The JR brought by Options (formerly Carey Pensions) gave the Court of Appeal the opportunity to revisit SIPP operator duties, specifically due diligence obligations and what is expected of SIPP operators when a potential client is introduced by unregulated firms to unregulated investments. 

The Court of Appeal previously considered SIPP operator duties in Options v Adams [2021] and found against Options for breach of Section 27 of the Financial Services and Markets Act 2000 (FSMA). We previously reported on that decision here.  For the purposes of the JR, it's relevant to note that Mr Adams' appeal in relation to the alleged breach of COBS 2.1.1R (the FCA Handbook rule requiring a firm to act honesty, fairly and professionally) was refused, and so the High Court decision which found that there had been no breach of COBS 2.1.1R was left untouched. 

The complaint and subsequent FOS decision subject to the JR (the FOS decision) considered broader allegations than those in Adams.  The FOS decision concerned alleged breaches of duty by Options for failing to identify and act on various 'red flags' with the unregulated introducer, CL&P, and the Store First investment before the complainant opened their SIPP (and to refuse the application and investment as a result). The allegations (and FOS' findings) of inadequate due diligence were broadly based on a finding that Options had failed to identify various red flags with CL&P when it started accepting introductions in August 2011 (including the fact they were paying incentives to members to invest in Store First and might be advising clients on the SIPP where they did not have relevant regulatory permissions to do so).  The interesting part of the FOS decision was that it found a breach of COBS 2.1.1R when the High Court on similar facts had not in Adams.  Did this difference matter to FOS' approach and reasoning?

The Issues 

The Court of Appeal in the JR had to consider SIPP operator due diligence obligations (which the FOS has routinely found apply to SIPP operators based on the FCA's thematic reviews in 2009 and 2012 and finalised guidance in 2013). There were three grounds for the JR: 

• Ground 1 - the FOS decision awarded compensation in circumstances where a court would not have done so, and the FOS decision failed to acknowledge this and give reasons for holding the SIPP operator responsible where a court would not have done so. 
• Ground 2 - FOS erred in finding that Options owed duties to prospective members of a SIPP to carry our due diligence on introducers and the investments selected.
• Ground 3 - FOS' conclusions in relation to breaches of duty were irrational.

Ground 1 raised a point of wider importance to FCA regulated firms as it goes to whether FOS can make a decision and go on to award redress based on findings of a breach of the FCA Handbook Principles alone (where a court would be unable to do so, as a breach of the Principles cannot form the basis of a cause of action before a court) and whether in doing so FOS can be accused of departing from the relevant law (which FOS is required to consider under the FCA Handbook provision, DISP 3.6.4R) and did FOS in such circumstances have to give reasons for that departure. 

The Court of Appeal Decision

The Court of Appeal rejected Options' challenge on all grounds. 

Ground 1 

On Ground 1, the Court of Appeal rejected the argument that if FOS finds a firm liable in circumstances where a court could not or would not do so, they should say so in terms and provide reasons for doing so. Options argued that this was an obligation on FOS relying on the judgment in R (Heather Moor & Edgecomb) v FOS [2008] in which the judge confirmed that FOS "is free to depart from the relevant law, but if he does so he should say so in his decision and explain why".  

The Court of Appeal confirmed FOS is not required to consider distinctly whether a firm has breached legally actionable duties and, if not, give reasons for upholding the complaint.  Instead, it is sufficient for FOS to determine the complaint having considered the relevant law, regulator’s rules and guidance and (where appropriate) properly supported views of good industry practice.  The Court of Appeal noted that the FOS does not need to "determine a complaint in accordance with the common law" (i.e. FOS does not need to apply the law as a court would). 

Ground 2 

The Court of Appeal found that although Options’ contracts with its customers did not impose due diligence duties, the due diligence obligations referred to in the FOS decision could be derived from the FCA guidance publications (notably the 2009 Thematic Review).  In respect of Options' reliance on the High Court decision in Adams (where the COBS allegation was dismissed), the Court of Appeal distinguished the finding of the High Court on the basis that it involved considering the post-contract position (whereas the FOS decision was based on pre-contract failings).  

The Court of Appeal did not express a view on the scope and effect of COBS 2.1.1R (whether it extends to pre-contract due diligence) on the basis "it is better to leave consideration of that matter to a case in which it is of central relevance" (i.e. the court felt it did not need to consider COBS 2.1.1R because it had found FOS had legitimately upheld the complaint based on the Principles).

Ground 3 

The Court noted the high bar for establishing irrationality and concluded that FOS was entitled to uphold the complaint insofar as it concerned introducer due diligence on the basis that Options ought to have made a check for Mr Wright directly on the FCA website, rather than relying on World Check for FCA alerts.  On investment due diligence, the Court of Appeal accepted that there were some issues with the factors relied on in the FOS decision but did not consider that they reached the threshold of establishing that the FOS decision was irrational. 

Implications

For SIPP operators

For SIPP operators, this appears to be the end of the road for challenging FOS on the basis that there are no pre-contract due diligence obligations. It seems that to defend a complaint based on pre-contract due diligence failings (or challenge a FOS uphold on that basis) there will have to be particularly strong evidence to show that there was no breach of the Principles in accepting business from an unregulated firm or allowing a certain investment (for example, if it can be argued there were no red flags or that the red flags were indiscernible at the time). 

For FCA regulated firms

The judgment confirms that FOS only has to consider – rather than apply – the relevant law (which has been found to include the FCA Handbook Principles) and give adequate reasons for their decision. So the FOS does not need to approach complaints as a court would and it is likely the FOS will be immune from challenge provided it can show it has broadly considered the relevant law, guidance, and best practice and reached an informed decision based on that (without having to identify a cause of action or find a specific breach on the part of the regulated firm or otherwise explain where it upholds a complaint where a court would not do so). This is unhelpful to firms that find themselves on the wrong side of decisions at FOS.  

The Court of Appeal judgment also refers to various authorities on FOS' jurisdiction which confirm that FOS should be given significant leeway in determining complaints. In rejecting Options' argument around the need to distinguish between actionable and non-actionable provisions of the FCA Handbook and explain a departure from the law when upholding a complaint based on breach of the latter, the Court of Appeal noted that the FOS regime is a "quick and informal means of resolving certain disputes" and that to preclude the FOS from determining complaints on the Principles "would seriously limit the effect of the Principles".

The ability to determine complaints in this 'relaxed' fashion, coupled with the Court of Appeal's finding that the Principles are part of the relevant law, may leave firms concerned about where they stand given FOS' ability to uphold complaints where the firm considers it has complied with what was expected of it (as here) given the high-level nature (/lack of specificity) in the Principles. It raises a question as to whether FOS will ever have to explain a departure from the law given the FOS can uphold a complaint based on a breach of the Principles, where breach is assessed on the FOS' subjective view of good practice.  The Court of Appeal's endorsement of this approach is particularly concerning to firms in circumstances where FOS compensation limits are now at £430,000 for post-1 April 2019 breaches.

That said, there may still be room for firms to challenge complaints alleging post-contractual breaches of the Principles or COBS and where the contract sets out clearly the scope and limitations on the FCA regulated party, given the Court of Appeal's apparent reluctance to address the scope of COBS 2.1.1R and whether it extends to pre-contractual services. 

The corporate plan notes that it is produced against a rapidly changing pension landscape – with a movement in the defined benefit market in particular towards fewer, larger, pension schemes and – against this backdrop TPR notes that its vision is to have fewer, well run schemes, delivering good outcomes.  

The focus on ensuring schemes are "well run" includes (1) closer engagement with the professional trustee industry and wider promotion of the general code (launched in January), (2) a focus on climate related financial disclosure reporting requirements, (3) high quality delivery of administration services and preparation to deliver the pensions dashboard and (4) learning lessons from the impact of liability driven investments on the wider financial market.  As for good outcomes, to TPR this means a continued focus on employer auto enrolment duties, monitoring the defined benefit market, ensuring defined contribution savers are offered appropriate choice at decumulation and protecting savers from scams.  

To meet these aims – TPR's corporate plan includes (1) working with the DWP on superfunds (another consolidator model and an alternative to buy-out for defined benefit schemes), (2) addressing "… market issues of administration" and investigating "… data quality issues", (3) delivering a regulatory framework for collective defined contribution models and (4) evolving its approach to master trust supervision including challenging trustees' focus on value for money ahead of new legislation.  There is also reference to a new standardised assessment of value for money in the defined contribution sector (which as this is a joint initiative means the FCA as well), with key elements including investment performance, cost and charges and quality of services, and developing guidance on decumulation (an FCA focus as well).  On decumulation, TPR notes the government's support for the potential for schemes to offer decumulation products and proposing a new legal duty on schemes.

TPR proposes to "work closely" with some of the largest professional trustee companies and develop a framework for oversight of professional trustee firms.  TPR also proposes to "deliver a regulatory intervention looking at how schemes are meeting [TPR's] expectations in respect of measuring and improving data and act where trustees fail to meet our expectations" and to work with the DWP to explore policy options on the mandatory accreditation or authorisation of administrators.

TPR also plans to create three new regulatory "directorates" – (1) regulatory compliance, (2) market oversight and (3) strategy, policy and analysis.  The one of most interest is likely to be "regulatory compliance" – with this directorate targeting schemes and employers to protect savers' money.  TPR also says that the "industry should expect us to interact with them differently" and "… where we find bad actors, we will not be afraid to tackle them, delivering quicker routes to enforcement to ensure savers are protected".

Key takeaways

 TPR's approach is relevant to pension trustee liability insurers and professional indemnity insurers for pension administrators, professional trustees and actuaries.  The key focus areas of most interest are likely to be:

• Schemes offering decumulation products – decumulation has been a recent focus of the FCA in its retirement outcomes review.  The onus on schemes to offer decumulation products potentially transfers risk to scheme trustees operating decumulation models and when it comes to setting out the options for pension savers.  The guidance that TPR proposes to publish in this area is going to be key to consider when considering what risks this might pose for pension trustees.
• Administration – the proposal to consider mandatory accreditation or authorisation of pension scheme administrators will be of interest to professional indemnity insurers in this area, alongside administration firms.  There is also a focus on scheme administration – value for money, investment return data, and data quality.  The quality of data is going to become a particular focus with the pensions dashboard and it may be with that in mind that TPR is focussing (as it has in the past) on the quality of data.
• Development of collective defined contribution and superfunds – with the requirement to provide value for money pushing the agenda for scheme consolidation, there is a focus on collective defined contribution and superfunds – these new forms of scheme offer new opportunities as well as challenges for insurers and trustees alike.
• ESG – there is also a focus on so-called "improved ESG recognition" with TPR referring to climate related financial disclosure reporting requirements, with a focus on improving the quality of reporting and the understanding of risk.
• Professional trustees – with the increase in professional trustee involvement in schemes, TPR proposes a framework for overseeing professional trustee firms – perhaps greater oversight and potential regulatory action is to be expected going forward.

There is a lot in the corporate report for those involved as pension scheme trustees, the day to day running of trust based pension schemes or employers with auto-enrolment duties. What happens next and how TPR implements its corporate plan is something that those involved with trust based pension schemes and auto-enrolment need to keep an eye on – including their insurers.

The High Court Decision

The appeal arose from a High Court judgment in the case of CMG Pension Trustees Ltd v CGI IT UK Ltd which was handed down on 1 August 2022. The case concerned the trustee of a pension scheme's ability to recover overpaid benefits by reducing subsequent pension payments – "recoupment". For trustees to recoup overpayments, the conditions outlined in Section 91 of the Pensions Act 1995 had to be satisfied. One of these conditions under Section 91(6) required that in points of dispute regarding the recoupment amount (which was a dispute in the case), deductions could not be applied unless the obligation to do so “has become enforceable under an order of a competent Court”.  

The High Court held that when recouping overpayments from future pension payments a declaration of overpayment from a "Court of competent jurisdiction" would suffice.  This was because the member would not have to repay the overpaid sums directly, but rather the trustee would retain money from subsequent instalments of pension payments. 

The High Court then found that the Ombudsman was not a competent court and as such had no powers of enforcement, meaning applications should be brought in the County Court for declarations of overpayments.

The Court of Appeal Case

Following the High Court Decision the Ombudsman intervened and appealed, arguing that it was a competent court for the purposes of Section 96(1) Pension Act 1995. 

Following both parties' submissions, the Court of Appeal unanimously ruled that the Ombudsman is not a "competent court" for the purposes of Section 91 Pensions Act 1995.

The Court of Appeal emphasised that the Ombudsman only ever had jurisdiction where a matter was referred by a member or beneficiary of a trust and this one-sided jurisdiction was not resemblant of a court. The Court of Appeal stated that it was unlikely Parliament intended for the Ombudsman to hold the power of enforcement in cases where the trustee had no personal right to apply for enforcement.

Implications

In light of the CMG decision, where a member disputes the trustees' attempt to recover overpaid benefits from future pension payments, the trustees must obtain an order from the County Court albeit this should just be an administrative function as the County Court is not reconsidering the merits and instead only enforcing the Ombudsman's determination.

The Ombudsman has since commented on the Court of Appeal's decision noting that the DWP is supportive of legislative changes to formally empower the Ombudsman to bring outstanding overpayment disputes to an end without the need for a County Court order.  The Ombudsman has also produced a factsheet following the CMG decision and notes that to facilitate enforcement action before the County Court it will set out a schedule of the amount and rate of recoupment in its determinations (and it has done that in its first determination since the CMG decision).

A further practical implication of the CMG decision is that strategically members may dispute the amount or rate of recoupment to push a case to the Ombudsman and the County Court – this will incur further costs for trustees seeking to recoup overpayments and those costs may be passed on to any administration provider to a pension scheme where it can be said that they are at fault for any overpayment.  Although the Ombudsman notes in its factsheet that it hopes parties can come to an agreement in overpayment cases, there may be a strategic advantage for members to "string out" cases given the additional costs and time involved to obtain an order for recoupment.  

On 9 April 2019, the Complainant emailed the Administrator requesting that £20,000 be released from his SIPP and provided to the Administrator the required documentation to facilitate the release. On 18 April 2019, the Administrator confirmed to the Complainant that £20,000 less the relevant tax deduction would be paid from his SIPP into his nominated bank account by close of business on 29 April 2019.

Prior to the release of the monies, the Complainant's email account was hacked by a fraudster. The fraudster emailed the Administrator via the Complainant's email address, stating that there was an issue with his bank account receiving transfers and requested that the funds be transferred into an alternative bank account. The Administrator sent the forms required to facilitate the bank account change unknowingly to the fraudster and during exchanges which followed, the fraudster requested that the monies be paid into an international bank account or a third party's bank account; the Administrator confirmed neither of these options were possible.

Following further exchanges between the Administrator and the fraudster, the Administrator stated that the payment request was already on the banking run for April and so the recipient account could not be amended. The £20,000 payment was subsequently released to the Complainant's bank account on 29 April.

On the following day, the fraudster emailed the Administrator with completed forms requesting that a further £20,000 be released. The Administrator sent the forms to the Complainant's financial adviser (the Adviser), and on 13 May 2019, the Administrator confirmed that the further £20,000 would be released into the bank account nominated by the fraudster.

Following the release of the further £20,000, this time into the fraudster's bank account, the Complainant noticed that his SIPP account stated that he had withdrawn a total of £40,000. The Complainant asked the Adviser to confirm its records as he had only withdrawn £20,000, following which, the Adviser contacted the Administrator to request that it confirm its records with the Complainant. The Administrator contacted the Complainant to confirm the payments, however the email was intercepted by the fraudster who confirmed that the payments were correct.

The Complainant maintained to the Adviser that he had only requested a single payment of £20,000. The Adviser asked the Administrator to review the payments and whilst the Administrator was carrying out the review, the Adviser contacted the Administrator to confirm that it appeared as though a fraudster had hacked the Complainant's email account, which had led to the further £20,000 being released to a bank account unconnected with the Complainant.

The complaint to POS

A complaint was subsequently made to POS about the Administrator.  The Administrator rejected the complaint broadly on the basis that the fraudster had provided the required documents, and that the Administrator had verified the documents said to have been certified by an accountant who had been verified via a search on Companies House. The Administrator also stated that it expected the Adviser to carry out its own verification process before counter-signing the documents sent to it by the Administrator. Furthermore, the Administrator asserted that the Adviser failed to identify and react when it had every opportunity to do so.

POS Determination

In upholding the complaint against the Administrator, the Ombudsman found that the Administrator owed a duty to the Complainant in relation to the payment verification steps it had taken and had breached that duty.

The Ombudsman concluded that the Administrator should have undertaken additional checks following the request to change the receiving bank account details noting a number of "red flags":

• The fraudster requested that the money from the SIPP be transferred to an international bank account and shortly following the Administrator's refusal to do so, the fraudster requested the money be transferred to a third party bank account, which the Ombudsman described as unusual.
  
  
• The bank statement submitted by the fraudster when making the request (which was falsely presented as having been certified by an accountant) should have raised suspicions. The branch address on the bank statement, the address of the accountant who purportedly certified the statement and the Complainant's address were all in different locations and of some distance from one another, and so it was unlikely that the bank statement was a truly certified copy.
  
  The bank statement was of low resolution and whilst the content of the statement was typical and uncontroversial, it was clear that the certified copy wording had been physically scanned at a low resolution, and then most likely copied and pasted as a separate image onto the copy statement (which was at a visibly higher resolution).
  
  
• The fraudster's assertion on 23 April 2019 that there was a "little problem" with their UK bank account meaning that it could not accept deposits was unlikely, particularly given the successful genuine payment to the Complainant's bank account on 29 April 2019.
  
  
• Whilst the email sent by the fraudster to the Administrator was not illegible, it evidenced a number of errors.

The Ombudsman stated that whilst some of these factors may not have been sufficient to prompt further checks in themselves, when taking them together, they should have enough to cause suspicion and prompt the Administrator to carry out additional checks. The Ombudsman suggested that the Administrator could have sought to verify the certification through contacting the accountant directly through the accountancy firm's contact details to confirm that the accountant did indeed certify the document or speak to the Complainant.

The Administrator was directed by the Ombudsman to pay the Complainant a sum equal to that required to ensure that the Complainant held the same number of units had the fraud not happened, less any fees payable to the Administrator throughout the period since the fraud. The Administrator was also required to pay the Complainant £1,000 for the distress and inconvenience caused.

What can be learnt?

Whilst the Ombudsman has included what further checks the Administrator may have taken in this instance, the determination does not specifically set out what checks an administrator should carry out when dealing with a request from a customer to transfer funds. This reflects the reality that administrators will need to keep internal policies under consistent review and there must be flexibility to allow for the identification of increasingly complex fraud and arguably an amount of "detective work" if requests do not "stack up" which may lead to further checks being needed.

This case serves as a useful reminder to all administrators when receiving transfer requests, and especially when doing so via email, to remain vigilant at all times and to have the internal policies and procedures in place in order to be able to respond appropriately to potential
fraud.

To read the determination, please click here.

If implemented, the proposals will heap further pressure on an already heavily regulated sector. The FCA refers to the impact that failing firms have on the FSCS levy, whilst noting that this has actually been 'falling overall recently'. They also note that, between 2016 and 2022, the FSCS paid out £760 million in compensation in respect of failed PIFs, but that just 75 firms accounted for 95% of the total. 

The FCA's proposals beg some difficult questions, in our opinion:

• How, precisely, will the FCA expect firms to quantify both unresolved redress liabilities (i.e. potential liabilities for complaints that have been made but which are unresolved) and prospective redress liabilities (i.e. potential liabilities for foreseeable harm or systemic problems that may give rise to an obligation to provide redress to a consumer)?  This, in our experience, is an extremely difficult and contentious area – both in terms of whether a future liability will arise at all (i.e. should a complaint be upheld / does a systemic issue requiring redress arise) and in terms of what the amount of that liability might be. 
• We therefore question what benefit there is to making an entire sector hold additional capital against complaints that will not have been upheld and which may never materialise (although the FCA estimates that only a third of the market will actually have to set aside capital). 
• The paper is (perhaps unsurprisingly) silent on the impact it could have on firms if significant capital is tied up against potential liabilities that never become payable. 'Productivity' is a popular word in economic discussions at present and it's hard to see how these measures would have a positive impact on it (despite the paper  seeking to explain how the proposals will benefit the FCA's growth objective). 
• The justifications for the measures include incentivising firms to resolve complaints quickly and to identify systemic or recurring issues - all admirable aims but this potentially loses sight of the fact that complaints or claims need to follow due process and there is often disagreement between the FCA / FOS and the advice firm on whether or not a complaint should be upheld (or whether a systemic issue requiring redress exists). 
• Actually quantifying potential future liabilities is always a very inexact science.  The recent redress scheme for transferring members of the British Steel Pension Scheme (BSPS) is a good example of this.  When initiating the scheme, the FCA forecast very large liabilities for providing redress, but subsequent movements in gilt yields have resulted in redress liabilities plummeting to comparatively low levels.  Had the FCA's proposed new capital retention rules been in place at the outset of the FCA's work on BSPS, many firms would likely have had to put aside very large amounts of capital for potential liabilities that, ultimately, did not materialise.  This in itself could have put firms out of business unnecessarily and resulted in more exposure for the FSCS.
• We also question whether requiring firms to set aside capital for potential liabilities in respect of claims already received or for systemic issues already identified will amount to closing the stable door after the horse has bolted.  In our experience, by the time firms receive large volumes of complaints or have identified any significant, systemic issues requiring large amounts of redress to be paid, the damage will already have been done and those firms without sufficient capital or PI cover at that point will likely fail anyway.  After all, by the time these issues are identified, no one will be willing to provide additional investment into such firms.
  
  Subject to the results of the consultation, the FCA proposes to publish a final Policy Statement in the second half of 2024, with the aim that any new rules will come into force in the first half of 2025.
  
  Anyone wanting to provide feedback on the proposals can do so here:  CP23/24 Online Feedback Form

By way of background, RMMIs are types of investments which can be promoted and sold to retail consumers but are subject to specific restrictions. Examples of RMMIs include non-readily realisable securities (such as shares in an unlisted company, Peer-to-Peer agreements, Peer-to-Peer portfolios, and certain qualifying crypto assets). As the name suggests, they are often high-risk investment vehicles for retail consumers.

The FCA have been open in their desire to reduce the number of individuals investing into RMMIs and, in August 2022, published a report which required companies to use clear warning signs on their websites for consumers dealing with these risky investments. The FCA's goal was for firms to make it clear that the investments are high-risk and that any recommendation appropriately matches an investor's attitude towards risk. The new rules also banned bonuses, gifts, and other incentives in connection with these investments. The new (stricter) rules were introduced between August 2022 and February 2023. 

FCA's recent review 

The FCA has recently conducted a review to establish how well firms were complying with the new regulations. 

The FCA assessed 13 firms against 5 different criteria:

1. Incentives to invest;
2. Cooling off period;
3. Risk warnings;
4. Client categorisation; and 
5. Appropriateness. 

The FCA considered how these firms dealt with the new regulations around RMMIs under each of the five headers and have now released a report outlining the good and bad practices that they have observed in their assessment. 

What's made the FCA happy?

The FCA highlighted examples of good practice, which included providing clear and accurate information regarding each investment, providing consumers with additional tools to help them understand and calculate their net worth and subsequently warning customers that the RMMIs may not be suitable for them if they did not meet the requirements outlined in their surveys. This last finding supports what the FCA has often been keen to reiterate - that advisers shouldn’t simply agree with whatever is requested by customers – advisers should challenge customers to make sure that they are getting the best outcome for them.

The FCA also praised firms for providing consumers with resources to carry out their own research to understand the products offered and the associated risks with the investments. So, if you’re a customer looking to invest, you might expect some more homework from your adviser! 

What can firms do to improve?

The FCA weren’t entirely happy though. Examples of poor conduct included consumers being asked leading or simplistic questions that directed the consumer to the 'right' answer, altering the risk warnings to deviate from the wording within the FCA regulations and re-naming the categories or describing the categories in a manner which downplayed the risks of investing. 

The FCA also found certain firms did not meet the prominence requirements for the risk warnings and some designs reduced the prominence of these warnings. Indeed, some firms confirmed their marketing teams were unhappy at the requirement for prominence of the risk factor, on the basis that it might put customers off. 

The Next Steps 

The FCA now expect firms offering RMMIs to review their recent report and carefully reflect on the examples of good and poor conduct provided, before considering if internal operational changes need to be made. It might seem that firms have a small period of grace to make changes, however the FCA are unlikely to be quite so forgiving if a further review finds there are still failings.  

We anticipate that the FCA will keep heavily monitoring to shield consumers from making unwise investments which are not adequately labelled as high risk. Firms should stay vigilant and responsive to the changes and recommendations imposed by the FCA to avoid further criticism and stringent investigations – after all, the FCA has confirmed they will look to take robust action against firms not complying. 

The new rules contain the following primary elements:

• Tougher regulations on advertising – The FCA will enforce stricter rules to ensure that promotions related to cryptoassets are clear, fair and non-misleading.
• Comprehensive risk disclosures – There will be a stronger emphasis on providing investors with comprehensive risk disclosures. This ensures that investors are fully informed about the potential risks associated with investing in cryptoassets.
• Prohibition of incentivisation – The new rules will prohibit the use of incentives to entice investors to invest in cryptoassets. This includes bonuses, additional "free" cryptoassets or any form of incentivisation.

Financial services professionals, especially those engaged in disseminating promotional material related to cryptoassets or advising on them, will have to tread carefully, ensuring adherence to the new FCA rules. They must maintain high levels of accuracy, clarity and fairness when presenting any promotional information or advice to consumers.

The FCA urges firms to assess their compliance with the regime. It warns that failure to comply may result in alerts being issued and promotions being removed or blocked. Seeking legal advice is recommended to avoid committing offenses and facing enforcement action.

Insurers of firms promoting cryptoassets must also understand the rules so as to be able to properly assess their insureds' potential exposure to this new regime.  Critically, we believe that it is important to note that the FCA's definition of financial promotion does not just cover the more obvious kinds of mass-marketing usually associated with "promotion" (for example advertising in print, websites or social media).  Rather, it includes any "invitation or inducement to engage in investment activity or to engage in claims management activity that is communicated in the course of business", so will also capture advice on investing in cryptoassets.

While the rules may initially look burdensome due to the added steps required and increased regulatory scrutiny, they might contribute to the industry's maturity, ensuring more measured, transparent and ethical practices around marketing of cryptoassets. By placing emphasis on transparency and consumer protection, the FCA's regulations could help in sculpting a more robust and trustworthy environment for digital assets.

The matter referred to the Tribunal was fairly complex, but for our purposes the FCA alleged that Bluecrest Capital Management (UK) LLP (BCMUK) had failed to manage a conflict of interest. Bluecrest operated two investment funds: the External Fund, which was open to investors, and the Internal Fund, which was only available to employees and directors of Bluecrest. During the period under investigation, some portfolio managers were transferred between the two funds. The US Securities and Exchange Commission ("SEC") announced in 2020 that the parent company (Bluecrest Capital Management Limited) had agreed to settle charges concerning disclosure, misstatements and omissions in relation to the transfer of managers between the Funds. SEC issued a plan for US based investors to be compensated for management fees paid in connection with the affected investments.

The FCA sought to impose a redress scheme paying similar redress to non-US investors; a supervisory notice required BCMUK to pay redress to non US investors. A financial penalty of £40,806,700 was also imposed for breaches of Principle 8 (which you will of course know requires a firm to manage conflicts of interest fairly).

In very brief terms, the Tribunal's decision concerned 2 case management applications:

1. The FCA's application to amend its statement of case and to rely on a draft rejoinder to its case on redress; and
2. BCMUK's application to strike out elements of the FCA's statements of case. 

The strike out and rejoinder applications concerned whether the FCA had pleaded a case as a matter of law that was capable of supporting the redress requirement it sought to impose – specifically, the FCA was looking to impose a redress requirement on the firm pursuant to s.55L of FSMA and the Tribunal was to consider whether it could do so under this provision, or only under s.404F(7) of FSMA (and, if so, whether the FCA's case as pleaded was capable of meeting the relevant requirements). 

The Tribunal noted that the disciplinary notice issued by the FCA demonstrated a considerable amount of 'muddled thinking' and a lack of clarity as to why it believed there had been a breach of Principle 8. However, they summarised that the disciplinary notice alleged that BCMUK breached Principle 8 for two reasons:

1. In respect of the External Fund it failed to manage the conflict that arose from the manner in which it allocated portfolio managers; and
2. It failed to make adequate disclosure of the conflict to investors when marketing the External Fund.

The FCA sought to make four amendments to its statement of case, which we don’t need to dwell on for the purposes of this blog. In brief, the Tribunal allowed two amendments to be made, concerning the adequacy of disclosure to the External Fund's directors (given that they were allegedly subject to the same conflict as BCMUK) and an allegation that BCMUK was obliged to provide services to the External Fund's investors in carrying out regulated activities (both making arrangements with a view to transactions in investments and arranging / bringing about deals in investments) and thus these investors were indeed 'clients' of BCMUK. Crucially however, amendments alleging breach of Principle 8, Principle 7 and COBs 4.2.1(R) in respect of the treatment of investors as clients were not allowed, as these did not fall within the subject matter of the reference and the Tribunal had no jurisdiction to consider them.

The strike out application

 The strike out application concerned two questions:

1. What statutory requirements did the FCA need to satisfy before imposing a redress requirement on BCMUK as a single firm; and
2. Did the FCA have a reasonable prospect of satisfying those conditions based on its pleaded case.

BCMUK argued that there was no freestanding power under s.55L of FSMA to impose a redress requirement. They submitted that, on proper interpretation of s.55L and s.404F(7) (and reading in the requirements of s404 more broadly), a redress scheme could only be imposed if 4 statutory conditions were satisfied:

1. Consumers had suffered loss (loss)
2. The loss had been caused by a wrong on the part of the firm (causation)
3. The loss was suffered by a consumer to whom a regulatory duty was owed (duty)
4. That the loss was caused by an actionable wrong (actionability)

The FCA argued that it did not need to satisfy the requirements of s.404F(7) or the requirements of s.404 more broadly in order to impose a single firm redress scheme, stating that the relevant consideration was contained at 55L of FSMA which required only that "it appears to the FCA that…it is desirable to exercise the power in order to advance one or more of the FCA's operational objectives." The FCA also referred to the consumer protection objective, arguing that considering whether they had the power to impose a redress requirement only required it to conclude that it was desirable to do so in order to advance its operational objective of providing an appropriate degree of protection to consumers. 

The Tribunal noted that FSMA included 4 powers of redress (including s.404 and the use of FOS) and that each of these required loss, for that loss to have been caused by the wrong of the firm, and the existence of a duty. The consumer redress powers also required that the wrong be actionable at law.

The Tribunal went on to note that the FCA interpretation would lead to a 'surprising result', in that it would mean they could compel redress to be paid without a statutory requirement to establish loss, duty, breach or causation. It would also mean that they could do so without needing to show that the firm had breached a regulatory requirement at all or that the redress even related to regulated activities. The Tribunal's view was that the power at 55L(2)(c) must be constrained to an extent greater than that argued for by the FCA so as to avoid unreasonable or absurd results. They concluded that this power was constrained by s.404F(7) and the rules under s.404 and that the FCA was required to establish the 4 conditions of loss, causation, duty and actionability before a redress scheme could be imposed on a single firm. The Tribunal noted that it would not make sense if the FCA could impose a single firm review without establishing the four conditions when a multi-firm redress scheme under s.404 explicitly required these to be established.

The Tribunal concluded that there was no freestanding power under s.55L to impose a redress requirement on a single firm, and that any such power was restricted by the terms of s.404F(7), and that the same statutory conditions (being a need to establish loss, causation, breach and actionability) to be satisfied under s.404 had to be satisfied under 404F(7). Furthermore, breach, causation and loss were to be determined in accordance with the approach of the civil courts.

The Tribunal accepted that the FCA's case had real prospects of success on the first three conditions. However, on actionability, the Tribunal noted that whilst breaches of the FCA's Rules were actionable at law, breaches of the Principles of themselves were not. The FCA's proposed amendment to rely on a breach of COBs 4.2.1R had been rejected (I told you above that this was crucial) and so their pleaded case proceeded solely based on alleged breaches of Principle 8. The Tribunal held that there was no power to impose a single firm redress scheme based on breach of the Principles. The Tribunal did note that the FCA itself chose not to plead (for example) that there had been a breach of COBs in the original statement of case and could, subject to any issues, bring a fresh case. However, the case as pleaded was deemed to have no real prospect of success in establishing any actionable loss as was required by 404F(7). The redress requirement could not therefore be lawfully imposed.

This serves as a useful reminder of the limits on the FCA's power to impose a redress scheme. This could be increasingly relevant with the advent of the Consumer Duty and the FCA's current Thematic Review into later-life income. It seems unlikely that the FCA will seek to impose redress schemes based solely on breaches of the Principles again, but the key takeaway from this case is that there needs to be a legal liability before the FCA can impose a redress requirement on a firm. When faced with the imposition of a redress scheme, it is wholly legitimate for a firm to argue that (for example) no duty was owed to those suffering losses or that limitation has expired. It will also need to be established that any breach of duty was causative of any loss allegedly suffered.  

The "overseas advice model" applies to members of UK Defined Benefit pensions who are based overseas, and where overseas advice firms target members about transferring into alternative arrangements.

For pension transfers with a cash equivalent transfer value over £30,000, members must receive "appropriate independent advice" from an FCA-authorised firm before trustees can transfer benefits to a defined contribution scheme.

To satisfy the requirement of obtaining advice, scheme members are typically introduced by overseas firms to UK advice firms, with the transfer of funds and subsequent investment of those funds then arranged by the overseas firm. 

The risks to consumers and UK advice firms

The publication on the FCA's website (link provided below) provides several scenarios which present risks to consumers and UK advice firms. The key issues within each scenario centre around the adequacy of due diligence on overseas firms; contact with the member; the quality / type of advice; potential for excessive charges to the consumer in overseas arrangements; and members insisting to proceed contrary to advice provided.

As part of their harm prevention and detection obligations, firms should ensure that they conduct thorough due diligence on both the overseas advisers and the offshore investment products. This involves assessing the reputation, regulatory standing and track record of the advisers, as well as evaluating the transparency and regulatory framework of the offshore investment.

Firms should also assess the suitability of offshore investments for the individual consumers, taking into account their risk tolerance, financial objectives and other relevant factors. Risks will arise where the UK advice firm has had little or no interaction with the member and relies solely on information provided by the overseas firm. Clear and transparent disclosure to consumers should be provided, ensuring they understand the risks and benefits associated with offshore investments. Abridged (not full) advice will not suffice.

Charges on the member should be considered by UK advice firms in their advice on the transfer, particularly where charges on overseas investment products can be complex and, in some cases, higher than the potential investment growth on a realistic projection.

Where the UK advice firm recommends that the member remain in their scheme and the member subsequently becomes insistent on requesting a transfer, this may be an indication of coaching or that the member is acting under the influence of the overseas firm, and such situations should be treated by firms with caution.

With the introduction of the Consumer Duty looming, this FCA publication serves as a reminder that firms should pay particularly close attention to those duties when receiving introductions from overseas firms.

In short, the FCA will expect UK advisers to treat overseas referrals with extreme caution and firms will need to robustly document all due diligence and advice work if they are to avoid future criticism from the FCA.

Please click here to read the FCA publication.

The FOS budget and plan for 2023/24 notes a reduction in its current caseload with it expecting to have resolved 205,000 customer cases, reducing the number of cases in progress by 40% to below 70,000 cases during 2022/23.  The focus on reducing the number of complaints sat at FOS is reiterated for 2023/24 with the aim that it will exit 2023/24 with a complaint stock of 47,000 complaints and it will "continue to resolve cases quicker, without compromising quality". In the plan FOS acknowledges that "it continues to take us too long to resolve cases".

Other strategic priorities include:

• Completing the alignment of casework structure to industry areas
• Enabling complainants and respondent business to "self-serve" through digital portals
• Improving the quality of data and to leverage data to share "high quality insight" with industry

FOS service standards include for complaints received from 1 April 2023 that 70% of cases are resolved within three months from the point FOS accept the complaint and 90% within 6 months from the point FOS accept the complaint.

The FOS budget and plan also includes details of trends it is monitoring and expecting to see – for the investment and pensions areas – it notes an expected increase in complaints given the British Steel consumer redress scheme, a rise in investment and cryptocurrency scams, more complaints relating to surrender and execution delays, performance and portfolio management complaints due to cost of living concerns and the overall impact of living concerns.  Other notable trends identified include uncertainty over the impact of funeral plans and an increase in mortgage related and consumer credit complaints due to interest rate rises. Respondents to the FOS budget and plan also highlighted the new consumer duty as being an area likely to result in a short-term increase in complaints as the duty is implemented from the end of July 2023 for new and current products.

The FCA 

As with FOS' plan and budget, the FCA also highlights the cost of living and consumer duty as challenges for 2023/24. 

The FCA focuses in its budget and plan for 2023/24 notably include areas where it will take on regulatory oversight – with cryptoassets and deferral payment credit – now falling within the FCA's regulatory regime.

The FCA's plan and budget also outlines three focuses:

• Reducing and preventing serious harm

This is split between – dealing with problem firms, reducing harm from firm failure, improving oversight of the appointed representatives regime, reducing and preventing financial crime and delivering assertive action on market abuse.

For the advice market the notable sections are "reducing harm from firm failure" and the appointed representatives regime. 

The section on reducing harm from firm failure includes "improving the redress framework" with the plan noting "We want to see more consumers get redress from the firm that owes them money so that a smaller proportion of costs are passed on to other regulated firms…" with an outcome for the FCA identified as being "firms that create a redress burden are more likely to bear the associated costs themselves".  The FCA proposes to achieve this outcome by consulting on guidance for firms on redress calculations, reviewing access to FOS for small and medium sized enterprises and developing proposals to improve complaints reporting.  Further the FCA is to introduce a new regulatory return requiring 20,000 solo regulated financial firms to provide a baseline level of information about their financial resilience.

With the new appointed representatives regime, the FCA wants to achieve stronger oversight by principals to reduce harm caused through appointed representatives.  The FCA's plans include undertaking more assertive supervision of high-risk principals and supporting consideration of potential legislative changes.

• Setting and testing higher standards

This focus encompasses putting consumers first, enabling consumers to help themselves, environmental, social and governance (ESG) priorities and minimising the impact of operational disruptions.

There is emphasis an on the consumer duty – the plan notes that additional funding assigned to the consumer duty allows the FCA to undertake sector-specific supervisory work to identify and "assertively supervise" and enforce against activities that undermine effective competition and good consumer outcomes.  The FCA also plans to create an additional interventions team within enforcement – in place at the time the consumer duty comes into force.  There is also an emphasis on the cost of living crisis and with that debt advice – with new rules planned to ban debt packagers from receiving referral fees.

The plan also emphasises supervisory activity over financial promotions, misleading marketing and disclosure around ESG-related products and actively monitoring how effectively firms and listed companies implement climate related financial disclosures.

• Promoting competitive and positive change

A key facet is the Future Regulatory Framework (i.e. what the UK's financial services regulatory framework will look like following the UK leaving the EU) with changes to the listing rules and implementation of changes from the Wholesale Markets Review.  Activities here include bringing forward proposals on asset management regulation.

Overall, there are some interesting insights into what we can expect for 2022/23 – the consumer duty is a running theme for both the FOS and FCA as is the cost-of-living crisis.  Both the FOS and FCA also emphasise the use of data as a way to develop their oversight and activity and the FCA notes some areas where it appears to have a particular focus including ESG reporting, the promotion of investments, asset management regulation and the appointed representatives regime.  However, the what really matter is what the FOS and the FCA do – and that's something we will have to wait to see.

HM Treasury has stated that the FSM Bill will:

• Implement the outcomes of the FRF.
• Maintain the UK’s position as an open and global financial hub.
• Harness the opportunities of innovative technologies in financial services.
• Increase the competitiveness of UK markets and promote the effective use of capital.
• Support the levelling up agenda, financial inclusion and consumer protection.

A line-by-line examination of the FSM Bill took place during the final day of the committee stage. The most recent issues that have been considered include (but are not limited to):

• Regulation of climate and nature offsets.
• Limiting powers of the Prudential Regulation Authority.
• Banking reform.
• Safeguards in place for policy holders following failure of an insurance company.
• Introducing an ability for the FCA to require the Financial Ombudsman Service to refrain from exercising its powers in certain circumstances.
• Duties of pension providers and investment managers.
• Duty of the Financial Conduct Authority to report on financial inclusion and powers of regulators.

A full list of the issues discussed is set out in a press release published on Parliament's website, along with a revised version of the FSM Bill. The FSM Bill will now move on to the report stage for further scrutiny.

Financial services firms and their insurers should continue to monitor these consultations to see what changes make it into the final bill.

The review was conducted as a result of the FCA's concern that some firms with very fast growth presented an increased risk of harm to customers and other market participants. It focused on the impact of this rapid growth on the FGFs' financial and non-financial resources, including their risk management practices, governance arrangements and adequacy of financial resources. The FGFs were required to provide the FCA with documents including, business plans, internal capital adequacy process documents, wind-down plans and financial projections for review.

