired the information due to their connections with the company.Secondary insider: someone who has come across the information, directly or indirectly, from a primary insider.

Information reported through the London Stock Exchange’s regulatory news service is considered public information.

HintsInside information is often referred to as unpublished price-sensitive information.

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Market Abuse Regulation – the offence

• Behaviour that would constitute market abuse- Insider dealing- Improper disclosure- Market manipulation

• Artificial transactions: ‘Wash trades’• Spreading rumours• Submitting incorrect trade details• Abusive squeezes

• Civil offence- Financial penalties and regulatory sanctions

4. Market Abuse

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Data protection – introduction

• Basic principle: ‘Public should know or be able to find out who is processing personal data and for what purpose’

• Data Protection Act 2018 and General Data Protection Regulation (GDPR) requirement- Register with the Information Commissioner as a data controller or data processor- Processing personal data in accordance with the data protection principles- Answering subject-access requests received by individuals

• Personal data- Any information that can (or can be used to) identify a data subject

5. Data ProtectionMinistry of Justice

Information commissioner's officeIndependent public body

Data Protection Act

Freedom of Information Act

Registration

Firm’s data Controller

Data input

Further information

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Data Protection Act 2018 principles:

• Processed lawfully, fairly and in a transparent manner in relation to individuals.

• Collected for specified, explicit and legitimate purposes and not further processed in a manner that is incompatible with those purposes.

• Adequate, relevant and limited to what is necessary in relation to the purposes for which it is processed.

• Accurate and, where necessary, kept up to date; every reasonable step must be taken to ensure that personal data that is inaccurate, having regard to the purposes for which it is processed, is erased or rectified without delay.

• Kept in a form which permits identification of data subjects for no longer than it is necessary for the purposes for which the personal data is processed.

• Processed in a manner that ensures appropriate security of the personal data, including protection against unauthorised or unlawful processing and against accidental loss, destruction or damage, using appropriate technical or organisational measures.

5. Data Protection HintsWhenever a breach of the data principles occur, there is a duty to report this breach to the ICO. In situations where there is a risk to the rights and freedoms of the data subject, there is a duty to report breaches to the individuals concerned.

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Complaints procedures

• Procedures of the firm must be:- In writing- Drawn to the attention of customers at first point of contact or when documentation is

first provided- Sent to customers on request- Sent to complainants when a complaint is received, unless the complaint is resolved

in three business days

• Timing- Send written acknowledgement of a complaint (and a copy of the complaints

procedures) promptly from receipt of the complaint- If the complaint is unresolved:

• Within eight weeks:- Send a final response; or- Inform the complainant that he may approach the FOS within six months

6. Complaints and Compensation

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Financial Ombudsman Service (FOS)

• Eligible complainants- Private individuals- Institutions worth no more than £1m

• Compensation- Maximum award to complainants: £355,000 (and reasonable costs).- If the complainant accepts the award, it is binding on the firm.- If the complainant rejects the award, they can pursue the matter through the courts.

6. Complaints and Compensation

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Financial services compensation scheme

• A claim can only be made once a firm is in liquidation

• Maximum pay-out per claim: 100% of the first £85,000 for Deposits

• Maximum pay-out per claim: 100% of the first £85,000 for Investments

• Maximum pay-out by the scheme: unlimited

6. Complaints and CompensationFurther informationAuthorised firms are responsible for funding the FCA, the FOS and the FSCS.

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EthicsEthics Compliance

Prevention Detection

Principles-based Laws-/rules-based

Values-driven Fear-driven

Implicit Explicit

Spirit of the law Letter of the law

Discretionary Mandatory

7. Integrity and Ethics in Professional PracticeFurther informationFinancial products are not like other products that we buy. Generally we cannot see it or touch it, and it often comes with no guarantee. Also, it can take many years before we know whether it is working or not. Add to this the fact that sometimes we don’t even understand it, and the need for ethical behaviour from sales people is clear.

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Positive effects of ethical approachesGeneral concept

• All parties within society have a vested interest- Self interest can lead to one (or no) party winning

- Shared interest can lead to all parties winning

• Key indicators of ethical business approaches:- Retention of high quality staff

- Retention of clients

The process of ethical behaviour

• Open – Are the full details available to all involved?

• Honest – Does it comply with applicable law or regulation?

• Transparent – Is everyone involved fully aware of the implications?

• Fair – Does it consider all involved parties fairly?

7. Integrity and Ethics in Professional PracticeA bank manages investments for a broad range of clients. The internal auditor at the firm prepares a presentation on ‘improving the culture of business ethics in the industry’.

Which of the following topics should not be included?

A. The positive impact of ethical approaches on long-term profitsB. How positive ethical approaches can enhance staff and client

retentionC. Ways of ensuring that staff within the firm always hit their sales and

profitability targetsD. Developing a values-driven approach to ethical practice within the

firm

Keeping on target

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CISI code of conduct – members

7. CISI Code of Conduct

Principles Stakeholders

Personal accountability Self, clients, regulators, colleagues, market participants, firm, profession, society

Client focus Clients

Conflict of interest Clients, market participants, regulators

Respect for market participants Clients, market participants

Professional development Profession, clients, colleagues

Aware of capabilities Clients, profession, market participants

Respect others and the environment

Society, colleagues, clients, regulators, market participants, profession, professional body

Speak up & listen up Society, colleagues

Which of the following is true of the CISI code of conduct?A. It forms best practice for the members of the InstituteB. All members of the Institute are obliged to follow itC. It applies to everybody working in the financial services industryD. It has been made statutory by the FCA

Keeping on target

Answer to question on previous slideC: Ways of ensuring that staff within the firm always hit their sales and profitability targets.

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financial services regulation and professional integrity

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