Out-Law Analysis | 12 Feb 2021 | 3:10 pm | 7 min. read
The UK's Financial Conduct Authority (FCA) has set out its approach to authorising international firms and their subsequent supervision, following a public consultation.
The FCA considers that international firms, particularly branches, could present 'risks of harm' in three main areas: retail customers; client assets; and the UK's financial markets.
The regulator has published an approach document (26-page / 490KB PDF) and feedback statement (13-page / 274KB PDF) in which it provides insights into these risks, and how it considers that they can be mitigated. The FCA is not making any changes to its rules.
The FCA is anticipating an uptick in numbers of international firms applying for authorisation under Part 4A of the 2000 Financial Services and Markets Act (FSMA), including applications from the 1,500-odd firms currently in the Temporary Permissions Regime (TPR). The document may also be relevant to firms seeking FCA authorisation under other legislation and those international firms requiring dual regulation, for whom the Prudential Regulation Authority (PRA) is the lead regulator.
International firms seeking Part 4A authorisation under FSMA must have an establishment or physical presence in the UK (a "UK branch"). The FCA expects this to be "an active place of business in the UK" – so typically a registered address alone will not suffice. They must ensure they can meet the minimum "threshold conditions" FSMA sets out, not only as a condition of authorisation, but as an ongoing requirement once authorisation is granted.
The FCA is anticipating an uptick in numbers of international firms applying for authorisation, including applications from the 1,500-odd firms currently in the Temporary Permissions Regime.
The threshold conditions establish the minimum standards the FCA will require an applicant to satisfy in respect to a number of areas including financial resources, business model, and overall suitability for authorisation. The FCA must also be comfortable that it can supervise the applicant effectively.
The applicant must satisfy the FCA that it is a fit and proper person to be authorised. For this it will need to provide information on a range of areas including that the people managing it are suitably skilled and experienced; and that it will be run soundly and prudently, and in such a way as minimises risks of it being used in connection with financial crime.
The document confirms that the FCA typically expects senior managers managing the applicant's business in the UK "spend an adequate and proportionate amount of their time in the UK to ensure those activities are suitably controlled". They must have the necessary authority to take independent decisions in respect of the branch's day-to-day business and to challenge strategic decisions regarding the firm as a whole. The firm must also comply with the requirements of the Senior Managers and Certification Regime (SMCR).
Applications are assessed by the FCA "on their merits and on a case-by-case basis".
Authorisation of a firm "applies to the entire firm including its overseas offices". This means the whole firm, including its offices outside the UK, benefit from the permissions the FCA grants so must satisfy the FCA's minimum standards for authorisation at the point of authorisation and going forward. This broad view of the applicant is an important pointer for firms preparing their application. They too must think widely and identify and address all risk areas likely to be of potential regulatory concern.
Firms should also be able to demonstrate that they are "ready, willing and organised" to be authorised.
Where international firms propose to provide services requiring authorisation to UK customers from outside the UK then the FCA "will seek to ensure that this is appropriate" and that it can "effectively supervise" such services. Its supervisory relationship with the establishment in the UK will be relevant, along with understanding the degree of oversight the UK branch has over activities carried on in this way with UK customers.
Arrangements between regulators in the UK and the home state will be important considerations for the FCA in assessing the application of an international firm. Relevant aspects include the "comparability" of the home state's regulation and approach to supervision; whether it complies with relevant global standards particularly in relation to insolvency; and if there is a cooperation agreement between the relevant regulators and arrangements for sharing confidential information.
Differing regulatory rules and approaches in overseas jurisdictions may complicate supervision by the FCA, particularly when overseas firms have regulatory obligations to their home state regulator in respect of their UK branch and these overlap with UK rules. As an overseas head office and its UK branch would generally be wound up together on insolvency, there could then be risks to the protections for UK customers of the branch. When considering the applicant against the statutory minimum standards for authorisation, the FCA will consider whether there is what it describes as a "heightened potential to cause harm" in respect of the branch's activities, and whether such risks can be adequately mitigated.
The FCA will consider both the potential for the international firm to cause harm – referred to as the "risks of harm" - and the level of these risks when assessing the applicant against the relevant minimum standards for authorisation. Three potential risks are particularly relevant to international firms:
Although these risks are not unique to branches, the FCA considers they are particularly relevant to international firms especially when carrying on business via a branch. The FCA approach document provides examples of risk mitigation measures for these three risk areas.
Retail harm could arise on insolvency or on a firm's departure from the UK without compensating its UK retail clients. The FCA will consider the factors that may make such harm less likely and will take account of those when considering both the firm's ability to mitigate the risk and its impact on the firm in terms of meeting the minimum standards for authorisation. There may be factors that could reduce the possibility of failure or of the firm not being able to compensate its customers in the UK, such as the home state's prudential requirements and regulatory oversight, or monitoring of wind-down plans and international cooperation for resolution arrangements, if applicable. There may be additional, more firm-specific factors too, such as the importance to a firm of maintaining its reputation in other markets making it less likely to avoid its responsibilities in the UK.
Partner, Head of Finance and Projects
The broad view taken of the applicant is an important pointer for firms preparing their application. They too must think widely and identify and address all risk areas likely to be of potential regulatory concern
The nature and scale of the firm's retail business will also be important. The FCA expects "mitigants to be commensurate with the likely level of risk, for example, the size of the firm's retail business". The FCA will also consider the branch-head office relationship to understand if it provides any additional comfort. Independent management and oversight at branch level, the branch's systems and controls and the expertise of those carrying out the control functions may all be relevant for mitigating risks to retail clients.
Client asset harm can result if the UK's rules on safeguarding client assets while a UK branch is a going concern are not aligned with the home state's insolvency law requirements. Firms are expected to have considered how to mitigate resulting risks to client assets held in a UK branch on insolvency. The FCA will consider the risk of harm to client assets and client money separately and firms should be able to explain the protections or structures they would put in place to tackle risks.
Wholesale harm, or market risk, is more likely to derive from dual-regulated large international firms. Smaller, solo-regulated and new entrant businesses pose less of a risk of wholesale harm as they will be unlikely to generate the size or sufficient business to impact market integrity in the UK. Risk will, however, be considered by the FCA on a case by case basis and, where such risk "is likely to become real", the FCA will want to understand the mitigants the firm will put in place. These must be "adequate relative to the level of risk." Other relevant factors the FCA could consider include the anticipated level of supervisory cooperation; the prudential regime that applies to the international firm; and the "credibility and quality" of the firm's wind-down plan. There may also be more bespoke mitigants that individual applicants can offer in respect of their particular business.
The FCA will also consider specific risks relevant to the applicant firm's sector and business model, citing operational resilience and financial crime risk as examples. It will asses risks and their mitigation in light of its experience regulating other similar firms.
Where the FCA continues to have concerns that mitigating factors are not sufficient to address risks, it may impose limitations on the scope of the applicant's permission. This could include restrictions on the financial instruments or customer categories with which the applicant can do business; or imposing requirements on the firm to do or not do certain things to constrain the scope of its business operations and reduce the potential for harm. The FCA may also refuse to permit the firm to carry on a certain activity or activities. Incorporating a UK subsidiary may be another approach, for instance to address risks of jurisdictional misalignment in respect of client assets on insolvency, and making it easier for the FCA to take action should the need arise.
25 Sep 2020