The FCA has published the results in considerable detail, however the two key findings are that FGFs tend to have risk management and governance frameworks that don't keep pace with their rapid growth, and FGFs’ own assessment of the adequacy of their financial resources also didn’t reflect their increased size and scale. The effect is that there is an increased risk of poor outcomes for consumers and disorderly firm failure.

The FCA has provided detailed feedback to the FGFs and have put in place remediation plans where appropriate. 

The publication further sets out the FCA's expectations for FGFs to mitigate against risks, which include:

• Having robust plans in place to understand their likely future growth, and to maintain sufficient resources to manage growth or unexpected stress.

• Updating their risk management framework (including risk appetite and limit framework) and governance arrangements to ensure that they remain proportionate and fit for purpose.

• Ensuring that the assessment of adequacy of financial resources continues to be commensurate with the size, complexity and forecast growth of the business.

• Embedding a liquidity risk management framework including liquidity risk policies, controls, contingency funding plans and stress testing.

• Ensuring that their wind-down plan is robust.

• Providing accurate and complete data in their regulatory submission.

The FCA says that it expects all FGFs to continually identify, assess and manage the risks arising from their activities and associated growth. They must also hold adequate financial and non-financial resources to cover these risks and mitigate potential harm.

The key takeaway from all this is that firms that are particularly successful should ensure that they take as much care to improve their risk management, governance and financial security as they take to improve their bottom line.

Similarly, insurers of firms that appear to be growing rapidly should take particular care to ensure that the firms are meeting the FCA's expectations.  Nothing is more likely to derail a runaway success story than an FCA intervention.

The FCA has faced criticism for the scheme, which unusually is implemented on an "opt-out" basis, meaning firms are having to put their clients through the scheme even if they have not complained or asked to be included, unless they specifically opt-out. 

The FCA is also facing a legal challenge to the scheme, due to be heard by the Upper Tribunal in April.  This challenge is made on behalf of firms who are part of the British Steel Adviser Group.  One key aspect of the challenge, we understand, relates to the fact that, as a result of rising gilt yields, redress for those given unsuitable transfer advice, as calculated using the FCA's own methodology, is now much lower than it was last year when the scheme was established.  It has therefore been argued by the British Steel Adviser Group that there is no longer a need for the scheme to be implemented because ex-members of the BSPS have not, in fact, lost out as a result of their transfers to the extent the FCA first believed.

With this challenge ongoing, the FCA has published three recent articles criticising a few firms who are part of the British Steel Adviser Group for making unsolicited settlement offers to consumers who would fall within the scope of the redress scheme.  They made their initial criticism of these offers on 26 January 2023  where they described the offers as misleading and warned consumers on losing their right to be part of the scheme if they accepted these.  The FCA made further comments on 7 February  where they demanded that unsolicited offers be withdrawn and no further offers be made. 

The latest publication, on 22 February  sets out that the FCA has required two of the firms that made unsolicited offers to continue to apply the redress scheme even to those clients who accepted the offers.  This is a significant development as the original scheme rules exclude anyone who has accepted a full and final settlement offer from being part of the redress scheme. 

Whilst the FCA is concerned that firms making unsolicited offers to clients are offering less redress than the clients would be entitled to under the redress scheme, in many cases the FCA may be proved wrong on this, given the movements on redress costs mentioned above.  The FCA continues to refer to historic figures, which they say shows average redress costs are £45,000.  However, it is now expected by many in the industry that average redress costs will be far lower. Indeed, in our recent experience, often no redress is due at all.   

Whether this adds further fuel to the legal challenge remains to be seen.  In the meantime, firms now face little choice but to proceed with putting their BSPS clients through the scheme. 

Previous FCA work on this topic, known as 'Assessing Suitability Review 2', was paused to allow FCA resource to concentrate their response to Covid. This thematic review will examine how the retirement income advice market is operating and focus on advice provided to consumers to ensure firms understand the needs of consumers and provide consistently suitable advice with a quality outcome for consumers.

Of particular interest is pension drawdown which is the process by which consumers withdraw regular income from a pension whilst the balance of the capital fund remains invested. This contrasts with purchasing an annuity which requires a saver to use their pension fund (or some of it) to purchase retirement income.

Pension drawdown has become more popular since the advent of Pension Freedoms in 2015. It was available prior to the Pension Freedoms but the amount that could be taken was limited. That restriction has been removed and there has been an increasing shift towards consumers drawing income from their invested pensions funds.

In practice many consumers will take advice from a financial advisor on how to invest their pension and on what level of income to take. Given the broader range of options now available on retirement it is important consumers receive suitable advice when they access their pension funds. The advice can be complex so it is important that the advisor businesses understands its client's needs and delivers consistently suitable recommendations.

A key concern, given the financial pressures in the current economic climate, is that consumers draw too much income and run out of money in retirement. This is particularly relevant given increasing life expectancies and rising living costs. If a consumer does deplete their fund they may claim they should not have been exposed to the risk and blame their advisor for not properly assessing their income needs in retirement, not advising on a sustainable level of income withdrawal and / or failing to challenge their income objectives.

The review began early in Q1 2023 with the FCA aiming to publish a report setting out its findings in Q4 2023. It is in the information gathering stage with the FCA, noting that this is a relatively new area of concern. With significant sums having been transferred from defined benefit pensions in recent years, and combined with the challenging economic climate, this is an area that is likely to attract continued attention from the FCA.

The FCA review will link to the lifetime mortgages work in the FCA 2022/23 Business Plan to better understand outcomes for consumers in later life. The findings will also provide an important indicator of how firms are implementing the Consumer Duty.

Firms selected for review can expect to be contacted in early 2023.

The letter then addressed the 6 conclusions from the Committee's earlier report:

1.  The regulatory system left BSPS members open to being manipulated and taken advantage of by unscrupulous financial advisers who personally profited from giving bad advice

The FCA is said to share the significant concerns of steelworkers, MPs and other stakeholders about the levels of unsuitable advice and has met with 400 steelworkers to provide support and listen to concerns.  Since the inception of a joint protocol between the FCA, Pensions Regulator and Pension Protection Fund in January 2019 there has been greater joint working and early intervention to address risk.  Actions have included issuing joint proactive statements, setting out the concerns and action each organisation will take and noting such steps were taken in relation to the Rolls Royce pension scheme and P&O pension scheme. 

2.  The FCA has consistently been behind the curve in responding to the catastrophic impact on BSPS members

The Committee recommended that the FCA should examine what can be done to improve data and insight to take a more proactive approach to regulation.  The FCA agreed with the recommendation and noted that since 2018 it has been collecting more defined benefit (DB) pension transfer data from advisory firms across the market.  The FCA's rules since October 2020 have also required firms with permissions to advise on pension transfers to report a range of key data metrics to the FCA on a half-yearly basis.  Risk indicators are triggered from this data, including volume of business conversion rate, resource levels, income levels and "DB business trends" with supervisory reviews and actions being undertaken on such triggers.

3.  The FCA has not been sufficiently proactive or timely in using its enforcement powers

The FCA has said that enforcement activity related to BSPS is a "high priority".  The FCA has c. 30 ongoing investigations into firms and individuals relating wholly or partly to BSPS advice.  The investigations are said to be at an advanced stage with 5 having entered either Stage 1 settlement discussions or the Regulatory Decisions Committee.  If a matter is resolved at Stage 1 the FCA can publish information about it, if following Stage 1, the subject contests the matter it moves into the Regulatory Decisions Committee or Upper Tribunal process.  48 firms have withdrawn from the DB pension transfer market.  The FCA is also taking steps to enhance its approach to unregulated activities performed by authorised firms. 

4.  The way that compensation has been provided in the BSPS case has been slow and unfair and the FCA should also resolve differences in the levels of compensation received by BSPS members to date

The DB redress methodology is designed to put consumers back in the position they would have been in had they not transferred to a personal pension scheme and this is done by estimating the amount they will need at retirement to purchase an annuity that would replicate the DB pension benefits they would have received.  That amount is then discounted to determine the amount needed in today's terms – the redress amount is then the difference between the amount needed in today's terms and the current value of an individual's transferred personal pension pot.  Changes in economic circumstances between calculations explains why consumers in apparently similar positions receive different levels of compensation as the calculation is a point in time calculation.  The FCA is also considering whether it might be appropriate to increase FSCS limits and is due to publish a feedback statement on that in late 2022.

5.  Seven years after the Pension Schemes Act that introduced the pension freedoms, regulated bodies are still not clear on the FCA's expectations for consumer protection

The FCA has engaged extensively with BSPS members including direct mailings in 2018, 2019 and 2020 and local events in 2019 and 2021.  Further, following face to face meetings in late 2021 there was an uplift in FOS complaints.  That said the FCA accepts that it can do more to proactively engage with consumers.

6.  The current compensation arrangements do not always protect consumers, can create wider costs to firms and may not have the capacity to cope with future risks in the advice market

The FCA, FOS and FSCS are to write to the Committee on 21 January 2023 to explain what they are doing to manage risks in the redress system for financial advice.  The FCA rejects the Committee's recommendation that the FCA's handling of the wider DB pension market should reviewed.  The FCA says that the "… harm associated with BSPS is unique and not replicated elsewhere…" with the FCA's evidence suggesting 46% of BSPS transfer cases were unsuitable compared to 17% in high risk firms in non-BSPS pension transfer cases.  Stats that seem to be forgotten before FOS.

Although we wait to see the FCA's letter itself, notably the FCA rejected any suggestion that it should look at its own role in the supervision of the wider DB market outside of BSPS, saying BSPS is "unique" (which is perhaps not always seen in FOS decisions on final salary transfers). 

The FCA's response, based on the Committee's minutes, also refers a lot to the proposed BSPS consumer redress scheme and a consumer redress scheme being the appropriate approach in cases such as BSPS to deliver redress to customers but also repeating a number of times the time it takes, given the statutory tests, to put such a scheme in place.  The minutes also refer to the FCA's understanding that many consumers who transferred out of BSPS "… are not considering making a complaint about the advice they were given.  Some of these consumers have vulnerable characteristics and need help to identify whether the advice they were given was unsuitable.  The FCA took this into account when considering whether a section 404 scheme was desirable compared to alternative options to ensure consumers receive redress…" which may imply an unwillingness to drop any automatic opt-in as part of the redress scheme.  We await the next chapter for BSPS with the response to the s.404 consultation due in the coming months.

The FCA's review aligns closely with their business plan for 2022/23 which aims at reducing financial crime by lowering the incidence of money laundering through the firms it supervises. Its focus on challenger banks stemmed from the UK's 2020 "National Risk Assessment of Money Laundering and Terrorist Financing" (the NRA) which raised concerns that criminals may utilise these services to set up money mule networks. Whilst challenger banks have not universally been defined, these innovative modern financial practices are generally associated with the ability to open accounts quickly in a bid to attract customers and reduce the market concentration of traditional high street banks. 

Review Parameters 

The FCA chose to focus their analysis on a sample selection of six retail challenger banks, of which 50% constituted a sub-set of digital banks. Digital banks normally: (i) offer personal current accounts, (ii) operate without a branch network and (iii) provide financial services through smartphone apps. The sample selection was chosen to reflect those challenger banks that provide similar offerings to more traditional retail banks, and therefore excluded both e-money issuers and payment services providers. Of those sampled, analysis was focused on but not limited to: 

• Governance and management information;
• Policies and procedures;
• Risk assessments; 
• Identification of high risk / sanctioned individuals or entities;
• Due diligence and ongoing monitoring; and
• Communication, training and awareness.

Whilst this review pre-dated the significant expansion of sanctions against Russia in recent months, the main controls assessed by the FCA apply equally to firms' management of sanctions, specifically in instances where firms are utilised for sanctions evasion. 

Review Outcomes

 The use of innovative technology and non-traditional methods of identity verification (such as passport photo images and video selfies) have enabled customers to be onboarded quickly. This supports the NRA's finding that challenger banks depend on rapid growth for survival. However, in a recent statement the executive director of markets at the FCA Sarah Pritchard made clear that "there cannot be a trade-off between quick and easy account opening and robust financial controls". 

The FCA's review has consequently identified the following key areas of development for challenger banks to review and act upon where necessary: 

• Controls to be commensurate with the bank's expansion: challenger banks should apply a risk-based approach to Anti-Money Laundering controls and ensure their financial crime control resources, process and technology remains fit for purpose as their business expands. 
• Improve upon Customer Due Diligence: Most challenger banks did not obtain details about customer income and occupation, making assessment of the customer's relationship with the bank difficult to determine.
• Improve application of Enhanced Due Diligence: Some challenger banks did not apply Enhanced Due Diligence and did not document it was a formal procedure in higher risk circumstances. 
• Improve customer risk assessment frameworks: Some challenger banks had under-developed frameworks which lacked sufficient detail and others had no framework at all. 
• Improve transaction monitoring alerts: There was ineffective management of transaction monitoring alerts, including inadequate or inconsistent rationale for discounting alerts. 
• Increased volume of Suspicious Activity Reports (SARs): The increase in SARs reported by challenger banks as they exit customer relationships for financial reasons raised concerns as to the adequacy of due diligence checks when onboarding. 
• The financial crime change programme: There is ineffective management of these programmes, including inadequate oversight and a lack of pace in implementation, meaning control frameworks are unable to keep up with changes to their business models.
• Principle 11 notifications: There were instances of significant crime control failures where no Principle 11 notifications had been made, despite firms being expected to notify regulators of anything relating to a firm which the FCA would reasonably expect notice of.

Summary

This review has provided challenger banks with an opportunity to reflect on whether their firm's financial crime frameworks are fit for purpose at present and/or require urgent or future amendments. By completing a "gap analysis" of these common weaknesses, challenger banks will be able to enhance their services and better manage their exposure to associated financial crime risks, enabling the FCA to respond more swiftly to shifting economic and geopolitical climates.

This review is of particular importance to FI/D&O insurers. Where challenger banks fail to ensure their financial control practices keep pace with market growth, money mule networks may seek to capitalise on this "gap". Any significant liabilities incurred by the banks in this respect may well be passed on to insurers, who will be expected to cover the legal defence costs incurred and any damages or settlement arising from these financial claims. Given the FCA's focus on this emerging sector, challenger banks (and their FI/D&O insurers) will also be exposed to greater risk of potential FCA enforcement action should the banks not take heed of the concerns arising from the FCA's review and ensure their processes are fit for purpose. FI/D&O insurers will want comfort on these issues when underwriting these risks going forward.

No doubt in anticipation of redress being required, the FCA's letter refers to firms' need to maintain adequate financial resources under Principle 4 and suggests firms may want to consider the effect on solvency that any liability to BSPS transfers may have. Firms are then implored to retain assets and not to dispose of these other than in the ordinary course of business. Firms are also told not to seek to cancel authorisations without first consulting with the FCA.

The imposition of a redress scheme would be a draconian measure. The only comfort comes from the fact that this would only address transfers completed during 1 March 2017 – 31 March 2018, being the time in which members had the option of choosing to retain their BSPS pension (which would ultimately fall to the PPF) or transferring to the proposed new scheme on offer (which became BSPS2) or transferring to a private pension. However, this is perhaps the only logical next step given that the FCA has already written to transferred BSPS members twice and held clinics encouraging people to complain about the advice received. The FCA itself came into criticism from the National Audit Office for its handling of BSPS transfers and this seems to have led them towards an industry wide redress scheme after apparently having gone cold on the idea earlier this year, saying more information was required.

A dispassionate observer might be of the view that former BSPS members have had ample opportunity to review the advice received, given the high profile of BSPS transfers in recent years. One might even conclude that the members who have not complained are happy with the outcome and perhaps even enjoying retirement. This is apparently not enough for the FCA who, having done all they can to encourage complaints now seem to want to further punish the industry. Their concern perhaps comes from the fact that around 8,000 members transferred from BSPS but only a small proportion of these members have complained, with only somewhere between 300 and 400 complaints having been made to FOS (which obviously does not include complaints to firms that did not progress to the Ombudsman or direct to the FSCS). Nevertheless, this highlights the scale of the potential scheme, with thousands of instances of advice to be reviewed. This could create logistical headaches for the FCA, which is already involved with enforcement action against around 40 firms in relation to British Steel advice. Beyond this, one wonders if the FCA has even considered what level of funds may be available for redress in circumstances where many firms have already stopped giving pension transfer advice and have limited PI cover available. Perhaps a better alternative would be to allow firms to use resources to deal with complaints that are actually received, rather than stirring up the potential for redress payments in circumstances where the deck is stacked against the advisor when looking at suitability.

The consultation should open in March 2022 with a decision to be made once this has closed – watch this space for any further developments.

The facts of the claim were not complicated.  The Claimants, Mr & Mrs White, had a baby on the way and were separately living with their parents.  They were looking to purchase a property to accommodate their growing family and approached Homemaker Mortgages, an appointed representative of the Defendant broker Mortgage Intelligence Ltd, to give them advice on the options available to them. Mr White was an electrician and Mrs White a fraud handler at the time.  

The broker recommended that they enter into an interest only mortgage (IOM) with Northern Rock (the Lender) and completion took place in October 2005.  The record of suitability completed by the broker indicated that the Claimants intended to use ISAs to repay the capital of the mortgage at the end of the term.

After a failed attempt to remortgage in 2017, in May 2019 the Claimants remortgaged onto a capital repayment mortgage (CRM).  The Claimants then brought proceedings in March 2020.

The Claim

The usual allegations that we see in claims brought by Pure Legal were made:

• failure to advise the Claimants of the need for a suitable repayment vehicle and/or advise the Claimants to enter into the IOM when a CRM would have been more appropriate for their needs; and
• failure to ensure that the Claimants had a suitable repayment vehicle in place in order to repay the outstanding capital at the end of the term which was said to have caused them to purchase their property on an unaffordable interest only basis.

The Claimants claimed that the Defendant's breach of duty caused them to suffer loss, namely:

1. the cumulative interest that they paid to the Lender over the course of the recommended IOM less the cumulative interest that they allegedly would have paid under a hypothetical CRM; plus
2. the amount by which the capital sum would have been reduced under the counterfactual CRM at the time of redemption in May 2019 (the Capital Loss).

Strike Out

It was Claimants' position that they were entitled to rely on Section 14A Limitation Act 1980 (Section 14A) to argue that their claim was in time for limitation purposes, as they did not have the requisite knowledge for the purposes of Section 14A more than three years before the claim had been issued.

Section 14A permits a claim in negligence to be brought within six years from the accrual of the cause of action (the primary limitation period) or, if later, three years from the earliest date on which the claimant had the knowledge required for bringing an action for damages in respect of the relevant damage and a right to bring such an action (the secondary limitation period).  The ‘knowledge’ required to bringing an action for damage means knowledge of:

1. such facts as would lead a reasonable person who had suffered such damage to consider it sufficiently serious to justify commencing proceedings for damages; and
2. knowledge that the damage was attributable to the act or omission which was alleged to constitute negligence and the identity of the party responsible.

Around October 2017, the Claimants went to another mortgage broker to discuss re-mortgaging their property because of Mrs White's redundancy earlier that year. It was the Claimants' position that they were advised that because of the redundancy they were not eligible for a CRM but that they would have been eligible for a CRM in 2005.  The Claimants asserted, therefore, that it was in 2017 they acquired relevant knowledge for Section 14A purposes as they realised the advice in 2005 had been "bad advice".  

A strike out application on limitation grounds was made and went before the Leeds County Court.

The Judgment 

Following consideration of Section 14A and the relevant case law (including other cases involving claims brought by Pure Legal for alleged mortgage mis-selling), the Judge defined the limitation issue on the basis of when did the Claimants know (or ought to have known) that the capital fell to be paid at the end of the mortgage term and that it was incumbent on them to ensure that something was in place to pay it?

In answering that question, the Judge reached the following findings:

1. The Judge had "no hesitation in concluding that the [Claimants] had no prospect of overcoming the limitation issue" and had acquired relevant knowledge years before March 2017 (three years before the claim was brought).

Around the time the mortgage was incepted in 2005, salient details regarding the mortgage were included on the key facts illustration, the mortgage application form, the mortgage record of suitability sent to the Claimants and the Lender's completion letter. 

The judge was unpersuaded by arguments made by the Claimants that the fact they were unsophisticated financial service users meant they could not understand the different forms of finance available for the funding of a property or the undesirable position which they would find themselves in at the end of the term of the interest only mortgage when the capital fell to be repaid.  The judge concluded that the warnings on the mortgage documents were not complicated or obscure rather they were crystal clear and eminently comprehensible.  As such, is was not realistically arguable that lay people such as the Claimants would not understand those documents.

Furthermore, it was the Claimants' case that they did not have ISAs in place, as indicated on the mortgage record of suitability.  This meant the Claimants had no capital repayment vehicle for the purposes of repaying the capital due at the end of the mortgage term.  The Judge found that "this positively counts against [the Claimants]" on limitation. If the advice was being offered on a mistaken or false premise, because its suitability was even partially dependent on the existence of ISAs, then that was clear from the mortgage record of suitability which a reasonable person would have read.

Accordingly, the claim was out of time 6 years from when the mortgage incepted as the damage was patent from the outset of the mortgage in 2005 and not latent, and so Section 14A had no application.  The Claimants knew that they had a mortgage where the capital was due at the end of the term with nothing in place from which the capital could be paid.

2. The judge confirmed that, even if he was wrong on point 1, the claim would still have been brought out of time as:

• the Claimants took out mortgage holidays in September 2010 and 2011 which generated correspondence from their Lender drawing attention to their mortgage being interest only with the capital remaining to be paid;

• even if that was not enough, from at least 2012 (although probably before), the Claimants received annual mortgage statements that had information regarding the interest only mortgage.

Even if the Claimants did not read the repeated warnings from the Lender on those documents, the judge was of the view that could not assist them as, on the authority of Cole v Scion (2020) EWHC 1022 (Ch), they were deemed to have the constructive knowledge that reading the documents would have provided.  

3. As a final blow to the Claimants, the judge confirmed that, even if the documentation contained in the Lender's correspondence was insufficient, the Lender's call log confirmed that there was a call in 2015 between Mrs White and her Lender when she described them as having been in financial disorder when asked what their plan was to pay the interest only balance.

Furthermore, the Judge confirmed that he would have struck out the claim even if the Claimants had been permitted to amend their pleading by way of an application made on the day of the hearing.  The Claimants sought to assert that the advice was defective as (1) the Claimants were not told of the more suitable option of a CRM or other funding options which did not depend on a very sizeable lump sum being due at the end of the mortgage term, or alternatively (2) the recommendation that they take out a mortgage at all to purchase the particular property was defective. The Judge confirmed his view that, even on this non-pleaded basis, the claim was time barred as the limitation clock started when the Claimants had knowledge of material facts about any damage of a nature sufficiently serious to pursue by litigation that damage was capable of attribution to the applicants. 

The Judge also confirmed that had he not struck out the claim on limitation grounds he would have partially struck out the Capital Loss claimed.  The Claimants sought to rely on Emptage v Financial Services Compensation Scheme Ltd v (2013) EWCA Civ 729 in pursuing the Capital Loss.  However, the judge concluded that Emptage was wholly distinguishable on the facts, confirming that it merely decided that, in assessing the compensation to which Ms Emptage was entitled via the FSCS, account could be had to the loss caused by the occurrence of the risk to which she was negligently exposed.

Accordingly, the judge was of the view that, by entering into the IOM, the Claimants had in no sense “lost” any part of the capital sum which was repayable when the mortgage was redeemed.  Had the Claimants taken out a CRM there would still have been an obligation to pay, not just the interest, but also the capital.  The Capital Loss could not, therefore, be considered a recoverable head of loss in the claim even if it had not been struck out entirely.

Where does that leave these claims?

This claim is one of hundreds that have brought by claimants represented by Pure Legal in relation to allegedly negligent advice to enter into interest only mortgages from 2005 to around 2009.  Common amongst those claims is the claimants looking to rely on Section 14A in trying to persuade the Court that their claims are not statute barred and have, therefore, been brought in time.

As such, the judgment in White will come as a relief to the mortgage broker market and provides useful guidance on limitation for those ongoing claims.  The judgment confirms that the information contained in standard mortgage documents was sufficient to set the time running for the purposes of Section 14A.  Furthermore, the mortgage statements lenders are required by their regulator to send out annually (again with standard wording and warnings) also provide claimants with enough information to start time running, even if it is a claimant's position is that they never read their statements.  A reasonable person is expected to read their correspondence and is, therefore, deemed to have the knowledge that reading them would have provided.

This successful strike out application follows a string of recent hearings in disputes involving claimants represented by Pure Legal where the defendant has been successful in defeating the claimant's position on either limitation.  

White further confirms that the Capital Loss being claimed by Pure Legal's clients is entirely over-inflated and a bad claim in law.  Once the Capital Loss is disregarded, the value of the claim in White reduced by 80%.  

With the judgment in White now having been handed down, this is a yet further positive judgment for the mortgage broker market.  With the administration of Pure Legal we may now be seeing the beginning of the end of these claims.

The aim of the change is to ensure firms make client-focused TCFD-disclosures throughout the investment chain, to allow investors to make informed decisions, whilst serving as a broader benefit to the financial markets through better asset pricing. It is also hoped it will help asset managers' development of increasingly popular environmental, social and governance (ESG) products and allow firms to provide information in a way that is "clear, fair and not misleading".

These consultations follow the FCA's introduction of a rule in December 2020 requiring companies with a UK premium listing to state in annual reports whether they have made disclosures that are consistent with TCFD's requirements and if not, why. The rule applies to accounting periods beginning on or after 1 January 2021, which gives an indication of how quickly firms will be expected to comply.

This FCA's incentive stems from the UK's endorsement of the TCFD's recommendations in 2017, with its stated aim to "help identify the information needed by investors, lenders, and insurance underwriters to appropriately assess and price climate-related risks and opportunities".  The FCA is part of a taskforce of regulators and government bodies that aims to make TCFD-aligned disclosures mandatory across the UK by 2025.

So, what should the new stakeholders expect? The rules are expected to align with those proposed by the Department for Work and Pensions (DWP). In January, the DWP proposed broadening the scope of climate risk analysis to cover not just the environmental impact of pension scheme portfolios, but also sponsor covenants and actuarial valuations. Schemes with assets exceeding £5bn could be expected to meet the new requirements from October 2021, and trustees would need to publish a TCFD report within 7 months of the end of the scheme year.

The FCA's plan to extend the TCFD-disclosure requirements is unsurprising as ESG investing continues to grow in popularity. As an example, NextWealth has estimated that one fifth of financial advisers' client conversations concern ESG investments as of March 2021, up three-fold since October 2019. This trend seems likely to continue as governments set targets for zero-emissions (as the UK has with its 2050 target). With this comes an expectation of greater transparency as to where and how money is invested.

The FCA's initiative should encourage the financial services sector to lead the way in the regeneration of the economy during the climate crisis. Some may be concerned about the challenge this presents, as a firm's disclosure report may be dependent on the information provided by others in the market. The issue is not going away, and we expect the disclosure requirements to become easier as more firms are required to align with TCFD's disclosure requirements.

The Claimants, Mr and Mrs Colborn, approached the Defendant mortgage broker's adviser, Ms Bristow, to provide them with advice concerning the purchase of a property. The advice in question took place in around March 2006, with the mortgage completing in June 2006. At the time of the advice, the Claimants were living in rented accommodation and had several unsecured debts. 

On an Initial Enquiry Form, the Claimants indicated that they wanted an "interest only [mortgage] for the first three years to review to repayment", since they wanted to concentrate on paying off their debts in the first instance. It was important for the Claimants that they consolidated their debts into the mortgage and that the mortgage would be "interest only to convert to repayment after 3 years [when] other com[mitments] are cleared."
Ms Bristow provided the Claimants with standard documentation, including a Key Facts Illustration, a Mortgage Suitability Report and an application form. The Claimants signed the application and Mortgage Suitability Report, both of which reflected their needs and circumstances. The Claimants then accepted a mortgage offer from their lender and entered into the interest only mortgage.

After several years had passed, the Claimants had taken no steps to convert the mortgage into a capital repayment mortgage and were regularly in arrears on their repayments, resulting in possession proceedings being issued against them. The Claimants sold the property in 2018, redeeming the mortgage in full, and moved into rented property. 

The Allegations

In essence the Claimants' case was that it was negligent of Ms Bristow to recommend an interest only mortgage without there being a repayment vehicle or viable repayment strategy in place, and that switching to a repayment mortgage and overpaying towards the capital were not viable repayment strategies. The Claimants sought damages of £41,138.85, comprising the difference in interest between an interest only mortgage and a capital repayment mortgage and the amount of capital that would have been paid off under a repayment mortgage.  

The allegations advanced follow very similar allegations in other Pure Legal cases, with the crux being that an interest only mortgage should not be recommended if a capital repayment mortgage was affordable.

The Judgment

The judge dismissed the claim on the basis that it was statute barred by virtue of the Limitation Act 1980. In reaching his judgment, the judge made the following key findings likely to be relevant to other claims for negligent mortgage advice brought by Pure Legal:

1. The judge characterised the allegation as one where the claimants alleged that their mortgage was unsuitable because there was no repayment vehicle or viable repayment strategy in place. Having identified the basis of the claim, the judge turned to consider what the relevant "damage" was and the "material facts" relevant to that damage.
2. The damage was the fact that the claimants had entered into an unsuitable mortgage and it was allegedly unsuitable because there was no repayment vehicle or viable repayment strategy in place.
3. The relevant material facts were (i) the mortgage was on an interest only basis; (ii) there was no repayment vehicle or viable repayment strategy in place; (iii) the capital sum would not reduce and, unless something changed, the Claimants would still be liable to pay the same in full at the end of the mortgage term.
4. The Claimants knew at the outset each of these three material facts. The contemporaneous documents made that clear, in particular since the Claimants had signed those documents, indicating that they had read and understood them.
5. Therefore, the Claimants knew enough right at the outset to question the advice they had been given and at least begin to investigate whether they had been misadvised by Ms Bristow. Section 14A did not apply at all in this case, since all relevant facts were patent from the outset when the Claimants entered the mortgage.
6. In any event, the Claimants received correspondence from the lender, notably a letter in April 2010 enclosing the annual mortgage statement with standard advice indicating that the mortgage was on an interest only basis and showed that the capital was not reducing. By 2010 at the latest, the Claimants had at the very least constructive knowledge that (i) something had gone wrong (at least, as alleged), (ii) what had allegedly gone wrong was attributable to Ms Bristow’s advice; and (iii) their financial position was detrimental to them, by contrast with how they believed it would be.

The judge did not conduct a formal analysis on negligence but would have found that Ms Bristow had not been negligent and would have dismissed the claim in any event.  In reaching this conclusion the judge noted that the Claimants wished to take out an interest only mortgage to keep monthly payments to a minimum for the first two or three years to allow them to consolidate and pay off their unsecured debts and then to convert to a repayment mortgage for the remainder of the mortgage term. In view of these objectives, the judge concluded that Ms Bristow acted reasonably in recommending the interest only mortgage that she did. 

In addition, the judge noted that, in light of the decision in the case of Ross v Attanta, the Claimants had abandoned the claim for the amount of capital that would have been paid under a repayment mortgage. This meant that the claim was at best limited to the difference in interest between an interest only mortgage and a capital repayment mortgage, which in this case was just £5,110.03. The judge remarked that claims companies and solicitors in these types of claim should take a realistic view of the value of the claim at the outset in order to avoid costs becoming disproportionate to the value of the claim.

Where does this leave the mortgage broker and PI insurance market?

The decision will come as welcome relief for mortgage brokers and the PI insurance market. In particular, in his judgment, the judge conducted a detailed analysis of the legal framework on limitation, considering the leading House of Lords case of Haward v Fawcetts, then finding that the claim was clearly statute-barred, since the Claimants had the relevant "knowledge" for limitation purposes at the very outset, or at the latest upon receipt of correspondence from their lender.

Equally as important was the application of the High Court decision in Ross v Attanta as to the quantification of loss, with the judge finding that the Claimants could not claim for the capital sum in addition to the difference in interest on the different types of mortgage product. In fact, the Claimants abandoned that element of their claim on the final day of trial, in light of the Ross case.

Over the last 18 months or so, mortgage brokers and their PI insurers have been inundated with litigation, predominantly brought by Pure Legal. This decision now provides useful and crucial judicial commentary on these cases in particular with regard to limitation and loss. It also provides useful judicial support for the reasonableness of recommending an interest only mortgage where individuals have specific reasons to want to keep monthly payments as low as possible.

The fact that the judge roundly dismissed the argument that a claimant did not have knowledge for limitation purposes to bring such a claim until they were told that they could have afforded, and were otherwise eligible for, a capital repayment mortgage at the time of allegedly negligent advice is key.  This part of the decision arguably drives a dagger to the heart of claims brought by Pure Legal.  

The background to the Court of Appeal judgment is with respect to redress arrangements put in place by banks to compensate customers so far as there was a mis-selling of interest rate swaps. The Claimant, Mr Davis, bought two interest rate swaps in 2002 and 2005 respectively from Lloyds Bank plc (the Bank). He participated in the Bank's review process and as a result of the review the Bank offered him compensation in respect of both financial products. Mr Davis accepted the basic redress offer in relation to the 2002 swap; but not in relation to the 2005 swap. Having rejected the redress for the 2005 swap he sought to bring a claim for breach of statutory duty.

The Issues

At case management stage the court ordered the initial hearing of two preliminary issues:

Issue 1: “Did the Claimant make a complaint under DISP in relation to the sale of the interest rate hedging products which are the subject matter of the proceedings?”

Issue 2: “If so, was the Bank bound by the statutory duties under DISP 1.4.1R to assess the Claimant's purported complaint in accordance with the terms of what had been agreed between the Defendant and the Financial Conduct Authority regarding the Defendant's review process into interest rate hedging products?”

Guidance from the Court of Appeal

It was agreed that Issue 2 only arose if the answer to Issue 1 was "yes". The High Court found that no complaint under DISP had been made and Mr Davis appealed. The Court of Appeal upheld the High Court's decision that no complaint had been made by Mr Davis with respect to the 2005 swap. The Court of Appeal provided some useful guidance as to what constitutes a complaint under DISP. DISP is defined in the FCA Handbook as:

“any oral or written expression of dissatisfaction, whether justified or not, from, or on behalf of, a person about the provision of, or failure to provide, a financial service or a redress determination which:

(a) alleges that the complainant has suffered (or may suffer) financial loss, material distress or material inconvenience; and

(b) relates to an activity of that respondent … which comes under the jurisdiction of the Financial Ombudsman Service.”

The Court of Appeal first confirmed that acceptance of an invitation to participate in a review and the subsequent conduct of the review cannot, without more, be treated as a complaint for the purposes of DISP. The Court of Appeal then went on to say:

There are three relevant aspects to the definition. First, so far as the form of a complaint is concerned, there must be an expression of dissatisfaction. Although the definition does not say so in terms, it is obvious that the expression of dissatisfaction must be one that is communicated to the provider of the financial service. Second, it is not just any expression of dissatisfaction that qualifies as a complaint. The expression of dissatisfaction must be about “the provision of, or failure to provide, a financial service or a redress determination”. The conduct of a review under an agreement such as the one in this case is not the provision of a financial service. It must also be a complaint about something which comes under the jurisdiction of FOS. A complaint about the review process does not come under FOS’s compulsory jurisdiction. Third, a complaint must also allege that the complainant “has suffered (or may suffer) loss” etc. It is common ground that because the definition of “complaint” includes part of a complaint, a complaint (as defined) may be contained in a series of communications.

Whether a communication or series of communications meets this test is a question of interpretation. The ultimate question is: what meaning would be conveyed to a reasonable recipient of the communication or series of communications? In determining that meaning, the context in which the communication was made is of the utmost importance. Although it is possible for a complaint to be contained in more than one communication, I do not consider that it is permissible to attempt to construct a complaint by a mosaic of acontextual statements made in the course of a series of communications.

The Court of Appeal analysed the wording of the communications Mr Davis relied upon as meeting the definition of "complaint". Although Mr Davis had referred in these communications to being better off without the product, the Court of Appeal held that that did not mean he was dissatisfied with it as he was referring when making this comment to his net worth. The Court of Appeal finding that "The purpose of the interest rate swaps was to deal with the risk that interest rates might move. The fact that, with hindsight, they moved in the wrong direction, thus meaning that Mr Davis was worse off in net worth terms than he would have been if he had not entered into the transaction, does not amount to a complaint about the fact that he was sold the product in the first place. But to say that, in retrospect, Mr Davis bought the wrong product does not, in my judgment, amount to a complaint about the provision of the financial service in the first place."

Takeaways

It is normally relatively straightforward to identify when a complaint satisfies the DISP definition and which in turn triggers the complaint handling rules under DISP. However, there are some instances where there is a dispute. Further the Court of Appeal commentary around a complainant relying on a number of different communications to constitute a complaint is helpful.

Knowing when a complaint is made for FOS purposes is important when considering time bar, as the 6 and 3 year rules for a complaint at FOS are judged by reference to when the complaint is first made. The Court of Appeal judgment helpfully breaks this down in to three component parts – "expression of dissatisfaction", about "the provision of or failure to provide a financial service" and must allege that the complainant "has suffered a loss". The latter part does not mean the loss has to be quantified just that it is alleged. This should mean that most data subject access requests if limited to a request for documents under data protection regulations without something more do not qualify as a complaint for DISP purposes and so will not stop time running for FOS complaint purposes. However there will always be grey areas and firms will have to continue to look at what is said and the wording of correspondence to see if it passes the threshold to constitute a "complaint".

Through its review of the market, the FCA state that there is some high quality advice that is being provided to consumers but it maintains that, for the most part, advisers continue to struggle with understanding the regulations and guidance surrounding defined benefit transfers. As a result, advisers continue to fail to provide consistent and suitable advice mainly due to poor record keeping and confusion regarding what constitutes acting in a client's best interest or whether a conflict of interest might exist.

The guidance also provides further clarity with regards to financial promotions, the scope of which will cover unsolicited personal meetings, social media posts and voicemails left for clients. It also highlights issues and provide examples of good and bad practice in order to assist firms in identifying weaknesses in their existing advice processes. 

The FCA recommends that all firms utilise its Defined Benefit Advice Assessment Tool in order to understand how the FCA will review the advice provided. 

The FCA continues to refine guidance in order to overhaul the approach to defined benefit transfer advice.  The watchdog hopes that this will lead to better advice processes which it also hopes may lower professional indemnity (PI) costs for advice firms. This may be wishful thinking as underwriters will be more interested in the standard of advice given in the past (from which claims may subsequently arise) than in the (hopefully improving) standard of advice in the future.  What's more, the hardened PI market has been impacted by other factors, such as the increase to the Financial Ombudsman Service's compensation limit to £355,000.    The FCA's finalised guidance can be found here.

Mr Adams transferred an existing personal pension into a SIPP administered by Carey (now t/a Options) following the involvement of CLP Brokers Socieded Limitata (CLP), an unregulated introducer.

Mr Adams instructed Carey to open a SIPP, transfer his existing personal pension and purchase rental units from Store First (a storage pod lease in Blackburn) with the monies held in his SIPP. Mr Adams received an incentive as part of the transaction (unbeknownst to Carey).

Mr Adams’ investment in Store First did not perform well.  As the only FCA regulated entity in the chain, Mr Adams issued proceedings against Carey.

The Allegations

Three key allegations were made against Carey:

1. Breach of s.27 of the Financial Services and Markets Act 2000 (FSMA) rendering the SIPP unenforceable;
2. Breach of COBS 2.1.1R which requires any FCA regulated entity to act 'honestly, fairly and professionally in accordance with the best interests of the customer'; and
3. Carey should stand responsible for the negligent investment advice provided by CL&P for which it was said Carey was liable as a result of a joint venture, common design or agreed common business model as between Carey and CL&P.

The High Court Decision

The proceedings came before HHJ Dight in March 2018, with the judgment following some 26 months later in May 2020. The High Court dismissed the claim against Carey on all three counts. We reported previously on the High Court decision and an analysis of that can be found here.

Mr Adams appealed in respect of s.27 and COBS but did not appeal the joint enterprise allegation.

Court of Appeal Decision

The appeal came before LJ Newey, LJ Andrews and LJ Rose. After a 3-day hearing, the Court of Appeal dismissed the appeal in respect of any alleged breach of COBS 2.1.1R but upheld the appeal in respect of s.27 FSMA.

The s.27 Allegation

Mr Adams alleged that his Carey SIPP was necessarily entered into as a consequence of something said or done by CLP in the contravention of the "general prohibition" rendering the SIPP unenforceable.  In effect, the allegation was that CLP had done something that they were not authorised to do in either advising on or arranging Mr Adams' SIPP with Carey and as a result the transfer to the Carey SIPP and investment in Store First had to be unwound.

In deciding whether to uphold the allegation, the Court of Appeal had to consider whether CLP breached the general prohibition by carrying on regulated activities. Two regulated activities were relied upon (1) advising on investments (defined in Article 53 of the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (the RAO)) and (2) arranging investments (defined in Article 25 of the RAO).

