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CP20/20: The FCA’s approach to authorising international firms

  • United Kingdom
  • Brexit
  • Financial services and markets regulation
  • Financial services

06-10-2020

Introduction

On 23 September 2020 the FCA published Consultation Paper 20/20: Our Approach to International Firms (“CP20/20”).  The CP comes in the wake of an anticipated increase in the number of international firms seeking authorisation at the end of the Brexit transition period, when EEA firms will no longer be able to operate in the UK in the same way as they currently do under the passporting regime.

CP20/20 is relevant to EEA firms that intend to seek authorisation in the UK in the future, both those entering the Temporary Permissions Regime (“TPR”), as well as firms from non-EEA countries which have applied or intend to apply for authorisation in the UK, or which are already authorised in the UK.

The paper has two focus points: how the FCA assesses international firms’ compliance with the minimum standards; and, in circumstances in which international firms are considered to present higher risks of harm, how those risks can be mitigated.

Who the consultation applies to

This consultation applies to international firms that require authorisation, including:

  • European Economic Area (EEA) firms which have applied for authorisation in the UK, or intend to seek authorisation in the future, including those which have given notice they will join the TPR
  • international firms from non-EEA countries which have applied or intend to apply for authorisation in the UK, or which are already authorised in the UK

This consultation does not apply to:

  • Firms which do not require authorisation to operate in the UK. This includes, for example, persons relying on the Overseas Persons Exclusion in article 72 of the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001
  • Firms required to be authorised or registered under the Payment Services Regulations 2017
  • Firms required to be authorised or registered under E-Money Regulations 2011 which have their registered office in the UK
  • Depositaries, trustees and managers (also referred to as operators) of UK authorised funds (including UK UCITS schemes).  Subject to the temporary application of the TPR for EEA firms that have opted into the regime, the relevant on-shored legislation requires such entities to be incorporated in the UK, and for their affairs to be administered in the UK
  • International alternative investment fund (“AIF”) managers.  After the Brexit transition period, and subject to the temporary application of the TPR for EEA firms that have opted into the regime, only firms with their registered office in the UK can obtain permission to manage an AIF
  • International benchmark administrators.  The relevant on-shored legislation does not allow non-UK entities to obtain permission for benchmark administration, but there will be a separate regime under which they can apply to be recognised

FCA’s proposed approach

All firms wishing to be authorised in the UK are required to meet certain minimum standards set out in the relevant UK legislation.  In the case of firms seeking authorisation under the Financial Services and Markets Act 2000 (“FSMA”), the relevant minimum standards are known as the “threshold conditions”, set out in Schedule 6 to FSMA and the FCA guidance in the COND Handbook.  Once authorised, firms need to meet the minimum standards at all times.

Whilst the minimum standards apply equally to both UK and international firms, there are some additional factors which international firms need to consider, eg the nature of their UK and overseas  operations, their personnel or decision making structures, and their systems and controls.

The FCA’s assessment of an international firm against the relevant minimum standards will consider whether the activities of its UK branch poses a heightened potential to cause harm and whether those risks can be adequately mitigated.  CP20/20 identifies three potential risks of particular relevance for international firms: retail harm, client assets harm and wholesale harm; and provides guidance as to how firms can mitigate these risks.

If following an assessment the FCA takes the view that an international firm meets the minimum standards, it will authorise the firm (although it may consider imposing limitations or requirements as part of any approval, outlined below).  If, however, the FCA considers that the minimum standards are not met, it may refuse the firm permission to conduct the relevant regulated activities.  

Main considerations

General expectations for international firms

CP20/20 sets out the main considerations the FCA takes into account in its assessment of whether international firms meet the minimum standards.  These are particularly relevant to international firms operating from a UK branch, although they may also be relevant to UK subsidiaries with overseas parents:

Nature of a firm’s operations

Authorised firms must be capable of being effectively supervised; the FCA must be able to access relevant information, monitor the firm on an ongoing basis and make regulatory interventions to respond to specific harms or events.  This will normally require a firm to have an active place of business in the UK.  The FCA states a firm must have adequate personnel, systems and controls for the effective supervision of the firm’s UK activities.  The FCA will assess the degree of cooperation between the FCA and the home state supervisor, the firm’s business model and whether the firm’s strategy for creating value is implemented in a prudent manner in the interests of consumers.

Personnel and decision making

The FCA will consider the ability of the firm to comply with the Senior Managers and Certification Regime, which requires that firms have effective governance structures and management oversight in place, with clearly defined individual senior management accountability.  Before authorising an international firm to operate from a UK branch, FCA will need assurance as to the adequacy of the firm’s decision-making framework.

Systems and controls

Any firm authorised to operate in the UK must have appropriate non-financial resources including systems, controls and human resources.  If an international firm’s UK operations are dependent on services provided from parts of the firm located outside the UK, the FCA will consider whether these arrangements could impair the FCA’s ability to supervise the firm effectively.

