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The FCA’s response to COVID-19 and expectations for 2020

  • United Kingdom
  • Financial services disputes and investigations
  • Other

11-06-2020

The FCA published a speech delivered by Megan Butler (Executive Director of Supervision – Investment, Wholesale and Specialists) on 4 June 2020 regarding the FCA’s response to the COVID-19 pandemic and its expectations for the remainder of the year.

Whilst the speech was delivered to an audience of financial advisors and wealth managers, it is of importance to the wider financial services industry as Ms Butler focused on priority areas for the FCA, in particular operational and financial resilience.

Highlights

The highlights of the speech included the following:

  • In operational terms, Ms Butler noted that financial advisors and wealth managers have responded well so far to the COVID-19 crisis.
  • However, Ms Butler said there is now a need to transition from the immediate “incident response” towards focusing on longer-term impacts.
  • Ms Butler said that the key areas of focus for the FCA included operational resilience, financial resilience (and within that the preservation of client assets and money) and acting with integrity.
  • In relation to the latter, Ms Butler said that the FCA has identified some firms which have tried to avoid their liabilities to customers by closing down companies and setting up new ones. She emphasised that these practices are unacceptable and the FCA will continue to take action against firms conducting such activities.

The FCA’s priorities

Megan Butler commented that in operational terms, the financial services industry has responded well. She said there has been no significant erosion of clients’ access to services, business continuity arrangements appear to be working and any glitches have been overcome. She considered that overall firms are coping and adapting to the “new normal”.

Ms Butler recognised that much of the FCA’s work dealing with the COVID-19 crisis to date has focused on immediate relief, such as on mortgages and unsecured lending products. However, she said that as the FCA adapts to the long-term impact of COVID-19, it has begun to transition from the immediate “incident response” towards focusing on longer-term impacts and its strategy for tackling these.

Ms Butler referred back to the FCA’s Business Plan[1], published last month, which sets out the regulator’s priority areas over the next three years. The five key drivers of the FCA’s response to the COVID-19 pandemic are ensuring:

  • there is a good level of operational resilience;
  • the FCA understands firms’ financial resilience so that firms can fail in an orderly manner;
  • markets can function enabling price formation and orderly trading;
  • customers are treated fairly; and
  • customers are aware of the risk of, and protected from, scams.

The FCA’s expectations of firms during this time

In relation to operational resilience, Megan Butler said that the FCA expects firms to have contingency plans to deal with major events and that these plans have been properly tested. She noted that the FCA’s operational resilience consultation paper, published late last year, sets out its 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 COVID-19.

By way of recap, the key messages in the FCA’s consultation paper were as follows:

  • The proposed requirements and expectations for firms and providers of financial market infrastructure 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 mush 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.

Megan Butler stated that the FCA is actively reviewing the contingency plans of a wider 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.

She said that the FCA is proposing that firms identify and document the resources that support their important business services. Doing such mapping can help firms identify where vulnerabilities may exist in their people, processes and technology and allow them to consider if further investment is required, for example, to enable their staff to work from home effectively for a prolonged period, and therefore maintain the availability of their important business services and the confidentiality and integrity of client data).

Ms Butler said that 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”.

She appreciated that many firms face serious practical challenges due to COVID-19, including in their operations dealing with consumer complaints, but welcomed firms taking initiatives going beyond usual business practices to support their customers. She said that the FCA’s rules already provide flexibility to firms in many areas and that the regulator expects them to use this flexibility to support consumers, bearing in mind consumers’ individual circumstances.

In relation to financial resilience, Megan Butler said that the FCA is beginning to see a key impact of COVID-19 in its significant downward pressure on many firms’ revenues. She warned that financial pressures could give rise to harm 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.

Ms Butler conceded that in the current climate, some firms may exit from the market altogether. In these circumstances, she said that it is imperative to minimise any delay in the return of client money and assets, and to take action ahead of time to prevent shortfalls in what they should be holding on their clients’ behalf. To that end, she said that the preservation of client assets and money is central to the FCA’s focus in the wealth management sector.

The outcomes the FCA is focusing on

Megan Butler said that the FCA wants all firms to take consumer and market outcomes into greater account when they design and deliver services. With respect to the wealth management sector she said that the outcomes that the FCA continues to pursue are as follows:

  • Firms must maintain adequate arrangements to protect client money and custody assets according to their requirements. Some firms are reporting an increase in client money balances during the COVID-19 pandemic. Firms are required to consider the best interests of their clients at all times. Pursuant to this, firms are expected to return balances which are unlikely to be reinvested in the short term. In any case, the FCA is 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.
  • The FCA will assess how the wealth and advice market has reacted to COVID-19, including how service propositions and customer behaviours have changed. However, as these changes take hold, the FCA still expects 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. The FCA is building its 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, the FCA also still expects firms to prevent financial crime and market abuse through adequate controls and governance.

Bad Practices

Megan Butler said that whilst the financial services industry will work together to manage the effects of COVID-19, the FCA will take actions where it sees bad practices:

  • She said that a few firms have tried to avoid their liabilities to customers by closing down companies and setting up new ones (a process called “phoenixing”).
  • In addition, the FCA has caught firms pre-emptively setting up new entities and applying for authorisation before complaints and liabilities at their existing entities have crystallised (a practice called “lifeboating”).
  • The FCA has 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.

Megan Butler stated that the FCA’s message is very clear: the above practices are completely unacceptable and totally out of line with being fit and proper, a requirement on all authorised persons. Firms should be thinking about this as they hire people as certified individuals. If firms are considering such courses of action, Ms Butler warned that the FCA will be on to them and will use all its regulatory tools to stamp it out. If firms have outstanding liabilities to customers, they should not expect to be allowed back into the regulatory perimeter.

Analysis

Whilst it is encouraging that the FCA considers that financial advisors and wealth managers have responded well so far to the COVID-19 pandemic, we question whether Megan Butler’s speech may have been a missed opportunity for the FCA to share some valuable lessons learnt from the crisis in relation to operational resilience. We speculate whether the FCA is considering issuing further guidance on operational resilience as the COVID-19 pandemic has placed a different complexion on the concept of severe but plausible disruption scenarios, the standard the FCA currently intends to use for stress testing whether a firm is operationally resilient.

The crisis has also called into question the effectiveness and reliability of business continuity planning by firms and their critical outsourcing providers. Firms who relied too heavily on business continuity sites (and had limited capability for home working) were caught out and found themselves scrambling to implement contingency measures without a proper and full examination of the associated risks. In the coming weeks and months, firms will be well advised to review and reassess those measures taken since the onset of lockdown on 23 March 2020, ensuring that they satisfy regulatory requirements and do not expose themselves (and their clients and customers) to unnecessary risk.

Whilst many outsourced service providers are themselves not regulated, we do expect to see a continuation of the trend for increasingly robust and prescriptive regulations applicable to financial services institutions and their outsourcing arrangements, both with respect to third party service providers and intra-group arrangements.

 

 


[1]   Please see the Eversheds Sutherland’s update on the FCA Business Plan 2020/21 at the following link: https://www.eversheds-sutherland.com/global/en/what/articles/index.page?ArticleID=en/Financial_services/FCA-Business-Plan-2020-2021_150420