This raised a number of issues – (1) what was the designated investment – was it the Carey SIPP and/or the Store First investment, (2) did CLP arrange or advise on that designated investment and (3) did Mr Adams enter in to the designated investment as a consequence of what CLP did?

What was the designated investment?

Mr Adams sought to argue that converting rights under the Carey SIPP into an investment in Store First was a designated investment. 

The Court of Appeal found that the investment in Store First did not fall within the definition of designated investment.  That said, they took a different approach to the High Court by finding that the transaction must be looked at as a whole (from disinvestment of Mr Adams' personal pension plan all the way to the investment in Store First). Unlike the High Court, that focussed on actions related to the creation of the Carey SIPP.

In making this finding the Court of Appeal referred to and expressly approved the reasoning in TenetConnect.  In particular, the concept in TenetConnect of a "single braided stream of advice".  The Court of Appeal said that advice given about regulated and unregulated investments where the advice on the unregulated investment justifies the advice on the specified investment, leads to the advice on the regulated investment becoming part of the regulated advice.

Did CLP provide advice?

Mr Adams argued that three parts of the transaction involved regulated advice – the sale of his existing personal pension with Friends Life, the Carey SIPP and investing in Store First.  As above, although the designated investment when looking at Article 53 was not the Store First investment, advice on Store First was still capable of being advice on the designated investment if it formed part of a "single braided stream of advice".

The Court of Appeal found that the "simple giving of information without any comment will not normally amount to 'advice"', but "the provision of information which is itself the product of a process of selection involving a value judgment so that the information will tend to influence the decision of the recipient was capable of constituting advice".  Also "advice on the merits need not include or be accompanied by information about the relevant transaction.  A communication to the effect that the recipient ought, say, to buy a specific investment can amount to advice on the merits without elaboration on the features or advantages of the investment".

The Court of Appeal found that Mr Adams had been advised to switch his pension to the Carey SIPP, as "steering an investor in the direction of a specific SIPP provider is certainly capable of being advice on the merits of a particular investment" although the recommendation was to invest in Store First, that carried with it advice to switch to the Carey SIPP and with it advising on a designated investment.

Did CLP arrange the Carey SIPP?

This issue involved two questions (1) did CLP arrange the Carey SIPP and (2) did that "bring about" the transaction to which the arrangements relate.  There were 6 steps relied on by Mr Adams as constituting "arranging": procuring a letter of authority, procuring a discharge from the existing personal pension, undertaking money laundering investigations, completion of the Carey SIPP application form, instructions to Store First and explanations that CLP were expected to provide in relation to key features and terms of business.

The Court of Appeal first considered what "bring about" required in practice.  The Court of Appeal found that the words were not consistent with the "but for" test for causation and did not mean there needed to be a direct connection; instead the arrangements "must play a role of significance".  The Court of Appeal then referred to the 6 steps relied upon by Mr Adams and, in light of the "bring about" test, found that those that met the test were: procuring the letter of authority, undertaking money laundering investigations and completing the application form.  In rejecting the High Court analysis that CLP's acts did not necessarily result in any transaction, that the process was outside of CLP's control and the fact the steps were administrative, the Court of Appeal said that "… what CLP did was thus significantly instrumental in the material transfers" with "sufficient causal potency".

Did Mr Adams enter the transaction as a consequence of what CLP did?

Having found that the arrangements brought about the transaction, the Court of Appeal simply stated that the "in consequence of" test (relevant to both advice and arrangements) had also been met without further analysis.

As a result, Mr Adams' s.27 claim succeeded.

s.28 FSMA – a defence to s.27?

Although the Court of Appeal found that CLP had acted in way that breached s.27, that did not mean that the Carey SIPP had to be unwound.  Carey relied on s.28 which allows a court to uphold an agreement – here the Carey SIPP - if the court considers it just and equitable to do so.  When considering whether it is just and equitable to uphold the agreement, the court had to have regard to whether the provider "knew" that the third party was doing something it was not authorised to do.

Here the Court of Appeal found that "knew" meant actual and not constructive knowledge, and that Carey did not have actual knowledge of CLP's unauthorised acts.  That said, the Court of Appeal went on to find that it was appropriate to take in to account, when performing the balancing act of what is "just and equitable", to consider whether the provider should reasonably have known that the unauthorised party was doing something they were not authorised to do.  On balance, the Court of Appeal decided not to exercise their discretion citing the following reasons (albeit the reasons do not appear to be an exhaustive list as it was said to "include" the following factors):

1. One of the main aims of FSMA is consumer protection and consumers should be protected even against their "own folly" (including the fact Mr Adams had decided to make the investment despite acknowledging he understood the risks and had himself misled Carey);
2. Section 27 was "designed to throw the risk associated with doing business with unregulated sources onto the providers";
3. The volume of introductions from CLP put Carey on notice of the danger that CLP was recommending clients to invest in storepods and to set up Carey SIPPs for that purpose;
4. By May 2012 Carey was aware that CLP had misinformed them about incentives customers were receiving; and
5. Carey actioned Mr Adams' investment after it had become aware of the problems with CLP, including that one of the directors was on an FCA blacklist.

Breach of COBS 2.1.1R

Mr Adams' pleaded case was that Carey had acted in breach of COBS 2.1.1R on the basis that (1) establishing a SIPP was manifestly unsuitable given the modest size of the transfer value, (2) the investment in Store First was manifestly unsuitable for Mr Adams' pension fund as it was illiquid and subject to valuation risk and (3) it had breached the guidance and expectation of the then FSA in the September 2009 thematic review.  On appeal Mr Adams moved away from his pleaded case to allege more broadly that Carey breached COBS 2.1.1R in dealing with an unregulated intermediary, admitting in to Mr Adams' SIPP an asset that could not realistically be valued and proceeding with the investment despite what it learned in May 2012.

Given the way Mr Adams sought to argue his case before the Court of Appeal bore "little relation to the Particulars of Claim" the Court of Appeal found that the COBS claim "must fail" and that "… Mr Adams might anyway have struggled to overcome the Judge's finding that any breach of duty was not causative of loss".

Where does the decision leave the SIPP market?

The SIPP industry has faced a lot of pressure in recent years, in large part as a result of the uncertainty over whether they could rely on the scope of their duty defined in their contractual arrangements, or if the various FSA/FCA publications expanded that duty.

Whilst the High Court decision provided somewhat of a reprieve, will it last in light of the Court of Appeal decision?

First, the helpful High Court findings remain intact with respect to the application of COBS 2.1.1R.  Namely that COBS 2.1.1R must be seen through the prism of the contract; COBS 2.1.1R does not expand the contractual duties.  Further, causation is relevant and must be tested for breaches of the FCA Handbook.  A point often overlooked by the Financial Ombudsman Service.

That said, the Court of Appeal decision makes it clear that wider duties in tort were not tested or considered.  There was no allegation in negligence against Carey and as a result no expert evidence at trial.

So, this is the good news.  The bad news is that the Court of Appeal's judgment is unhelpful when it comes to business introduced from an unauthorised party.  The Court of Appeal decision arguably sets a low bar when testing whether the actions of the unauthorised party are enough to qualify as "advising" or "arranging".  Further, the finding that even where a regulated party has no actual knowledge of what is happening, that that lack of actual knowledge is not enough to save a regulated party under s.28 is potentially far reaching.  In circumstances where the FSA/FCA has not at any point prevented regulated entities from dealing with unregulated parties, to push the risk on to regulated parties could have far reaching consequences within and beyond the SIPP market.  This is particularly the case if merely arranging money laundering documents is enough to cross the threshold into engaging in a regulated activity.

It is difficult to unpick how the Court of Appeal came to their decision under s.28.  First, the factors listed in the application of s.28 appear to be some but not all of the factors taken into consideration – we do not have the exhaustive list.  Second, we do not know what factor tipped the balance or if we should look at the factors cumulatively.  Third, the reference to business volume is a nebulous concept as when does that kick in – customer 3 or customer 300? 

What next?

Will the unanswered questions be answered? We await to see if there is an appeal to the Supreme Court and if permission to appeal is granted. 

However, in the meantime, regulated entities may well start to sever ties with unregulated parties given the risks raised with the judgment.  Further, we wait to see the reaction of FOS given the COBS 2.1.1R position remains intact from the High Court decision and the comments made by the Court of Appeal around causation – this may well raise difficulties for FOS in finding against SIPP providers on IFA advised business.

RPC will be hosting a Webinar on Monday 12 April 2021 at 12.30pm to discuss the outcome of Adams v Carey and its implications. If you would be interested in attending this session, please do contact Ash Daniells (Ashley.Daniells@rpclegal.com).

The FCA emphasises that companies should recognise that fair treatment and outcomes for those with vulnerabilities should be the same as other customers. The guidance specifies that, in order to achieve this, companies must support their customers through the entire consumer journey. This should be done by ensuring that staff are trained in recognising what their consumers are likely to be vulnerable to and in understanding their needs. The FCA requires companies to monitor and evaluate whether this is achieved. It is possible that the FCA may be contacting companies to request information as to how they have adapted their business model and culture to ensure that all of their customers, including those with vulnerabilities, are treated fairly. 

The FCA guidance will continue to hold firms accountable for mistreating vulnerable customers and it is therefore important that all businesses become familiar with the guidance and can demonstrate compliance. The FCA intends to review the impact of the guidance within 2-3 years to establish whether it is having a positive impact on the fair treatment of vulnerable customers. 

The FCA's finalised guidance can be found here 

The FSCS has explained that it is continuing to see an increase in pension related claims, albeit that it has in fact reduced its forecast for the anticipated cost of SIPP operator claims.

Advisor frustration at the large FSCS levy increases has not been quelled by recent news that the FSCS has just paid £1.2m to investors advised by Capital & Income Solutions (now in liquidation) that provided DB transfer advice. Furthermore, that sum is only applicable to 20 claims and it is anticipated that there are over 600 pending.

There has been much commentary from the advisor community, many of whom feel that they are being punished for the mistakes of others by having to pay increased FSCS bills and that proactive steps by the regulator may have stopped the behaviour that led to compensation payments in the first place. Many advisors believe that the regulator only steps in once it is too late and more should be done to identify firms that are in breach of regulations which would, in turn, protect financial advisors from increased bills in the future.

No formal protest has been put to the FSCS so far but given the market uncertainty caused by the pandemic in 2020 and the likelihood of further FSCS claims linked to poor investment advice, it would appear that the 2021/2022 FSCS bill is only likely to rise further still.

Rathi is currently the UK head of the London Stock Exchange and was previously the director of the Financial Service Group at HM Treasury. He is expected to take up the CEO role in Autumn this year.

Incoming chief executive Rathi, who is of British-Asian Background, will be the first BAME individual to lead the regulator.

Rathi has said he wants to create a diverse FCA in the coming years, 'supporting the recovery with a special focus on vulnerable consumers, embracing new technology, playing our part in tackling climate change, enforcing high standards and ensuring the UK is a thought leader in international regulatory discussions.’

Good and poor outcomes

The FCA's review of the broader market identified some "good outcomes" where consumers benefitted from the stability of a long-term fixed interest rate, unlocked wealth from their main or only asset (their home) and did not have to make monthly interest payments.  However, some consumers received unsuitable advice in the FCA's view with the following "poor outcomes" identified:

• Younger consumers not being told of their other borrowing options which may have been cheaper and more flexible;
• Short term benefits, such as consolidating debts and freeing up cash, being wiped out by the long-term cost of equity release.  Interest roll-ups operate by compounding interest over many years so debt ends up being several times the amount borrowed.  Interest roll-ups were specifically highlighted as being  particularly damaging where consumers had surplus income that could have been used to repay debts rather than consolidating them;
• Consumers paying substantial early repayment charges only a few years after taking the loan as their circumstances changed;
• Consumers limiting their ability to release further cash or downsize in the future without repaying their equity release in full.

Given the "poor outcomes" identified and a potential issue that consumers did not understand the short and long term impact of equity release and/or the differences in risk to traditional mortgages, the FCA took a closer look at the sales and advice process of lifetime mortgages reviewing a sample of case files from several firms.

The FCA's equity release findings

The FCA says that its findings from file reviews were "mixed", with 3 significant areas of concern identified:

• Insufficient personalisation of advice
• Insufficient challenging of customer assumptions
• Lack of evidence to support the suitability of advice

Personalisation of advice

The FCA notes that to give high quality, suitable advice, advisers need to know their customers well, and understand their circumstances, requirements and motivations.  "… We were disappointed to find that evidence on file indicated advisers had largely adopted a form-filing approach to fact finding…".  The publication provides the following examples:

• Advisers not sufficiently accounting for the different financial circumstances of customers.  For example, those in their 50s still working vs those who had retired;
• Advisers relying wholly or substantially on the Key Facts Illustration (KFI) to show customers the long-term costs and implications of taking a lifetime mortgage whereas "better examples of advice" involved advisers supplementing the KFI and taking time to ensure customers thoroughly understood the costs and implications;
• The impact of debt consolidation was not properly explored including alternative solutions where, in particular, customers had debts on a low interest rate or with a short period remaining being consolidated for no compelling reason;
• The customer's financial circumstances not being given sufficient weighting by the adviser for example where customers had significant surplus income recorded;
• Advisers recommending changes to property ownership to allow equity release to take place without sufficient discussion of the impact of that.

Challenging customer assumptions

The FCA implies that customers sometimes contact advisers with a product bias towards equity release.  The FCA says "… When giving advice, advisers should consider alternatives and be prepared to challenge, where appropriate, customers' initial requests, rather than simply take customers' orders or preferences without question…".  The FCA refers to advisers that did not explore why customers had certain preferences or consider any potential negative impact.  The FCA also refers to examples where a customer's desire to refinance debts into a product with no monthly repayments was accepted without any advice on the impact of consolidating those debts.

Evidence of the suitability of advice

On reviewing files the FCA found inadequate evidence to demonstrate suitability of advice, including examples of generic text to justify why alternatives were not considered.  The FCA "… encourages firms to ensure that the customer's voice can clearly be 'heard' in the file.  By this, we mean the customer's own words, phrases and explanations are noted, and not just responses recorded in the form of tick boxes or selected from a list of options…".  The publication notes that most verbal interactions were not recorded and in those cases, good written records were vital.  Further, although suitability letters were not a requirement, the FCA found some ran to 20 pages or more and these are said to run the risk that important advice is not picked up by customers.

What next for the FCA in light of its findings?

The FCA is addressing its findings with firms within the sample and it will be undertaking further work to review the suitability of advice in the lifetime mortgage / equity release market.  If the FCA finds breaches of its rules, it warns it will take necessary supervisory action.

The FCA says that firms should ensure that their advice processes are sufficient and highlights the following areas:

• Firms need to ensure that they take reasonable steps to obtain sufficient information from customers to provide advice;
• When giving advice to enter into an equity release transaction, firms should ensure the advice given is suitable;
• Firms should ensure that they collect and retain the necessary advice to support that assessment of the suitability of advice and how it is determined

For customers, the FCA notes that equity release should be considered a long-term transaction and if a customer is unsure or does not full understand, they should not progress until the adviser has explained things clearly.  For customers who are unhappy with the advice they have received, the FCA points them in the direction of the firm and FOS.

Lessons Learned?

Current statistics suggest that there has been an increase in the take up of equity release products during the Covid-19 pandemic with customers using their home to release cash perhaps to help themselves or family members.  However, taking out an equity release product has a long term impact and the FCA appears concerned that that long term impact is not fully understood by customers.  A number of the FCA's findings and comments sound very similar to those we have reported on in relation to the defined benefit pension transfer market – to make sure that the advice is personalised to the customer, to include lots of personal information about the customer, not to use "tick box" approaches as the advice must reflect the personal circumstances of the customer, to challenge customers' initial instructions / objectives if they are unrealistic and suitability letters should not be long for the sake of it.

It appears that some supervisory action may come off the back of the FCA's file reviews, whether that is past business reviews or via section 166 skilled person reviews is unclear, but it looks like the equity release market will remain a focus for the FCA.

The FCA's list of questions / statements that "may be more likely" to show a customer received "poor" advice

The checker says that if the adviser failed to ask all of the following questions the customer "may be more likely to have received poor advice":

• Information about the customer's family, and how much income the customer needs to support their family during retirement;
• Information about the customer (and where relevant their spouse/partner) and employment, current income, spending, tax position, entitlement to state pension or state benefits;
• Information about the customer's health (and spouse/partner where relevant);
• The customer's and their spouse's other pensions and assets or debts and any dependency on state benefits (and partner's details, if relevant);
• Priorities and spending plans for retirement;
• The risk the customer felt comfortable with and the extent to which the customer was prepared to accept a reduced lifestyle in retirement if investments performed poorly.

The checker also provides that if any of the following statements are true, the customer again "may be more likely to have received poor advice":

• The adviser did not check the customer's understanding of a DB and defined contribution pension scheme and their risks and benefits, or explain these so the customer could understand what they were giving up;
• The adviser did not consider how the customer could achieve the retirement the customer wanted by keeping their DB pension;
• The DB pension transferred was the customer's only or largest guaranteed pension and the customer had few other assets to support them in retirement, apart from the state pension;
• The adviser recommended a transfer and purchase of an annuity even though the customer was in average or good health;
• The adviser did not show how the customer could meet at least their essential income needs such as paying bills and rent from the DB pension for the customer's lifetime and instead focussed on one or more of the following – (1) flexibility and control of the customer's pension, (2) maximising death benefits payable in the event of death, (3) helping the customer retire early and (4) helping the customer take a larger tax-free lump sum;
• The customer did not believe the sponsoring employer of the DB scheme would continue in business and the adviser did not show how the customer's retirement needs might be met if the DB scheme fell in to the Pension Protection Fund;
• The customer is in a scheme recommended by the adviser where the charges are much higher than expected;
• The adviser recommended the transfer to maximise potential good investment returns and did not show how the income might reduce, keep up with inflation or last into a customer's later years if the investment returns were poor or charges were high;
• The customer's pension funds are invested in hotels, student accommodation, storage pods, leisure developments, parking schemes, forestry, precious metals/stones or other unusual investments;
• The adviser recommended against a transfer but (1) hinted the customer should transfer anyway, (2) did not explain the value of the existing DB scheme, (3) did not explain the risks of a transfer and (4) gave a list of risks of proceeding with the transfer without making those personal to the customer.

The FCA's view on what a customer should do next

The checker says that if a customer agrees with at least one of the statements set out above, and there are quite a lot, "it is possible you may have received poor DB transfer advice and you might have a valid complaint". 

However, the checker also helpfully goes on to say "… If you were always going to transfer, no matter what your adviser said about the disadvantages, it is less likely that you have a complaint".  A recognition by the FCA of the issue of causation which many of us feel is often overlooked.

The checker then sets out how a customer can complain to a firm and FOS.  It also says that a customer does not need a claims management company to help them make a complaint as the FOS will investigate any complaint independently.

What next?

Its an interesting development for the FCA to set out its views quite so explicitly on what may constitute "poor" (notably not unsuitable) advice and provide guidance for customers on how to make a complaint.  The FCA is of course actively writing to all members that transferred their DB pension out of the British Steel Pension Scheme at the moment on what we assume will be similar terms to that in the advice checker.

In terms of how the FCA is approaching its concerns with the DB transfer market, the FCA has other tools in its weaponry to address these.  We know supervisory work is ongoing and there are some past business reviews being undertaken, but the FCA appears to have stopped short of a consumer redress scheme which would have impacted the entire market.

The FCA's remarks in the advice checker about customers that would have transferred regardless of any advice they may have received are also helpful.  And something to be raised at FOS where appropriate.  The reference to claims management companies is also an interesting one and perhaps the next supervisory focus for the FCA will be those companies and the charges they levy?

The key changes to the DB transfer rules are:

1. Contingent charging

From October 2020 there is to be a ban on contingent charging for DB transfer advice, subject to two carve outs.  The statement accepts that there is no data that contingent charging created a conflict of interest but it is said that the ban on contingent charging is a proportionate response to consumer harm.  One of the reasons given is that "… as most consumers would not benefit from a transfer, we expect the ban to be effective in reducing both the numbers of consumers who proceed to a transfer following advice and the harm that unsuitable transfers cause…".

The effect of the new rules is that firms will need to charge the same amount for advice whether or not they recommend a transfer and as a result firms will need to set a total charge for activities.  The ban also applies across 2-adviser models and so both firms (one providing the transfer advice and the other the investment advice) must levy charges that they collect whether or not the transfer goes ahead.  Also a firm must charge at least as much in relation to pension transfer advice as if they were offering investment advice on funds of the same value.  This latter proposal is designed to prevent firms from gaming the ban by charging a token fee for initial advice albeit this measure does not apply where charges are paid partly or fully by an employer or trustee.

There are two carve outs; first for cases of serious ill health and second for serious financial hardship albeit the application of the carve outs is limited and firms must report when they rely on these carve outs in terms of both the number of times the carve out is used and the revenue generated.  The Guidance Consultation sets out some helpful examples of good and bad practice on the intended operation of the carve outs.

2. Triage and abridged advice

Triage is a non-advisory service intended to be used for an educational process so that consumers can decide whether to proceed with regulated advice.  The difficulty with the triage service is if it can result in a binary decision – transfer or do not transfer – this raises the risk of providing advice.  As a result the FCA has said that firms should not use decision trees or traffic light questionnaires for non-advised triage services so that the use of triage services does not result in a binary decision and with it, regulated advice.

The bigger change is the introduction of an abridged advice process.  This is to enable advisers to provide the consumer with a lower cost personal recommendation not to transfer or to tell the customer that it is unclear whether they would benefit from a pension transfer on the information collected through the abridged advice process.  The adviser must for these unclear cases check if the consumer wants to continue to full advice and check they understand the associated costs.  This process involves a fact find and risk assessment but does not include an appropriate pension transfer analysis (APTA), transfer value comparator or consideration of any proposed defined contribution arrangement. 

Following the consultation, abridged advice includes consideration of the benefits (notably not the downsides) of the existing DB scheme.  Abridged advice must be checked by a pension transfer specialist and if a customer moves to full advice, the cost of the abridged advice must be taken off the full advice charge unless the customer uses different advisers.  Firms can provide abridged advice free of charge but must not do so in an attempt to game the ban on contingent charging.  The option of providing abridged advice comes in on 1 October 2020 and so can only be adopted after that date.

On abridged advice the statement says "… where clients proceed to full advice having previously received abridged advice where the outcome is unclear, we still expect some consumers to be advised not to transfer… where abridged advice results in a recommendation not to transfer, but clients proceed to full advice, with indications that they may become insistent clients, we have added guidance that, in most cases, we expect the advice to continue to be that the individual should remain in their existing arrangement.".

3. Managing conflicts – the presumption in favour of the workplace pension scheme (WPS) default fund

The FCA's issue with conflicts comes down in large part to ongoing advice charges.  The statement says "… The default fund of a WPS should be appropriate for all members without the need for ongoing advice.  Given the high-charging products that many consumers are currently transferred into, our proposed changes would also reduce the product charges for consumers who transfer in the future."

The FCA proposes that instead of an adviser having to show that a recommended defined contribution scheme is at least as suitable as a WPS the adviser instead must be able to demonstrate that the recommended defined contribution scheme is more suitable than a customer's current default arrangement in a WPS.  The APTA analysis must also include the WPS default arrangement. 

There are transitional provisions for the introduction of this new rule.  This means in practice that where a suitability report is prepared within 3 months of the new rule, firms may omit the comparison with a WPS in APTA provided they can demonstrate that the advice process started before 1 October 2020.

4. "Empowering customers"

There are further changes to how charges are disclosed and referenced in documents.  This includes that the engagement letter must set out charges for abridged and full advice as well as the charges for ongoing advice.  There must also be a 1 page summary in the suitability report including charges, the recommendation, a statement on the risks of the transfer and information about ongoing advice to be provided.  Firms must also be able to evidence that the customer can demonstrate they understand the risks of proceeding with a DB transfer before finalising the recommendation and keep a record of this evidence.

Alongside these key changes, there are also technical amendments to expand the definition of "arranging" a pension transfer, to the transfer value comparator in relation to the technical assumptions adopted and cashflow modelling.

The key change is likely to be the introduction of abridged advice and how that is used going forward by the market.  It does appear to offer another tool for firms and customers to at least look at the option of a DB transfer in a cost effective way and for customers then to decide whether to proceed with full advice.

However, the tone and content of the statement does, in our view, once again emphasise the FCA's view on DB transfers – that they are not fond of them (to put it mildly).  Whilst some of the changes appear to make it more difficult for customers to obtain DB transfer advice (such as the ban on contingent charging) the FCA is also conscious not to remove DB transfer advice as an option for customers where it might be the best option for them (hence the introduction of abridged advice).  That said, both the triage service and abridged advice appear to be designed to warn off customers from DB transfers, emphasising the risks and the abridged service only results in a recommendation not to transfer or advice that the position is unclear.  Further, the introduction of the rule requiring an adviser to show that a proposed defined contribution scheme is more suitable than a default arrangement in a WPS is hard to square with the comment in the FCA's guidance consultation.  The guidance consultation states that a client is more likely to have the required attitude to transfer risk where they want to manage their own investments; if most (suitable) transfers will be recommended to those wanting to manage their own investments, why require firms to specifically use WPS default funds as a principle comparator and require the firm to prove any alternative fund is more suitable?  It looks to us like yet another, high hurdle for firms to overcome to demonstrate positive advice to transfer is suitable in the FCA's eyes.

The core proposals in the statement are due to take effect in October 2020 and it will be interesting to see what shape the DB transfer market is in by that time and how these changes are then taken forward.

The key theme that comes through is the more detailed the record keeping and specific to the customer's personal circumstances the better.  However, for many the guidance note is unlikely to be particularly ground breaking and the examples of good and bad practice perhaps look too much at extremes of advice rather than addressing the grey areas where no doubt advisers would prefer some further guidance from the FCA.

There are some important points to take from the guidance, particularly when it comes to areas where we often see criticisms of DB transfer advice either at FOS or from the FCA.  In particular:

• Know your client / fact find – the guidance sets out the type of information to cover in key areas including a client's personal and family circumstances, financial circumstances including income and current and future outgoings, other assets, knowledge and experience of transferring and investing, attitude to transfer risk, attitude to investment risk and the customer's objectives and needs including any relevant dates and amounts needed to achieve these.  The guidance then states: "… If you do not collect the detailed information that you need to give advice, your file is likely to have material information gaps" albeit that this does not necessarily render the advice unsuitable.  The FCA places particular emphasis on how questions are asked including the importance of using different question styles and open questions when conducting a fact find.
• A customer's personal and family circumstances – this refers to family health histories acknowledging that these are relevant but it is the client's own health and longevity that is important and so advisers "should manage client expectations" as a customer may not necessarily inherit a parent's health condition.  Enquiries should also be made of the DB scheme to ascertain what spousal and dependant's benefits are available (and Annex 1 includes a scheme data template setting out the information a firm should consider collecting from a ceding arrangement).
• A customer's other assets including other pension provision – where advice is based on joint finances the information needs to include the spouse's assets and sources of income.
• A customer's knowledge and experience of transfers and investments – where a client has worked in financial services a firm should still take reasonable steps to assess their knowledge and experience and should not assume that a client is knowledgeable and experienced in investments. When assessing a client's knowledge and experience information should include the types of investments and services with which the client is familiar, the nature, volume and frequency of the client's investment transactions and the level of education, profession or relevant former profession of the client.  Although a client may have held investment products the guidance provides that this does not mean that they have appropriate knowledge and experience.
• A customer's attitude to transfer risk – the assessment is said to be of a client's behavioural and emotional response to the risks and benefits of giving up guaranteed benefits.  If a firm is using standard risk profile questionnaires "… it is likely they will not have properly assessed attitude to transfer risk…".  The guidance note states – "… a client is less likely to have the required attitude to transfer risk where they want certainty of income in retirement and/or do not want to manage their investments or pay for advice on investments.  A client is more likely to have the required attitude to transfer risk where they do not want any restrictions on their ability to access funds and/or want to manage their investments or pay for advice on investments…".
• Objectives and needs – if a firm gives advice based on objectives such as "flexibility" or "control of my pension" these are "unlikely to be sufficiently personalised to enable a suitable personal recommendation, without further detail".  It is also said that a tick box questionnaire is unlikely to enable an adviser to understand a client's objectives properly.  An adviser should challenge a client's objectives if they are unrealistic or based on false information with specific reference made here to the PPF.  It is said that when balancing needs and objectives adviser processes should adopt a 3 stage process – identify all client objectives and needs, identify where needs and objectives are in conflict and work through specific compromises with the client documenting the reason/rationale.  The guidance states "… Its unlikely you will be able to recommend a solution that meets all the client's needs and objectives.  The recommendation you make will be based on an overall consideration of whether the client can bear the risk of transfer to achieve their objectives…".
• PPF – scheme deficits should generally not be used as a reason to transfer and advisers should make it clear to the customer that a scheme deficit does not mean the scheme is about to enter the PPF. 
• Death benefits – unsuitable advice is said to commonly overemphasise the value of death benefits available on DB transfer.  Where a customer does have a need for death benefits consideration should be given to life insurance as an alternative to transfer.  Consideration must be given to how both the DB scheme and the proposed defined contribution scheme would provide death benefits by making comparisons on a fair and consistent basis at different points in time. 
• Early retirement – customers seeking DB transfer advice often state that they want to retire early but without further information about the underlying reasons and when and how they intend to retire, in these circumstances the advice "may" fall short of the FCA's expectations.  "Advisers are not order-takers.  You should be prepared, if needed, to tell clients that retiring early is not financially viable…".  Where income is reduced as a result of taking a pension early from a DB scheme that should not be presented as a penalty. 
• Pension commencement lump sum – customers sometimes want to transfer to access cash to pay off a mortgage or debt; other options to service that debt must be considered first.
• 2 adviser model – sometimes the transfer advice is provided by one firm and the investment advice by another.  Where there is a 2 adviser model the guidance states that a firm advising on the transfer should not comment on the intended investment explicitly "… If you do, you will carry responsibility for the investment advice as well as the DB transfer advice…".
• Suitability reports – reports should always be provided in good time and if a ceding scheme is being changed or replaced the report should be provided in draft form with the recommendation only finalised once the change or replacement arrangements are certain (how that works given the time limit on cash equivalent transfer value quotes is not dealt with).  The guidance sets out views on how a report should look and with regard to its content with an emphasis on including detail about the client and should "tell the story of your client – who they are, their approach to their financial life and their hopes and ambitions for retirement".  The guidance provides that a "good" report is no longer than 10-12 sides and anything over 25 sides should be reviewed.
• Insistent clients – the guidance says "… If you choose to use the insistent client process, you can still be liable for redress to an insistent client if you are found to have given information in a way that was not in their best interests and is likely to have caused them to disregard your advice and transfer…".  When dealing with an insistent client an acknowledgment should be obtained from the client in their own words; standard form wording is said to be unlikely to be sufficient.

It is also worth noting that insurers with practices that require an insured firm to refer proposed DB transfer advice to them before undertaking that advice may be at risk of providing advice on a DB transfer and as a result acting without requisite permissions.

Overall there is a lot of detail in the guidance consultation.  For firms that are providing DB transfer advice it is essential reading and for those conducting reviews in light of FCA supervisory exercises it is also worth reviewing to see how files hold up against this proposed guidance. 

The consultation on the guidance provides firms with a chance to raise areas where they consider further guidance is needed and to invite the FCA to clarify grey areas.  Hopefully this will lead to a more collegiate approach between the FCA and the DB transfer market going forward.

The FCA found that too many firms are failing to collect information necessary in their eyes to provide suitable advice – so-called files with material information gaps.  It is said that the most common areas where there are gaps in the fact find are – (1) anticipated income and expenditure in retirement and how this may fluctuate and (2) customer objectives and the role pensions play in meeting a customer's objectives.  Notably in the other documentation produced by the FCA, it is said that a file with material information gaps does not mean that the advice to transfer was unsuitable.  This is helpful.  However, with the starting assumption that any transfer is unsuitable when it comes to DB transfers, the more detailed information tailored to the customer on the file the better, particularly if a firm faces a complaint at FOS.  The level of detail and specificity needed is something that comes through strongly in the guidance consultation.

In this further supervisory phase of the FCA's work, it found 55% of files suitable, 28% with material information gaps and 17% unsuitable.  Notably, most of the unsuitable advice appears to have been found in 2016 and 2017 (with 55% and 47% unsuitable respectively).  In 2018 60% of the advice reviewed was found to be suitable, increasing to 80% suitable for advice in 2019 (albeit only 10 files were reviewed for that year).  Broadly, the FCA's view is that advice is improving.  However, despite improvements the FCA say that the 60% for 2018 is "well below our objective for this market".

Within the review were said to be 192 instances of advice on the British Steel Pension Scheme – a particular bone of contention.  In these cases the FCA found 21% suitable, 47% unsuitable and 32% with material information gaps.

The FCA notes that it is currently undertaking 30 enforcement investigations and that they have reviewed samples of advice from all 30 firms which will inform their decision-making to assist in concluding those investigations.  The FCA also says that it has asked firms to put things right if advice was unsuitable.

The next steps outlined by the FCA include engaging with firms where it has assessed advice processes and/or reviewed files and the FCA expects firms to put in place past business reviews and pay redress where standards have not been met.  The FCA is also writing to all 7,700 former members of the British Steel Pension Scheme to help them revisit the advice received and complain if there are any concerns.  A further data request is also to be sent to firms with the pension transfer permission.

The update is a further step in the FCA's supervisory / enforcement process for DB transfers.  It appears the FCA's focus on identifying historic unsuitable advice is coming to an end with the reported 30 enforcement investigations and other apparent instances where the FCA has invited firms "to put things right".  However, the FCA also still appears to be unhappy with the industry despite nearly half of those with DB transfer permissions (745 out of 1,649 firms) dropping their permissions and exiting the market.  What the FCA may do next is unclear but the FCA continues to accumulate information on the market and to actively monitor it.  Having said that, the 80% suitability rate for 2019 files reviewed by the FCA is encouraging for the market going forward. 

The firms were asked to provide feedback on the specific risk areas identified by the FCA and to set out details of changes made to improve the quality of their DB transfer advice.  It was expected that the FCA would review firms' responses and might potentially take further action against those firms it remained concerned with.

Redress exercises

In fact, the FCA has recently confirmed that so far none of the 1,649 firms have been contacted to carry out redress exercises based solely on the issues found in their response.

This is not to say that no firms have been contacted to carry out redress exercises at all but we are only aware of a small number of firms that have.

The FCA says that they will continue to review the suitability of DB pension advice, which will involve further work with the firms which have been contacted.

From the firms asked for information, 39 firms did not respond, although 14 are no longer active in the DB market.

Data analysis

The FCA have also revealed that it has not collected data on how many DB transfers have taken place since September 2018.

The FCA states that it holds no data for DB transfers in 2019 or 2020.

Despite this, the FCA says it is looking to collect DB transfer data through alternative methods. For instance, the FCA is using whistleblowing as a means of highlighting risks on an individual basis. The FCA has also proposed amending the Retail Mediation Activities returns, to ensure that firms provide a comprehensive view of their transfer advice.

What next?

It appears that the FCA's attention may not currently be fully focused on DB transfers. Whether the FCA will continue its analysis of DB transfers in the very near future remains to be seen. However, it seems likely that the FCA will regain its momentum at some point and it is clear that firms which continue to carry out DB transfers will remain center stage of the investigation.

• Breach of s.27 of the Financial Services and Markets Act 2000 (FSMA) rendering the SIPP unenforceable;
• Breach of COBS 2.1.1R which requires any FCA regulated entity to act 'honestly, fairly and professionally in accordance with the best interests of [the Claimant]'; and
• Carey should stand responsible for the negligent investment advice provided by CL&P for which it was said Carey was liable as a result of a joint venture, common design or agreed common business model.

In late 2016 / early 2017 it came to light that HMRC had raised a number of assessments on SIPP and SSAS providers involving in-specie contributions.  An RPC blog at the time documented these issues (https://www.rpclegal.com/perspectives/financial-services-regulatory-and-risk/in-specie-pension-contributions-what-is-the-fuss-all-about/). 

In a nutshell, in-specie contributions involve a taxpayer making a contribution of an asset in lieu of a cash contribution and tax relief is claimed on the asset contribution.  HMRC provided guidance on in-specie contributions since 2009 broadly stating that a taxpayer making such a contribution must first create a legally binding debt which the pension scheme is required to collect and an asset can then be used to meet that binding debt provided the asset is transferred at its open market value.

Following a change of forms documenting relief at source claims in 2016, splitting out in-specie from cash contributions, it appears alarm bells went off at HMRC as to how much tax relief was being claimed on in-specie contributions.  Enter the SIPPChoice case.

The First Tier Tribunal Decision

Before the First Tier Tribunal SIPPChoice succeeded and as our tax team covered at the time (https://www.rpclegal.com/perspectives/tax-take/sippchoice-ltd-taxpayer-can-claim-income-tax-deduction-for-contribution-in-specie-to-sipp/), HMRC's argument that contributions attracting tax relief meant only "money" payments was rejected. 

The First Tier Tribunal at the time also rejected HMRC's argument that no binding agreement to make a contribution had been agreed on the facts of the case.  Although the First Tier Tribunal did not accept the contribution form alone was enough to create a binding agreement between the taxpayer and SIPP provider, taking the circumstances as a whole (including the Trust Deed and associated rules and terms and conditions of the SIPP) a binding agreement had been reached.
 
The Upper Tier Tribunal Decision

HMRC appealed the decision on two grounds (1) the legislation provides tax relief for money payments only and not for transfers of assets, that is the case whether or not the asset is transferred in satisfaction of a money debt and (2) the First Tier Tribunal had erred in law in concluding that a binding contract had been entered into, to pay a sum of money to the SIPP and/or in determining that there was such a contract.

The Upper Tier Tribunal considered section 188(1) of the Finance Act 2004 that provides "… An individual who is an active member of a registered pension scheme is entitled to relief under this section in respect of relievable pension contributions paid during a tax year if the individual is a relevant UK individual for that year…" (our emphasis), alongside section 195 of the Finance Act 2004 which provides that for the purposes of section 188 references to contributions paid by an individual include contributions made in the form of the transfer by the individual of eligible shares within a company within a permitted period (i.e. 90 days from the date the taxpayer has a right to acquire the shares).

The Upper Tier Tribunal went on to consider whether the express "contributions paid" in section 188(1) includes contributions by way of transfers of assets or is restricted to contributions of money (whether in cash or other forms).  The Upper Tier Tribunal said that "paid" is not restricted to monetary payments.  However section 195 was an extension of the tax relief provisions under section 188 and informs the interpretation of "contributions paid" under section 188(1).  The Upper Tier Tribunal then said "… it makes no sense, in the context of provisions to relieve contributions to pension schemes, to restrict relief for transfers of eligible shares to a period of 90 days from acquisition if non-eligible shares are not so limited.  The logical inconsistency disappears if "contributions paid" is interpreted as restricted to monetary contributions…".

The Upper Tier Tribunal then went on to consider whether the transfer of a non-cash asset made in satisfaction of a pre-existing monetary debt met the definition of "contributions paid".  SIPPChoice argued that such a transfer did constitute "contributions paid" referring to HMRC's Pensions Tax Manual which states "… Giving effect to cash contributions.  As explained above, contributions to a registered pension scheme must be a monetary amount.  However it is possible for a member to agree to pay a monetary contribution and then to give effect to the cash contribution by way of a transfer of an asset or assets…".

Despite the language of the Pensions Tax Manual HMRC argued that the passage in the manual, although not clearly worded, was talking about set-off and did not mean that a transfer of assets could be substituted for a monetary payment.  There was no material difference between a transfer of an asset where there is a pre-existing liability to pay a sum of money and a transfer where no such liability exists.  In both cases, there was a transfer of an asset and no "contributions paid".

The Upper Tier Tribunal agreed with HMRC; as "contributions paid" means paid in money it cannot encompass settlement by transfer of non-monetary assets even if the transfer is made in satisfaction of an earlier obligation to contribute money.  However, the Upper Tier Tribunal also found that the Pension Tax Manual could not be interpreted in the way suggested by HMRC, finding that the natural reading is that HMRC did not see any objection to a promise to make a monetary contribution to a pension scheme being satisfied by a transfer of an asset or assets where the taxpayer and SIPP/SSAS provider both agreed to it.

The Upper Tier Tribunal also found that the taxpayer was never under an contractual obligation to SIPPChoice to make a contribution based on the documentation in the case.

The Ramifications for SIPPs and SSASs

We wait to see whether the decision is appealed.  However, if the position for in-specie contributions rests with the decision of the Upper Tier Tribunal where does that leave SIPPs and SSASs with outstanding tax assessments and taxpayers also facing such assessments?

First, we wait to see whether HMRC now seeks to enforce any tax assessments given the detrimental remarks made in the judgment about their "misleading" manual and so raising questions for judicial review.