Home state jurisdiction

FCA authorisation of a firm applies to the entire firm including its overseas offices.  This means for an international firm, FCA authorisation will apply to the legal entity incorporated outside the UK, including its UK branch and its overseas head office. Firms operating from branches often demonstrate a high degree of interconnectedness between their UK and international establishments.  As such, the FCA requires comfort in relation to the jurisdiction where the firm is incorporated and how arrangements in that jurisdiction affect the ability of the firm to meet the relevant minimum standards for authorisation.  For instance, to assess whether the UK operations are appropriately financially resourced by the firm and to avoid the risk that the firm cannot meet any legal and regulatory obligations arising from the UK operations, the FCA will take account of the comparability of relevant home state regulation, wind-down plans and whether the home state has implemented and complies with relevant global standards.  This includes, for example, whether the specific activities which the firm wishes to carry out through a UK branch are prudentially regulated in its home state. The FCA will also take account of the supervisory cooperation with the relevant home state regulator(s).

Assessing an international firm’s risks of harm

The FCA will consider the potential harm a firm may pose.  CP20/20 sets out three potential risks which are more relevant for international firms, especially those operating from branches:

  1. Is the protection for UK retail customers, including redress and supervisory oversight less effective than UK protection, for instance on the international firm’s insolvency or exit from the UK? (“Retail Harm”);
  2. Are the UK rules which protect client money and custody of assets aligned with the home state insolvency regime applicable if the international firm fails?  Any misalignment could negatively impact the outcome for UK clients (“Client Assets Harm”);
  3. Shocks or risks that originate from the international firm’s overseas offices could, in some circumstances, be more difficult to detect or prevent and could be passed to its UK office, affecting the stability and integrity of the UK markets in which it operates or to which it is connected (“Wholesale Harm”).

Mitigating risks of harm

The FCA will consider whether the firm offers adequate mitigation against the risks of any possible harm identified.  Part 4 of CP20/20 provides examples of ways in which international firms might be able to mitigate the three risks of harm outlined above:

Retail harm

Retail harm can arise where an international firm holds insufficient resources to compensate its UK retail clients during firm failure, or decides to exit the UK market without compensating its UK retail clients.

Factors that may reduce the likelihood of firm failure and of firms holding insufficient resources to compensate retail clients include, the level of prudential scrutiny and supervision applied to firms in their home state, the extent of any ongoing monitoring of recovery and wind-down plans, and the degree to which UK authorities may be involved in the recovery and planning process.  For firms with resolution arrangements, FCA will also take account of the extent of international cooperation for those arrangements.  The FCA will also consider the relationship between the branch and its head office, to identify whether it could gain additional assurance from how the branch is structured or resourced.

Client assets harm

Client asset harm can arise when there is a misalignment between the UK rules which apply for client assets safeguarded by a UK branch when the international firm is a going concern, and the insolvency laws which apply when the firm becomes insolvent.

The FCA will expect firms to satisfy them that the risks are appropriately mitigated, including, where relevant, by providing the FCA with information about their clients and how their assets which are safeguarded by a UK branch would be treated if the firm enters into insolvency proceedings abroad.  The FCA will expect firms to consider the risk of harm and be able to explain the mitigations they have put in place.

Wholesale harm

Wholesale harm can arise when shocks or risks that originate from an international firm’s overseas offices, which may be more difficult for the FCA to identify and prevent, have a negative impact on its UK branch and the integrity of UK financial markets.

For most firms, this risk will be small, as they are unlikely to have the scale or scope to have an impact on wider market integrity.  However, the FCA will consider, on a case-by-case basis, the extent to which this risk of harm is likely to become real and what mitigants are in place and whether they are adequate relative to the level of risk.  Relevant factors include the level of supervisory cooperation, the prudential regime the firm is subject to, and the credibility and quality of its wind-down planning.

Decisions following an assessment

The FCA will authorise firms which meet the minimum standards.  It may consider imposing limitations or requirements if necessary for it to be satisfied that the firm will meet minimum standards on an ongoing basis.

  • Limitations: a limitation may restrict a firm’s activities to reduce the potential for harm.  For example, the FCA might limit the number or category of customers a firm can deal with, or the number of specified investments that a firm can deal in.
  • Requirements: a requirement may be placed on a firm to take or refrain from taking certain action.  For example, the FCA might require a firm not to take on new business, or not to trade in certain specified investments.

Conclusion

CP20/20 sets out the FCA’s approach to authorisation of international firms.  This will be of particular importance for the 1,500 firms currently registered to enter the TPR at the end of the transitional period and begin the process of obtaining UK authorisation.  The FCA is not proposing to change existing rules or other provisions in the FCA Handbook through CP20/20, as it considers its current rules “appropriate and proportionate”.  Rather, it wants international firms to understand its approach and expectations.  As Nausicaa Delfas, FCA Executive Director of International says, international firms are, “a key contributor to the success of the UK financial services market”.

Next steps

The deadline for responses to CP20/20 is 27 November 2020 and they should be made on the FCA’s response form.  Following the consultation, the FCA will issue guidance explaining its approach to international firms.  The document will supplement and support existing guidance, including that on its approach to authorisation and supervision.