Financial Services Regulatory Enforcement mini-series, season 2, episode 5: How should you respond to an FCA intervention?

Nathan:

Hello, and welcome to the Ashurst Regulatory Enforcement Podcast. I'm Nathan Willmott, and I'm joined here in the Fruit and Wool Exchange in London by two fellow specialists in financial services regulation, my colleague Adam Jamieson and Oliver Assersohn KC of XXIV Old Buildings. Welcome to you, both.

Oliver:

Thank you for having me.

Adam:

Thanks, Nathan.

Nathan:

Now, today we're going to be discussing the increasing use, and I think the more aggressive use of the FCA's intervention tools, and these are tools that the FCA has widely communicated it plans to use as an alternative, in many cases, to formal investigations in order to try and root out harm before it occurs. Adam, tell us a little bit about the FCA's powers in this area and what your experiences are in seeing them.

Adam:

Okay. Well, look, we're going to talk about two particular acronyms, so we're going to be talking about VREQs and OIREQs. So these are voluntary requirements and own initiative requirements, and these are quite draconian powers I think that the FCA have. They've had them for a long time. I think the first one that I remember really coming onto the radar was requirements that were imposed on some of the payday lenders when the FCA took over regulation of consumer credit. And there was some of the measures they took in order to regulate that market involved use of these powers. And we're seeing them used more and more over the last couple of years in particular. And it really allows the FCA to impose or invite a firm to voluntarily offer to do something, which in the FCA's view advances its own operational objectives. So whether it's consumer protection or integrity of the market. So really wide concepts.

Nathan:

And so why would a firm come forward and voluntarily ask the FCA to impose requirements?

Adam:

Yeah, well, they're certainly not doing it out of the blue. This usually comes at the end of some kind of supervisory engagement that's gone on in a long dialogue with the FCA, or they get a letter out of the blue that the FCA's been monitoring an issue or picked up on an issue. They will say, "This is the basis of our concern about this issue." They may require the firm to provide information, sometimes on a compelled basis at the same time, but they will be saying to the firm, "We've got these concerns. This is what we think should happen. We'd invite you to enter into a voluntary requirement on the following terms, and we'd like you to do so by X time and X date." The threat to firms is that, look, if they don't do this on a voluntary basis, then the FCA will use their powers to impose it on a firm, on the FCA's own initiative.

Nathan:

I see. And Oliver, what sort of requirements would the FCA typically seek to impose?

Oliver:

They can be disastrous for a firm. On one extreme, they can include little things, like not taking on any new customers or not doing trades for a particular client that the firm might depend on for its revenue. The effect of an OIREQ or a VREQ can be to kill a firm stone dead or else strangle it over several months. That's the one extreme. A lighter extreme, there can be requirements that aren't so draconian, but this is an extremely powerful weapon that the FCA has, and we see it being used more and more, particularly through the VREQ mechanism.

Adam:

Yeah. The FCA talk about their regulatory toolkit. I think, certainly, an OIREQ can be probably be the hammer in the regulatory toolkit.

Nathan:

And so, the legal power itself isn't constrained in terms of the types of requirements the FCA can impose? It's pretty much up to the FCA's imagination as to what's appropriate? What are the tests that they need to consider in terms of whether or not to impose a requirement?

Adam:

Well, I think there's three bases on which they can do it. One is that, if the firm's failing or likely to fail to satisfy its threshold conditions, one is that they failed to carry on a regulated activity over the past 12 months, so we see that in fewer cases. Then, I think the most, the widest one and the one we would see most frequently with firms who are going about their day-to-day business is, whether it's desirable to advance one or more of the FCA's operational objectives, as I said, those are very, very broad consumer protection, promoting competition, integrity of the market.

Nathan:

That's a hugely broad and low threshold in terms of such a wide-ranging power. Oliver, what's the process once the FCA decides it wants to impose a requirement? What's the process for putting that into place?

Oliver:

Well, if an OIREQ or a VREQ can be opposed, typically through one of the FCA's internal committees, normally the Regulatory Transactions Committee, they do that through a supervisory notice. You get a first supervisory notice. You can challenge that through written representations normally, and if you're not successful in challenging it, then you get issued with a second supervisory notice. Either of those notices can be challenged before the Upper Tribunal by referring the matter to the tribunal.