But on the assumption HMRC does seek to enforce its assessments, tax charges are likely to arise for both SIPP / SSAS providers by way of scheme sanction charges and for individual taxpayers as unauthorised payment charges.  Most SIPP / SSAS providers include in their terms and conditions and/or as part of the trust documentation for the SIPP / SSAS that if a tax charge arises they can claw that back from the assets in the SIPP or the individual taxpayer. 

Whether or not such a claw back from within a scheme's assets itself triggers a tax charge is open to debate, but if pension funds are depleted and/or taxpayers have to pay out money to meet outstanding tax charges, then claims are likely to follow as taxpayers assert that they would have made a cash contribution had they known that their in-specie contribution risked a tax charge and so they should not be responsible for the tax charge. 

These type of claims will require an assessment of whether or not taxpayers could have made a cash contribution as alleged in the first instance.  However even if taxpayers get over this causation hurdle, on the basis of the judgment as it stands, it would appear that SIPP and SSAS providers can assert as part of any defence to such a claim that they reasonably relied on HMRC's tax manual at the time and so were not negligent for permitting in-specie transfers as a way to contribute to pension arrangements.

It is also worth noting that the issues here have a likely knock-on effect with respect to other complaints/claims we are seeing involving SIPPs and SSASs and investments in Elysian Fuels and Omega (unquoted shares in a bio-fuel business).  In particular, it is understood that many taxpayers that purchased shares in Elysian Fuels and Omega utilised in-specie transfers.  There are other fact patterns where shares were sold to SIPPs and SSASs, but the SIPPChoice judgment as it stands will give rise to tax charges on in-specie transfers and may lead to further complaints involving Elysian Fuels and Omega as a result.

What next?

The judgment has the potential to raise issues beyond SIPPs and SSASs as it could affect final salary scheme contributions.  However, what appears clear is that the judgment will cause further uncertainty for SIPPs and SSASs in what is already a difficult market.

In light of these concerns the FCA wrote to FOS on 15 April 2020 saying "… We know that the ombudsman service considers complaints based on the circumstances at the time and we want to provide as much reassurance as possible on this point, to ensure that firms respond positively to our measures, and consumers get the help they need…".  The FCA's letter went on to ask the FOS to confirm that "… in determining what is fair and reasonable in all the circumstances of the individual case, the ombudsman will take account of the operational challenges faced by firms during this period, and the FCA's revised expectations of what constitutes compliance with our rules, guidance and standards, as well as what countered as good industry practice at the time…".  The FCA statement is broadly a reflection of what is in the FCA Handbook, DISP 3.6.4R.

The Chief Ombudsman responded on 16 April.  The response states  "… in deciding what is fair and reasonable in the circumstance of an individual complaint, we must take into account relevant law; regulators' rules, guidance and standards; codes of practice and what the ombudsman considers to have been good industry practice at the time.  We do not make decisions with the benefit of hindsight…" (our emphasis).  The letter goes on to confirm that FOS will take account of guidance providing regulated firms with additional flexibility to help deal with difficult conditions.

The exchange between the FCA and FOS is perhaps not surprising in the current climate when it is all hands to the pump to keep things going during the current crisis and as already noted, the wording adopted does broadly reflect that in DISP.  However, the categorical confirmation from the Chief Ombudsman that FOS does not use the benefit of hindsight to make decisions is likely to leave some with experience of FOS raising an eyebrow; for many that is not always the experience and instead many facing complaints often are left feeling that FOS has moved the goalposts somewhat.

Will the crisis see a change of heart at FOS or is this just limited to dealing with complaints arising during the pandemic? Whatever the answer, when responding to complaints before FOS it may be worthwhile, depending on the circumstances, adopting the quote from the Chief Ombudsman that FOS does not make decisions with the benefit of hindsight and see whether that results in a different approach; with the benefit of hindsight of course.

The FOS has already begun to receive Covid-19 related complaints and warns that there will be significant delays in processing new complaints.  Consumers are expected to wait up to 4 weeks to receive an acknowledgement and cases will take several months to be allocated.  The current estimated timeframes for complaint resolution range from four months for banking and mortgage complaints to seven months for investment and pension complaints.  Highly complex cases, those involving fraud for instance, will take even longer.  This may come as no surprise for financial services firms well used to the FOS taking many months or even years to resolve complaints.  However, it is worth noting that, at present, it may take some considerable time for firms (and their insurers) to be notified about new complaints referred against them.

The FOS also flags that instances of fraud have been on the rise since the start of the pandemic as the ill-intentioned have seen new opportunities among the chaos.  The FOS has published a useful checklist to help people stay safe while working from home, and regularly updates its website with details of the latest scams.  Firms may wish to share these details with clients to assist them in staying safe.

Fraud cases aside, the FOS is expecting to see an increasing number of complaints in other areas of financial services, most notably complaints about insurers.  In this regard the change to the definition of 'eligible complainant' in the FCA handbook last year will allow more insureds to refer complaints.  The FOS has urged insurers to treat customers fairly in these difficult times and to "think beyond a strict interpretation of the policy terms and consider carefully what’s fair and reasonable in each case, taking into account the unprecedented situation".  However, the FOS does accept that whether cover is available will depend upon the policy terms and it notes that policyholders unhappy with their insurers will, as usual, need to complain to their insurer first, before approaching the FOS.

The FOS also expects future trends to include increases in complaints relating to mortgage and credit products, travel and wedding insurance policies, as well as general financial difficulties.

It is worth noting, as the FOS does in its update, that the FOS' binding award limit has increased to £355,000 for complaints referred on or after 1 April 2020 about acts or omissions by firms on or after 1 April 2019.  New complaints in relation to Covid-19 issues will attract this higher award limit, which will potentially have a significant impact on firms and their insurers.

The FOS continues to plan ahead, even in these uncertain times, and has published its strategic plans and budget for 2020/2021.  The FOS is increasing its per-case fee (generally paid only by larger firms) for the first time since 2013 while retaining the "free case" allowance at its current level of 25 and freezing the minimum levy paid by firms.  These steps appear to be intended to relieve pressure on some of the smaller firms in the industry, which may be the most vulnerable to the current circumstances.

• '12 week rule' is now the '36 week rule' for FCA regulated firms

In recognition of the heightened need for temporary arrangements to cover absences, firms are now able to appoint an individual (not approved by the FCA) to cover for the temporary absence of a Senior Manager for up to 36 weeks. Temporary absence can include staff that are furloughed (see also below). 

Where a firm needs to rely on this modification of the rules, it should notify the FCA that temporary arrangements are to last longer than 12 weeks and that it consents to the modification. No details are provided on how to notify, but we would suggest getting in touch with your regular contact and/or checking Connect to see if it has the necessary functionality.

Note that this modification to the rules does not currently apply to dual regulated firms but the FCA and PRA are looking into whether it should (see FCA and PRA Statement).

• No need to submit updated Statement of Responsibilities (SoR)

To minimise the burden on firms at this time, the FCA has confirmed that firms do not need to submit updated SoRs for temporary changes in responsibilities in response to the pandemic. However, firms should still clearly document any changes to responsibilities and functions which may include, as noted last week, updating governance maps and job descriptions.

• Furloughed staff

Senior managers put on temporary furlough will retain FCA approval during the absence and do not need to be re-approved on their return. 

Note that the FCA expects that certain required functions such as Compliance Oversight, the MLRO, or Limited Scope Function should only be furloughed as a last resort.

The Committee presented six key conclusions and recommendations that may be broadly summarised under three headings: (i) the equivalence regime; (ii) approaches to regulation; and (iii) international cooperation in the financial services industry.

Equivalence regime

It was agreed in the Political Declaration that the future UK-EU relationship in financial services will be based on equivalence. Equivalence is a unilateral mechanism whereby trading partner A recognises partner B's trading standards and enforcement as equivalent to their own. This is already widely used between the EU and third countries, such as Japan, the USA and Canada. The Committee emphasised that the UK government should closely cooperate with the financial services industry to highlight the areas where equivalence is most important to UK financial services and prioritise these discussions with the EU.

The Committee warned that discussions around disruption to financial services should be addressed separately from broader negotiations on the UK-EU relationship so as to avoid these discussions becoming politicised.

There is a further concern that businesses may not be able to rely on equivalence for their cross-border activities if equivalence decisions can be withdrawn at short notice. Instead, the committee recommend that there should be a regular and structured regulatory dialogue and a phased approach to any withdrawal from equivalence decisions with clear timelines and consultation with the industry.

Approach to UK regulation

Brexit provides an opportunity for the UK to take a new approach to financial regulation by delegating more powers to its regulators. The regulatory regime may benefit from increased flexibility and the ability to respond to market changes with technical expertise.

The Committee emphasised that effective scrutiny of regulators should be maintained. In response to any increased delegation of powers, there will need to be an increase in parliamentary oversight of regulators' activities.

The Committee recommended that, as UK and EU regulations start to diverge, the UK should tailor its regulatory regime to the UK context. This may be done through targeted adjustments to the regulatory regime, in particular through considerations of UK divergence from the EU in its implementation of the final Basel III standards and of other international standards.

International cooperation

Post-Brexit, the UK has an opportunity to lead international cooperation in the financial services industry. The Committee recommends that such cooperation should include multilateral discussions in order to develop common global regulatory standards and to build close relations with jurisdictions sharing a common approach.

The FCA considers firms to be best placed to decide which staff are essential for the provision of financial services. Whilst a firm has flexibility to make its own assessment, the FCA expects key financial workers to include a limited number of people and recommends that the Chief Executive Officer Senior Management Function (SMF1) (or the most relevant member of the senior management team) is accountable for ensuring the firm has in place an adequate identification process. 

The guidance sets out a two-stage test of identifying:

1. the activities, services or operations which, if interrupted, are likely to lead to the disruption of essential services to the real economy or financial stability; and
2. individuals that are essential to support these functions.

The FCA considers that key financial workers might include, among others, persons essential for running branches and online services, processing payments, insurance claims and renewals and individuals in finance, IT, risk management, compliance and audit supporting those roles and ensuring the firm meets its customers' needs and regulatory obligations. It may also include individuals essential for the overall management of the firm, for example those within the Senior Managers Regime.

The guidance states that firms should consider issuing a letter to 'key financial workers' that can be presented to schools on request.

Read the new guidance here.

In an announcement on their website last week, POS have confirmed that from the 18 March 2020 their office has closed in line with the COVID-19 lockdown rules set by the government. This means that they can no longer deal with any correspondence that has been received by post since that date, nor will they be able to for the foreseeable future. As a result, whilst the current lockdown remains in place, POS have confirmed that they will only be focussing on existing enquiries and complaints and will not be accepting any new complaints. Not only does this mean that new complaints won't be actioned, but consumers will need to re-submit their complaint once the restrictions have been lifted and the office has been reopened.  POS advises that all existing complaints will be progressed as normal.

Of course, consumers will want to know what impact this will have on the ability to bring a complaint, especially given the POS' 3 year time limit. POS have confirmed that they are aware of the impact on the complaints which are nearing the 3-year time limit and that they will use their discretion to extend the usual time limit for those new complainants

The Financial Ombudsman Service

The FOS have also released a similar update on their website, confirming that their office has now closed, whilst also requesting that complainants do not send anything in by post while the lockdown continues. Unlike POS, the FOS are not yet issuing a total ban on new complaints. However, they ask anyone who has recently sent in a complaint form by post to resubmit their complaint through their new online form. The FOS have also confirmed that their phone lines remain open but with limited availability (between 9.30am and 2.00pm, Monday to Friday) and calls should only be made if someone is facing severe ill-health or financial hardship. As a result, the FOS have confirmed that it will take them longer than usual to respond to any correspondence.

We anticipate that there will be a lull in new referrals to FOS, or at the very least a lull in new complaints being processed. Of course, on the issuing of final response letters a complainant has 6 months to refer their complaint to the FOS (DISP 2.8.2). There is currently no guidance on how the 6 month referral period will apply but we anticipate the FOS will take a more lenient approach to the 6 month rule. As such those responding to complaints will need to be aware they are unlikely to be able to rely on the 6 month time limit as strictly as before; given that the closure of FOS is likely to count as a reasonable excuse for not having referred complaints in time.

The FOS may in due course confirm whether a similar amnesty to that offered by POS will be put in place for complaints that fall foul of the 6-month time limit.

Impact on complaints

Both the POS and the FOS are currently operating at a significant backlog when it comes to dealing with new complaints and correspondence. It may be that this reduced service will allow them to clear some of the backlog and so we may see some older claims that have been pending for a long time start to become active again. Indeed we have already seen an increase in final decisions being received over the last week. 

The FCA is working with the Money and Pension Service which is due this summer to set up a directory in accordance with the FCA criteria. Note however, based on recent guidance from the FCA, certain activities are being scaled back as a result of the COVID-19 pandemic so this may change. 

Organisations and firms are also permitted to create alternative directories and firms are free to signpost to compliant directory (or directories) of their choosing.

Firms must implement the signposting requirements by 5 November 2020. 

Additionally, the FCA is also looking to publish guidance aimed at improving consumer understanding of the travel insurance market including the implications of PEMC exclusions.

Read the FCA's policy statement here.

Insurance

The FCA is having regular conversations with insurers to ensure that they manage any impact of the COVID-19 crisis on their operations. On 19 March 2020, the FCA published an update on how COVID-19 could impact consumer insurance, focussing on travel, home and motor covers.

Mortgages

On 20 March 2020, the FCA issued new guidance on how it expects mortgage lenders and administrators to treat customers fairly during this situation. Steps that the FCA expects lenders to take to provide support are: payment holidays arrangements and a temporary stop to repossession actions. For more information on these steps, click here.

Scams

The FCA also wants to raise awareness that consumers could be susceptible to scammers during this time, noting that scammers are opportunistic and will likely prey on the vulnerable in the current climate.  These scams may take many forms and could be about insurance policies, pensions or investment opportunities.  The FCA suggests that, to protect themselves, consumers should:

• Reject offers that come out of the blue.
• Beware of adverts on social media channels and paid for/sponsored adverts online.
• Use the FCA Register and Warning List to check who they are dealing with.
• Do not click links or open emails from senders they don't already know.
• Avoid being rushed or pressured into making a decision.
• Call back existing providers who call them unexpectedly.
• Not give out personal details (bank details, address, existing insurance/pensions/investment details).

More information can be found here.

The FCA is keen to stress that they are reviewing their work plans so firms can delay or postpone activity which is not critical to protecting customers and market integrity. This will allow firms to focus on supporting their customers during this difficult period. 

The FCA is postponing and/or delaying activity and aspects of its regulatory changes programme which are not critical to consumers and market integrity in the short term.  Immediate action has been taken to extend the closing date for responses to their open consultation papers and Calls for Input until 1 October 2020.

Publications, and other planned work, due before the end of June have also been delayed. Delayed publications include the GI Pricing Final report and Consultation Paper on remedies, CP20/4: Quarterly Consultation No 27, the Motor Finance Policy Statement, Vulnerability Guidance and Research, and the Consumer Credit Act (CCA) review.

The full list and further information is set out on the firm specific webpage here.

Under The Consumer Insurance (Disclosure and Representations) Act 2012 (CIDRA), members of the public who purchase insurance are under a duty to take reasonable care not to make a misrepresentation when entering into the policy. If a consumer knowingly breaches this duty and this misrepresentation induces the insurer to enter into an insurance policy, the insurer can potentially avoid the policy. Avoidance of the policy renders it void as if it had never been entered into by the parties. The insurer may also be able to retain the premiums paid by the consumer to date. For less serious breaches, where the misrepresentation is honest and reasonable, the insurer may still have a range of remedies, including reducing the amount payable.

The FOS' research focussed on three principle areas of insurance – home, motor and travel, where they most frequently see issues with misrepresentation and underinsurance. Regarding home insurance, the FOS has seen a number of cases where consumers have incorrectly valued their possessions, normally due to insufficient care taken in calculating their value, with jewellery coming up multiple times in their case studies.

For motor insurance, principal areas of complaints relate to consumers having their policies avoided due to failing to disclose to insurers modifications to the car (with modifications to wheels being cited in the case studies), or consumers failing to notify insurers that they are using the vehicle for commuting.

Finally, for travel insurance, the majority of complaints relate to consumers being left without cover and forced to pay expensive medical bills while abroad due to alleged failure to notify their insurers about pre-existing medical conditions.

While most of the advice is principally for the benefit of consumers, there are some takeaways for insurers. Firstly, it is apparent that the FOS is concerned that insurers are taking too hard-line a stance under the act to avoid paying out under policies for minor breaches. The FOS will in such circumstances come to the aid of the consumer and force the insurer to pay out under the terms of the policy. 

It is also clear from the FOS' enquiries outlined in the case studies that they will expect to see that proper enquiries were made by the insurer where accusations are made against a consumer of failing to disclose material information. An insurer merely sticking to a telephone script and not following up on potential issues at the time of the initial call to set up the policy may lead the FOS to deem that an insurer has failed to sufficiently follow up on disclosures by a consumer.

However, so long as adequate questions were asked and the consumer can be shown to have either misled the insurer or that they were reckless regarding disclosure, then the FOS may allow the insurer to avoid paying out under the insurance policy. It is important, therefore, for insurers to review their systems and ensure that proper investigations are being made and accurate records being kept, in the event that a future complaint is made to the FOS.
 

The fear that consumers are being left without an adequate retirement income is a significant threat to the pension sector and so the FCA has prioritised the following as key areas to be tackled.

Defined Benefit Transfers

The FCA warns that poor advice and high-profile failures of defined benefit (DB) schemes are resulting in consumers cashing in their pension when it is unsuitable for them to do so, or worse still, opting out of the pensions savings market without any viable pension product in place.

Although transfers out of DB schemes stopped growing in the latter half of 2018, the FCA reports that unsuitable transfers from DB schemes could cost consumers £20 billion in "client guarantees" in the next five years. The FCA continues to be worried that consumers lack the experience to know whether a transfer is a good decision for them and whether it will really meet their long-term needs. As a result of transferring out, consumers are left vulnerable to pension scams whilst firms are at risk of claims for mis-selling pensions.

Poor value products

The watchdog is concerned that the compound effect of unsuitable non-workplace pensions products, coupled with high charge rates, can erode savings by £40 billion over the next five years.

The lack of transparency in relation to charging structures prevents consumers from being able to make cost comparisons between products and providers. In turn, this means consumers are unable to make informed decisions as they are unable to assess whether a product is good value for money.

Workplace advice

The FCA has also raised issue with the advice being given to employers in respect of workplace pensions. Workplace advice operates outside the FCA's regulatory perimeter and so presents a potential cause for concern. The lack of competitive pressure in this area means that advisers do not have the incentive to compete on price or service.

Next steps

The FCA's role in the pension savings market has become increasingly significant over the years, with the FCA extending its scope by working alongside The Pensions Regulator and the Department for Work and Pensions.

With a tighter rein, the FCA continues to promote greater competition and measures of protection for consumers. However, some argue that the FCA is overreaching itself and does not understand the rationale behind consumer choices, such as in respect of DB pension transfers.  Furthermore, the FCA's recent heavily critical approach in relation to pension transfers has caused many advisory firms to leave the pension transfer market, meaning consumer choice is rapidly reducing and, indeed, access to advice on this critical and complex area is becoming hard to come by.

Despite PPI complaints breaking the 2million mark, this last-ditch flash in the pan is expected to taper off over 2020 as the deadline for PPI complaints expired in August 2019.

While the FOS is busy working through this backlog, amid a number of other established FOS complaint streams, we anticipate the rise in complaints about DB pension transfers and SIPP schemes to continue.

The Data

FOS figures for complaints about DB pension transfers show that in quarter 2, (July to September 2019) the FOS received 157 complaints and had an uphold rate of 34%. In quarter 3 (October to December 2019) the number of complaints rose to 213 (a 35% increase) but with an uphold rate of only 29%.

Similarly, for SIPP schemes, in quarter 2 the FOS received 597 complaints and had an uphold rate of 56%.  Quarter 3 saw an increase in complaints to 653 (a 10% increase) but a drop in the uphold rate to 49%.

What we have seen on the ground

Those with an ear to ground will be aware that pensions related complaints have been a thorn in the side for pension advisers and SIPP operators alike over the last few years as the FCA seeks to clarify what it says it always expected of the pensions industry from the outset.

It is interesting, nonetheless, that despite the very high profile of the FCA's concerns about pension transfers, the actual number of complaints in this area remains comparatively low.  (Indeed, many of the complaints that have been made are not about the suitability of the advice provided but about delays in the transfer processing.)

What we are seeing, however, and what the figures don't show, is that there are strong indications that the driver for the rise in pensions complaints is the prevalence of claims management companies (CMCs) and the efforts they are going to in order to generate complaints in these areas, thus replacing the income lost due to the end of PPI complaints.

This certainly marries up with our experience as we have seen a sharp rise in pensions related complaints fronted by CMCs. At the same time, we are aware of a number of reported incidences where CMCs are flouting their obligations under the Claims Management Conduct of Business Rules with cold calling and promises of guaranteed cash to customers.

What we expect next and the battle grounds

We expect pensions related complaints, particularly about DB transfers and SIPP investments, to continue to rise as CMCs continue to permeate these markets.

While the drop in the percentage of upheld complaints suggests the FOS may be starting to get to grips with the issues, it is just as easily explained by the likely increase in complaints from the unmeritorious end of the complaint spectrum as CMCs blanket these markets for clients.

While the pensions market would be well served to get its house in order for the barrage of pensions related complaints to come, RPC has had some promising traction in not only responding to the complaints, but also by adopting strategies that undermine the CMCs credibility and competence with the FCA.

As those that follow developments in the SIPP market will be aware, SIPP providers have been facing an increasingly difficult battle before FOS when it comes to due diligence undertaken on assets at the time assets are incepted in to a SIPP.  The Berkeley Burke judicial review confirmed the FOS' position on what it considers are the due diligence obligations of SIPP providers at paragraph 35 of the High Court's judgment.

In the wake of the insolvency of Berkeley Burke and, as a result, the end of the appeal of the High Court judgment, we are aware that the FOS wrote to SIPP providers with complaints pending before FOS inviting those SIPP providers to revisit complaints in light of the High Court's judgment.  We also understand that FOS has been reopening previous complaints upheld in favour of SIPP providers.

Other scenarios

These developments are arguably limited to the issue of what FOS considers it is fair and reasonable for a SIPP provider to do in terms of due diligence when incepting an asset into a SIPP.  They arguably do not deal with what the legal obligations on SIPP providers are (we are waiting for Adams v Carey for hopefully some clarity there), what if any ongoing due diligence obligations fall on a SIPP provider and what obligations of due diligence does a SIPP provider have for investments made via an investment manager (including discretionary fund managers, discretionary investment managers and offshore bonds) (IMs).  It is this latter issue which appears to be coming to the fore following recent insolvencies of investment managers which hit the press this week (albeit for an IFA firm).

Investments via an IM

We are not aware of any published FOS decisions on this issue, so what is it a SIPP provider may have to do? To start with the FCA has spoken about this.  In the FCA Handbook No.28 the FCA broadly appear to say that a SIPP provider should put contractual arrangements in place to ensure that an IM portfolio comprises "standard" assets and a "standard" asset is one that can be valued on a continuous basis. 

But what more should the SIPP provider do? In our view a SIPP provider should check the permissions of the IM for any obvious fraud risks (does the IM have relevant permissions and what can it invest in compared to the contractual documentation in place?).  Also, if the SIPP business is coming from an IFA, does the IFA have relevant permissions and if there is no IFA, is there an unauthorised introducer involved?

Beyond this, what more is it a SIPP provider should do? For example, should it be checking what investments have been made by the IM and questioning these investments if they are, for example, high risk or a single asset class? This is where the difficult questions come in.  Most SIPP providers were unaware of what investments an IM had made until the introduction of the capital adequacy rules in September 2016.  As a result, no ongoing monitoring was conducted to check investments fell within the contractual arrangements SIPP providers had in place with the IM, but equally no check was conducted on the underlying investment – but does this matter?

This is the key question for SIPP providers facing complaints about losses held within IM portfolios.  In our view – if the IM is properly regulated with the right permissions, the contractual documentation as required by the FCA is in place and there is an authorised IFA (and ideally one unconnected to the IM) directing the IM investments – then there are good defences for the SIPP provider.  This is because the SIPP provider has conducted due diligence on the investment, it is just that the investment is the IM.  Further, if a SIPP provider went further and started raising questions around the investments held via IMs there must be a risk the SIPP provider strays beyond its permissions into providing investment advice – a breach of FSMA – and as a result there is a good argument that once the investment via the IM is made there is not much the SIPP provider can do about it.

What next?

There are some high-profile insolvencies of IMs at present – SVS Securities, Strand Capital and Horizon Stockbroking Limited – we are expecting and have already seen complaints arising out of these insolvencies.  As always, the complaint against the SIPP provider typically comes where the SIPP provider is the only remaining regulated entity in the investment chain.

We may shortly see some of the unanswered questions around SIPP provider due diligence and IMs answered as a result.

This blog post will focus on two recent publications regarding the monitoring and regulation of crypto-assets, namely:

1. The Financial Stability Board's review of the potential systemic global impact of stablecoin cryptoassets; and

2. The Financial Conduct Authority's consultation on the cost of supervising the cryptoasset industry in the United Kingdom.

Financial Stability Board Reviews Stablecoins

One type of crypto-asset that is particularly in the international spotlight are stablecoins.

In brief, stablecoins are a type of a crypto-asset designed to maintain a stable value relative to another asset, such a unit of currency.  Stablecoins have gained traction as they attempt to offer the best of both worlds - the instant processing and security or privacy of payments of cryptocurrencies and the volatility-free stable valuations of government issued currencies.  However, the term itself should not be read as an endorsement as to their value, stability or legal standing.

The Financial Stability Board (FSB) is an international body that monitors and makes recommendations about the global financial system.

On 18 October 2019, the FSB issued a note on the regulatory issues surrounding stablecoins, which it had delivered to the G20 meeting of finance ministers and central bank governors in June 2019. 

It was the G20 leaders' intention at the June 2019 meeting to make united efforts to address major global economic challenges. The result of that meeting was the G20 Osaka Leaders' Declaration which included an acknowledgement as to the potential risks concerning the crypto-asset industry, stating:

"Technological innovations can deliver significant benefits to the financial system and the broader economy. While crypto-assets do not pose a threat to global financial stability at this point, we are closely monitoring developments and remain vigilant to existing and emerging risks. We welcome on-going work by the Financial Stability Board (FSB) and other standard setting bodies and ask them to advise on additional multilateral responses as needed."

The FSB's note builds upon work undertaken by the G7 working group, published by the Committee on Payments and Market Infrastructures in October 2019.  Both the FSB and the G7 recognise the potential benefits of stablecoins contributing to the development of global payment arrangements that are faster, cheaper and more inclusive than present arrangements whilst highlighting the significant risk of these particular crypto-assets.

The FSB's note addresses, in particular, the announcement by private sector firms of their intention to launch stablecoin-type arrangements for domestic and cross-border retail payments.  The FSB note, therefore, states that this development has the potential to reach a global scale which, in turn, could alter the G20's current view that crypto-assets do not pose a risk to global financial stability as stablecoin arrangements could potentially become a source of systemic risk as they have:

• a large potential user base and have the potential to grow quickly.  As a result, stablecoins could become of systemic importance in individual jurisdictions, including through the substitution of domestic currencies or even on a global scale.

• features of different types of financial services such as payment systems, bank deposits and foreign currency exchanges as a result of which they may give rise to new financial stability risks.

• the potential for extensive and impactful linkages to the existing financial system.

• the potential to cause instability to financial markets through adverse confidence effects such as concerns about market manipulation and lack of market integrity, anti-competitive behaviour, lack of adequate data protection, money laundering, terrorism financing and other illicit financing activities.

It is the FSB's intention that, in an attempt to counter these potential systemic risks, it will:

• review existing supervisory and regulatory approaches and emerging practices in this field, focussing upon cross-border issues as well as taking into account the perspective of emerging markets and developing economies.

• consider whether existing supervisory and regulatory approaches are adequate and effective in addressing financial stability and systemic risk concerns as set out above; and

• advise on possible multilateral responses, if deemed necessary, including developing regulatory and supervisory approaches to addressing financial stability and systemic risk concerns at the global level.

The FSB therefore plans to submit a consultative report to the G20 Finance Ministers and Central Bank Governors in April 2020, and a final report in July 2020.

To read the FSB's note, please click here.

The Financial Conduct Authority consults on the cost of supervising cryptoasset businesses

In July 2019, the UK Government announced that the Financial Conduct Authority (FCA) will be the anti-money laundering (AML) and counter terrorist financing (CTF) supervisor of UK cryptoasset businesses under the money laundering regulations (MLR), from 10 January 2020.

A UK cryptoasset business must therefore comply with the requirements of the MLRs from 10 January 2020 and the FCA will start supervising businesses from 10 January 2020, irrespective of whether they have registered or not.

The FCA's consultation paper sets out they expect that:

• New cryptoasset businesses (that intend to carry on a cryptoasset activity after 10 January 2020) must be registered before they can carry on the activity; and
• Existing cryptoasset businesses (which were already carrying on cryptoasset activity before 10 January 2020) may continue their business, in compliance with the MLR, but must be registered by 10 January 2021 or stop all cryptoasset activity.

Applications for registration will open on 10 January 2020.

The FCA's proposals will see it recover its costs from cryptoasset businesses through a one-off registration fee and an annual fee.

As cryptoasset activities will be new activities under the MLRs, the FCA has limited information on the different business types and the relative complexity involved in assessing them.  Couple this with the decentralised nature of this business, rapid technological development and that there are over 1,000 cryptocurrencies available, it is no surprise that the FCA is consulting to consider its next steps.

The regulator proposes to distribute recovery of the costs of setting up and operating the registration process equally between all applicants. The FCA estimates the total cost of this process is approximately £400,000 and it is currently aware of about 80 potential applicants, though more are expected over time.  The FCA accordingly proposes to set the registration fee at £5,000. This fee will also be paid by businesses that are already authorised or registered with the FCA and which must register with the FCA to carry on cryptoasset activity.

In terms of the FCA's ongoing regulatory costs in this field, they will seek to recover these via periodic fees (i.e. variable annual fees).  It is proposed that the amount a business will have to pay annually will be calculated based on its usual ‘tariff’ basis. The FCA has proposed that:

• It will create a new fee block for cryptoasset business;
• The tariff will be based upon income with the FCA's standard definition of income applying;
• Fee-payers will report on the basis of their accounts, for their financial year ending during the previous calendar year. This means that the 2020/21 fees would be based on their accounts for their financial year ending up to 31 December 2019; and
• It will consult on what an appropriate minimum fee threshold should be for this business class.

 The deadline for responses on the registration fee is 11 November 2019, whilst the deadline for answers over the periodic fee is 10 December 2019. RPC will be sure to discuss the findings once released.

To read the FCA's consultation paper, please click here.

The AMS is part of a new framework, which aims to improve professionalism across the industry by:

• Providing evidence of the quality of actuarial work;
• Promoting best practice; and
• Considering issues of relevance to members in the profession.

The FRC was supportive of the review with Stephen Haddrill, Chief Executive stating:

"We welcome the IFoA’s new monitoring scheme which will provide insight into the quality of actuarial work and the effectiveness of actuarial standards. By promoting best practice and the importance of actuarial work the new scheme is a positive step for the actuarial profession."

The IFoA has confirmed that regular Thematic Reviews will take place (ensuring that areas or work relevant to actuaries are covered) as well as data gathering on an ad hoc basis. These will include questionnaires and analysis of insights from other regulators. The changes will also see the introduction of a new Actuarial Review Team which will undertake reviews on topics relevant to actuaries.

The AMS will encompass two thematic reviews in 2020, focusing respectively on pensions and insurance (areas where it was felt that the profession requires the most assistance and guidance).

Pensions

The pensions review will focus on the actuarial factors used to calculate member benefits.  It will look at current practices adopted by actuaries including how factors such as commutation at retirement are determined for pension schemes and how frequently these factors are reviewed.

Insurance

This review will consider the role of actuarial advice in the pricing of specific general insurance products.  The IFoA has recognised that pricing is a complex area for actuaries and the review will consider the processes adopted by actuaries and the challenges they face when providing advice in this area.

We can expect the AMS to produce regular feedback in relation to the findings of the thematic reviews, which will be of wide interest within the industry.  Here at RPC we will await the AMS' findings with interest and report further upon any significant findings.

"2018 saw the equity release market cement its position in the mainstream of financial services" states David Burrowes, Chairman of the Equity Release Council. Well, if 2018 was the year it was cemented, 2019 will be the year it expands that position substantively. Equity release is becoming an increasingly popular option with more than £4bn of borrowing released in the last year. It is understood that 22,126 equity release plans were taken out between January and June 2019; 5.6% more than the same time the previous year. The figures show a trend of equity release products becoming more popular once again, after years out in the cold following concerns that the product was not well protected and was not transparent for individuals.

Introducers (who for equity release products are typically advisers who lack the permissions necessary to advise on equity) create partnerships with other advisers who they will refer clients to. Of the advisers surveyed it is understood that an estimated 11% of their income in the next 5 years will come from equity release referrals, which has led to suggestions that equity release is having a resurgence.

The Equity Release Council has recently been encouraging advisers and regulators to promote equity release more in an attempt to help deal with the rise in the number of retired individuals needing a cash injection. Indeed growing consumer demand has meant that the number of equity release products has risen from 130 types of product in August 2018 to over 221 today.

Despite the encouragement for individuals to consider equity release as a potential option, advisers should remain cautious not to recommend such products to everyone. There are a large number of risks associated with equity release products that advisers should highlight to anyone considering equity release, including:

• Interest rates are higher than a typical mortgage product, which can lead to interest charges mounting up over several years. In some cases, families have owed the entire value of the house to the equity release company;

• A home reversion equity release plan effectively sells part (or all) of a property to the provider, meaning that any investment in the property and subsequent property value increases will be lost;

• A lump sum of cash from the equity release may change an entitlement to state benefits meaning that individuals could forfeit entitlement to benefits such as pension credits

 Advisers will need to ensure that equity release is the most suitable option available to that specific individual and that there are no other options (including pension lump sums or downsizing to a smaller property).  

The principal aim of the Consultation Paper is to provide a series of proposals intended to reduce the number of consumers transferring out of their DB pension schemes  - something that the FCA considers is not in most people's best interests to do. The FCA is also seeking to reduce the scope for conflicts of interest, empower consumers to make better decisions and enable advisers to give better advice. There are two key proposals in the consultation that may have slipped through the net in mainstream media coverage. 

Firstly, the FCA proposes introducing "abridged advice", acting as a mechanism to filter out consumers for whom a pension transfer is not suitable. Where a firm considers that it is appropriate to provide abridged advice, it will allow them to provide a lower-cost alternative to full pension transfer advice. Through abridged advice an adviser must still carry out crucial components of the advice process, including "Know Your Client" and risk assessments, but does not require a firm to provide Appropriate Pension Transfer Analysis (APTA) or a Transfer Value Comparator (TVC).  

However, through abridged advice, a firm cannot recommend a transfer and can only either recommend that the consumer does not transfer or recommend that they must take independent, full pension transfer advice to establish whether a transfer is suitable. In essence, abridged advice allows the firm to provide quicker and simpler advice, which carries less of a regulatory burden, but which will only result in a "no" or "unclear" outcome for the client.

Secondly, the FCA considers that, where a transfer from safeguarded benefits to flexible benefits is suitable, the presumption should be that the pension funds should be transferred into an available workplace pension scheme (WPS). This is because it is a lower-cost and (likely) lower risk pension than the more usual destinations for pension transfers, such as SIPPs.  Furthermore, transferring funds into an existing WPS will be less likely to require ongoing advice and the costs associated with the same.

If they think that another scheme is more suitable, firms will need to demonstrate why that is the case. The FCA has listed some examples of specific reasons it considers as valid for not using a WPS and these are strikingly limited. In essence, the regulator is apparently aiming to prevent transfers into anything other than a WPS, except for previously experienced investor clients.  

This proposal has received less media attention than the proposed ban on contingent charging but could have greater ramifications for advisers, since it is likely to reduce the fees advisers are able to earn from ongoing advice charges.

Furthermore, the FCA has provided a clear and unambiguous indication that it will be at the adviser's risk to transfer a pension into anything other than a WPS. If that is the intention, the adviser needs a very good reason to do so.

To read FCA Consultation Paper CP19/25, click here

• the Senior Managers Regime (SMR) which focuses on regulatory approval for senior individuals in each firm;
• the Certification Regime, under which the onus is on firms to assess whether employees who could harm the firm or its customers are "fit and proper" to perform their roles; and
• the Conduct Rules, which are high-level standards of behaviour for all individuals working in financial services.

Policy Statement

On 26 July 2017 the FCA published a Policy Statement, which sets out near-final rules on the extension of the SMCR to FCA sole-regulated firms and sets out the final rules on a new directory of the individuals working in financial services.

The headline points from the Policy Statement are:

1. It confirms that a firm's Head of Legal function will not come under the SMR due to the fact that the disclosure obligations expected of individuals within the SMR would be incompatible with the Head of Legal function requirement to maintain legal privilege. 
2. It amends the criteria for the "Enhanced" regime, which identifies firms to which the FCA will apply extra requirements.
3. It clarifies the requirements and scope of the Certification Regime in respect of the "client dealing" function and circumstances where a Senior Manager also carries out a systems and controls role.
4. It extends the Senior Manager Conduct Rule that obliges senior managers to "disclose appropriately any information of which the FCA or PRA would reasonably expect notice" to non-approved executive directors at Limited Scope firms.  This corrects an anomaly where some non-executive directors at such firms were caught by this rule, but executive directors previously were not.  Now, all directors at Limited Scope firms will be required to comply with this rule.

Stocktake Report on SMCR in the Banking Sector

The FCA has also recently published a Stocktake Report looking at how the banking sector has embedded the SMCR since March 2016 in a bid to assess whether there are any issues that require more focus from firms and/or the FCA. 

The report finds that most firms have made a "concerted effort" to implement SMCR.  For sole-regulated firms looking to prepare for the December implementation deadline, the key takeaways from the report are:

• The Conduct Rules are the "critical foundation" for a firm's culture.  The FCA found that staff generally understood the Conduct Rules but it found that many firms were unable to explain what a conduct breach looked like in the context of their business.  The FCA plans to increase its supervisory focus on the Conduct Rules and considers that clear mapping of the Conduct Rules to a firm's values, as well as role-specific training will be indicators of how well the Conduct Rules are understood and implemented by firms.
• The FCA found many Senior Managers remained concerned as to the meaning of their responsibility to take "reasonable steps" to prevent a regulatory breach.  The FCA referred back to the guidance in the Decision Procedure and Penalties manual and noted it will not issue further guidance in this regard, but instead encouraged Senior Managers to think more "broadly" and to create an environment where the risk of misconduct is minimised. 
• Firms have implemented systems to oversee the employees falling within the Certification Regime and the FCA found they have generally broadened their approach to assessment of staff beyond solely technical skills.  The FCA found that managers are in a better position to assess the behaviours of their certified staff, but there were some issues, such as most firms could not demonstrate how they ensure consistency of their assessment approach across the population of certified staff.

With only a few months until SMCR is extended to all FCA sole-regulated firms on 9 December 2019, incoming firms would do well to take these findings onboard as they prepare to join the ranks of firms under the SMCR.

The 95 Claimants deposited money in a 'Ponzi' scheme operated by the director of one of Sense's ARs.  Sense discovered the scheme in 2014 on receiving a whistle-blower notification and immediately reported the scheme to the FCA, leading to the scheme's collapse.  The funds placed into the scheme were almost entirely lost.

In a lengthy High Court trial that took place in 2018 the Claimants asserted that Sense was liable for their losses on various grounds.  Mr Justice Jacobs dismissed the claim, accepting expert evidence that Sense was a "very good firm" and not at fault in not having discovered the scheme.  The Judge also found on the facts that the AR had no actual or ostensible authority to run the scheme.

The Claimants obtained permission to appeal to the Court of Appeal on two grounds, neither of which alleged any wrongdoing by Sense: (1) that Sense was liable by operation of s.39 Financial Services and Markets Act 2000 ("s.39"); and (2) that Sense was liable on the basis of the general doctrine of vicarious liability.  This was the first case in which the Court of Appeal had been asked to consider the interpretation of s.39.

The Court of Appeal today dismissed the appeal.  In relation to s.39, the provision under which principal firms accept liability for certain actions of their ARs, the Court found that it is entirely valid, as Sense had done, to place limits on the scope of the permission granted to an AR.  S.39 allows a principal to authorise the whole or part of a regulated activity.  The Court accepted that Sense had only given permission for its AR to do business through the Company Agencies it maintained with individual product providers.  The scheme had not been business done through such agencies and therefore fell outside the scope of the business for which Sense had accepted responsibility in writing.  Consequently, Sense was not liable under s.39 for the AR's acts.

This finding will be helpful to any advice network seeking to rely upon contractual restrictions on the AR business for which it has accepted responsibility, including in the context of complaints to the Financial Ombudsman Service, which is obliged to take account of the law on this issue.

In relation to vicarious liability, the Court was dismissive of the Claimants' argument that Sense was vicariously liable at common law for the actions of its AR.  Even if the general principles of vicarious liability did apply to an AR relationship (a point the Court decided it did not need to determine) the Court noted that the AR: (a) was part of a recognisably separate business from that of the principal; and (b) was not 'assigned activities' by the principal.  Although the decision was on the facts this finding is encouraging for financial advice networks defending allegations of vicarious liability for ARs.

The Court of Appeal's judgment can be found here and a detailed case note published by Sense's counsel exploring the detail of the decision and its significance further can be found here.

The aims of the rules are to ensure investors have clear and accurate information about the investment risk of a product, to allow them to make suitable investment choices and to understand that their capital is at risk and they may suffer losses.

In summary the following key rules will be implemented:

• Marketing restrictions will be applied in an attempt to protect unsophisticated investors.

   

• Appropriateness assessments will be introduced when no advice has been given to the investor.

   

• The Mortgage and Home Finance Conduct of Business sourcebook (MCOB) and other Handbook requirements will now be applicable to P2P platforms that offer home finance products, where at least one of the investors is not an authorised home finance provider.

These changes are discussed more below.

Marketing restrictions

P2P platforms will soon be restricted to marketing to sophisticated and high-net-worth investors, those receiving regulated investment advice or those who certify that they will not put more than 10% of their investment portfolio in P2P loans. The FCA states this is an attempt to protect unsophisticated investors who are unaware of the risks involved with P2P lending.

This change has not been welcomed by all with Rhydian Lewis, chief executive of RateSetter, one of the largest P2P platforms, accusing the regulator of "patronising normal people".

Appropriateness test

Although not quite a ground-breaking introduction given such a system already exists in crowd bonds and equity crowd funding, the test aims to help assess whether the investor has an understanding of a number of matters, including the relationship between the borrower and the platform; that returns may vary; that all capital is at risk; and that there is a lack of FSCS protection.

Christopher Woolard, executive director of strategy and competition at the FCA, said: "These changes are about enhancing protection for investors while allowing them to take up innovative investment opportunities. For P2P to continue to evolve sustainably, it is vital that investors receive the right level of protection."

The introduction of the test is not without questions, as many P2P platforms will now be asking themselves: when does the test need to take place – at the time of registering with the platform or when the investment is made? Further clarification is likely to be needed from the FCA if firms are not to be caught out.

Introduction of the MCOB requirements

There is currently no P2P market for home finance, however the FCA understands that some P2P lenders are moving into the home finance lending sector. They would not currently be able to offer the same level of protection that that a consumer would have if they purchased a mortgage in the traditional sense.

Requirements will include the P2P lender ensuring that any investor is able to afford the sums due under the contract and largely mirror the MCOB requirements.

The application of these rules will have immediate effect.

Where next for P2P?

The rules provided by the FCA are undoubtedly a step in the right direction. Given so little is known about P2P lending and the obligations of the platforms offering such services, it is alarming to consider that a survey of 4500 P2P customers in 2018 found that 40% of those surveyed had invested more than their annual income.

The rules should provide greater protection to consumers and greater clarity to P2P platforms. It is also an acknowledgment that P2P lending is here to stay, with the regulation providing a degree of authority to P2P platforms who can no longer be viewed as 'new' unregulated providers.

P2P platforms have until 9 December 2019 to implement the majority of these changes. To read the FCA's policy paper, please click here.

The survey revealed that many accountants have seen a noticeable increase in the number of clients approaching them for advice surrounding the potential risks resulting from Brexit. The Managing Director of the company (Wolters Kluwer) conducting the survey noted, "while there continue to be uncertainties, Brexit offers many opportunities for accountants."

Those firms surveyed identified the impact upon the customs, excise and VAT procedures as being their key concern regarding the UK's withdrawal from Europe. The survey also showed that accountancy firms consider that technology will be the most important aspect to ensure that clients are able to deal with the impact of Brexit.

The Institute of Chartered Accountants (ICAEW) has also recently commented on the potential detrimental impact leaving the EU may have on the UK's economy. Last month, Mr Manuzi (regional director for Europe of the ICAEW) told the Brexit Select committee that, "it is likely we may well see after November 1 a flurry of profit warnings from companies finding themselves in completely unprecedented circumstances." If this is the case the accountancy profession is likely to be kept busy in the autumn of this year. Those accountants involved in the auditing of companies' accounts are also likely to be keeping a close eye on the impact caused by Brexit upon their client's accounts.

As noted in our previous update the outcome of Brexit will also have an impact on those auditors of UK PLCs with a presence in Ireland. Earlier this year Ireland’s accounting watchdog is understood to have written to the largest audit firms in the UK encouraging them to prepare for a “no-deal” Brexit. Notably, the Irish Auditing and Accounting Supervisory Authority has made clear that a hard Brexit will result in UK audit firms becoming classed as “third country” auditors in Ireland. As a result these firms will have to register with the Irish authorities to continue the auditing of Irish companies. The ICAEW's update on the position at the end of May this year noted that nature of the eligibility requirement for UK audit firms in Ireland after Brexit remains unclear.

The information obtained seems to have only heightened the FCA's concerns about such business.  In brief, 3,015 firms were surveyed of which 2,426 had provided advice on DB transfers between April 2015 and September 2018.

Of key concern to the FCA is that, of 234,951 customers receiving advice, 162,047 (69%) were advised to transfer. The FCA is concerned that this doesn't tally with their opening position, being that firms should begin from the assumption that a defined benefit pension transfer will not be in a client's best interest.

It should be stressed that the FCA has not assessed the actual advice given in respect of these transfers and its concerns are simply in respect of the raw data and how this tallies with the presumption of unsuitability. (For example, high levels of transfer recommendations may simply reflect a firm's effective triage of clients prior to the provision of full advice.)

Nevertheless, Dawn Butler (Executive Director of Supervision, Wholesale and Specialists of the FCA) has commented as follows:

"It is deeply concerning and disappointing to see that transfers are still being recommended at the levels we have seen."

This is perhaps a premature statement given that the advice itself has not been reviewed but nevertheless the FCA will now be ramping up its oversight of what is already a heavily supervised area. The FCA has already started visiting firms that are most active in this field and will be writing to firms where the potential for client harm has been identified from the data they have provided.  It seems that that FCA is especially concerned about the 1,454 firms that have recommended transfers to 75% or more of clients.

What happens next will depend on what potential client harm the FCA ultimately identifies but it certainly seems possible that we could see further information requests and perhaps even s.166 reviews following this.

 
Raphaels contracted with outsourced providers to deliver services which were vital for the performance of its Payment Services Division. These outsourced services included the authorisation of payment transaction requests from Card Payment Systems on behalf of the bank (the service was ultimately sub-contracted). It was held that Raphaels failed to have appropriate processes in place to enable it to understand and assess the business continuity and disaster recovery arrangements of its outsourced service providers, specifically how they would manage the ongoing operation of their card programmes if a system failure were to occur.

 The absence of such processes came to light on Christmas Eve 2015 when Raphaels' card processor was hit by a technology problem that caused a complete failure of the authorisation and processing services provided to Raphaels.

 The incident lasted over eight hours, during which time 3,367 customers were unable to use their prepaid card and charge cards. A total of 5,356 transactions were attempted and failed. There is unlikely to have been a worse day for this to happen given the last minute Christmas shopping that would have undoubtedly have been taking place.

Mark Steward, FCA Executive Director of Enforcement and Market Oversight said: "Raphaels systems and controls supporting the oversight and governance of its outsourcing arrangements were inadequate and exposed customers to unnecessary and avoidable harm and inconvenience. There is no lower standard for outsourced systems and controls and firms are accountable for failures by outsourcing providers."

Whilst Sam Woods, Chief Executive Officer of the PRA, said: "Firms ability to manage outsourcing of any critical activities is a vital part of maintaining their safety and soundness. Such outsourcing is an important part of a firms operational resilience, and particularly so in the case of Raphaels given the level of reliance on outsourcing in its business model.

In addition, this was a repeat failing which demonstrates a lack of adequate and timely remediation. This is a significant aggravating factor in this case, leading to an uplift in the penalty."

In fact, the incident in question took place just one month after the FCA had fined Raphaels £1,300,000 for "potentially putting its safety and soundness at risk" after it failed to properly manage an outsourcing deal for its cash machines.

The fines and decisions from the FCA and PRA should put regulated firms (and in particular financial institutions and investment managers who regularly use outsourcing services under the Payment Services Regulations) on alert to ensure adequate and appropriate systems are in place for outsourcing activities. The investigation was also critical of the deeper flaws in Raphaels' overall management and oversight of outsourcing risk across all levels; something that other firms will need to consider if they wish to avoid similar criticism.

The joint FCA and PRA investigation identified weaknesses throughout Raphaels' outsourcing systems and controls which the firm ought to have known about since April 2014. These included: 

• a lack of adequate consideration of outsourcing within its Board and departmental risk appetites;

• the absence of processes for identifying critical outsourced services;

• and flaws in its initial and on-going due diligence of outsourced service providers. 

During Tribunal hearings held in 2017 and 2018 it was held that the auditors of the Tanfield Group failed to identify discrepancies in the most significant items on the company's balance sheet. In summary, the issue for the FRC Disciplinary Tribunal was whether the identified failings amounted to misconduct.  The Tribunal's decision is the result of a near decade long legal process which included an unsuccessful judicial review application by the auditors to challenge the regulator's pursuance of an investigation. In this update we concentrate on the FRC's comments on the differences between misconduct and negligence.

Misconduct vs. Negligence

By way of background the FRC's rules and procedures set out that "Misconduct" is,

"an act or omission or series of acts or omissions, by a Member or Member Firm in the course of his or its professional activities (including as a partner, member, director, consultant, agent or employee in or of any organisation or as an individual) or otherwise, which falls significantly short of the standards reasonably to be expected of a Member or Member Firm or has brought, or is likely to bring, discredit to the Member or the Member Firm or to the accountancy profession."

The FRC grappled with the distinction between a finding of negligence and a determination of misconduct for the purposes of assessing whether the auditors should have signed off a "clean" audit report for the Tanfield Group.

One key area for contention in the Judicial Review application brought by the auditors was whether the FRC should have proceeded to a formal complaint in the first place. The auditors had submitted that the alleged misconduct fell within the category of conduct described in the FRC guidance as a ‘non-trivial failure’. On this basis the auditor argued that a 'non-trivial failure' did not meet the threshold of 'misconduct' in the FRC's accountancy scheme disciplinary arrangements.

At the FRC Tribunal the Executive Counsel submitted that whilst negligence was not misconduct, conduct which fell short of "gross incompetence" could nevertheless amount to misconduct. Whereas the auditors emphasised the need to beware of evidence which amounts to no more than an expression of opinion by an accountant as to what they would have done in the same circumstances, and the need to distinguish between best practice, acts or omissions "falling short" and acts or omissions "falling significantly short".

Both parties referred to the test as to whether a "responsible" or "reasonable" body of professional opinion could do as the accountant did, the "Bolitho Test" following Bolitho v City and Hackney Health Authority. The auditors submitted that there is scope for differing interpretations as to the meaning of the relevant professional standards and that more than one professional view may satisfy the Bolitho Test. Interestingly, there was an absence of consideration of the Courts' more recent interpretations of the test for negligence, such as in the case of Coutts v O'Hare for instance where the judge moved away from the test in Bolitho. In more recent times the Courts have questioned whether the test for negligence should be more focussed on what a claimant would be expected to be told to put them in an informed position as opposed to whether an individual has met the commonly accepted practices.

Notably, the FRC held that, "it is not bound to unquestionably accept the evidence of an expert as to what reasonably competent auditors would do in any given circumstances". The FRC was unpersuaded by the auditors' position that, "another way of testing the position is to ask whether the shortcomings are so serious that they would undermine public confidence in the accountancy profession". The FRC stated that this "adds a gloss" on the wording of the relevant rules which refers to conduct that "is likely to bring discredit to the Member or the Member Firm or to the accountancy profession" as a separate basis for a finding of misconduct.

The Tribunal's Assessment of the Correct Approach

Following a detailed review of the differences between misconduct and negligence the Tribunal considered that the appropriate approach to determining misconduct was as follows:

1. Step One

   Start by considering the position of each respondent in respect of each allegation and ask whether the conduct relied upon justifies a "falling short" criticism. This requires consideration of whether no reasonable or responsible body of opinion could support the conduct.

   To the extent that the answer to above question is "no" then that it is the end of the matter.

2. Step Two

   Next, to the extent that the Tribunal considers that one or more criticisms of falling short are established, then for each allegation the Tribunal will consider whether in fact the conduct is not merely serious but sufficiently serious to cross the threshold into significance so as to justify a finding of misconduct.

   The FRC's decision makes clear that ultimately the judgment as to whether an individual's actions amount to misconduct will be at the discretion of the regulator. The views and opinion of accountancy experts in contested regulatory hearings will be useful but not decisive. The two step test as referred to above may however provide a useful tool in defending regulatory actions against accountants in circumstances where an individual's actions although sub-standard do not cross the bridge to amounting to "misconduct" if it can be shown their errors were not sufficiently serious.

Binary options are products where a bet is made on the difference between the entry and exit prices of an underlying asset, to be measured after a set period of time.  Key to the definition of such instruments is that the potential payment available to investors is set from the outset, and the outcome is "all or nothing".  The FCA believes that there is an inherent risk to retail consumers from such products, such as their complex pricing structure and highly speculative nature making them akin to gambling products, and promoting addictive behaviours in a similar way.

In its policy statement, the FCA has taken pains to confirm the position post-Brexit, confirming that it intends that the rules will continue to apply to the same firms as they applied under EU law pre-Brexit.  Whilst the FCA has also confirmed that compliance with the FCA's rules will necessarily mean compliance with the ESMA equivalent, there are a few key differences which should be highlighted:

• ESMA has authority to impose restrictions for a three month period only, therefore its prohibitions must be renewed to remain in effect (ESMA's latest renewal will also take effect on 2 April 2019, for a period of three months), whereas the FCA's rules are made on a permanent basis; and

• the FCA's prohibition is more wide ranging than ESMA's, taking in securitised binary options which are exempt from ESMA's ban.

On the second point, the FCA has addressed the view (raised by respondents to its consultation) that securitised binary options do not expose retail consumers to the same amount of risk as "over-the-counter" binary options.  The FCA found that whilst securitised binary options are arguably less prone to aggressive marketing, and their longer duration may limit the risk of compulsive gambling behaviour, it still considers the products pose an "inherent risk of harm to retail consumers", which is not sufficiently reduced by the additional features of securitisation such as being sold with a prospectus.

The FCA's concerns with binary options appear to be, at least partly, due to the probability of retail consumers being left with less than their initial investment: in responding to respondents' requests for clarification, the FCA has noted that structured products where the lower of two pre-determined fixed amounts is at least equal to the retail consumer's total payment (i.e., the consumer is guaranteed to get at least their investment back) will not be considered to be binary options.

Less than one month in to 2019 and the FCA have provided perhaps the biggest sign that cryptocurrencies are here to stay. A consultation paper from the Crypto Asset Task Force was released last week, which aims to provide guidance on the long-awaited crypto regulation.

The announcement comes after the FCA has faced pressure from Parliament in relation to the lack of regulation, despite the FCA's actions and statements throughout 2018 leading most to believe that regulation was around on its way. Indeed in April 2018, RPC wrote of how deregulated cryptocurrencies could soon be a thing of the past.

Of course, the FCA can be forgiven for its delay. After all, most people had never heard of cryptocurrencies five years ago, and the regulation of such a complex issue isn’t an easy task to undertake.

Indeed the question remains how would regulation work? It is hoped we will have some answers following the consultation paper. The FCA will focus on where cryptocurrencies would be defined as: 

• Specified Investments under the Regulated Activities Order; or

• Financial Instruments under MIFID II. 

The paper will also discuss whether cryptocurrencies fall under the Payment Services Regulations or the E-Money Regulations.

It is hoped that the final guidance, to be released after the consultation has ended, will allow firms to have a greater understanding as to whether the cryptoassets they are dealing with, fall within the regulatory remit.

RPC also understand that Treasury Select Committee will be publishing its own consultation paper in the coming months, which will explore "legislative change to potentially broaden the FCA's regulatory remit to bring in further types of cryptoassets". Once this is released, we will of course review and provide our thoughts.

The consultation will remain open until 5 April 2019 and RPC will be awaiting the results with interest. 

The FCA collected information from 45 firms and conducted a file review on 18 of them. It is understood that of these 18 firms advice was given to 48,248 clients on their DB pension schemes. The regulator carried out a review of 154 transfers. The FCA report noted:

"We are disappointed to have found that less than 50% of the advice we reviewed was suitable. Our results are based on our targeted work and are therefore not representative of the whole market. However, it is particularly concerning that, despite our feedback to the sector, firms are still failing to give consistently suitable advice."

The FCA's findings identified that of the sample cases reviewed 48% were suitable, 29% of cases were unsuitable and 23% of cases were unclear. The "unclear" cases had been categorised where firms failed to collect key information as part of their fact finding or where they did not conduct sufficient analysis to demonstrate (for example in the suitability report) why their recommendation is suitable.

The FCA made clear that their efforts to improve the standards of advice were unrelenting. The clear message was that the FCA would not hesitate to use their investigatory powers where they consider there is evidence of misconduct.

The Key Findings

The key findings from the FCA's recent review were as follows:

1. The FCA remains concerned that the transfer advice in a number of cases does not take account of the client's individual needs and circumstances.
2. There is also concern that at the senior management level not enough is being done to identify and mitigate the risks associated with DB transfers. This is said in some cases to be down to managers misunderstanding potential conflicts of interests caused by their charging structures.
3. The FCA had identified that in some cases where there are volumes of transfers the processes adopted by advisers does not take into account the individual needs of the customers.
4. The FCA was in praise of those firms where the senior management had adapted their controls and compliance checks in recognition of the "high risk nature of this type of business".

The FCA's recent publication has prompted a mixed response from commentators. The former technical specialist at the FCA noted on his website at the end of last week that he had little sympathy for advisers involved in the advice process suggesting the "sector has had everything it needs from the FCA" to ensure it remains compliant. One of the key issues that some commentators in support of the FCA's crackdown on unsuitable advice have identified is that too often some advisers are using generic objectives when assessing a client's decision to transfer.

However, the FCA's report was not welcomed by many advisers with the chief executive of the Personal Finance Society labelling it as "reckless and wholly disproportionate”. The criticism was based on the fact that the regulator's assessment was based on only a limited sample which is said to be insufficient to make any conclusive findings. The FCA's publication has also been criticised as scare-mongering the public and may "serve to compound the issue".

There is certainly a danger that the FCA's publications make an already difficult market more hostile for advisers and their professional indemnity insurers. No one would suggest that taking steps to identify "rogue advisers" lacks merit but the regulator's heavy-handed approach has the risk of tarring all advisers with the same brush. The target of "rogue advisers" makes for an uncontroversial soundbite as was seen from the Prime Minister last week when Mrs May indicated that she would ensure that the Treasury looks at the issue with the FCA. However, the reality is that the number of actual "rogue advisers" are minimal in the context of the whole DB transfer market. There is risk from the public's perspective that the labelling of "unsuitable" advice becomes bundled up with actual fraudulent activities.

Speaking at the Regulation of Cryptocurrencies event in London, Christopher Wollard, Executor Director of Strategy and Competition at the FCA stated: "The FCA will consult on perimeter guidance by the end of 2018. This will help clarify which cryptoassets fall within the FCA’s existing regulatory perimeter, and those cryptoassets that fall outside. HM Treasury is to then consult on whether the regulatory perimeter requires an extension to capture cryptoassets that have comparable features to specified investments, but currently fall outside the perimeter."

As part of the same speech, Mr Wollard has confirmed where the FCA's taskforce have identified the main problems and areas of concern. Broadly, they have announced that cryptoassets are currently used in three ways:

• As a means of exchange, enabling the buying and selling of good and services, or to facilitate regulated payment services;

• For investment, with firms and consumers gaining direct exposure by trading cryptoassets, or indirect exposure by trading financial instruments that reference cryptoassets; and

• To support capital raising and/or the creation of decentralised networks.

The taskforce have noted that whilst cryptoassets are not currently used in the UK as a major exchange tool, there are potential advantages and disadvantages to the UK market. The main concerns the task force have are:

1. Harm to consumers. The risk is to those who invest in unsuitable products, and as a result may face large losses and be exposed to fraudulent activity. They may also be exposed to the failings of service providers and struggle to access market services;

2. Harm to market integrity. Should market crashes and misconduct continue, this poses a real risk to consumer confidence being damaged in the wider market; and

3. Risk of financial crime. This is partly as a result of the ease of which cryptoassets can be used to aid illegal activities such as money laundering and fraud.

Other points from Mr Wollard's speech include the announcement that HM Treasury will conduct a comprehensive global response to the use of crypto assets for illegal activities such as money laundering, with the aim being the creation of legislation to counter this growing problem. The FCA has also confirmed it intends to work collaboratively with international counterparts, especially given the prevalence of crypto assets in jurisdictions such as the US and Hong Kong.

The announcement came after cryptocurrencies suffered another setback on Tuesday 20 November, when bitcoin (the most well-known and actively traded digital currency) fell by more than 10%, its lowest since October 2017. Those with an interest in cryptocurrencies have long warned that the continued growth experienced over the last 12 months would not last and the decline seems to have started. Indeed bitcoin remains 66% down from the beginning of 2018.

Whilst some may suggest that such falls in value have prompted the FCA to act quicker, and indeed has provided them with more pressure, others are arguing that this indeed takes the pressure of the regulator. Gillian Dorner, deputy director at HM Treasury has stated: "We want to take the time to look at that in a bit more depth and make sure we take a proportionate approach".

 In 2012, the SFO began investigating Barclays regarding a capital raising it undertook at the height of the financial crisis in 2008. As part of that capital raising, Barclays reportedly loaned £2.4 billion to the state of Qatar around the same time that it received more than £7 billion in emergency funding from two Qatar entities.

Through the fundraising, Barclays avoided the need for the type of bail-out that resulted in government ownership of banks such as Lloyds and RBS.

The SFO's investigation centred on whether the Qatari loan was used to fund the capital investment, which is a criminal offence under English law for listed companies, known simply as "unlawful financial assistance".

Following a lengthy five-year investigation, Barclays Plc was charged in June 2017 with conspiracy to commit fraud and the provision of unlawful financial assistance to Qatar. Similar charges then followed for another Barclays entity, Barclays Bank Plc, in February 2018.

Despite public pressure to see successful banking prosecutions relating to the financial crisis, all charges against both Barclays entities were dismissed by the crown court in May 2018. The SFO sought the High Court's consent to reinstate the charges by way of an unusual procedure known as a voluntary bill of indictment, but this application was also dismissed on October 26, 2018, ending the SFO's prosecution.

Continued risk to Barclays

Notwithstanding its success against the SFO and avoidance of a potentially significant fine, the SFO was never the only authority interested in Barclays in relation to the Qatar funding. As a result, Barclays is not necessarily "out of the woods" in relation to corporate liability.

Specifically, the UK Financial Conduct Authority's (FCA) investigation into the matter could now continue and Barclays is still battling a $1 billion lawsuit brought by another investor in relation to the fundraising. In addition, it is possible the U.S. Department of Justice may revisit this matter under the U.S. Foreign Corrupt Practices Act 1977 now it knows the SFO cannot take any further action.

The risk of fines and multiple proceedings could therefore continue for several years.

What impact does the Barclays case have on the future for corporate criminal liability?

While many may consider the end of the SFO case against Barclays to be a significant blow for the whole area of criminal corporate liability, detailed analysis is difficult until the reasons for the charges being dismissed are made public.

In that regard, given the reporting restrictions on the Barclays Bank judgments (because of the related trials of individuals which will take place in 2019), it is unclear at this stage why the SFO's case against Barclays was not allowed to proceed.

Whatever the fact-specific rationale, however, the charges against Barclays probably required the SFO to show not only that the law had been broken in some way but also that the company was liable according to a 19th century rule of corporate liability known as the "identification principle". This rule is therefore likely to be thrown back into the spotlight in 2019/2020; it could well become a focus for UK legislation, and material changes to criminal corporate liability could follow in the UK.

The identification principle and corporate liability

The "identification principle" governs almost all areas of corporate crime except bribery (since 2011) and tax evasion (since 2017). This principle requires prosecutors to prove that those individuals constituting "the directing mind and will" of the company, usually directors, knew about, condoned or played a part in the wrongdoing to secure a conviction against the company itself.

The test is difficult for prosecutors to meet, especially in relation to large international corporations.

This test was, for instance, an obstacle to the prosecutors in the phone-hacking scandal several years ago, where charges could not be brought against the employer of the journalists responsible, News Group International.

"The present state of the law means it is especially difficult to establish criminal liability against companies with complex or diffuse management structures," the Crown Prosecution Service's statement announcing the decision not to prosecute the corporate said.

By contrast, English cases where prosecutions of corporates have been successful usually relate to small companies, such as Smith & Ouzman Ltd, a company which specialises in printing security documents. The company, along with two of its employees, was found guilty in January 2014 of making corrupt payments to influence the award of business contracts in Africa.

The different outcome in cases such as Smith & Ouzman and News International has, for some time, led commentators and prosecutors alike to identify an inherent advantage for large companies over small companies when it comes to criminal liability.

Alternatives to the identification principle

 Cases such as News International and now Barclays will likely result in the UK legislature looking again in 2019 or 2020 at corporate criminal liability. When they do, they will have an obvious alternative to consider. Specifically, the SFO no longer has to struggle to meet the "identification" principle for two important areas of economic crime: bribery and tax evasion.

Under the UK Bribery Act 2010, a company commits a strict liability offence if it fails to prevent bribery that takes place for its advantage by any employee or associated person, unless the company can demonstrate that it had "adequate procedure" in place to prevent the bribery.

The same principle applies to tax evasion under the Criminal Finances Act 2017, whereby a company commits an offence if it fails to prevent the facilitation of tax evasion by those who provide services for or on its behalf, unless it has reasonable prevention measures in place.

For both bribery and tax evasion, the detailed requirements to prevent offending are contained in guidance documents that are, in effect, mandatory.

Where next?

In this context, it is not hard to imagine that the Barclays case will lead to calls to end the "identification principle" and legislation to extend the UK Bribery Act 2010 and tax evasion laws to create strict liability offences in other areas of economic crime (mirroring calls made in 2016/2017). Like much in this area, however, this may not be straightforward and any changes would need to resolve several practical difficulties satisfactorily.

First, analysis will be needed as to whether it is appropriate to move the law so quickly from directors creating liability to any employee, no matter how junior. In addition, complying with new guidance on adequate procedures, e.g., regarding economic sanctions and fraud, could create significant costs to UK business at a time of national cost-cutting and Brexit-related uncertainty.

Finally, regulatory requirements already exist for a number of entities, for instance, in relation to money laundering. To avoid duplication and confusion, clarity would be required where new guidance and current regulations overlap.

Toward a fairer system?

In the short term, the end of the SFO investigation into Barclays does not necessarily mean the end of any investigation and litigation relating to the Qatar fundraising. The FCA and the U.S. Department of Justice may both decide to step in. In the medium term, the decision to dismiss the SFO's prosecution may be more important as a case that leads to a fairer system of corporate liability across all sizes of corporates. In the longer term, however, any such change to the law will need thoughtful planning and practical, professional and business input to be truly successful.

Anti-money laundering legislation has been coordinated across the EU through a series of directives over many years. In England, these have been implemented through Part 7 of the Proceeds of Crime Act 2002 (POCA) and subordinate legislation, most recently, the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (the ML Regulations). These fall into two sections for those outside the “regulated sector” and those within the “regulated sector”.

Those outside the regulated sector may commit a money laundering offence if they deal with the benefit of a crime while knowing or suspecting that it is such a benefit (subject to certain defences). Those in the regulated sector (eg, banks and other financial institutions, lawyers and accountants) have additional obligations. In particular, they must:

• be registered with a regulator for antimoney laundering purposes
• put in place “know your client” (KYC) or “customer due diligence” (CDD) measures to ensure that they know the identity of their customer or client and monitor their money laundering risks
• train their staff on money laundering risks
• report to the National Crime Agency (NCA) any knowledge or suspicion of money laundering via a nominated officer (typically called the money laundering reporting officer (MLRO)), and
• ·not “tip off” their customer or client that any report has been made.

Over 18 months to March 2017, the NCA received over 600,000 reports of potential money laundering, demonstrating that this is a significant source of information for law enforcement.

However, the art market has not generally fallen within the regulated sector to date. Although dealers (including auction houses) accepting cash payments of €10,000 or more fall within the regulated sector, most stay outside the regulated sector by refusing to accept cash payments near or at that level.

To find out more about the recently approved Fifth Money Laundering Directive (5MLD), the practical issues it raises and existing guidelines available, download the full article below.

In these circumstances, the SFC can be expected to commence more section 300 proceedings, especially where the impugned transactions are within the SFC’s enforcement priorities and involve conduct in Hong Kong but with respect to shares listed overseas.

Some key points

• Section 300 makes it an offence to engage in any conduct that is fraudulent or deceptive with respect to any transaction involving securities, futures contracts or leveraged foreign exchange trades. This is not limited to dealing in shares that are locally listed.
  
  
• A “transaction” for this purpose is widely construed. It can be one or more components of a share dealing with a view to making a profit or avoiding a loss (such as, the purchase, sale, or giving of instructions to an intermediary). Taken as a whole, these components can also constitute a transaction.
  
  
• The defendant does not need to be a party to the impugned transaction(s). It is enough that they use fraudulent or deceptive conduct in connection with a transaction; for example, the use of inside information to make a profit or avoid a loss.
  
  
• Where conduct amounts to insider dealing with respect to locally listed shares, an offender should be pursued for insider dealing (under section 291) and not for an offence under section 300.
  
  
• Conduct contrary to section 300, like insider dealing, is not victimless. The courts in Hong Kong appear to have little difficulty in finding that the victim is an identified counterparty or, more generally, the public at large.
  
  
• Conduct contrary to section 300 can be pursued by the prosecution authorities in Hong Kong in the criminal courts. A criminal conviction can carry a heavy custodial sentence. However, the SFC can also launch civil proceedings, pursuant to section 213 of the Ordinance, to seek (among other things) compensation for a counterparty or class of investors, injunctions, orders preventing dealings and to recover the SFC’s significant legal costs.
  
  
• Section 300 does not have extra-territorial effect. It is enough that there is some connection with Hong Kong; for example, that the disclosure or misuse of inside information takes place in Hong Kong. The transaction, however, might be executed in Hong Kong or overseas.

On the first main issue, the court held that properly construed “in a transaction involving securities” meant “in connection with” or “in relation to”. There was no requirement that a defendant be a party to the transaction – it was enough that their fraudulent or deceptive conduct was used in connection with the transaction. Adopting a purposive approach to statutory interpretation and accounting for the legislative history of section 300, “involving” had a wide meaning (as befits a statutory provision designed to protect confidence in the markets).

The court was also dismissive of the appellants’ argument that their purchase and sale of the shares did not fall within section 300 because it would strain the natural meaning of the section if it extended to preparatory steps antecedent to the dealing. As one of the judges noted, it was not clear why this distinction mattered and a “transaction” could include a part of the share dealing or the whole transaction.

The court also considered that the defendants could, in any event, be said to be “parties” to share dealings and their scheme clearly came within section 300.

As regards the second main issue (on whom the fraud needs to be practised), the different judgments of the court reiterated that insider dealing in Hong Kong listed securities (punishable under section 291) and insider dealing in overseas-listed securities (punishable under section 300) are not victimless crimes. They constitute a fraud on the public and “cheating”. Further, the bank (as offeror of the tender for the shares in the Taiwanese company) had been a counterparty and a fraud or deception had been practised on it specifically.

There are other aspects to the judgments. Notably, section 300 is not a “catch all” provision. It catches specific conduct, albeit widely construed. Further, where conduct constitutes insider dealing (in locally listed shares) it should be pursued as such and not under section 300.

Comment

Overall, the judgments are not an easy read. The way the issues were argued was complicated. However, reduced to their basics, the Court of Final Appeal adopted an expansive approach to the interpretation of section 300, taking into account the mischief at which it is directed.

The outcome in the case is no surprise and was widely anticipated. The Court of Final Appeal has not traditionally been sympathetic to technical arguments that seek to get around the plain meaning of words used in a statutory provision that operates in the interest of the public and the integrity of the markets.

The SFC will be delighted with the result. Where a person plays a part in any transaction involving securities or regulated trades, and the disclosure or misuse of inside information occurs in Hong Kong, that person risks a criminal prosecution in Hong Kong or civil proceedings brought by the SFC under section 213, or both. The SFC has a record of using section 213 to good effect to pursue contraventions of the Ordinance. To date, some of those whom the SFC has pursued have had to pay significant compensation and heavy legal costs. On reflection, few such defendants can have thought that their transgressions were worthwhile. The SFC has forged a reputation as the lead market regulator in Hong Kong and its section 213 jurisdiction extends to market misconduct committed in Hong Kong involving transactions on overseas stock exchanges.

It will also not be lost on many that two of the defendants in this case are lawyers. They have been found to have participated in serious misconduct, albeit in the context of civil proceedings. One of the judgments (at paragraph 30) approves of the proposition that a fiduciary who misuses inside information for gain or to avoid loss, dishonestly misappropriates that information which makes the conduct fraudulent. Matters for these two defendants may not stop at the Court of Final Appeal.

The information provided in this article is intended to give general information only. It is not a complete statement of the law. It is not intended to be relied upon or to be a substitute for legal advice in relation to particular circumstances. Specific circumstances require specific advice.

After setting out its definitions and classifications (explored in Part 1 of this series[1]), the SMSG considers recent market developments in the virtual asset world and makes use of revealing graphics produced by Satis Group[2] to highlight notable trends.

EU Jurisdictions: Approaches to Regulation

The SMSG undertook a major exercise in reviewing regulatory approaches of securities agencies to ICOs and crypto assets in 36 European jurisdictions. Their findings offer an insight as to the spectrum of regulatory proactivity across Europe and the countries which feature at either end of it. 

While the SMSG found that none of the jurisdictions examined had imposed severe limitations or outright bans for ICOs and crypto asset initiatives, countries such as Malta, Switzerland, Lithuania, Gibraltar, Jersey and the Isle of Man were ahead of the pack in terms of active engagement. Engagement in this sense indicated that a country was expressly legislating and developing specific methodologies, criteria or guidelines for assessing how and to what extent ICOs could be considered as financial instruments and thus fall under financial services framework.

A number of countries are clustered mid-table, adopting what the SMSG call a "wait and see" approach. Austria, Belgium, Bulgaria, Denmark, Estonia, Finland, Germany, Ireland, Luxembourg, Netherlands, Portugal, Spain, Lichtenstein and Guernsey and the UK all fell into this category – these jurisdictions have not specifically restricted or prohibited ICOs or crypto asset initiatives but maintain a watchful eye and measured approach, wary of legislative instruments already in force in the territory.

The third tranche of countries the SMSG identified were those that had taken no apparent position as to regulation of ICOs or crypto assets. The SMSG acknowledged that a lack of available information did not necessarily mean that initiatives were entirely restricted nor permitted. Countries in this category included Croatia, Czech Republic, Greece, Hungary, Italy, Latvia, Poland, Republic of Cyrprus, Romania, Slovakia, Slovenia, Sweden, Norway and Iceland.

Regardless of the regulatory approach for crypto asset issuers, the SMSG found that securities authorities in nearly all of the jurisdictions had published warnings to the public about investment risk. While the majority of these had emerged around the time of ESMA's dual reports in November 2017[3], which were aimed at investors and firms respectively and described ICOs as "very risky and highly speculative investments", the SMSG found that some authorities had been alerting consumers to cryptocurrency risks as early as 2013. Ultimately though, the vast number of investments in crypto assets across Europe over the past 12 months indicates the warnings have done little to dissuade, particularly given that many investors admitted to buying crypto assets without carrying out checks or considering the issuer's white paper. The report advises that investor protection relies on jurisdictions establishing and maintaining a robust regulatory framework and enforcement regime.

Having taken stock of trends and developments across Europe, the SMSG warned that the various divergent approaches to regulation of crypto assets had created an uneven playing field, hampering the creation of an internal market in the field. It recommended that ESMA take steps to provide much-needed clarity on the application of existing regulation to crypto assets, for the benefit of all involved.

[1] https://www.rpclegal.com/perspectives/financial-services-regulatory-and-risk/crypto-assets-and-icos-as-seen-by-esmas-smsg/

[2] https://research.bloomberg.com/pub/res/d28giW28tf6G7T_Wr77aU0gDgFQ

[3] See https://www.esma.europa.eu/sites/default/files/library/esma50-157-829_ico_statement_investors.pdf for investors and https://www.esma.europa.eu/sites/default/files/library/esma50-157-828_ico_statement_firms.pdf for firms involved in ICOs.

The main complaint made by consumers is that they had allegedly been advised by the intermediary to mortgage their property on an interest-only basis without having an adequate repayment strategy in place to pay off the capital sum at the end of the mortgage term. In some cases, the complainants had re-mortgaged their existing property and/or consolidated their debts by taking out a re-mortgage product.

The consumers argue that had they been so advised about the need to repay the capital and of the risks involved, they would have taken out a different product more suited to their needs or not entered into the mortgage at all.

It is somewhat peculiar to be seeing such a high volume of cases being reported across the market, with some intermediaries reporting in excess of 60 claims each, that it begs the question: what is the cause of this wave of complaints with which the industry is now confronted?

In 2006/07 the mortgage market was remarkably volatile, with 49% of total complaints reported to the Financial Ombudsman Service ("FOS") that year relating to endowment mortgages.

At the time those mortgages were sold (around the late 1980s) many firms said that they had merely acted as an "introducer" for their clients, which seemed to conflict with reports from customers, who claimed that they were specifically advised that an endowment mortgage was the best thing for them.

The Financial Services Authority, as it was formerly known, shifted the regulatory framework on 31 October 2004 with the introduction of "M-Day", when the regulator took over responsibility for mortgage lending, advising and arranging. It was at this time that the FSA introduced the Mortgage Conduct of Business Rules (MCOBS), which governed the relationship between mortgage lenders and borrowers in the UK.

With this new regulatory structure in place, intermediaries were required to provide much clearer information to clients, allowing them to compare and understand mortgage products more easily. Intermediaries also had to state whether they were providing an advised sale, i.e. recommending that the customer buys the mortgage product, or a non-advised sale, whereby the mortgage was simply presented to the customer and it was down to them whether or not to accept the offer.

Following the financial crisis, the regulator made wholesale changes to the financial services landscape again, in order to protect consumers further. One notable change was to remove non-advised sales from MCOBS, changing these to "execution-only" sales. This rendered non-advised sales more difficult to process and placed more responsibility on intermediaries to assess whether a repayment strategy had the potential to repay the capital, in particular with interest-only sales.

So why are we seeing these claims now, especially since the majority of these mortgages still have plenty of years left on their term? In 2013 the newly-formed FCA issued a warning about interest-only mortgages purchased before the recession without a capital repayment vehicle in place. The regulator was concerned that people had sought to rely on an increase in their house price to support the repayment of capital, which was no longer a viable option in the climate.

In January this year the FCA issued a press release on the subject, urging action and expressing concern that shortfalls in repayment plans could lead to borrowers losing their homes.

These regulatory warnings, as well as numerous news articles, have likely contributed to this series of claims against intermediaries. Certainly, some legal claims practices have identified a gap in the market and now represent a sizeable chunk of those affected on a no-win-no-fee basis and have begun to issue letters of claim.

In terms of what to look out for in defending these claims, intermediaries should consider the following:

(1) The time periods that apply to the claims – the primary 6 year period for limitation would have passed and so complainants are likely to argue that they have only had sufficient knowledge to be able to bring a claim within the last 3 years. Intermediaries should be looking to see if the consumer has re-mortgaged or sold the property to bolster limitation arguments;

(2) The scope of their retainers with the complainants – whether intermediaries were acting on an advised or non-advised basis affects the extent of their duty to the complainants;

(3) The extent that appropriate risk warnings were communicated to the claimants at the time – contemporaneous documents should show that risk warnings were given about interest-only mortgages, where intermediaries have kept their files; and

(4) Whether an interest-only mortgage was the most appropriate mortgage – where a complainant was consolidating debts or had a low income, it may be the case that an interest only mortgage was their only realistic option in order to secure their specific objectives.

One consequence of the SMCR is the reduction of information that will be stored on the FCA Register.

Currently, details of all individuals performing Controlled Functions are set out on the Register. However, under the SMCR, only Senior Managers will be on the Register. As such, the FCA opened consultation (CP18/19) on a new FCA “Directory”, in response both to reported requests from the industry for continued transparency of stakeholders in the industry1 and the growing feeling that the Register, in its current form, is not quite up to scratch2.