Nathan:

And what's the FCA like in terms of negotiations in this? Because presumably, where you are faced with the prospect of difficult requirements that are difficult to meet, how much scope is there for having a sensible conversation with the FCA in order to balance the impact on the firm with objectives that the FCA has in imposing those requirements?

Adam:

It's obviously fact-specific, but there is scope to negotiate, certainly in relation to most voluntary requirements. The difficulties that firms face are often some of the time constraints, because the first thing is, if it comes out of the blue that the FCA has got concerns about a particular event or particular issue that's led them to seek the requirements, is looking at the evidence and considering, "Well, look, have the FCA just got the wrong end of the stick here, or are there important points we need to make about actually whether a VREQ is appropriate at all or necessary, whether actually things can be done to fix the problem if it hasn't already been fixed through more informal, voluntary commitments to the FCA, without the need for what is a much more formal process, even a VREQ?"

There is room to negotiate. You can, obviously, think about if it is deemed that, "Okay. Perhaps a VREQ is necessary," well, what's the scope of it and can we limit it in a way, such that it doesn't go too far, it isn't disproportionate, and it doesn't have too much of an adverse impact on the business and kill it, as Oliver says, but it's often a very time-pressured situation.

Nathan:

And what's your experience in terms of the FCA, how successful those negotiations are? Does it depend on the type of firm? I mean, you mentioned the FCA bringing these requirements to try and kill a firm, in some circumstances. Otherwise, in more tailored circumstances, in relation to a particular issue. Is the FCA willing to change its mind? Is it concerned about the scrutiny that might come from the-

Adam:

I think they are when they know that perhaps their legal basis for potentially seeking to, say, impose an OIREQ isn't sound, that they will listen to those arguments, because the FCA and supervisors, they can get the wrong end of the stick about issues. Actually, if there's strong arguments why that's not the appropriate course, then my experience is that they will listen, but obviously, in some cases, it might have flowed from a long period of frustration with a firm, a lot of information coming forward, and if they feel confident on the grounds that they've got to try and impose a requirement or ask a firm to enter into a voluntary requirement, then they can be very stubborn.

Oliver:

I mean, the FCA, I suppose, like any decision-maker, can only ever make its decisions on the basis of the evidence it has. Often, it'll be coming into these discussions with the benefit of a 166 report or some other evidence that gives it very serious concerns about the firm that they're looking at. One way in which the firm might improve its chance of negotiation is if it's able to obtain further evidence, which was not available to the FCA when it first had those concerns, when it first raised the issues with the firm. So, for example, if a 166 report has identified 15 issues with the firm's performance, and the firm is able to fix those issues during the course of its discussion with the FCA, and prove that it has done so, that obviously gives it a massively strengthened hand in the negotiation. Realistically, it's unlikely every issue will be fixed, but if it at least can be shown that it's moving in the right direction, in my experience, that can be a helpful starting point for a negotiator to try and get the FCA to change tack.

Nathan:

And what's your experience in terms of whether the imposition of requirements does get overturned when challenged? Is that something that's very rare, or does it happen regularly?

Oliver:

It's not that common, and I think one of the issues that a lot of firms face is that if we're challenging it in the Upper Tribunal, it can be months before you get a substantive hearing, by which time, if the requirements are so stringent that you want to challenge them, the firm may be dead already. There's not an easy solution to the problem. But one avenue, I think, a firm should consider is making application for suspension to the tribunal, and you do that under Rule 5 (5) of the tribunal rules, and what the rule says is:

"In a financial services case, the Upper Tribunal may direct that the effect of the decision, in respect to which the reference has been made, is to be suspended pending the determination of the reference, if it is satisfied that to do so would not prejudice, (a) – the interest of any persons, whether consumers, investors or otherwise intended to be protected by that notice, (b) – the smooth operation or integrity of any market intended to be protected by the notice or the stability of the financial system of the UK."

Obviously the last category is a biggie, stability of the financial system of the UK. Typically, it's the first one that's the battleground. It is suspending the notice, going to prejudice the interest of any person, typically consumers that's intended to be protected by the notice. The leading case on this is the case of Sussex IFA v. FCA, where they set out the kind of facts the tribunal will look at. The key point is that of prejudice under the rule. The case also stresses that this is a case management tool so, the tribunal also has to be persuaded. It's in the interest of justice to make an order suspending the requirement. Practical difficulty with this is when you're in the Upper Tribunal, the hearings are in public, your firm's name will appear on the tribunal register. The hearing could be in public, and you could get a public judgement , so if the FCA's concern is that the firm has got problems with financial crime controls, for example, that's going to be a damaging process in itself for the firm. Again, there's not an easy solution to that. One option for a firm concerned about that is to apply for privacy to the tribunal for their name not to appear on the register, for the hearing not to be in public, and for a judgement not to be published, which identifies them.