The Directory is proposed to be a public register which contains information on additional individuals carrying out a broad range of roles in the financial services industry. Entries will not just be Senior Managers, but will include financial advisers, traders, portfolio managers and Appointed Representatives (ie the Directory will extend beyond the SMCR).

In line with the culture of responsibility represented by the SMCR, and also mindful of the impracticality of the FCA being responsible for the Register but being reliant on firms to provide up to date information, firms will be responsible for keeping their information up to date on the Directory (and ultimately, this responsibility will rest with one specific Senior Manager).

The FCA wants to introduce the Directory in time for the first roll-out of the SMCR to Insurers, so comments have been invited until 5 October. However, firms will have the 12 month transitional periods noted above to ensure that their data on the Directory is complete.

Fitness and Propriety requirements; Regulatory references

Existing approved persons need to be adjudged to be “fit & proper”. Under the SMCR, firms will also be required to assess and monitor (at least once a year) the fitness and propriety of Senior Managers, Certified Persons and Non-Executive Directors. The test is familiar; but the evidence requirements are fuller, and include criminal records checks and regulatory references.

Firms will also have to request a reference from candidates’ past employers, and past employers will have to share specific information, set out in a standard FCA template. These “regulatory references” are intended to help firms make better-informed decisions about candidates, but also represent another cultural shift; this time in how the industry shares information about past personnel.

Details to be included in regulatory references include any disciplinary action taken due to breaches of the conduct rules and any findings that the person was not fit and proper. Equally, firms must disclose any other information relevant to assessing whether a candidate is fit and proper (eg, the number of upheld complaints), covering the previous six years (unless it relates to serious misconduct, in which case there is no time limit). Firms will need to use their judgment when considering what is relevant, on a case-by-case basis. And, importantly, firms will have to be careful not to enter into arrangements that conflict with their disclosure obligations. Firms will also need to update regulatory references where new, significant information comes to light.

This being the SMCR, responsibility for a firm’s compliance with its regulatory reference obligations will sit with a specific Senior Manager and that Senior Manager will be accountable for any failures. Practically, we would expect maintenance of personnel records in line with the SMCR, GDPR and general employment law requirements will be one of the technically most challenging and novel issues for firms. In particular, how will firms look to address the twin challenges of accurate references to ensure that perceived “bad apples” do not persist in the industry and navigating GDPR subject access requests without incident?

Responsibility maps

A responsibility map is a document that sets out a firm’s governance and management arrangements, and how responsibilities are allocated to individuals with the firm. Whilst only Enhanced firms are required to generate and maintain a responsibility map, it seems to us that all Core firms would also benefit from generating and maintain a responsibility map, and from doing so as an early part of their implementation of the SMCR.

Firstly, the responsibility map will help to clarify the firm’s structure and relationships in pictorial form. We envisage it would be based on a staff organogram, and would therefore enable a firm’s management to see reporting lines. If there are any dead-ends or errors, a responsibility map should show these up early in the process.

Secondly, maintaining the responsibility map will help with continuing obligations. Being able to see how changes in personnel and structure impact the map should help firms realise quickly and simply what forms of notifications and updates they may need to make. This will be particularly true for (the majority of) firms that operate a range of applications across a range of media and where changes made on one system or data-source do not automatically feed through to all the rest of the firm’s systems.

Thirdly, we would expect a responsibility map to be a standard part of operational due diligence requests to firms going forward, and being able to proactively provide one (appropriately redacted) may add value to early engagements with potentially key stakeholders.

Handover policies and procedures

Another requirement of Enhanced firms only, but likely to be of benefit for Core firms too (especially for business management and ODD purposes), is the requirement to have handover policies and procedures in place. The FCA wants Enhanced firms to ensure that outgoing Senior Managers provide incoming Senior Managers with all the information and materials they could reasonably expect to have in order to do their job effectively.

Impact of the SMCR on firms’ insurance arrangements

In addition to the obvious impact on firms’ regulatory filings, compliance and HR policies and internal documentation, firms should also be considering the impact of the SMCR on their insurance arrangements.

Firms would do well to keep an eye of the wording of their D&O and PI policies and look to understand what impact of the greater accountability of Senior Managers will have on any claims. Firms may need to make amendments to their insurance arrangements, and staff may also seek additional protection through firm insurance policies in light of the greater level of accountability. Even if firms are satisfied with their existing insurance arrangements for their own purposes, it would seem reasonable to expect investors to ask about these issues and to expect suitably reasoned responses.

Moving from being a Core firm to becoming an Enhanced firm

As firms change, Core firms may grow to meet the criteria of Enhanced firms. Mindful of the additional burden and infrastructure required of Enhanced firms, and such firms will have to carry on their business seamlessly, such firms have one year to comply with the additional requirements of being an Enhanced firm, running from the date the firm meets the Enhanced firm criteria. 

^{1. In other words, people like to be able to search the Register.}

^{2. For example, the FCA’s chastisement by the Complaints Commissioner who, in a report published 3 July, decided that a consumer’s loss was facilitated by the FCA’s “woefully” inaccurate register, which had not been updated for four years despite the FCA having information to show that the firm directly responsible for the loss was not trading. Having previously denied responsibility, the FCA announced (also 3 July) it would make a payment to the consumer of £22,137.50 (50% of their loss), in addition to the £150 the FCA had initially offered. See here.}

The SMSG is a group of representatives responsible for providing technical advice on policy development to the European Securities and Markets Agency (ESMA). The report takes stock of the various approaches currently deployed by European Member States in relation to crypto assets and ICOs, as well as making recommendations to ESMA as to steps it could take to mitigate the risks posed to investors and general financial stability by ICOs and crypto assets.

Definitions

The SMSG acknowledges that the language of crypto assets is often deployed inconsistently between different jurisdictions, issuers and investors and frequently interpreted incorrectly in the media. It aims to clarify matters by setting out its interpretation of key terms. Of course, until a unified set of nomenclature is adopted there will be scope for differences of understanding, but the SMSG's definitions, detailed below, are worth considering:

Crypto asset: a generic term for virtual currencies, cryptocurrencies, virtual assets and tokens.

Virtual currency: a digital representation of value that is neither issued by a central bank or a public authority and only rarely attached to a fiat currency, but is accepted by a growing number of natural or legal persons as a means of payment and can be transferred, stored or traded electronically.

Cryptocurrency: a subset of virtual currency which is secured using cryptography. Generally, cryptocurrency transactions are recorded on a distributed ledger technology database, either public or permissioned by a central authority. The SMSG identified 1930 cryptocurrencies in existence as at 11 September 2018, mostly using distributed ledger technology like blockchain.

Token: a broad term which encompasses many crypto assets and can be defined by comparing with account-based assets. An account-based system relies on the ability to verify the identity of the owner, while a token-based system relies on the ability to verify the validity of the token itself. A token, like a banknote, is a bearer's asset. Banknotes include multiple physical security features. In the crypto asset world, tokens are secured by cryptographic keys.

ICO: the initial offering of any crypto asset.

Categories of Crypto Assets

There is no universal classification of crypto assets. However, the Swiss Financial Market Supervisory Authority (FINMA) has adopted taxonomy in February 2018[1] guidelines which the SMSG endorsed. Again, as with the definitions, until a unified taxonomy is adopted there will be scope for differences of understanding, but by adopting FINMA's approach, the SMSG at least seeks to avoid adding yet more noise to the existing clamour.

FINMA sorts crypto assets into the following groups:

1. Payment tokens: a means of payment for acquiring goods or services by which the holder of the asset has no claim on the issuer. Virtual currencies, including cryptocurrencies like Bitcoin, are examples of payment tokens.

2. Utility tokens: provide access to a specific application or service but are not accepted as a means of payment for anything other than their specific purpose.

3. Asset tokens: represent assets such as a debt or equity claim against the issuer of the token. For example, asset tokens could promise a share in future company earnings or future capital flows. They are analogous to equities, bonds or derivatives.

• Conduct Rules
• the Senior Managers’ regime
• the Certified Persons’ regime

Conduct Rules

The main tier of Conduct Rules, which apply to all staff, requires that personnel act with integrity, as well as due care, skill and diligence, must be open and cooperative with regulators, must pay due regard to the interests of customers and treat them fairly and must observe proper standards of market conduct. There is little that is ground-breaking in their content but the key innovation of codifying the Conduct Rules is that they are directly enforceable by the FCA. The FCA has stated that the Conduct Rules are “a meaningful change in the standards of conduct we expect from those working in the industry…by applying the Conduct Rules to a broad range of stall we aim to improve individual accountability and awareness of conduct issues across firms”.

The Conduct Rules apply both to a firm’s regulated and unregulated financial services activity (including activity carried on in connection with a regulated activity). In other words, financial services personnel will have to adopt the new conduct culture in all their work. Operating within the Conduct Rules will need to be inherent in everything staff do, rather than applying the Conduct Rules as a sort of “go/no-go” hurdle to be cleared prior to implementation of a decision.

The Conduct Rules apply to almost all personnel of a financial services firm. This includes all Senior Managers, Certified Persons, Non-Executive Directors (who are for other purposes outside of the SMCR to a greater degree than they are of the Approved Person regime) and all other staff except for those who do not perform a role specific to financial services. The FCA calls these exempt staff “ancillary staff” and the new rules contain an exhaustive list of what constitutes ancillary staff roles. These include: receptionists, post room staff, reprographics staff, facilities management, events management, security guards, invoice processing, audio-visual technicians, vending machine staff, medical staff, archive records management, drivers, corporate social responsibility staff, data controllers and processors, cleaners, catering staff, personal assistants and secretaries, information technology support, and human resources administrators.

All non-ancillary staff will need to be trained on how the Conduct Rules apply to their role. This will require bespoke education and engagement.

Additional Conduct Rules for Senior Managers

Certain additional Conduct Rules will also apply to Senior Managers. Senior Managers must take reasonable steps to ensure that: the business of the firm for which they are responsible is controlled effectively; the business of the firm for which they are responsible complies with the relevant requirements and standards of the regulatory system; any delegation of their responsibilities is to an appropriate person; and that they oversee the discharge of the delegated responsibility effectively. Senior Managers must also disclose appropriately any information of which the FCA or PRA would reasonably expect notice. Again, it’s not the content that is new, but the adoption of these principles in black and white, and that Senior Managers will be held accountable to them.

For Senior Managers seeking to demonstrate that they have adequately met their Conduct Rule obligations, there has been much discussion (and no doubt there will be much more to come) about the concept of “reasonable steps”. Some commentators think that this will lead to more collective decision making, further administrative burden on firms, more meetings and ultimately “analysis paralysis”. At this time, it remains to be seen how this question will be answered by the industry, but we think it is important to remember that most of the firms being brought under the aegis of the SMCR in December 2019 are relatively small, lightly staffed enterprises. It will be uneconomic for most of these firms to introduce layer upon layer of committees, task forces and approval bodies. However, it should not be seen as a negative for such firms to seek to record their decisions and decision making processes in a systematic manner. On the buy-side of the asset management industry, it was not too long ago that trades were recorded on scraps of paper and the logic for decisions was not formally recorded in an OMS or PMS. However, practice evolved, and it seems reasonable to expect a similar evolution for systematic recording of management decisions in light of the SMCR.

Senior Managers

By virtue of their importance to the direction and operation of a firm, senior managerial personnel will be required to comply with the most extensive level of obligations under the SMCR. In addition to the extended conduct rules and fitness and propriety standards required, Senior Managers will need to be approved by the FCA, and to meet the SMCR’s fitness and propriety standards.

Part of the approval process will include the role and duties of Senior Managers being set out in a “Statement of Responsibility”1 which will act as a yardstick to measure each Senior Manager’s activities. Each Senior Manager will owe a “Duty of Responsibility” to the FCA, so that if the relevant firm breaches an FCA requirement, the Senior Manager responsible for that area can be held to be directly and personally accountable if they did not take “reasonable steps” to prevent or stop the breach.

The FCA has established a range of “Senior Manager Functions” (similar to “Significant Controlled Functions” under the existing Approved Person regime), and firms will apply for individuals to carry out specific Senior Manager Functions. However, the FCA considers that the SMCR does not require firms to change their governance structure or to hire new people to fill specific roles. As such, if a firm is not required to have a particular function, the SMCR will not change that. But (as with the Approved Persons regime), there will be certain roles that every business must have. The FCA refers to these as “Required Functions”. For most Core firms, the only Required Functions will be compliance oversight and anti-money laundering oversight. However, in addition to this, as well as being responsible for matters inherent in their roles, Senior Managers of a firm will be required to apportion between them responsibility for a handful of key conduct and prudential risks. The FCA refers to these items as “Prescribed Responsibilities”.

A “Senior Manager” will be any individual who performs a Senior Manager Function, whether based in the UK or abroad (ie there is no territorial limit). And one person may hold more than one Senior Manager Function at any one time.

Firms may outsource the carrying out of particular functions to a third party, but the accountability for that function cannot be outsourced, and will remain the responsibility of a specific named Senior Manager at the firm (and oversight of delegation is an explicit Senior Manager Conduct Rule).

Staff who are not Senior Managers of a firm but whose activities could result in “serious harm” to the firm, consumers or market integrity will be subject to the Certified Persons regime. Certified Persons need to be fit and proper to carry out their duties, and will report (ultimately) to a Senior Manager, but the “certification” process will be owned by and maintained by the firm itself and its Senior Managers rather than by the FCA. A firm may have many or no certified persons.

Unlike the situation with Senior Managers, the Certified Persons regime is subject to territorial limitations. A person is out of scope if they would otherwise be carrying out a Certified Person function but are based overseas, do not deal with UK clients and are not a “material risk taker” (ie Remuneration Code staff).

It is possible that one individual can be both a Senior Manager and a Certified Person of a given firm. The FCA considers such a scenario to be unlikely in “larger” firms, but it could arise where a director of a firm also has authority to execute trades. If an individual is “double hatting” in this way and the two roles they are performing are very different, the FCA expects that the person will be certified by the firm as well as approved by the FCA as a Senior Manager.

Converting to the SMCR from the approved person regime and relevant transition periods

The FCA has also provided some much needed colour on the process of converting existing firms from the Approved Person regime to SMCR.

Conversion

The FCA expressly told the SMCR Briefing on 11 July that they have sought to minimise the administrative burden of moving to the new regime for firms. Accordingly, the FCA envisages that, wherever possible, the conversion process will be automatic. Core and Limited Scope firms are not, by default, going to be expected to make submissions to the FCA and the FCA has published outlines for the automatic mapping of certain functions from the Approved Person/Controlled Function regime to the SMCR/Senior Manager/Certified Person regime.

In line with the maxim that “you only get out what you put in”, the FCA quite reasonably requests that firms review their existing FCA filings and approvals, and makes any appropriate amendments well in advance of the commencement of the SMCR. This should help to ensure that the conversion process is smooth for firms and the FCA. Or at least, that’s the theory. As mentioned above, firms are responsible for their own classification and filings. As such, automatic mapping or not, firms will still have to ensure that they are correctly represented under the SMCR, and make any amendments necessary. Responsibility for a firm’s compliance with its regulatory notification obligations under the SMCR will sit with a specific Senior Manager and that Senior Manager will be accountable for any failures.

Transition periods

The SMCR commences for most firms (ie Solo Regulated Firms) on 9 December 2019, but the FCA has also announced two noteworthy transition periods.

As such, by 9 December 2019, Solo Regulated Firms MUST have:

• identified all Senior Managers and Certified Persons, and
• trained all Senior Managers and Certified Persons on the Conduct Rules.

Firms will then have 12 months to complete the initial certification process2.

Firms will also have those 12 months to train non-Senior Managers and non-Certified Persons on the conduct rules. 

^{1. At their SMCR Briefing on 11 July, the FCA suggest firms consider Statements of Responsibility to be “statements of accountability” and impressed the point that the contents of Statements of Responsibility should set out what an individual is accountable for rather than what they functionally do.}

^{2. Accordingly, it looks to us that there is a typo on page 52 of the guide for Solo Regulated Firms. “9 December 2019” should be “9 December 2020”.}

Further warnings followed in December 2017 and February 2018, when the SFC issued circulars highlighting the risks of becoming involved in cryptocurrency-related investment products, ICOs and cryptocurrency exchanges. These warnings culminated in March 2018 in the SFC taking action against an ICO issuer named "Black Cell" for allegedly offering digital tokens redeemable for equity shares. The SFC stated that this amounted to a regulated "collective investment scheme", and Black Cell was forced to halt its token sale and reverse all Hong Kong transactions. 

The fact that the SFC is now turning its attention to cryptocurrency exchanges should come as no surprise. Such exchanges often play a key role in the flow of "fiat" currencies into and out of the digital token economy, which makes them a prime target for regulation. Major concerns identified by regulators include protecting investors from extreme price volatility and market manipulation, and the potential use of exchanges to facilitate money laundering and other criminal activities. Perhaps, most troubling of all are the potential cybersecurity risks of trading on exchange platforms, which have been demonstrated by several high-profile events such as the US$500 million hack of Japanese exchange Coincheck in January 2018.

The SFC's next move, under its new chairman, Tim Lui Tim-leung, will be watched closely by all those involved in this nascent industry. Hints at the likely direction regulation will take may be gleaned from other parts of the world. While certain jurisdictions, such as Mainland China, have taken a hard line on digital token issuers and exchanges, banning many of their activities outright, it is unlikely that the SFC will take this approach. It is more probable that Hong Kong will draw on the more positive models adopted in other major financial centres. For example, the US and Japan have introduced requirements for cryptocurrency exchanges to be registered with local regulators, although so far they do not have a comprehensive regulatory framework in place. More progressive frameworks are currently being constructed in smaller jurisdictions such as Gibraltar and Malta.

A key challenge facing the SFC will be to introduce regulation which adequately protects the investing public without establishing overly large financial and practical barriers to compliance. If this balancing act can be achieved, regulation should be a positive move – both for Hong Kong's fintech sector, providing much-needed certainty to exchange platform operators and their customers, and for its economy as a whole, allowing Hong Kong to take full advantage of its position as one of the world's leading financial centres when participating in this emerging market.

In the meantime, exchanges and other cryptocurrency-related businesses should do all they can to prepare for regulation, including implementing adequate KYC (client due diligence), AML, counter-terrorism and cybersecurity measures.

Whilst the SMCR has been hovering in the background for some time, other more pressing developments have been attracting larger headlines and bandwidth. The principal effect of recent FCA statements has been to set a hard timeframe for the commencement of the SMCR. In an uncertain world, we expect that this will focus minds and allow firms to plan for the SMCR’s impact with a welcome degree of certainty.

In order to assess the impact of the SMCR on a firm and its personnel, the first task will be to identify whether the firm is a Core, Enhanced or Limited Scope firm. Most firms will be Core firms. The next task will be to identify staff’s current roles and responsibilities. With this information, a firm can then map their set up to the requirements of the SMCR. The final piece in the puzzle will be to address any gaps or issues that arise.

Overview

The FCA published comprehensive industry guidance¹ on the new regime, together with their final policy statements, “near final” rules and material on a handful of additional housekeeping SMCR issues on 4 July 2018. ²

The FCA also published proposals for a new “Directory” of financial services workers; an expanded and modified database to augment the existing FCA Register .

This series summarises key takeaways from the FCA’s publications, and gives some of our thoughts on them.

As with any new regulatory initiative, it is vital to learn the relevant “newspeak”. We have highlighted the new words and phrases we will all need to adopt in this series.

There is still a long way for all of us to travel in to the brave new world of the SMCR; so it’s a good time to settle down, buckle up and get ready for the ride. If you have not read the FCA’s guidance, there is time to do so, and we would recommend that every stakeholder does so in conjunction with this series. The guides are readable, pragmatic and can be tackled in bite-sized chunks.

The SMCR represents a paradigm shift in the financial services industry in the UK and has been designed and brought in to increase individual accountability and responsibility throughout the sector. It is important to remember this new view of the world when thinking about the SMCR, as this philosophy underpins the entire regime.

The FCA’s own view is that the SMCR is an integral part of their effort to improve “culture” within the financial services industry. The FCA considers that the collective behaviour of individuals creates a firm’s culture. Whilst the FCA is not looking to mandate what an individual firm’s culture should be; it is setting minimum standards of behaviour. As the FCA indicated at their SMCR Briefing on 11 July 2018, one of the aims of the SMCR is to try to get the industry as a whole to move from a compliance culture to a culture of seeking to “do the right thing”.

The logic behind this change is well known and has been much discussed since the last financial crisis. As a result, the SMCR demands all personnel in the financial services staff not only have a clear understanding of their role, function and place in their business but also that they conduct themselves responsibly since they will be held individually, personally and directly accountable.

The SMCR will replace the existing “Approved Persons” regime, however, the FCA has confirmed that the Appointed Representative regime will remain in place and unchanged by SMCR.

As expected, the FCA is staggering implementation of SMCR.

Implementation for all firms which are solely regulated by the FCA is Monday, 9 December 2019. The FCA refers to such firms as “Solo Regulated Firms”, but the key takeaway here is that ALL firms (no matter what the nature of their business) that are purely regulated by the FCA need to focus on the December 2019 implementation date. The firms in this category will constitute the bulk of the financial services industry (with the exception of banks, who are already subject to the existing senior managers regime (or SMR), and dual-regulated insurance providers, who will be brought in to the SMCR in December 2018, see below). Investment managers, product distributors, insurance brokers and consumer credit providers will generally be considered Solo Regulated Firms. This series primarily focuses on the impact of the SMCR on Solo Regulated Firms.

Insurers who are regulated by both the PRA and the FCA will be brought into the regime on Monday, 10 December 2018. For the purposes of the SMCR, the FCA is generally referring to such entities simply as “Insurers”, but the key point here is that ONLY dual regulated firms need to focus on the December 2018 implementation date. Analysis of the position for Insurers is beyond the scope of this series, especially given our understanding that Insurers are generally well prepared for the SMCR and in advanced stages of implementation.

Three types of firms under the SMCR: core, enhanced and limited scope

The Solo Regulated Firm universe is made up of three tiers:

• “Core” firms
• “Enhanced” firms, and
• “Limited Scope” firms.

The majority of firms will qualify as “Core”, which essentially represents the baseline expectation and requirements of the SMCR.

A small number of large and complex firms will be subject to additional “Enhanced” requirements, which are more onerous and closer to the regime already in operation and applied to banks. As the nomenclature suggests, the Enhanced regime is designed to recognise that larger more complex firms are more likely to require larger, more complex oversight.

The SMCR applies at legal entity level. As such, some groups will have firms subject to different levels of obligations under the SMCR. But in some circumstances the FCA may allow Core firms within such a group to be treated as Enhanced firms in line with other group firms.⁴

A small number of firms will have a reduced level of obligations under the SMCR. These “Limited Scope” firms will generally be ones that benefit from exemptions under the existing Approved Persons regime.

The FCA will contact all existing Solo Regulated Firms in advance of December 2019, with an assessment of their status under the SMCR (ie Core, Enhanced or Limited Scope). But, this assessment will merely be indicative; particularly given it will be based on information which each firm has provided to the FCA. As such, and in keeping with the culture of accountability that the SMCR engenders, each firm is responsible for determining their own status based on the relevant FCA rules.

In the next part we will ask what the SMCR is going to mean for you...

^{1. For FCA solo regulated firms, see here. For Insurers, see here.}

^{2. For the FCA’s policy statement on the implementation of SMCR for FCA solo regulated firms, see here. For the FCA’s policy statement on the implementation of SMCR for Insurers, see here. For FCA’s final guidance clarifying on the “Duty of Responsibility” under SMCR for FCA solo regulated firms and Insurers, see here.}

^{3. See here.}

^{4. The FCA will consider applications from any Core firms seeking to opt up to Enhanced status, but the FCA anticipate the only scenario where such an opt up will be sought is in the context of group seeking to align standards amongst all relevant entities.}

The change has partially been driven by analysis undertaken by the FCA, which it says revealed that the average compensation for 'high value' complaints (being complaints upheld by the Ombudsman with a compensation recommendation in excess of the existing cap) was £305,000. This was based on a sample of 40 files against an estimated 2,000 such cases being decided each year (based on FOS' estimates).  

The increased limit will only apply to complaints regarding acts or omissions that took place after the date the new limit comes into force (provisionally 1 April 2019). For complaints about acts or omissions before 1 April 2019 that are referred to FOS after 1 April 2019, the limit will be increased to £160,000.

The FCA have also confirmed that the two new award limits will be automatically adjusted going forward from 1 April 2020, to keep in line with inflation.   

At the same time as announcing this new consultation on increasing the FOS award limit, the FCA also confirmed that it will extend access to the FOS to larger SMEs. Currently individual consumers, small charities and trusts, and ‘micro‑enterprises’ (those with annual turnover / a balance sheet of less than €2m and fewer than 10 employees) are eligible to complain to the Ombudsman. Now larger small and medium‑sized enterprises, with an annual turnover of below £6.5m and fewer than 50 employees, will be eligible to complain to the FOS (provisionally from 1 April 2019).

As a consequence of these changes it seems likely that there will be more FOS complaints from larger businesses (possibly meaning more insurance disputes end up before the FOS) together with a greater number of high compensation awards.  (The FCA estimates that increasing the limit will result in £113m more compensation being awarded each year – but that’s before account is taken of the fact that more high value complaints are likely to be referred to the FOS if the limit is increased.)  All of these complaints will be dealt with under the FOS jurisdiction, which does not require it to apply the law, does not involve a rigorous examination of evidence (for example, there is no mutual disclosure process and witness evidence is rarely, if ever, challenged in person) and is final and binding at the complainant's choice without any route of appeal for firms.

These changes raise interesting questions about the role of the FOS.  What was originally intended to be a quick, informal and free service to handle low value complaints has arguably morphed into something it was never intended to be. The FCA believes that 'high value' complaints make up only around 1% of the total volume of complaints resolved by the FOS and argues that there is not necessarily a correlation between value and complexity. However, it seems to us that whilst the FOS jurisdiction of quick, informal justice is justifiable for lower value cases, the inevitable compromise to firms' rights to access to justice is not justified for high value cases.

Beyond this, the change, if implemented, will undoubtedly mean increased PI premiums for financial services businesses. Indeed the FCA has confirmed they estimate an overall increase in insurance premiums of £77m per annum. Nonetheless, they appear to recognise the importance of this issue, as they are calling for detailed submissions on the likely impact of their proposals on PI premiums.  Of course, the biggest impact will be for smaller firms who cannot afford the increased premiums.  The FCA also appear to fail to recognise the risk of insurers pulling out of this market altogether.

Speaking at the Association of Financial Markets in Europe's annual conference on 2 October 2018, Mr Randell confirmed that any regulatory change in the wake of Brexit should be "phased and co-ordinated in a proportionate way". The announcement came just days after the comments of John Glen, the Economic Secretary to the Treasury, who stated that that the government will do “whatever it takes” to ensure the City’s role as a global financial centre continues. This would include new schemes relating to regulation and tax. The FCA however is aiming to avoid too many new regulations after Brexit.

The FCA appears committed to ensuring high-standards remain and has warned against the watering down of those regulations that were brought into force after the latest financial crisis in 2008. This, Mr Randell suggests, would be a great mistake, suggesting that "the seeds of the next crisis" would grow should watering down take place. "After each crisis, we bring in a weight of new regulation. We push it up the hill to implementation. And then we deregulate. And then a new crisis starts the process all over again."

The regulator also suggested that 'reinventing the wheel' isn’t the best practice. New rules should not always be written, when existing ones are already in place. “We must keep an open mind about our existing regulation and be ready to make it better where it is not producing the outcomes we need to produce,” Mr Randell reiterated.

Whilst kneejerk reactions will not help the financial sector, changes will undoubtedly need to be made in the aftermath of Brexit. The FCA will need to work closely with other EU member states to ensure regulatory standards are maintained. Mr Randell summed up by confirming that “We will need to redouble our engagement with our policymaking and regulatory colleagues in Europe and across the world, to continue to influence global standards of financial regulation.”

This case arises out of an investigation by the Financial Services Authority (the FSA) (now replaced by the Financial Conduct Authority) into the misselling of interest rate hedging products (IRHPs) by various high street banks.  Barclays Bank, along with others, acknowledged that it had missold IRHPs to customers and voluntarily agreed to compensate these customers.  As part of this process, it agreed with the FSA that it would appoint a "skilled person" under s166 FSMA, who would oversee Barclays' redress process and report back to the FSA on a regular basis.  In addition, the skilled person would review the compensation offers made to customers in order to provide an opinion on whether the offer was appropriate, fair and reasonable.  KPMG was appointed by Barclays and approved by the FSA.

Holmcroft was a customer of Barclays that was missold IRHPs.  Barclays offered Holmcroft compensation for some of its claimed losses, but not all.  KPMG approved the offer and Holmcroft sought judicial review of KPMG's decision on the basis that it failed to discharge its public law duty of fairness.

First instance decision in favour of KPMG

At first instance, the Divisional Court found that KPMG was not amenable to judicial review, principally because: (i) Barclays' redress scheme was voluntary, meaning that the FSA could not have imposed it on Barclays; (ii) the relationship between KPMG and Barclays was contractual and the customer was not a party to the contract; (iii) the FSA had no statutory obligation to carry out the role KPMG conducted for Barclays; and (iv) overall there was not a sufficiently "public law flavour" to KPMG's role to allow for judicial review to be available.

Endorsement by the Court of Appeal

The Court of Appeal approved the Divisional Court's findings, but noted that it had focussed too narrowly on the source of KPMG's power.  It should have taken a wider view of the regulatory position and factual context in which KPMG fulfilled its function.

The Court of Appeal found that, fundamentally, Holmcroft's claim was a private law matter.  Holmcroft was essentially pursuing private law rights by public law means.  Compensation was to be negotiated subject to private law principles, including limitation, causation and heads of damage and the appropriate forum for enforcing payment, if agreement had been reached between Holmcroft and Barclays, was the courts.  The FSA had not imposed a system for this process and had no role in the negotiation of compensation between Barclays and its customers.  Therefore, KPMG was not performing a public law role amenable to judicial review.

The Court acknowledged that in reaching this finding, it was exposing a gap in the protection provided to customers as there would be no means of redress in public law if the compensation offered by banks was insufficient but approved by the skilled person.  Customers would still retain the right to seek redress through the courts in the usual way and could take steps to protect their position while negotiations with the bank continued in order to avoid running out of time to bring a claim, such as entering into a standstill agreement with the bank or issuing a claim on a precautionary basis – although in the case of many IRHP claims, that may not be possible.

The role of a skilled person

The Court of Appeal provided firms that act as a skilled person with some comfort that they are unlikely to be exposed to judicial review by third parties in the future.  However, it is notable here that a deciding factor was that the FSA had no role in the negotiation of compensation between Barclays and its customers.  No doubt the FCA, which intervened in the proceedings to support KPMG, will be pleased with the result given the increasing reliance it has placed on skilled person reviews in recent years.  However, it remains to be seen whether the same decision would be reached where a skilled person acts at the direction of, or in conjunction with, the FCA when arranging a compensation scheme.

The incident was originally reported by Mr Ngo's employer to the Hong Kong Monetary Authority (“HKMA”), which then referred the case to the SFC for further investigation. The SFC found that Mr Ngo was in breach of his employer’s internal policies, the Personal Data (Privacy) Ordinance (Cap. 486) (“PD(P)O”), and the Code of Conduct for Persons Licensed by or Registered with the SFC (“Code of Conduct”).

Comment

In the wake of several large-scale scandals such as the Facebook-Cambridge Analytica data scandal, there has been a growing global focus on the need for stronger data protection regimes, most notably with the 2018 implementation of the General Data Protection Regulation ("GDPR") in the European Union.

While the GDPR's sanctions regime is far harsher than that available under the PD(P)O, industry regulators in Hong Kong, such as the HKMA and the SFC, have recently shown a growing interest in data protection. In 2010, the SFC issued a circular to licensed corporations on “Compliance with the PD(P)O”, recommending that corporations have internal controls in place to ensure compliance.  In 2014, the HKMA revised its circular on “Customer Data Protection”. In 2016, the SFC issued a further circular on “Cybersecurity”.

The SFC has wide powers to take disciplinary action against licensed persons and registered institutions (ss.194-197, Securities and Futures Ordinance (Cap.571) (“SFO”)); it has shown no hesitation in exercising these powers to enforce Hong Kong’s data protection laws, as demonstrated by this Decision, which follows other similar Decisions made in January 2018 and May 2016. A key factor in each of these Decisions is that the SFC is keen to send a deterrent message to the market, in each case banning the offending individual from re-entering the industry for between 6 and 12 months.

While no enforcement action has so far been taken by the SFC against regulated institutions for data breaches or other cybersecurity failings, such institutions should take heed of the SFC's clear readiness to use its powers to enforce the PD(P)O. As seen from the 2010 Circular, the SFC expects institutions to have adequate internal policies, controls and practices to ensure compliance. A serious breach of the PD(P)O could lead to an institution being de-registered under the SFO for a lack of internal controls. Institutions should therefore carefully review and test their existing policies and practices to minimise the risk of serious consequences.

CFDs

We reported on ESMA's initial adoption of these measures in June 2018, which restrict the marketing, distribution and sale of CFDs to retail investors, by imposing the following requirements:

a. leverage limits on opening positions;    

b. a margin close out rule on a per account basis;    

c. negative balance protection on a per account basis;    

d. a restriction on the incentives offered to trade CFDs; and    

e. a standardised risk warning.

ESMA originally put these restrictions in place as a result of its and national regulators' growing concerns regarding the increasing losses being suffered by retail investors engaging in CFD trading (as discussed in our July 2017 article).  These concerns resulted in ESMA issuing a call for evidence in January 2018 in relation to its proposed intervention in the market to protect retail investors, using its newly acquired powers under MiFID II. 

Following this consultation, we reported on ESMA's announcement in March 2018 that it intended to introduce the above restrictions for the sale of CFDs.  However, as ESMA is only able to implement these measures for a period of three months at a time under MiFID II, it must decide whether or not to renew them for a further three months on an ongoing basis.  On 28 September 2018, ESMA conducted its first renewal process and decided to renew all of the existing restrictions on CFDs. 

Binary Options

At the same time as intervening in the CFD market earlier this year, ESMA also chose to impose a total ban on the sale of binary options to retail investors from 2 July 2018, which it considered necessary as it found that they posed an even greater threat to retail investors than CFDs. 

Interestingly, when it came time to consider the renewal of this ban on binary options in August 2018, ESMA altered its position to a limited extent by allowing the sale of binary options to retail investors, if they meet the following criteria:

a. it has two pre-determined pay outs, neither of which is less than the initial investment of the customer; or    

b. it has all of the following features:      

     i. the term from issuance to maturity lasts for at least 90 days;    

     ii. it is accompanied by a public prospectus; and  

     iii. it is fully hedged by the provider or another within the same group.

ESMA considered that binary options that fall into either of these categories have sufficiently mitigated the risk of investor detriment and it has, therefore, excluded them from the ban on the sale of binary options, which otherwise continues unchanged.

Next Steps

For my preference, the report leans too heavily on the views of one or two witnesses who are bordering on aggressive toward crypto, and focusses too much on Bitcoin rather than seeing cryptocurrencies and blockchain technology as a constantly evolving ecosystem.

But even so, the conclusions and recommendations are broadly reasonable and may be found here. The key points are:

• Crypto-assets are risky and a target for criminal activity;

• Crypto-assets currently fall outside of the FCA's regulatory perimeter in the UK. ICOs, and crypto-assets, exploit a regulatory loophole. This situation is unsustainable; and

• Crypto-assets and ICOs should be brought within the FCA’s perimeter as a matter of urgency.

In calling for regulatory certainty, the Committee dangles the carrot of Britain becoming a leading global presence in the crypto-asset space if we get our approach to the sector right. But, what form will UK regulation of crypto-assets take? And when can we expect it to be introduced?

The report calls for activities involving crypto-assets to become "regulated activities" and thus inside the FCA's regulatory perimeter. In practical terms, however, the report has no binding effect. It is a suggestion; a meaningful one from a respectable source but merely advisory at this stage. In order to change the relevant rules, the Treasury needs to make a proposal which will be open to consultation. After the closure of the consultation, the final rule change will be published, and an implementation date set.

However, in order to reach the proposal stage, the Treasury will need to have a view on exactly what changes they want to make. It is not as simple as saying "crypto-assets and ICOs are regulated". The relevant terms need to be defined and the range of activities to be regulated will need to be scoped out. This is all virgin territory, so likely to involve much discussion and negotiation; with stakeholders, legislators and regulators.

Add to that, that any change is going to mean an expansion to the role and remit of the FCA, and there will need to be discussions to ensure that the FCA is clear what they are being asked to do, that they have the capacity to handle it, that they have the technical expertise to understand the sector, and that they have considered (and addressed) the consequences of any changes (for example, they'll likely need to update their forms, handbooks and regulatory guides at a minimum). And, of course, the FCA needs to have the funding to do all this.

A recent change to the Regulated Activities Order (which is the change suggested in the report), was first consulted on by the Treasury in September 2016, and came in to force in January 2018. And that was far more straightforward than the changes we are looking at now.

So, on the one hand, with political will and civil service bandwidth, it could be that crypto-assets and ICOs become regulated in the UK in the next few (say, six) months. On the other hand, this is a complex change, with lots of moving parts and international ramifications. It is being proposed against a backdrop of Brexit, a government with a small majority and myriad other issues looming large.

Recent statistics released by the FCA show that victims of pension scams have lost an average of £91,000 each.    Those deemed to be most at risk to pension scams are people aged 45 – 65.

Recent research reveals that almost one third (32%) of pension holders in that age group do not know who to contact to check they are speaking with a legitimate pension provider or adviser.  Further, within the same group, one in eight people (12%) would trust an offer of a free pension review from someone claiming to be a pension adviser.

The ScamSmart advertising campaign, broadcast across TV, radio and social media adverts, is designed to bring to the public's attention the most common tactics used by scammers which include:

• Cold calling

• Unexpected contact about your pension via post, telephone or email

• Unusual or overseas investments being offered (which are not regulated by the FCA)

• Time-limited offers

• Claims to "unlock" funds from a pension (which is normally only possible to someone aged 55 or over).

As a result the FCA and TPR have urged the public to be "on their guard" when receiving unexpected offers about their pension and to always make sure they check precisely who they are dealing with.  In addition they state that individuals should:

• Reject unexpected pension offers

• Check who they are dealing with before making any changes to their pension arrangements

• Not be pressured or rushed into making any decision regarding their pension

• Consider getting impartial advice.

 Those contacted in respect of their pensions are encouraged to visit the ScamSmart website before making any decisions to change their pension arrangements (www.fca.org.uk/scamsmart).

The move by the FCA and TPR has been welcomed by many in the industry, particularly in light of the delays in the government's intention to ban cold calling.  In November 2016, the government announced its plans to introduce a ban on pension cold calling.  This was intended to come into force in June 2018.  However, the deadline was missed and the government instead announced a consultation open until 17 August (here).  It is understood that once the government has received and considered all responses, the regulations will be presented to Parliament in the autumn.

Mr N was employed by the Northumbria Police Authority (the Authority).  He had been employed by the Authority for 14 years and was a member of the Police Pension Scheme (the Scheme).  He became a deferred member on 12 December 2012 when he made an application to stop making contributions to the Scheme.

At age 39 Mr N sought advice on the possibility of transferring to another pension provider where he could access his pension at 55.  The Pension Ombudsman's decision noted that Mr N was concerned at this time that his pension would not be accessible under the Scheme's rules until he reached 60 and that the Scheme's rules may increase normal retirement age from 60 to 65.  He contacted a company called Pension Transfer UK.  Mr N received a follow up call 2 weeks later from Viva Costa International, an unregulated introducer of work to IFAs, and he was then referred to Gerard Associates Limited, a firm of financial advisers.  Mr N was recommended a transfer to the London Quantum Retirement Benefits Scheme (London Quantum).  London Quantum appears to have been a defined contribution scheme established in 2012.

Following what is said in the Pension Ombudsman decision to have been advice from Gerard Associates Limited, Mr N transferred his funds from the Scheme to London Quantum.  The transfer was made in August 2014 with a value of c. £115,000. 

In 2015, Mr N reviewed the documents that he had been given in 2012 and was concerned to note that he had signed up to a high risk investment as a sophisticated investor.  He was unable to obtain satisfactory responses from the administrator of London Quantum or Gerard Associates Limited.  The Pensions Regulator appointed an independent trustee to London Quantum in June 2015 and that independent trustee is currently trying to reconcile the assets of London Quantum.  It appears that London Quantum was part of a pension liberation scheme (whereby members accessed their pensions before reaching 55).

Mr N brought a complaint before FOS against Gerard Associates.  This was rejected as being outside of FOS' jurisdiction on the basis that no regulated activity had been undertaken by Gerard Associates; it appears that Gerard Associates' position was that it did not provide any advice and Mr N appears to have been advised by a separate unregulated person or firm.

Mr N then brought a complaint against the trustees of the Scheme.  The Pension Ombudsman initially upheld the complaint.  It then held an oral hearing before providing its final decision.  The final decision also upheld the complaint.

The Pension Ombudsman's decision

The Pensions Ombudsman referred to the Pension Regulator's pension liberation fraud guidance of February 2013 issued before the transfer in late 2014 (the Scorpion Warning).  It then referred to previous determinations where it has been said that February 2013 marked a point of considerable change in the level of due diligence expected of trustees, managers and administrators when considering transfer requests from defined benefit schemes. The Pension Ombudsman noted that it had seen increased levels of enquiry and due diligence from trustees since 2013 and in fact, in many cases complaints centred on a delay in a transfer taking place given the enquiries undertaken by scheme trustees.

The Pension Ombudsman commented that the "… overriding consideration for a scheme trustee or administrator must be to evaluate the transfer application carefully in order that a valid statutory transfer right is complied with and an invalid transfer application is legitimately withhheld…".  The Pension Ombudsman then went on to comment on what the trustees of the Scheme failed to do in Mr N's case:

1. Failed to send the Scorpion Warning recommended by the Pensions Regulator since February 2013.  Although the warning was available on the intranet for employees and the guidance did not prescribe that the warning had to be provided directly to the member, the Pension Ombudsman said that it would be usual practice to send the warning and that was definitely the case by August 2014 when Mr N's transfer took place.

    

2. Failed to identify a number of features which other pension schemes identified as red flags for pension liberation and where other schemes had in fact refused transfer requests.  These red flags included that (1) London Quantum was sponsored by a dormant company, (2) it was clear that Mr N was not employed by the sponsor of the scheme (being the dormant company) given that he remained employed with the police force, (3) the location of London Quantum should itself have raised alarm bells as Mr N was based in the North East, and (4) there were only limited circumstances in which a serving police office would be allowed to have a second employment.

    

3. The Pension Ombudsman would have expected the member to have been asked why he was transferring to a scheme with an employer who did not employ the member and how he became aware of the receiving scheme.  Had such enquiries been made, the Pension Ombudsman said that in all likelihood the involvement of an unregulated introducer would have been identified together with the type of investments made through the receiving scheme.  The names of those involved and their link to pension liberation may also have been identified.  Further, Mr N signed forms to indicate that he was a sophisticated investor seeking a high-risk investment when he says that he was not such an investor.  It was found that had the trustees conducted adequate enquiries these issues are likely to have been identified and the concerns dealt with.

    

4. Failed to obtain a copy of the trust deed and rules of London Quantum to ensure that it met the statutory requirements for a transfer.

The trustees of the Scheme argued that Mr N would have made the decision to transfer even had he been provided with the leaflet and advised of the various risks.  The Pension Ombudsman rejected this argument finding that "… had the [trustees of the Scheme] acted more diligently, as I consider it should, Mr N would, on the balance of probabilities not gone ahead with his particular transfer.  There was simply too much for him to lose, with little in the way of potential discernible gain…".

Having found against the trustees, the Pension Ombudsman then considered section 99(1) of the Pension Schemes Act 1993 which provides a statutory discharge where the member exercises a statutory right to transfer out of a scheme and the trustees have "done what is needed to carry out what the member requires".  The Pension Ombudsman said that the statutory discharge did not apply in this case as "what needed to be done" included ensuring that appropriate due diligence was carried out and any warnings and concerns brought to the attention of the member.

The Pension Ombudsman directed that Mr N's accrued benefits in the Scheme should be reinstated and he was awarded £1,000 for distress and inconvenience.

The implications for trustees of defined benefit schemes

The Pension Ombudsman's decision has received wide comment in the pension press.  The finding against the trustees, however, should probably be seen in light of the factual circumstances of the case itself.  First, this was a pre-pension freedoms transfer, at that time there was no requirement for the member to have obtained regulated advice on their pension transfer from a firm permitted to provide pension transfer advice; that would not be the case now and instead if a transfer is value is over £30,000 the trustees must check that appropriate independent advice has been obtained – the Pension Regulator says that this means checking the FCA's register to ensure that the adviser is regulated to provide the advice and does not require a trustee to check the advice itself. 

Second, the transfer was to a pension liberation scheme, an issue which the Pension Regulator has highlighted to scheme trustees and which the Pension Regulator requires trustees to highlight to members.  Also, as a pension liberation scheme the pension had not been placed into a product, such as a SIPP, and there was unlikely to be any benefit in bringing a claim against the trustee of the pension liberation scheme that had already been replaced by the Pension Regulator. 

Third, the trustees of the Scheme had failed to provide the Scorpion Warning which most trustees would provide as a matter of course with any request to transfer.

Taking into account these factors, it is likely that the findings will be limited to pension liberation schemes and so, provided that the trustees conduct appropriate checks into the receiving scheme, provide the warnings set out by the Pension Regulator and check that for transfers over £30,000 that appropriate independent advice has been obtained, then the trustees should have a good defence to any complaint or claim brought by a member who later regrets their decision to transfer and those defences would include relying on the statutory discharge having carried out the necessary due diligence. 

Wider implications?

However, some of the commentary in the Pension Ombudsman decision arguably goes a little wider than just a pension liberation scheme. For example, the suggestion in the decision that trustees should ask questions around the transfer and potentially identify the involvement of unauthorised introducers has potentially wider implications. 

If it is the case that trustees of defined benefit schemes should identify and highlight the involvement of unauthorised introducers as a specific risk when a transfer request is made then this probably requires more due diligence than most trustees usually undertake.  This also raises the possibility of complaints and claims against trustees on the basis that they failed to highlight the risk of the involvement of an unauthorised introducer and the member arguing that they would not have transferred had that risk been highlighted.  Whether or not such complaints and claims are upheld remains to be seen.

At present, the stand-alone cyber insurance market lies predominantly in the United States, with only a fraction of the market in Europe. The majority of available reports and surveys focus on the US market and a continued deeper understanding of cyber risk is an ongoing challenge for the European cyber insurance industry.

The EIOPA report is the result of organised consultation with the industry and provides interesting and useful analysis on the current state of the market and predictions for upcoming years. It is based on a survey with responses to 14 qualitative questions answered by 13 insurance and re-insurance groups based across Europe.

Its key findings are as follows:

• There is a clear need for a deeper understanding of cyber risk. This concerns not only the assessment and treatment of risk in new propositions but also understanding the needs of clients.

   

• Cyber insurance coverage is predominantly focused on commercial business at present. However, interest in providing cover for individuals is gaining momentum due to an increased exposure to cyber risks, such as credit card and identity theft through the internet.

   

• The increase in cyber incidents, increased knowledge of risk and EU regulatory initiatives are expected to raise awareness and boost the demand for cyber insurance. New technologies will also continue to drive the evolution of cyber policies. This in turn is expected to establish cyber risk as a firm contributor to the economy.

   

• Qualitative models (based on risk assumptions of exposure, questionnaires and expert judgment) are more frequently used than quantitative models (based on actuarial pricing and rating tools) to estimate pricing and risk exposures and accumulations.

   

• Data analysis, specialised tools and specialised underwriters will be key to the proper estimation and pricing of risk, to ensure adequate provision of insurance coverage.

   

• It is suggested that regulation may be a welcome support to the industry to a moderate extent, if it could help to address some of the identified challenges.  

The report clearly sets out the growth potential of cyber insurance and the challenges the industry is facing, as well as the widening relevance and importance of cyber insurance in insurers' portfolios.

RPC have extensive experience in supporting insurers and their clients with this developing market both with breach response services and regulatory compliance. ReSecure is the RPC awarding winning service which responds quickly to cyber incidents, providing (with third party service providers) all of the help needed in the wake of a data breach incident.

Richard Breavington is available at rbreavington@rpclegal.com or 020 3060 6341 should you wish to discuss our ReSecure or cyber services further.

P2P lending was last reviewed by the FCA in December 2016, announcing at the time, its plans to address the gap in protections for customers. Since then it has monitored the situation and noted the variety of loan-based crowdfunding business models, of which some are becoming increasingly complex. Whilst the FCA regulates loan-based crowdfunding (also known as P2P lending) and investment-based crowdfunding (which falls outside of the FCA's present review), the FCA does not regulate donation-based or reward-based crowdfunding (hence, both of these fall outside of the FCA's review).

As part of its ongoing monitoring, the FCA has also noted poor practice among some firms in the crowdfunding industry. The proposals detailed below aim to improve standards in the sector whilst still leaving scope for further innovation.

The consultation is aimed at establishing views on the following proposals: 

• Proposals to ensure investors receive clear and accurate information about a potential investment and understand the risks involved

• Ensure investors are adequately remunerated for the risk they are taking

• Transparent and robust systems for assessing the risk, value and price of loans, and fair/transparent charges to investors

• Promote good governance and orderly business practices

• Proposals to extend existing marketing restrictions for investment-based crowdfunding platforms to loan-based platforms 

Executive director of strategy and competition for the FCA, Christopher Woolard has stated that: “The changes we’re proposing are about ensuring sustainable development of the market and appropriate consumer protections. We believe that loan-based crowdfunding can play a valuable role in providing finance to small businesses and individuals but it’s essential that regulation stays up to date as markets develop.”

Equally, the FCA was keen to ensure that not all P2P lenders were criticised, noting that some "P2P platforms already have more robust systems and controls in place".

The new proposals will also see tighter provisions when alternative funding is used for home loans. The FCA will seek to enforce its Mortgage and Home Finance: Conduct of Business rules on P2P platforms if they begin to deal in the residential lending market.

The FCA is asking for responses to the consultation by 27 October 2018 before it publishes rules in a Policy Statement later this year.

The discussion paper delivers on a promise the FCA made in the feedback statement to its 2017 Mission Statement, to address calls for an overarching "duty of care" for financial services firms.

The discussion paper sets out the FCA's regulatory and legal framework, its practical approach to regulation and its views on consumer outcomes (including redress) as background, and asks a number of questions of stakeholders:

1. whether there is a gap in its existing regulatory framework that could be addressed by a "new duty";

2. what such a new duty might do to enhance positive behaviours from firms, and incentivise good customer outcomes;
   
   

3. how a new duty would increase the FCA's effectiveness in tackling harms and achieving positive outcomes for consumers;

4. if the FCA should reconsider whether breaches of the FCA Principles should give rise to private rights for damages in court (or whether a new duty might give this right); and

5. whether a new duty would be more effective in preventing harm, meaning that redress might need to be relied upon less.

The FCA does not make any representations as to what a new duty might consist of or how it might be created, but gives a number of options: a rule introducing a new duty, a statutory new duty, extending existing "best interests" rules, or enhancing the existing principles with new rules or guidance.

The FCA recognises that this is an "important and complex" debate. Firms' views, and responses to its questions, are requested by 2 November 2018.

Is a new Duty of Care required?

Under the Financial Services and Markets Act 2000 (FSMA), the FCA has a single strategic objective: to ensure that the relevant markets function well. One of its operational objectives is to secure an "appropriate degree" of protection for consumers. Both FSMA and the FCA's principles of good regulation recognise that a consumer is required take responsibility for its decisions. So any regulatory intervention must be based on a balance between those two requirements.

In examining whether there is a gap in the regulatory framework, and potentially therefore a need for a new duty, this balance (or rather any imbalance), is the starting point. A new duty, whether framed as a duty of care or fiduciary duty, would be a significant burden on firms and it could swing the balance in favour of the consumer in many respects. 

In a statement made in 2009, it was made clear that the principle of treating consumers fairly (TCF) was seen as meeting that balance. A number of stakeholders who responded to the FCA's 2017 Mission Statement agreed with this analysis, and the Association for Financial Markets in Europe (AFME) made reference to a number of successful enforcement actions under TCF. However there were stakeholders, most notably the Financial Services Consumer Panel (FSCP), who believed that a wider duty of care was required.

Arguably, stakeholders are not best placed to answer the first question posed by the FCA. In order to consider where there are imbalances, regulation, enforcement and redress should be considered in the round, taking into account the wider regulatory environment, including stakeholder organisations, and involving the Financial Ombudsman Service (FOS). Are there consistent complaints to FOS which are not addressed by FCA regulation? Equally, are there areas of the FCA Handbook where enforcement is not successful or where mistakes are repeatedly made by firms? Are there areas of financial services where it is considered that consumers should be able to seek redress, but are unable to? These questions can only be answered with significant input from the FCA and FOS, and require a level of gap analysis that neither organisation is likely to have the bandwidth to complete in the current climate.

The FRC was last subject to a review six years ago, in 2011. However, in light of heavy criticism, with critics suggesting the watchdog is too close to the industry it supervises and following a series of high-profile corporate failures, a landmark review is now being conducted.

The review is due for completion by the end of 2018 and includes a public consultation. It will assess the FRC's governance, impact and powers.

In what may not have come as a shock to the regulator given the criticisms being made already, the review will also consider whether the FRC should be disbanded, or folded into another regulatory organisation.

With some of the FRC's harshest critics standing for the regulator to be disbanded or replaced, it seems entirely possible that the FRC's future is on the brink.

Perhaps unsurprisingly and in a bid to improve trust, the FRC has published a new Corporate Governance Code and has levied record high fines off the back of a number of audits, against auditors and accountants.

Most alarmingly, last month the FRC imposed a record high fine of £10million (later reduced to £6.5million) following allegations of misconduct off the back of an audit, being the highest fine it has ever raised.

So what does this mean for accountants, auditors and actuaries? Clearly, the FRC is showing no signs of going down without a fight, and seems to be using all means necessary to show its teeth. Certainly the fines being levied are not low value, and given that the FRC does not have a cap on the level of fines that it can raise against firms there is the possibility that even higher fines could be levied in the future.

The FCA's response provides that in September 2017 only around 2% of assets under management "with the largest contract-based SIPP operators" were invested in non-standard investments (NSIs).  This is said to be a total of £5.97bn against assets under management of £300.31bn.

The Work and Pensions Committee asked the FCA what due diligence SIPP providers are required to conduct on NSIs.  The FCA has said "… we require firms to comply with our Principles of Business and therefore conduct their business with due skill, care and diligence.  We also require them to treat their customers fairly.  We do not prescribe an exhaustive list of factors they should consider as part of their due diligence checks as we believe firms need to ensure that are taking effective, appropriate action in each individual case.  We do have rules in place which oblige SIPP operators to assess if there are problems with an investment and/or an introducer.  By carrying out this due diligence they would be required to take appropriate action, which may include declining to proceed with the investment…".

The FCA then makes a reference to a "recent intervention in a civil court case" (being Russell Adams v Carey) and goes on to say what it expects of SIPP providers listing 4 due diligence requirements:

1.     SIPP operators should take reasonable steps to ensure that they do not accept into  
         the SIPP an asset that is likely to give rise to tax liabilities.

         This is likely to be relevant to situations where the SIPP operator purchases assets   
         from a member as this can lead to unauthorised tax charges if the asset is worth less   
         than the amount the SIPP pays for that asset. It would also apply where the
         investment cannot itself be held within a SIPP.

2.     SIPP operators have a responsibility to take reasonable steps to ensure that a 
         proposed underlying investment for a SIPP is a genuine asset and is not part of a fraud
         or scam.

3.     A key part of the task of a SIPP operator is to receive, hold and administer the
         underlying asset held in the SIPP. In order to carry out that role in accordance with
         the client's best interests and COBS 2.1.1R a SIPP operator must satisfy itself that it
         or its trustee has proper custody of and good title to the underlying asset.

4.     SIPP trustees are subject to specific obligations to provide clients with realistic 
         annual valuations of assets held in a SIPP. Accepting an underlying asset into a SIPP 
         without having taken reasonable steps to ensure that it or its trustee will be able to 
         undertake realistic annual valuations would amount to a breach of COBS 2.1.1R and 
         a failure to act in the client's best interests. 

Steps the FCA is already taking

The letter also refers to the FCA's enforcement powers and that there is one live skilled person review into a SIPP provider involved with NSIs.  The letter also refers to a number of SIPP operators having offered and accepted voluntary requirements to cease accepting "higher risk" NSIs while they review their due diligence processes.  Two SIPP firms are said to have been referred to the Enforcement and Market Oversight Division.  There are also said to be 33 open investigations into advisers who the FCA is said to "suspect have given poor advice" and a further 4 advisers have been prohibited or banned from holding senior positions.

A ban on NSIs?

The letter confirms that the FCA is not "currently considering barring unregulated or NSIs from inclusion in SIPPs" as it believes "suitable advice from financial advisers accompanied with effective due diligence checks by SIPP operators is a more proportionate way of preventing harm to consumers rather than imposing a ban".  The FCA notes that not all NSIs are high risk, referring to commercial property and fixed term deposit accounts as examples of NSIs that are not high risk.  These assets are counted in the category of non-standard as they are not capable of being liquidated in 30 days but in relation to which the FCA says it would "not necessarily want to ban" for sophisticated and high net-worth individuals should they proceed on the basis of sound advice and consideration.

What next?

The letter is confirmation of the FCA's views on the due diligence requirements of SIPP providers and that a failure, the FCA considers, constitutes a breach of COBS that would be actionable under section 138D of FSMA.  Notably the letter does not go into detail in relation to due diligence on referrers of business including unauthorised introducers.  Instead the focus of the list of 4 due diligence obligations is on the investment itself.  This is probably a product more of the questions raised of the FCA than an indication of the FCA's views on unauthorised introducers.  What the letter does confirm is that the FCA has no plans to ban investments in NSIs.  However it does confirm that what the FCA does not like is so-called "mainstream" investors investing in NSIs.

We doubt that this is the last we will hear on the subject with a number of court cases in this area in the pipeline.

The problem is no longer an academic one. Figures released by the Office for National Statistics (ONS) show that cyber-related crime against businesses increased by 63% in 2017. The figures however are likely to be even greater, as in 2016, it was estimated that only 30,000 of the 1.8 million cybercrimes were reported. Loss of revenue, future business and consumer confidence are just some of the outcomes of a cyber-attack.

Considering the severity of the threat from cybercrime, the IMF (in their working paper "Cyber Risk for the Financial Sector: A Framework for Quantitative Assessment") have created a framework, which can be used to calculate the annual potential losses to the financial sector. Financial institutions are typically more vulnerable to such attacks because of the amount of reliance they have upon highly interconnected networks.

The framework will be particularly useful for the financial services sector, given the requirement to hold risk capital for operational losses arising from cyber-attacks. The system is created by using actuarial science and operational risk measurement to provide an estimate of how much capital a firm needs to have in order to cover the losses.

Of most concern is the announcement that in 5% of the worst cases, the average loss could be half of the bank's net income, raising serious questions as to whether it could realistically survive. This will of course have wide reaching implications, not just for the financial sector, but for the economy as a whole.

On 13 March 2018, the EU Council agreed to new measures¹ to require the mandatory disclosure by intermediaries or (in the absence of intermediary involvement, or where the intermediary claims privilege) taxpayers to their local tax authorities of certain cross-border tax planning arrangements. This came as a response to the OECD's Base Erosion and Profit Shifting (BEPS) project.

An "intermediary" for these purposes is anyone with an EU taxable presence (or EU professional services registration) who designs, markets, organises or makes available for implementation or manages the implementation of a "reportable" cross-border arrangement. Lawyers, accountants, bankers, investment managers and others are likely to be within this group.

Taxpayers may themselves be required to make disclosures under the new tax rules to the extent that they implement 'in-house' reportable arrangements or they use intermediaries protected by privilege.

The new rules must be implemented by member states by 31 December 2019, to be applied (in terms of reporting) from 1 July 2020. Both dates are therefore expected to occur during the Brexit 'transition' period. The uncertainty surrounding Brexit casts doubt as to whether the UK will impose these new rules, although the UK has been a vocal supporter of the OECD work in this area.

What is reportable?

At least one of the two or more countries involved in the arrangement must be an EU member state.

Although the target of the new rules are instances of so-called "aggressive" tax planning, the new Directive adopts an approach that whilst familiar (at least to UK tax advisors) is rather more convoluted. The new rules are similar to the UK's existing 'DOTAS'²  regime as, for the EU cross-border arrangement to be "reportable", at least one specified 'hallmark' must exist. In addition for many (but not all) of the hallmarks, one of the main benefits must be the obtaining of a tax advantage.

The hallmarks are broadly grouped as follows:

 Automatic exchange of information

Once reported, member state tax authorities will be required to automatically exchange information with authorities in other member states.

First, and subsequent, reports

Between 1 July and 31 August 2020, reports of all reportable arrangements implemented from 25 June 2018³ to 1 July 2020 must be made to the applicable member state tax authorities.

Taxpayers and intermediaries should therefore, from 25 June, start recording activities that will potentially need to be disclosed by the end of August 2020.

Afterwards, reportable arrangements will be reported quarterly, from 30 October 2020.

¹ Council Directive 2018/822.
² Disclosure of tax avoidance scheme.
³ Being the twentieth day following that of the new Directive's publication in the Official Journal of the European Union.

As we have previously reported, these steps have been taken as a result of mounting concern over the past few years by ESMA and national regulators, including the Financial Conduct Authority, regarding the risks that binary options and CFDs pose to retail investors.

In summary, ESMA has concluded that binary options are inherently risky and complex products that do not meet any genuine investment need of retail investors and can result in extensive losses, which has resulted in its decision to prohibit their sale to retail customers altogether.

Whereas, ESMA does consider CFDs meet a genuine investment need, so has instead sought to restrict their sale in order to limit the losses to which retail investors are exposed.

On 1 June 2018, ESMA formally adopted these new measures to restrict the trade of these products.  However, it is only able to implement these measures for up to three months at a time.  ESMA will, therefore, need to decide on a three monthly basis whether to extend and/or vary the applicability of these measures on an ongoing basis.

The new measures

The restrictions are as follows:

1. Binary options – a prohibition on the marketing, distribution or sale of binary options to retail investors.

2. CFDs – a restriction on the marketing, distribution or sale of CFDs to retail investors. The restriction consists of:

a. leverage limits on opening positions, from 30:1 to 2:1, varying according to the volatility of the underlying asset.

b. a margin close out rule on a per account basis. This aims to standardise the percentage of margin (at 50% of minimum required margin) at which providers are required to close out one or more retail client's open CFDs.

c. a negative balance protection on a per account basis, to provide an overall guaranteed limit on retail client losses

d. a restriction on the incentives offered to trade CFDs

e. a standardised risk warning, including the percentage of losses on a CFD provider’s retail investor accounts.

According to the Chair of ESMA, the measures "are a significant step towards greater investor protection in the EU. The new measures on CFDs will, for the first time, ensure that investors cannot lose more money than they put in, restrict the use of leverage and incentives, and provide understandable risk warnings for investors. ESMA’s prohibition on the marketing, distribution or sale of binary options to retail investors addresses the significant investor protection concerns caused by the characteristics of this product. This pan-EU approach is the most appropriate way to address this major investor protection issue."

Alongside its announcement, ESMA has published a Notice of its Product Intervention Decisions in relation to CFDs and binary options, detailing the decisions taken. ESMA has also published separate Product Information Analyses on binary options and CFDs, analysing evidence in relation to the provision of both products and the effect of proposed changes.

The FCA's Business Plan for this year, published in April 2018, expressed support for ESMA's intervention measures and stated that the FCA expects to consult on whether to apply ESMA's measures on a permanent basis, even if ESMA were to withdraw these restrictions in due course.  

Next steps

The FCA will no doubt be paying close attention to firms' responses to these measures and their impact on retail customers and will be liaising with ESMA in this regard. 

The aim of “stewardship” is, broadly, to make sure that companies’ operational processes and policies are robust and responsible. Whilst EFAMA’s previous guidance focussed on the exercising of ownership rights, and in particular voting and monitoring, the Code goes further, encouraging publication of an engagement policy which describes how the asset manager approaches stewardship. In it, EFAMA describes stewardship as being “engagement, ie monitoring of and interaction, with investee companies”, as well as the exercising of voting rights. Unlike the Financial Reporting Council’s UK Stewardship Code (the adoption of which is mandatory for UK authorised investment managers), adoption of the Code is currently voluntary. However, both codes apply a “comply or explain regime”.

EFAMA members are now encouraged to show, in an engagement policy, how they intend to integrate engagement into investment strategies, and how dialogue is conducted with investee companies. Previously an escalation option, this dialogue is now seen by EFAMA as an integral part of how managers act in investors’ interests. The changes are also intended to, EFAMA says, “encourage best business and management practices in companies on environmental, governance, human rights and social challenges”.

Ahead of SRD implementation, the Code is intended to provide useful guidance to asset managers across Europe as to how they should develop engagement processes, and also provide investee companies with an idea of the interaction and monitoring they might have to expect in the future.

Separately, the FRC is due to revise its UK Stewardship Code this calendar year (2018).

The key provision of the agreement states that the Ombudsman and TPR will look to share information where that disclosure would assist in their respective investigations.

In signing the agreement the Ombudsman and TPR acknowledge that whilst reforms in recent years such as auto-enrolment and pension freedoms have created opportunities, the industry has also seen a worrying rise in pension scams. 

A recent survey by the Prudential polled 1,000 individuals and found that 9 per cent had been approached about their pensions by what they now thought were scammers.  The research also identified that 33 per cent of individuals aged over 55 were concerned about the risk of being defrauded following the introduction of pension freedoms in 2015.  Recent data from Action Fraud confirmed that 991 cases had been reported since 2015, involving losses of more than £22m.

The research from Prudential also concluded that fewer than 18 per cent of those approached by suspected scammers had gone on to report their concerns.  In fact, according to the research, just under half of those approached by potential fraudsters stated that they did not report their concerns because they did not know who to contact or how to do so.

Against this backdrop, both the Ombudsman and TPR acknowledge that the pensions landscape is changing and that "key stakeholders need to work together… to protect pension scheme members and ensure a safe pensions saving environment".  There is, therefore, as acknowledged by the Ombudsman and TPR, an increased need for "robust governance standards".  In working more closely together, they aim to identify trends (such as scams) and deal with issues identified quickly and effectively.

The Work and Pensions Committee has issued a letter to the FCA asking 5 questions.  The letter states that during the Committee's examination of defined benefit transfers "… it has become clear that SIPPs are the primary vehicle used by unscrupulous advisers to channel individuals' pension savings into unsuitable investments…" the letter also states that "… Although the FCA has warned SIPP providers about what it expects of them regarding due diligence, it is not clear what repercussions a provider faces if these expectations are not met.  Primary responsibility for paying compensation for mis-selling falls to the financial adviser, who can evade this by folding their firm…".

The 5 questions raised by the Committee of the FCA are:

1. What is the value and proportion of funds transferred from DB pension schemes into SIPPs in the last two years which are held in the form of non-standard or unregulated investments?

2. What due diligence are SIPP providers required to conduct on the investments that they provide access to and how does the FCA monitor this?

3. What powers does the FCA have to punish SIPP providers for failure in due diligence, and how have these powers been used?

4. In what circumstances can a SIPP provider be deemed liable to pay compensation to a customer whose funds ended up in an unsuitable investment scheme, rather than the financial adviser who arranged the investment?

5. Is the FCA considering the option of barring unregulated or non-standard investments altogether from inclusion in SIPPs?

Those involved with complaints and claims against SIPP providers will be aware that these are some of the issues currently before the courts in Adams v Carey and the Berkeley Burke judicial review of a FOS decision from 2014. 

The disclosure of the Committee's letter coincides with the publication of FOS' annual review of complaints for the period 2017 and 2018.  The annual review provides that complaints in relation to SIPPs increased by 37% from 1,493 in 2016/2017 to 2,051 for 2017/2018.  The figures also indicate an 11% increase in complaints relating to pension transfers/opt outs with the number of complaints increasing from 496 to 553.

We anticipate that the headlines for SIPPs are not over yet and it will be interesting to see the FCA's response to the Committee's letter.

The FCA's submission commences with a helpful overview of how it considers different forms of crypto-assets (the FCA's term for cryptocurrencies) and products are positioned in relation to its regulatory perimeter.

As the FCA has stated many times before, cryptocurrencies are generally outside the scope of FCA regulation. Cryptocurrency transactions, including operating cryptoexchanges, also typically fall outside the FCA’s regulatory perimeter. Certain other crypto-related products will generally be in scope: derivatives with a crypto underlying, regulated payments services which use cryptocurrency, tokens representing transferable security and investment assets in cryptoassets. The last item is potentially curious, but given the FCA lists "Swedish registered exchange traded notes" as a use case, it seems to refer to ETFs (or other funds/structures) which allow investors to gain exposure to cryptocurrencies. However, the FCA points out that the applicability or otherwise of the FCA regime to a given crypto-asset or product needs to be assessed on a case by case basis.

The FCA also discusses what it sees as the main benefits and risks arising from cryptocurrencies, derived from the FCA's experiences on recent blockchain related initiatives including the Regulatory Sandbox. Benefits include high-speed, secure transfers of assets. Risks include the usual suspects of volatility, market abuse and market disruption by derivatives. On this last point, the FCA mentions ESMA's intention to limit leverage in crypto CFDs to 2:1 for retail products.

The FCA also discusses the risks of money laundering, noting that most crypto-related activities fall outside current anti-money laundering requirements in the UK, but accepting that many cryptoexchanges already carry out a degree of anti-money laundering checks on customers. However, the FCA points out that new EU rules are expected to be introduced later this year, to be implemented late-2019, which would apply anti-money laundering requirements to cryptocurrencies and exchanges.

In its submission, the BOE comes across as more sceptical of cryptocurrencies generally. This could be an outgrowth of the Bank's position as macro-prudential regulator and overall gatekeeper to the UK financial industry (through the PRA and FPC); in contrast to the more accepting tone of the FCA (which as a conduct regulator is faced with the challenges of engaging with businesses already active in the blockchain/crypto space). It could be a reflection of the BOE's position as central bank and/or an acknowledgement of the potential upheaval to traditional banking institutions and processes from blockchain.

The BOE states that it thinks it unlikely that cryptocurrency will replace commonly used payment systems, but this statement belies a monochromatic model of the world. Perhaps the most noteworthy item from the BOE's evidence is that it does not now plan to issue a digital currency, at least in the medium term.

The FRC's submission draws attention to the uncertainty surrounding the accounting treatment of cryptocurrencies or other tokenised assets. In particular, the FRC has flagged that this question is not yet on the agenda of the International Accounting Standards Board who set global accounting standards. This uncertainty leads to divergence of accounting practices as well as uncertainty around those practices as stakeholders seek to adopt appropriate accounting practices in the absence of official guidelines.

• Driving up standards of trusteeship and stewardship across all pension schemes 
• Authorising master trust schemes 
• Ensuring employers meet their automatic enrolment duties 
• Ensuring defined benefit (DB) schemes are effectively regulated  
• Working with government to implement the proposals set out in the white paper on the future of DB schemes

Mark Boyle, TPR Chairman, stated that: "The pensions landscape has been changing significantly. We are meeting this challenge by embedding a new regulatory culture and reinforcing our regulatory   teams on the frontline". It is understood that TPR will become "more vocal" about their expectations of those who are regulated.

The plan confirms that "It is important that we keep pace with the evolving landscape, take into account the social, economic and political environment, and are able to adapt to changing risks".

This is evidenced by the increase in the standards expected of trusteeship and stewardship across all pension schemes and TPR confirmed that "some important work” in this regard will be implemented over the next three years.

It is also expected that TPR will increase the number of enforcement cases. The plan refers to an emphasis being placed on smaller defined benefit schemes and a target to investigate 80% of DB scheme valuations.

Master trusts also feature prominently in the corporate plan. There has been an exponential increase in such trusts in recent years, with membership increasing from 300,000 in 2012, to 10 million today. Authorisation of the first master trusts is due to begin in October 2018.

To assist with the increased regulation, significant increases in resources will be provided to protect pension savers and to aid "frontline regulation", with TPR staff numbers increasing by 22% over the next three years.

The plan was revealed in the same week as TPR's announcement that they will authorise High Court Enforcement Officers (HCEOs) to enforce court orders where employers fail to pay penalty notices. Going further to show TPR's determination to increase intervention, the HCEOs will have the power to seize assets of employers who fail to pay their fines.

Recent developments in the US have seen members of Yahoo's senior management make payouts totalling $80 million dollars to shareholders following a class action, after Yahoo fell victim to a series of cybercrime attacks between 2014 and 2016. The case will have repercussions for D&O insurers, both in the US and across the pond as it was the first substantial data breach-related shareholder lawsuit recovery.

The decision by shareholders to now challenge directors and officers over their cybercrime concerns highlights just how much the problem has grown in recent years.

Directors have always been tasked with acting reasonably and in the best interests of the company. However in order to sufficiently protect themselves from claims, they need to ensure that policies, controls and procedures are in place to defend the company against cybercrime. Insurance policies will also need to be adjusted to ensure they adequately deal with the new wave of crimes. Underwriters are therefore likely to begin to question insureds about the level of their cybercrime protection, or indeed whether they have ever been a victim before. Equally, directors and officers will want to check that their policies do not exclude cybercrime claims.

The FSCS is the UK's statutory compensation scheme of last resort for the financial services industry and the question of how its funding ought to be allocated between different firms and sectors is acknowledged by the FCA to be controversial.

As a result of the FCA's recent consultation paper, product providers will now be required to contribute 25% of the funding requirements for the FSCS' insurance and investment intermediation funding classes.  In other words, product providers will have to help to pay for failed advisors' misselling of their products.  The FCA has confirmed that these plans will include discretionary fund managers as providers.

In addition, the FCA has confirmed it will increase the compensation limit in respect of claims relating to investment advice and provision (and, additionally, home finance intermediation and debt management claims) from £50,000 to £85,000.  Again, this will take effect from April 2019. The FCA has acknowledged that this could result in advisers' FSCS levies increasing.

Finally, the FCA paper also includes a further consultation on draft rules to ensure personal investment firms have professional indemnity policies that do not limit claims where the policyholder or a third party is insolvent, or where a person other than the personal investment firm (e.g. the FSCS) is entitled to make a claim.  The reasoning behind this is clear, with the FCA confirming "the changes are intended to ensure that more consumer claims are paid by insurers which could help to reduce the costs of the FSCS to other firms."

The consultation will remain open until 1 August 2018, and will no doubt be of particular interest to all firms, whether current or potential contributors to FSCS funding, and to insurers and brokers in the PII market.

Nonetheless, the FCA has identified other cross sector priority areas including: 

• Firms' culture and governance: the FCA states that this should drive behaviours and produce outcomes likely to benefit consumers and markets. The regulator refers especially to the finalisation of the Senior Managers and Certification Regime ("SM&CR") this year.

• Financial crime and anti-money laundering: this includes work embedding the new Office for Professional Body Anti-Money Laundering Supervision, and the financial crime review of e‑money (a report on which is planned for Q2 2018/2019).

• Data security, resilience and outsourcing

• Innovation, big data, technology and competition: the FCA notes that it will further develop its relationship with the ICO as GDPR comes into force, and will publish an updated Memorandum of Understanding setting out how they will work together. The regulator will publish a discussion paper on cryptocurrencies later this year with the Treasury and Bank of England.

• Treatment of existing customers: this includes continuing work on pricing practices in retail general insurance, and publishing a policy statement on providing SMEs access to FOS.

• Long-term savings, pensions and intergenerational differences

• High cost credit: this includes finalising the review of high-cost credit products. 

As well as this, the FCA has identified priorities for each sector, which include: 

• Wholesale financial markets: among other things, the regulator aims to report on money laundering in capital markets in Q1 2019/20 and publish a document on its approach to market integrity in Q4 2018/19.

• General insurance and protection: as well as implementing the Insurance Distribution Directive ("IDD") (which comes into force on 1 October 2018), the FCA will publish an interim report from the Wholesale Insurance Brokers Market Study. The regulator plans to conclude the first phase on diagnostic work on value in the distribution chain in 2018/2019, and to evaluate the effectiveness of 2015 rules on GAP insurance.

• Retail investments: the FCA will review the impact of FAMR and the RDR in 2019, and will continue to mitigate harm from firms selling CFDs and spread bets to retail consumers. The Investment platforms market study interim report will be published in summer 2018.
  

The FCA's priorities

Culture and governance remains a key priority for the FCA. As RPC has previously noted, during last year the FCA issued several final notices to individuals. We expect the FCA only to increase its efforts to hold individuals to account in this way. This summer will also see the finalisation of the SM&CR rules for all financial services firms.  At present the SM&CR regime applies only to banks, building societies, credit unions and certain investment firms.  The primary aim of SM&CR is to make individuals more accountable for their own and their firm's conduct and competence. The regime will start for insurers on 10 December 2018, and the implementation date for solo regulated firms is likely to be mid to late 2019. The expansion of this regime to all financial services firms represents a large shift for these firms in their organisational structure and accountability to the regulator.  Firms should be considering changes that will need to be made well in advance, in combination with adaptions necessary under GDPR and IDD (for insurers).

As expected, the Business Plan has also focussed on the pensions market, which has been a significant area of attention for the FCA and Parliament in recent months. In March this year, the regulator published its policy statement on changes to the rules for firms providing pension transfer advice, as well as a consultation paper on further changes to improve the quality of pension transfer advice. The Business Plan notes more plans for 2018, including the collection of data from all firms with pension transfer permission, to assess practices across the entire market and identify the most effective ways to reduce harm. This area will undoubtedly be subject to more focus this year in terms of regulatory change and enforcement.

Similarly to last year, the FCA's Business Plan continues to focus on the challenges and opportunities that technology poses for the financial services sector. The Plan notes two themes to address technological regulation, namely application and resilience, and highlights the role of FCA Innovate and the regulatory sandbox to encourage firms to develop and test new financial services products. As the FCA states, the withdrawal from the EU makes it more important that UK markets remain visibly reliable. Indeed the FCA plans to work with interested foreign regulators on a blueprint of a global sandbox. What remains to be seen is how much attention the regulator can dedicate to these other areas whilst Brexit demands its time and resources.

Regulation of cryptocurrencies in the UK however has not grown at such a fast pace. Indeed the UK regulators have been noticeably silent when it comes to defining or regulating cryptocurrencies, with the FCA only warning in September 2017 that investors should be prepared to lose all of their money if they invest in virtual currencies. Whilst  HMRC has provided guidance about how Bitcoins should be taxed, the FCA has not offered such guidance about regulation. This might be about to change. The FCA noted in its Business Plan earlier this month that it intends to release a discussion paper later in 2018 setting out its proposed guidelines on cryptocurrencies.

The FCA has announced that cryptocurrencies are capable of being financial instruments under the Markets in Financial Instruments Directive II (MIFID II); however it is keen to stress that they do not consider such currencies to be classified as currencies or commodities for regulatory purposes under MIFID II. Nevertheless, the FCA has recently noted that, "some models of use or packaging cryptocurrencies bring them within our perimeter, making the landscape complex".

Whilst cryptocurrencies remain unregulated (and currently outside of the regulatory scope of the FCA), this announcement should provide impetus for future regulation.

Financial professionals should tread carefully when offering advice surrounding cryptocurrencies and should remain cautious. For example, towards the end of last year the FCA published a consumer warning reminder that the FCA regulates Contracts For Differences (CFDs) which means that any firms offering CFDs in the trading of cryptocurrencies must be authorised and supervised by the FCA.

Customarily when investors lose money on such a wide scale, the FCA would require the firm responsible to establish a consumer redress scheme to compensate their clients. However, in this case, none of the defendants were authorised by the FCA, so it did not have the power to do so and was instead required to seek the court's assistance.

In 2014 the High Court found that Capital Alternatives and connected individuals had been operating unlawful collective investment schemes and that, as well as lacking the FCA's authorisation, the defendants had also made misleading statements for the purpose of inducing consumers to invest and/or remain in the schemes. 

On the basis of these findings, the FCA claimed compensation for the investors in the schemes.  On 26 March 2018 the court made a restitution order for £16.9m to be paid to the investors as compensation.  The order was made in relation to Capital Alternatives and the individuals involved in running the schemes – all of whom are being required to contribute to the £16.9m compensation pot.

This case shows the FCA's unwavering tenacity in pursing those who seek to offer unlawful investments to unsuspecting members of the public.  Mark Steward, the Executive Director of the Enforcement division of the FCA noted in the FCA's announcement on the matter that "this judgment should send a clear message to all of those who use corporate facades to sell dubious investments. We will do what it takes to hold them to account for their misconduct."  We anticipate the FCA will be keen to build on this success by taking more action of this nature in the future. 

We reported on ESMA's announcement in June 2017 that it was considering product intervention measures regarding this market, as well as reporting on ESMA's request for responses from the industry and investors to its specific plans in its Call for Evidence in January 2018.  Its latest announcement this week sets out the changes that will be implemented for CFD and binary options providers in the coming months.

CFDs and Binary Options – What's the difference?

CFDs and binary bets are complex products that are, essentially, gambles on the entry and exit prices of an underlying asset within a given time.  The asset can be anything that has a financial value, for example a currency, stock or index. 

The payment to (or from) an investor with respect to a CFD depends on the actual difference in entry and exit price, so losses can exceed the amount invested. 

In contrast, the payment with respect to a binary bet is set from the outset and, as the name suggests, the investor will either receive all of this amount or nothing at all if the bet goes against them.