That is a really difficult application to win on. For the firm to succeed, they essentially need to prove that if publication takes place, it will destroy the firm's business. In some cases, it'll be possible to get evidence for that, because we'll be able to say, "If this were to get out, it would irreparably damage my relationship with a key customer." The practical difficulty is it's going to be hard to get evidence of that. How do you get the evidence that the key customer's going to be put off? Do you call them up and say, "Hey, look. I'm just asking for a friend, but if I was to be caught doing this, if I were accused of this, what would you say?" So, it is a difficulty, but it's one that can be overcome, and it is possible to get evidence that can support that kind of application.

Adam:

Because I mean, retail businesses, retail firms are often the target of these types of powers. So, very often, I think the publicity point is really important, because particularly if the FCA's view is that this requirement's necessary to protect the firm's customers or the firm's potential customers, then the fact of litigating whether that's the case or not in public is obviously going to be not something firms are looking to do, so privacy will be really important in those types of circumstances.

Oliver:

Yeah. I completely agree. I mean, I think suspension power is one that perhaps isn't as widely known as it could be. I think there are cases where you think suspension possibly could have been applied for but wasn't for some reason, so it's good to get the word out there that the rule exists and applications can be made under it, and as to your point on privacy, there have been a lot of knock-backs on people applying for privacy, but looking at those judgments, often the concern of the tribunal is there wasn't evidence to support the concern that the business, et cetera would be destroyed. That's on us, because reading the judgments, it appears in some of the applications, it's been put on the base that it stands to reason our business will be destroyed or it's obvious that my livelihood will be destroyed in the case of individuals. In fact, if evidence was actually obtained, perhaps these applications could have turned out in a different way.

Adam:

Yeah.

Nathan:

And will those, you talked about the first supervisory notice and the second supervisory notice, will those typically be published? Will they already be in the public domain at that stage, or does the FCA tend to hold those back?

Oliver:

The fact of the requirements would appear on the register and the supervisory notice would generally be released.

Nathan:

So, presumably that makes it even more difficult to argue that by the time you get to the tribunal, the effect should be suspended because that information is already out in the public domain?

Oliver:

That information is out, so arguing for privacy by that stage can be difficult, so you need to take steps pretty quickly to say, "We will be making this application. Do not publish it, unless and until that application's been determined by the tribunal."

Nathan:

My sense is that the team that's been created within the FCA to deal with OIREQs has significantly expanded over recent times and has been encouraged to really test the boundaries of this power. Is that something that you are seeing in practice in terms of which requirements could be imposed and the circumstance in which they'll be imposed?

Adam:

I certainly think, and perhaps with the advent of the consumer duty as well there, there's an educational piece, I guess, at the FCA in terms of supervisors being aware of these powers and seeking to use them. I definitely think that there's, it would appear, a lot more awareness within the FCA about this tool, and supervisors do seek to use it more frequently than in the past. Then, on the legal and enforcement side, particularly where matters might be contested, they've certainly grown those teams, they have got more resource in that area than they have done before, and I think we see this in the growth, in the numbers in the annual report, as to the number of these cases that they're managing at any one time.

Nathan:

I wonder if you could just talk me through your thoughts in terms of what a firm should do if it becomes subject to these requirements. Either it agrees with its arm twisted to a VREQ, or it has an OIREQ imposed on it and it chooses not to challenge them, but are there any particular key points for firms in terms of implementing those requirements?

Adam:

Yeah, and I think this has been something which we've started seeing now in recent enforcement cases, and there have been a number, both on the FCA and the PRA side, where previously, I think it was the case that, look, the VREQ or the OIREQ was the fix to the issue. Then, there may be an enforcement case that flows in relation to the underlying issue too, historically looking back at the controls or whatever it may be. That can still be the case, but what we're also seeing is actually compliance with the VREQ or the OIREQ itself being the focus of subsequent enforcement action, because it hasn't been complied with, so I think this is the FCA saying these have got teeth and firms need to take them seriously.

I guess there's a couple of different parts to this. One is, particularly with a VREQ, can you do this, thinking about that from the outset, from an operational perspective, not just considering the legal basis of it, the scope of it, and how can we move out of the VREQ? Which is naturally, of course, big focus for firms is, "Well, look. What do we need to do to get this requirement lifted as quickly as we can? But actually, in the meantime, what are our controls and what's our governance around ensuring we can comply with it?" And that starts at the consideration of applying for it as to, "Well, look. If they want us to press the button and stop doing something, operationally, can we do that? Can we do it immediately? Can we do it on the date they need us to? If not, we need to make them aware of that and discuss that with the FCA as to how that implementation is going to work."

I think it's one of those situations, just like any, frankly, sort of regulatory change project that's being well-managed, you need proper governance around it. You need a proper steering committee. You need senior manager buy-in. Very often, with some requirements, there might be a need for attestations to be given to the regulator around compliance with the requirements, which will ordinarily come from a senior manager, so it might be obvious who that person needs to be, who will oversee compliance with the requirement, but even in the absence of that, I think you need to identify someone, probably should be on their statement of responsibilities. They need the right support, resource. They might need external advice. You might need to involve consultants to put in new sort of procedures.
Of course, to the extent things can be automated, that's great, but obviously you want to make sure you've got the right testing in place. Manual procedures to comply with requirements, obviously, probably carry a degree of operational risk too, and again, I think just the monitoring, the testing, probably the involvement of people from the second and third line in ensuring compliance with the requirements and oversight of senior management and the board are a real must now, because it's become a very high-risk area, and it's not just a case of you enter into the requirement and your pure focus is on doing the things you need to do to remediate the controls to get the requirement lifted, but actually, what are your controls to comply?

Oliver:

Yeah. It's a very natural human reaction, I think, to want to agree a VREQ when it's presented, because it's often after a time of intense scrutiny and pressure, and so it's very understandable that a firm might seek to cauterize that stress and pressure by creating something with the FCA that they think that they can then move on from. In practical terms, I'm interested in your experience. It seems often quite difficult for firms to come out of VREQs after they've been agreed. I suppose one issue for firms is to really consider deeply at the time the VREQ is offered or there's threat of an OIREQ, whether they can actually really live with the requirements that are being put in place, because if they know that they can't live with them, then in a sense, it might be worth just grasping that and challenging it.

Nathan:

They need to say so.

Oliver:

And saying so, yeah.

Nathan:

Yeah, absolutely.

Adam:

And understanding, clearly, in that context, what the FCA's expectations are as to the timeframe and the steps that would need to be taken, what validation or verification of controls would be required to then lift the requirement? Because you may have some understanding, loosely, as to what you need to do, but if it's not clear between both parties what that is, there can be frustration. "Oh, they've moved the goalposts." The board can become frustrated with management then around, "Well, look. Have we taken all the steps we needed to take because our expectation was this was going to be a six to nine month thing, but actually, here we still are after a year with this hanging over the business."

Nathan:

I think that's certainly right. The exit route when a VREQ is agreed or an OIREQ is imposed often isn't clear, is it? And once you've addressed the issues, that doesn't mean that they go away. They can sit there for some time.

Oliver:

Absolutely.

Nathan:

And obviously, the FCA is hearing the message from government in terms of the growth agenda and the secondary objective of advancing the competitiveness of the UK financial services industry. Just to finish, what sort of impact do you think that will have on the FCA's use of its intervention powers?

Adam:

I mean, you'd hope, on some of those borderline cases, that actually, where a firm is able to say, "Look, this isn't a reasonable or proportionate regulatory response, and actually it's going to have a really adverse impact on our business, and that's not entirely necessary. We're cooperating with you. We are committed to fixing this problem," you'd hope that reference to the secondary objective would it would assist in those discussions.

Nathan:

Well, I'm afraid that's all we have time for today on the Ashurst Regulatory Enforcement Podcast. Thank you very much, Oliver and Adam for joining me to discuss the FCA's use of its intervention powers. As always, thanks to you, the listener, for listening to the podcast. We are always very pleased to hear from you in relation to the issues we've been discussing, so please do reach out to us if you have particular experiences of the FCA's use of its intervention powers and how you feel that is developing under the new growth agenda. Thank you very much for listening. See you next time.