Prohibition on Binary Options

ESMA has concluded that binary options are fundamentally unsuitable for retail investors as they do not meet any genuine retail investment needs, but are essentially gambling products that attract compulsive gambling behaviour.  ESMA has, therefore, banned them entirely for retail investors as it considers that no less stringent measure would adequately address its concerns.

Restrictions on CFDs

On the other hand, ESMA considers CFDs do play a role in meeting retail investment needs.  Therefore, instead of prohibiting them, it plans to implement the following measures to protect retail investors:

• leverage limits on opening of positions by retail investors, which will vary depending on the volatility of the underlying asset

• margin close out rule on a per account basis

• negative balance protection on a per account basis

• restriction on incentives offered to retail investors to trade CFDs

• all marketing materials to contain a standard risk warning, setting out the percentage of retail CFD accounts that lost money with the CFD provider in the last 12 months.

The overall objective of these measures is to discourage retail investors from investing in CFDs in the first place and to limit their exposure to financial loss if they do.  The negative balance protection in particular means that, for the first time, retail investors cannot lose more money than they invest.

Next Steps

ESMA is only able to use its intervention powers in this regard for a maximum period of three months.  Therefore, it will have to consider at three monthly intervals whether to renew these measures or adapt them.  However, it seems likely that restrictions of some form or another are here to stay in the CFD industry.

The FCA has been very vocal about its concerns for retail investors in this sector, in particular regarding investments that relate to cryptocurrencies.  The FCA has confirmed its support for these measures and will likely be keen to enforce these restrictions in the UK on a permanent basis.

In publishing its recent paper, the FCA recognises that more is required, stating that "Increasingly, severe penalties and sanctions alone are not enough to reduce and prevent serious misconduct. We must increase the likelihood of detection in tandem with efficient investigations." 

This is against the backdrop that the FCA levied fines of £22.2 million in 2016, the lowest on record since 2013, when its predecessor, the Financial Services Authority, was criticised for its "light-touch" approach in the lead up to the financial crisis.

Two consultation papers have already been issued by the FCA this year (Our approach to enforcementand Our approach to supervision), in an attempt to ensure greater transparency in its procedures.

The FCA's March 2018 consultation paper titled "Our Approach to Enforcement", sets out:

• How the FCA identifies harm.

• How the FCA diagnoses harm through its investigations.

• The sanctions and remedies available to the FCA.

• How the FCA evaluates its approach to enforcement and measures its performance.

   

Consultations with respect to those papers close on 21 June 2018. The FCA also announced that it would be carrying out a fuller review of its Enforcement Guide.

This is likely to be of particular interest to any business utilising agency relationships. The case thickens the lines defining what conduct on the part of an agent could lead to recovery from the principal; in brief, vicarious liability will not attach if an agent is completing work outside of the course of the principal's business  (essentially, if the agent is on a frolic of his own).             

RPC recently acted for Positive Solutions at the Court of Appeal. We had originally been successful in striking out a claim (made on behalf of several claimants) at the High Court and the Claimants were appealing against this decision.

The claim itself can be summarised as follows: the Claimants were approached by a man called Qureshi and induced to invest in a property development being carried out with his business partner, Mr Warren. Mr Quershi explained that the monies could be raised via re-mortgages obtained through Mr Warren, an 'independent financial advisor'. Mr Warren was an agent of Positive Solutions, however, the Claimants did not meet him nor did they have any direct contact with him or Positive Solutions. Remortgages were obtained by Mr Warren via Positive Solutions' online portal, however, on the assumed facts for the purposes of the strike out hearing it was accepted that the mortgages were obtained using false information dishonestly put forward by Mr Warren. Some of the monies were used to pay off existing mortgages and the balance misappropriated and lost in the property investment scheme.

In the first instance, it was held that there was no sustainable claim arising out of any alleged direct duty on the part of Positive Solutions and the Court therefore ordered that the Claimants should amend their pleadings so that the claim proceeded based on vicarious liability alone. Both sides appealed to the High Court, who noted that (under the case of Cox v Ministry of Justice [2016] UKSC 10) a relationship other than that of employment was capable of giving rise to vicarious liability. However, the High Court found that the Claimants in this case failed the two stage test in Cox in that the tortfeasor (in this case Mr Warren) was not acting in the course of an integral part of the business activities of the defendant (in essence, he was on a frolic of his own).

The Claimants appealed this decision and the question for the Court of Appeal was therefore to what extent could Positive Solutions be vicariously liable to the Claimants for the actions of Mr Warren?

The Court of Appeal rejected the appeal, finding that the Claimants in this case could not satisfy the two stage test in Cox, which can be summarised as follows:

1.      was the harm wrongfully done by an individual who carried on activities as an integral part of the business activities of the defendant and for the defendant’s benefit, rather than his activities being entirely attributable to the conduct of a recognisably independent business of his own or that of a third party; and

2.      was the commission of the wrongful act a risk created by the defendant by assigning those activities to the individual in question, in which case liability will be imposed.

Here, the Court determined that the activities of Mr Warren (in making the mortgage applications) was part of a recognisable independent business of his own, being the property investment scheme. The use of the online portal to obtain mortgage monies was simply the means by which he obtained the funds to invest in the scheme. The Court held that, to call this an integral part of Positive Solution's business was "a complete distortion of the true position on the facts." It was held to be immaterial that Positive Solutions received commission for these transactions (with the judge noting that these payments were generated automatically and held within a suspense account, because the transaction did not appear on Positive Solution's books). The Court held that, in allowing the use of their online portal, Positive Solutions was merely presenting the opportunity for fraud to be committed and that this wasn't enough to hold them liable under the second limb of the test in Cox.

The Court also held that this was a case where not all the acts and omissions which would be necessary to make Warren personally liable in tort took place within the course of his employment or agency, from which it followed that Positive Solutions (as principal) could not be vicariously liable for his wrongdoing. In brief, the Claimants did not suffer loss when the mortgage monies were obtained and it was not until these were spirited away via the property scheme, which fell outside of Mr Warren's agency, that loss was suffered.

Given the above, the Court did not look at whether or not it was correct that reliance based torts such as deceit or misrepresentation committed by an agent are in a distinct category from cases such as Cox, so that the principal cannot be vicariously liable unless the agent had actual or ostensible authority to do the acts forming the basis of the claim. However, the Court did helpfully note that the position of agency was not being considered in Cox, which does at least offer some assistance on how that case should be interpreted and applied. 

In general terms, this decision should offer some comfort to professional businesses, whether they w utilise agency or employment relationships; this case demonstrates that (in the absence of authority) liability will only attach to an employer or principal if the employee or agent is acting demonstrably within the confines of the employer/principal's business and for its benefit. An employer and/or principal still needs to take care when representing to clients or third parties its employee/agent has authority at act on its behalf. However, in cases where an employee or agent makes sales or completes transactions outside of the scope of his its authority it will be difficult for liability to attach to the employer or principal in the absence of such representations.

The paper notes the increase in SIPPs since the introduction of RDR in 2012 and the pension freedoms in 2015.  Research referred to in the paper notes that in 2016 there were more than 14 million individual and stakeholder pension schemes with an average value of £22,000.  This compares to 1.7 million SIPPs with £90,000 being the average amount invested in streamline SIPPs and £240,000 in bespoke SIPPs.  Around 250 firms hold relevant permissions to provide pensions but not all firms are thought to be actively using those permissions.  It is estimated that the 5 largest SIPP operators control 60% of the market and that around half of all SIPP operators have portfolios comprising less than 2,000 SIPP accounts but that many of these operators offer bespoke SIPPs attracting higher-value clients who are fewer in number.

The paper is the start of a review into competition within the non-workplace pensions market and whether or not there is a need to go further to protect consumers.  The FCA will look in particular at the factors that influence the behaviours of consumers and providers and whether the current market dynamics ensure fair outcomes for consumers.  In particular:-

• If and how consumers know whether they would be better off switching funds, products or providers, and whether this knowledge informs their actions.

• The extent to which consumers who enter into a non-workplace pension scheme without advice shop around before doing so and what features consumers compare when shopping around.

• The extent to which an adviser was involved in or influenced consumers' decisions to enter into a non-workplace pension scheme  and why.

• The operation of the annual management charge together with paid up and exit charges

The FCA notes that they consider it possible that similar weaknesses identified in the market for workplace pensions may exist in the market for non-workplace pensions.  The FCA has previously conducted a review of workplace pensions and the discussion paper looks at the changes that resulted from that review and whether similar issues apply to the non-workplace pension market. However, the more interesting comments in the paper include:-

• The FCA notes "some emerging issues that cause concern" following the advent of the pension freedoms, including (1) how a competitive market will develop in the future, (2) competition is not working well for consumers who don’t seek advice, (3) consumers who move into drawdown may struggle with the complexity of the decisions they have to make particularly if they have not taken advice.

• De-facto default funds operate in the non-workplace market due to a lack of engagement, confusion and specific labelling used. For example, if a consumer invests in a lifestyle option they may conclude that they do not need to engage any further and that relevant investment changes will be undertaken by the provider without any input from the consumer.

• While the FCA "have regard to the general principle that consumers should take responsibility for their own choices and decisions, we know that there are factors that might limit their ability to do so".

• Although 60% of consumers switching to non-workplace pension products obtain advice at the time of the switch, there is little evidence that consumers continue to obtain advice on their pension investments and this is an area of concern.

It is perhaps unsurprising that the FCA is looking at the non-workplace pension market.  There have been a number of difficult headlines for those within this market, in particular SIPP operators.  The paper acknowledges the impact of the pension freedoms and refers to the difficulties for the pension transfer market in the wake of headlines over the British Steel Pension Scheme.  In light of all of these issues which impact on non-workplace pensions the review was perhaps inevitable.  However, the scope of the review does not look like it will cover issues currently affecting the non-workplace pension market including business referrals from unauthorised introducers and a non-workplace pension providers responsibility (if any) for a consumers investment choice.  We await the consultation paper later this year.

Background: requirements for litigation privilege

Ever since the House of Lords declined to engage with the Court of Appeal's exceptionally narrow definition of the 'client' in determining the application of legal professional privilege in Three Rivers (No 5), communications with most of a corporate's staff are likely to be privileged only if the communication is for the dominant purpose of conducting adversarial litigation that is in progress or in contemplation (litigation privilege).  That puts a premium on finding that dominant purpose when a problem arises and a corporate needs to find out what has happened from its staff.   

SFO v ENRC

In SFO v ENRC, Andrews J held that interviews conducted with employees as part of an internal investigation while the SFO was investigating were not privileged and should be disclosed to the SFO.  This was in part on the basis that litigation privilege did not extend to documents created to avoid potential criminal prosecution by the SFO. 

Bilta (UK) v RBS

Vos LJ has now taken a different line. 

Bilta is suing RBS for over £140m for alleged dishonest assistance and fraudulent trading in connection with VAT fraud.  HMRC had previously denied VAT relief of £86m to RBS on the basis that RBS knew or should have known that the underlying transactions were connected with fraud.   Bilta sought disclosure of employee interviews conducted on behalf of RBS in the context of the HMRC investigation, on the basis that the interviews were not conducted for the dominant purpose of litigation but to find out the facts and to persuade HMRC not to deny relief.

Despite apparent similarities with SFO v ENRC, Vos LJ held that, on the facts, these interviews were privileged and so RBS was not obliged to disclose them to Bilta.  Vos LJ declined to "draw a general legal principle from [Andrews J's] approach" to the facts in SFO v ENRC and instead emphasised the importance of taking "a realistic, indeed commercial, view of the facts".  Fending off HMRC's denial of relief was held to be "part of the continuum that formed the road to the litigation".

Onwards and upwards?

In its call for evidence of 18 January 2018, ESMA notes that it and several national competent authorities have taken actions to address the risks.  However, it says, these actions have not significantly reduced the risk to retail investors.  Using its new powers to intervene under MiFID II, ESMA is considering placing a prohibition on the marketing, distribution or sale of binary options to retail investors, and restricting how CFDs may be offered to retail investors. 

The FCA had separately announced its own proposals on restricting the marketing and sale of CFDs to retail investors in December 2016 (CP16/40), which were markedly similar to those now put forward by ESMA.  However, the FCA announced it would hold off on implementing these measures until after ESMA announced its proposals, as we reported last summer.  Therefore, it appears likely that the FCA's own proposals will now be dropped in favour of ESMA's, but the FCA has yet to confirm this.

CFDs and binary bets

CFDs and binary bets are, essentially, gambles on the entry and exit prices of an underlying asset within a given time.  The asset can be anything that has a financial value, for example a currency, stock or index. 

The payment to (or from) an investor with respect to a CFD depends on the actual difference in entry and exit price.  In contrast, the payment with respect to a binary bet is set from the outset and, as the name suggests, the investor will receive all of this amount or nothing at all.

The risk

ESMA considers that CFDs expose retail investors to a significant risk of financial loss, which is exacerbated by high leverage.  According to ESMA, retail investors are currently subjected to "aggressive marketing techniques" which include the offer of incentives to trade CFDs.

ESMA finds that binary bets expose retail investors to very high levels of risk and an inherently negative expected return.  Additionally, the short duration of trades and all-or-nothing nature increases a retail investor's exposure to losses and encourages addictive behaviour.

ESMA notes that both CFDs and binary bets are complex products, and it has found a lack of transparent information at the point of sale which limits retail investors' abilities to understand the risks involved.

Restrictions on CFDs

ESMA believes that investor protection can be adequately achieved for CFDs by restricting the marketing, distribution and sale of CFDs to retail investors.  In particular, ESMA wants to introduce:

• leverage limits.  These would range from 30:1 for major currency pairs to 5:1 for individual equities;

   

• a margin close-out rule, which would mean that retail clients would be routinely protected from losing more than they have invested; 

   

• negative balance protection, which would provide an overall guaranteed limit on retail client losses;

   

• a restriction on incentivisation of trading; and

   

• a standardised risk warning, potentially requiring firms to disclose the percentages of clients making losses and profits in previous quarters.

   

ESMA has not yet decided where cryptocurrencies fit within the MiFID framework and is considering imposing a lower leverage limit of 2:1 or 1:1, or even prohibiting cryptocurrency CFDs altogether given the higher risks involved in these instruments.

Prohibition of binary bets

ESMA notes that, unlike CFDs, the inherent features of binary bets mean that restrictions would not sufficiently address the concerns it has around retail investor protection as it does with CFDs.  It is, therefore, considering prohibiting the marketing, distribution and sale of binary bets to retail investors altogether.

The consultation period

In November 2017 the FCA issued warnings to consumers about these high-risk products, which was followed this week by the issue of a "Dear CEO" letter to providers and distributors of CFDs following the FCA's 12-month review of the market.  In it, the FCA noted that during the review period, 76% of retail clients lost money.  One CFD provider's arrangements were so poor that the FCA will "take further action".

What's the difference?

CFDs are, essentially, gambles on the entry and exit prices of an underlying asset within a given time.  The asset can be anything that has a financial value, for example a currency, stock or index.  The payment to (or from) an investor with respect to a CFD depends on the actual difference in entry and exit price.

CFDs are banned entirely in a number of countries including the USA, Belgium and Israel.  France has banned digital marketing of them. 

Firms offering CFDs in the UK are regulated by the FCA, meaning that consumers are able to benefit from the protections provided by the FOS and FSCS. 

Warning to consumers on cryptocurrency CFDs

Cryptocurrency CFDs allow investors to speculate on the change in price of a cryptocurrency such as Bitcoin, and are increasingly being marketed to retail investors.

In November 2017, the FCA warned consumers that the volatility of cryptocurrencies makes these products particularly high-risk.  This is exacerbated by the leverage that some firms offer, which can make cryptocurrency CFDs especially attractive to consumers, but leaves them open to a significant risk of losing far more than their initial investment.

Warning to providers and distributors of CFDs

The FCA's review of the CFD market looked at the supply of these "complex, high-risk instruments" to retail customers on an advisory or discretionary portfolio management basis.  The review was conducted over a 12 month period, and assessed 19 firms that provide CFDs to intermediaries and 15 firms which distribute the CFDs to retail consumers.

The FCA's areas of serious concern are:

• target market identification;

• communication, oversight and challenge;

• process whereby providers take on new distributors;

• the management of conflicts of interest;

• the use of management information and key performance indicators;

• client categorisation; and

• remuneration arrangements

 What next?

The FCA concluded that consumers may be "at serious risk of harm" as a result of the poor practices identified in its review.  It reported that several of the firms it had investigated have said that they intend to stop providing CFDs to firms which distribute them to retail customers on an advisory or discretionary basis.  The FCA has pledged to undertake further work on CFD providers and distributors.

In a response to the FCA's letter, Plus500, which operates an online trading platform for retail customers to trade CFDs, states that whilst the guidance is not directly applicable to their business model, they believe that "these and other changes will enhance the CFD trading landscape and ultimately reduce the number of providers to a core of higher quality operators".

This appears to be the result that the FCA is looking for; its approach is unlikely to have a big impact on CFD providers and distributors who are well-established in the market and have been following the rules. 

• Performance fees – How would these be accommodated in to any template? Is it even correct to do so?
• Other variable costs – How will these be calculated/estimated in any template? What will be the agreed/standard assumptions? And, conversely, how would any stock-lending profits be treated?
• Funds with less than 12 months' track record – Will there be no disclosure for such funds? Or estimated disclosure?
• Non-UK funds – Will these enjoy a competitive (dis)advantage if disclosure rules differ across jurisdictions?

To find out more, download our full insight into the FCA's proposals.

So what is an ICO? It involves a company issuing digital "tokens" or "coins" in exchange for either cryptocurrencies, such as bitcoin or ether, or normal currency.  The digital "token" or "coin" will often have certain rights or attributes attached to it and can be sold on to other investors (just like a share in a company). 

In 2017, over $2 billion in funding was raised via ICOs alone. In quarter 2 of this year, for the first time the total funds raised by ICOs exceeded those raised via traditional equity financing. The digital financing era has taken storm throughout the corporate world, and it isn't finished yet. Not just that, but the values of cryptocurrencies are soaring. The bitcoin, for example, has seen its value reach over $15,000 – an increase from around $1,000 at the start of this year.

Regulators globally have issued warnings to investors about the use of ICOs. After warnings were published by the US, Singaporean and Canadian financial regulators and a complete ban on ICOs was issued by the Chinese government this year, the FCA spoke out in September warning consumers about the risks involved with the digital financing process.

When considering whether an ICO will fall outside of the FCA's regulatory remit, the FCA has said that it will be decided case by case but that "depending on how they are structured, some ICOs may involve regulated investments and firms involved in an ICO may be conducting regulated activities". From that, it seems the FCA won't be letting the issuers of ICOs get away without a fight.

In recent news, the European watchdog has become the latest to issue a warning about ICOs, describing them as "very risky and highly speculative". It went even further to issue guidance for companies using ICOs and has said that in instances where an ICO qualified as a financial instrument, businesses must comply with EU regulations, including MiFID II.

The use of ICOs continues to grow, and financial regulators across the globe continue to look carefully at them. The high risk and speculative nature of these digital financing models will no doubt hit the headlines again and we will continue to look out for how the regulators propose to deal with them.

CP16-42  

This first consultation dealt with various ways in which the FCA felt that it might seek more fairly to share the burden of FSCS funding on firms and also how it might reduce the overall costs of FSCS funding.

A significant part of the original consultation involved discussions around ways in which personal investment firms' professional indemnity insurance could be changed to ensure that more liabilities would be picked up by insurance and so reduce the burden on (and thus funding requirements of) the FSCS.

Specifically, the FCA stated that firms' PII should provide a "front stop" for claims, leaving the FSCS as the "back-stop".  It said that its analysis showed justification for strengthening PII for personal investment firms, potentially through the use of mandatory terms.  Some of the changes mooted included: prohibiting specific product exclusions, restricting excess levels, provision of obligatory run off cover and even requiring event occurring (as opposed to claims made) cover.

Having met with the FCA earlier this year to discuss their proposals, we had understood that it would be producing a further consultation this autumn on changes to PIF firms' PII requirements. 

On Monday, the FCA published a second consultation on FSCS funding. 

CP17-36

This second paper contains various new proposals for consultation, including the possibility of:

• requiring firms with PII exclusions for active business lines to hold funds in a trust, to be released only to the FSCS should the firm be declared in default; and/or

• obliging firms to take out a surety bond to cover claims to the FSCS in the event of their failure (either in lieu of or in addition to existing capital requirements).

The paper also confirms that:

• the FCA will introduce provider contributions (including from Lloyd's of London) towards FSCS funding relating to claims caused by intermediary defaults – they are consulting on exactly how this will work; and

• the FSCS compensation limit for investment business will be increased from £50k to £85k.

However, with regard to the FCA's previous proposals for changing the rules on PII for PIF firms, the new consultation states that, based on its work since the first consultation, the FCA no longer plans to consult on significant changes to firms' PII requirements.

The FCA has concluded that, in general, the PII market is working well and that, on average, PIF firms were either satisfied or very satisfied with their PII.

Critically, the FCA has recognised that simply moving the burden of paying claims from the FSCS to PII may not be effective or reduce the overall cost (of PII premiums and FSCS levy) to firms.

The only potential change to PII on which the FCA is consulting further is the possibility of preventing PIFs from purchasing policies that exclude the insolvency of the policyholder or related parties, as the FCA believes these exclusions can prevent the FSCS from making a claim on the policy.

The FCA's conclusions on these issue will be good news for the professional indemnity market and, we believe, PIF firms themselves.  As the FCA itself has recognised, making substantive changes to PII requirements would likely increase (probably significantly) the cost of PII for all firms.

It remains to be seen whether the FCA's new ideas for providing additional "front-stop" protection ahead of the FSCS will be feasible.  In particular, the question has to be asked:  who (if anyone) will be willing to provide a surety bond to firms of the kind indicated by the FCA – at least at any sort of acceptable cost?

Responses to the FCA's second FSCS funding consultation are due by 30 January 2018.

A "skilled persons report" can be required by the FCA under s.166 of the Financial Services and Markets Act 2000 ("FSMA").  The report is confidential under s.348 FSMA, and would therefore not be disclosable without the permission of the subject, RBS.  A summary which does not contain information relating to an identifiable person would be disclosable.

Despite this, in August the BBC claimed that it had seen the report, which was commissioned to investigate RBS' Global Restructuring Group ("GRG"). 

Following the leak, the Treasury Select Committee wrote to Andrew Bailey stating that the balance had "tipped firmly in favour of full publication".  In his response, Andrew Bailey recognised the public interest in the outcome of the report but emphasised the importance of confidentiality to the process; the reports are conducted on the basis that they will not be published.  He instead offered to provide a "detailed summary" which had been reviewed by external Counsel.

This offer was rejected by the Committee: in a further letter Andrew Bailey agreed that a legal adviser appointed by the Committee would be allowed to review the full s.166 report.  On the 23rd October the FCA confirmed that the report had been provided.

In addition, the FCA has published an interim account, reviewed by the legal adviser, whose comments will be incorporated into a final account.  The legal adviser will however have to consider the "justification and reasonableness of any explanation" for any omissions in the published account.

In order to publish, the FCA must either obtain consent from RBS and Promontory, who conducted the skilled persons review, or use a "gateway".  The FCA used the so-called 'self-help' gateway at Reg 3(1)(a) of the FSMA (Disclosure of Confidential Information) Regulations.  This allows the FCA to disclose confidential information if the disclosure assists them in discharging their public functions.  One of the FCA's functions is to give guidance under s.139A FSMA: it is this function the disclosure is assisting.

The legal advisers will report to the Committee on 27th October, with Andrew Bailey appearing before the Committee on 31st October.

The FCA is due to make a decision soon on whether a formal investigation will take place.  FCA action will be limited as many GRG activities were unregulated; however it is possible that publication of accounts will lead to civil claims from GRG customers who may feel they have been mistreated.

The interim account notes the unregulated nature of the GRG's activities, stating that the review was conducted in reference to applicable laws and regulations as well as the standards set by the GRG itself and RBS, and general principles of "fair and reasonable treatment".  This is set within the context of contractual freedom and the commercial nature of the GRG. 

In a letter to the Committee Chair Nicky Morgan, the FCA's Chief Executive Andrew Bailey states that this publication is an "exceptional case and does not establish a precedent".  It is likely however that the threat of publication will play on the minds of firms subject to s.166 reports, which may reduce cooperation with skilled persons and therefore the efficacy of this investigatory power.

The FCA published a decision notice against Mr Rosier in 2013, on the basis that he failed to act with due skill, care and diligence and failed to take reasonable steps to ensure that Bayliss complied with the requirements and standards of the regulatory system.  This decision was referred by Mr Rosier to the Upper Tribunal. 

Although ultimately successful, the FCA's handling of the case was criticised, as reported here previously.  The judge in the case, Timothy Herrington, said that the FCA's publication of the decision notice was "deeply disappointing and troubling".

Despite this, Mr Rosier's permission to appeal was denied in March, and the FCA re-imposed the fine and ban on 5 October.

In the Upper Tribunal's original decision Judge Herrington said: "The tone and culture of the firm must be set from the top and we are not satisfied that Mr Rosier would set the right tone or that the culture of the firm would change."

On 12 October 2017, in an unconnected case, the husband and wife partners of Westwood Independent Financial Planners were banned from working in financial services for integrity failings.  The couple had significant liabilities to consumers from successful FOS complaints, and the firm had gone into 'sequestration' in 2011. 

A decision notice was issued in October 2016.  Mr and Mrs Chiesa sought disclosure from the FCA at the Upper Tribunal, claiming that the regulator had acted in bad faith.  This application was refused.

Mr and Mrs Chiesa had not disclosed all of their assets, preventing them being distributed to their creditors.  The FCA said they: "misled their creditors, especially the FSCS, in a calculated way. Their misconduct demonstrates a serious lack of integrity." 

These cases serve as a reminder to financial advisers not only of the importance of acting with integrity and due skill, care and diligence, but also that errors made by the FCA will not necessarily lead to a successful application for appeal.  Although both of these cases are rather extreme, the FCA is making clear its expectations of financial advisers and its determination to see cases through.

This article was co-authored by Katie Fry-Paul, Trainee Solicitor in RPC's Regulatory team.

(At that time, the FCA had three years from the date on which it became aware of the relevant misconduct for a Warning Notice to be issued.  The limitation period for FCA investigations has now been extended to six years under the Financial Services (Banking Reform) Act 2013).

The FCA subsequently reconsidered its calculations and agreed that it was in fact out of time to bring disciplinary action and the cases were dropped.

The individuals complained to the FCA and Commissioner.  The FCA partially upheld the complaints, concluding that it had not given adequate consideration to limitation in advance of the Warning Notices being issued - and apologised for this.

The Commissioner upheld the complaints against the FCA (Final Decision (FCA00062) and Final Decision (FCA00097)), likewise finding that the FCA should have acted sooner in response to the potential limitation issues.  However, the Commissioner did not agree with the FCA that a lack of awareness of the limitation issues was to blame.  On the contrary, the Commissioner found that the FCA had been aware of the limitation issue for several years, but had taken a hasty decision in 2011 that the documents received in 2010 were not relevant for limitation purposes and it had, therefore, discounted the issue prematurely.  The Commissioner found there was "no adequate explanation" for the FCA reaching the conclusion that these documents were not relevant to limitation and found that the FCA had given the matter very little examination in coming to this decision.

Overall, the Commissioner found that:

• the FCA demonstrated a "closed‑minded attitude" and a "lack of rigour" in its treatment of the limitation issue;
• the FCA had been unnecessarily slow in investigating the complaints internally; and
• it had failed to meets its duty to ensure proceedings were managed competently and fairly.
  

However, the Commissioner found no evidence of bad faith on the FCA's part, or a deliberate attempt to conceal the limitation issues from the RDC.

This decision follows closely on the heels of another complaint being upheld against the FCA for acting outside its powers under s166 FSMA by instructing a skilled person to award compensation on behalf of a firm when the firm had not consented to the skilled person doing so.

The FCA has said it is considering the lessons it can learn from these complaints.  No doubt it will be keen to ensure that limitation and other crucial building blocks sit at the forefront of its investigators' minds going forward to ensure investigations are not thwarted by technicalities in the future.

Tuesday's announcement from the FCA confirms these reports and provides some further detail.  The FCA's announcement confirms the number of firms visited over the last 2 years and the sample files it has reviewed.

Referring DB transfer business to specialist transfer firms

Based on the announcement, the key area of concern for the FCA appears to be specialist transfer firms – firms that obtain business from other firms that do not advise on DB transfers.  The FCA highlighted the risks for these firms back in August 2016 but says in yesterday's announcement that these firms have not taken those risks on board.  In particular, the FCA found:

• A lack of information sharing between the introducing firm and specialist transfer firm.  This resulted in the specialist firm not having enough information about a client's financial circumstances.

   

• Firms were advising on a DB transfer without knowing where the ultimate funds were to be invested.  This was on the understanding that this advice was to be provided by the introducing firm.

  
  

• Some firms used a transfer analysis based on a default scheme and/or fund, contrary to the FCA's January 2017 alert.

  
  

• There were potential resourcing issues for specialist transfer firms; these firms had not made sure that there were enough specialist transfer or compliance resources to meet increased demand.

Suitability

Out of 88 transfers, the FCA found, with regard the recommendation to transfer, 47% of cases suitable, 17% unsuitable and 36% unclear.  In relation to the suitability of the recommended product or fund, the FCA found 35% of cases suitable, 24% unsuitable and 40% unclear. 

 What next?

The FCA is already looking at the pension transfer rules under COBS 19.  We will have to wait for the results of that consultation.  However, the FCA's announcement also says that the FCA will continue to monitor this market and where appropriate assess firms who provide DB transfer advice.  The intention is that the FCA will carry out a further phase of supervisory assessments in the current business year.

Closing thought

At the heart of the DB transfer issue is an ideological tug of war between the pension freedoms; wanting to give the consumer choice and autonomy over what to do with their pension and the FCA's consumer focus which appears to prefer that members do not transfer their DB pension. 

For consumers, the FCA's focus on this market may lead to less choice as the number of advisers in the area fall and higher costs should consumers want to consider transferring their DB pension.  Perhaps an unintended consequence of the pension freedoms?

Regular readers of our blogs will have seen our earlier update on the FCA's key new conduct requirements arising from MiFID II and how this is likely to impact upon advisers when it is introduced in January 2018.

One of the key topics will be the impact the stricter rules as set out in MiFID II will have upon advisers' ability to accept inducements. The issue of firms accepting "excessive" inducements is clearly on the FCA's radar given their proposal in their third Consultation Paper to prohibit acceptance of hospitality benefits in their entirety apart from minor "non-monetary benefits". Some commentators have suggested that once MiFID II is up and running the "low hanging fruit" will be those firms which are falling short of the current guidance on inducements.

In broad terms under the new provisions a firm will only be permitted to receive an inducement in relation to the provision of investment advice where it is intended to improve the relevant service to a client, it will not prejudice a firm's requirement to act in the best interests of its clients and the firms will have to disclose any benefit provided.

Advisers have previously identified to the Regulator in the Consultation Response FG14/1 that there is an absence of tangible "examples of good and poor practice" in the current guidance. However, the FCA appears unwilling to provide examples of what would be an acceptable "non-monetary benefit" and instead they "consider the rules and Handbook guidance, together with our finalised guidance are enough for firms to understand our requirements".

The suggestion that the current rules provide clear guidance is perhaps undermined by a recent study that identified that of the 89 advisers asked 50% of those advisers considered the rules on inducements to be unclear.

The uncertainty regarding the permissible level of inducements is perhaps illustrated in the same recent study which showed that over a fifth of advisers rejected all hospitality events. The concern of some advisers to attend such events may create an unintended barrier for those smaller firms to grow both their professional development and their client networks in fear of breaching rules on inducements. Some respondents to the FCA's FG14/1 consultation indicated that this could also result in, "an unfair competitive advantage for those firms prepared to take a more liberal approach to their interpretation of the rules and guidance". 

Advisers will need to keep a close eye on how the Regulator seeks to implement the forthcoming rules on inducements and will want to avoid becoming a soft target for falling short of the existing guidance.

The FOS published its August newsletter showing statistics about the complaints it has received in Q1 of 2017.
 
The FOS received a total of 135,779 enquiries. Interestingly, 678 of these were in relation to SIPPs with 521 received as new cases and 181 having been referred to the Ombudsman. The data shows that SIPP complaints continue to be on the rise with no sign of the increase slowing down.
 
The statistics show a rise of more than 50% when compared with the same period in 2016, when the FOS received 427 complaints in relation to SIPPs. Of the 427 complaints received by the FOS in Q1 of 2016, 328 of these were new cases and 113 were referred to the Ombudsman. The increase is only expected to continue, with the FSCS confirming in January its intention to raise a £36million interim levy to fund an unexpected number of SIPP claims.
 
It is also clear that the FOS is treating these complaints seriously, having upheld 50% of the complaints in Q1 of 2017 and 66% of the complaints in Q1 of 2016.  Firms will take this as evidence that the cases are arguable and it is not unreasonable to defend SIPP complaints.

The data reflects a large number of complaints we are seeing about SIPP advice arising for a number of different reasons. These relate to unauthorised introducer issues, non-standard investments and issues with the valuation of assets held within SIPPs. There are numerous important issues to be decided by FOS; both in respect of its jurisdiction over SIPP complaints and its approach to the merits, particularly questions of underlying investment suitability.

C&CCC admitted that it had failed to comply with general direction 6.11 by not publishing minutes for four board meetings, held between April 2016 to August 2016, as soon as reasonably practicable after each meeting. C&CCC also admitted that it had failed to comply with the requirements of general direction 6.3(b) in respect of its August 2016 board minutes because it failed to provide the PSR with a link to the minutes on its website.

C&CCC's failures to comply with the requirements of general direction 6 constitute compliance failures under section 71 of the Financial Services Banking Reform Act 2013, whilst the PSR published details of the failures under section 72(1) of that Act.

The PSR decided that a public censure, rather than a financial penalty, was appropriate for a number of reasons.  These included C&CCC’s admissions to its failures, the company's engagement with the PSR from the outset of the PSR's investigation, the lack of any previous findings of compliance failures against C&CCC, and the fact that C&CCC did not derive any economic benefit from the failures. Furthermore the PSR noted that there had been no detrimental impact on payment system users, competition, or innovation.

It seems highly unlikely that the FCA would open an enforcement investigation in similar circumstances, and therefore for the small number of firms that are regulated by the PSR this action should serve as a warning as to the PSR's appetite to enforce against firms even for apparently less serious misconduct. 

The 'clickstream data' showed that of all the visits to the website to look at funds, fewer than 9% of customers engaged with charges (excluding visits to fund landing pages). And under 3% engaged with documents on the side, including Key Information Documents.  However, according to responses to an FCA study of the asset management sector, 77% of respondents said they looked at charges when they made their investment decisions and 45% said they were an influential factor in their choice.

The message is clear:  what customers say they do is not always what they do (to illustrate, the FCA's study referenced Netflix customers being asked about what they watch: most reported viewing enlightening foreign films and documentaries but download figures showed Hollywood blockbusters and entertainment of a more low-brow nature were downloaded  the most). 

The findings highlight an interesting interplay between what customers want from firms and what firms should be doing. For customers of this particular platform, charges were apparently not a top priority (only during 0.1% of visits did customers sort lists of funds by charge) – even if they might say they were.  However, the firm is still subject to a fundamental obligation to bring charges to customers' attention, comply with the FCA's disclosure obligations under COBS 6 and be fair, clear and not misleading about its charges.

This study may prompt the FCA to question how firms are engaging with and informing customers of charges. For example, whilst customers may not be actively seeking out information about charges, are they getting told the information further down the line from things like product brochures or application forms as part of the 'customer journey' to making an investment or buying a product?

It is easy to imagine how similar studies could be used by the FCA to monitor and assess firms in other areas. As it says in the report: "it is not difficult to imagine regulators using browsing data to understand consumer purchasing behaviours in all sorts of markets. This has huge potential to help us better understand the effectiveness of competition and the potential remedies."

Three linked appeals were heard by the Court of Appeal involving a number of banks and their review of interest rate hedging products.  The banks reached an agreement with the FCA in June 2012 that each would review the sale of its interest rate hedging products from 1 December 2001 to "non-sophisticated customers" and provide appropriate redress where mis-selling had occurred.  The terms of the agreement with the FCA remained confidential until February 2015.  Under the terms of the agreement with the FCA the bank had to assess whether its sales to customers of interest rate hedging products complied with the regulatory requirements, defined as the principles, rules and guidance contained in the FCA's Handbook and taking into account sales standards.  The terms of the agreement did not provide a right for an individual customer to enforce the terms.

The three claimants each claimed that the banks had mis-sold them the hedging products.  One claimant alleged from the outset that the banks owed it a duty of care arising out of the review.  In the other two cases it was not initially alleged that a duty of care was owed and the claimants sought to amend their pleading to allege a duty of care.  (See our previous blog on the CGL v RBS case here).  Permission to amend was refused on the basis that the amendments did not pass the summary judgment test.  The claimants appealed that decision.

It was alleged that the banks had failed to conduct the review in accordance with the undertakings the banks had provided to the FCA, with the agreed methodology and the review had been conducted negligently.  If the banks had conducted the review properly redress would have been offered.  Broadly it was said that the banks had voluntarily assumed responsibility to their customers to perform the review carefully.  The source of the assumption of responsibility was said to be the letter sent to each individual claimant setting out that the bank was to conduct the review if the customer opted in to that review.

The Court of Appeal concluded that no duty of care was owed:

(1)     the regulatory context weighed against the imposition of a duty of care as it would be unusual for the common law to impose a common law duty on a statutory regulatory framework where the effect of the statutory regime is that a non-private customer cannot sue in relation to a complaint or a complaint handling issue or a redress determination if a bank proactively sets up a redress scheme – if there is a failure to follow the terms of the agreement reached between the FCA and the banks the answer is for the FCA to bring enforcement proceedings and not to create a separate cause of action.

(2)     the correspondence sent to the claimants and the language used indicating that the banks would conduct a thorough review did not equate to an assumption of responsibility between the bank and the customer.  The banks were conducting the review not voluntarily but at the instigation of the FCA and to impose a duty would be to say that the banks assumed a duty to do what they had agreed with the FCA.

(3)     the fact that there was an independent reviewer under section 166 was a further indicator against imposing a duty of care.  In circumstances where the independent reviewer did not owe a duty to a customer in reviewing a decision it would be odd for the bank to owe a duty when reaching its initial decision.

(4)     the claims were otherwise time-barred and so to impose a duty of care would circumvent an otherwise time-barred complaint.  There was no lacuna to fill; the claimants could have issued proceedings or complained to FOS at any time with respect the allegations of mis-selling.  The imposition of a duty of care in respect of a complaint system could have far-reaching consequences and would not be fair, just and reasonable in the circumstances. 

The fact that we now have Court of Appeal authority that no duty of care is owed to a customer with regard to complaints handling itself will be welcomed by firms.  The decision also swiftly follows the High Court decision (in Mazarona) clarifying that FOS' jurisdiction did not extend to complaints handling under a review procedure and so all but draws a line under the issue.  Albeit that there is now an odd distinction between a voluntary review procedure (where no duty of care is owed and no otherwise actionable provisions) and complaints handling under DISP and s404 where certain provisions are actionable against a firm by a private person.

For firms conducting a PBR a failure to follow the PBR procedure is unlikely to sound in negligence and is instead a matter for FCA enforcement.  Strategically there may be advantage for firms to put in place voluntary PBRs sooner rather than later, to take themselves out of the DISP regime and into a non-actionable voluntary regime over which they have more control.

The decision of the CMA to approve the creation of the new entity comes against a backdrop of fast-paced change in the payment systems sector in recent years.  This has included: the recognition of a number of payment systems as systemically important under the Banking Act 2009, requirements to see increasing independence at board level of operators and the establishment of a new competition-focused payment systems regulator in 2015 (the PSR). 

The need for a consolidated operator

In November 2016 the Payments Strategy Forum (PSF) – established by the PSR as an industry-wide strategy setting forum to "unlock competition and innovation in payments" – issued a strategy for payments in the UK. Its vision was to meet the needs of current and future payments service users by:

• providing simpler access;
• ensuring ongoing stability and resilience;
• encouraging greater innovation and competition; and
• enhancing adaptability and security.

The strategy identified a number of issues which were standing in the way of this vision and corresponding solutions to resolve them.

One issue identified by the PSF was the number of payment systems in the retail payments sector, resulting in unnecessary complexity, increased costs for participants, and inefficiencies (as a result of duplication across the systems).  It was felt that as a consequence this also presented a barrier to direct entry for PSPs restricting competition in the downstream market.  The PSF's solution was the consolidation of the operators of Bacs, Cheque and Credit Clearing Company and Faster Payments, into one entity. 

The delivery plan

To implement this consolidation, the Payment System Operator Delivery Group (PSODG) was established to put forward a delivery plan for consolidation.  The PSODG set out in its report the following key recommendations:

• an NPSO should be incorporated with the existing three operators which are to be consolidated sitting underneath;
• the company purpose of the NPSO should be to "support a vibrant UK economy enabling a globally competitive payments industry through the provision of robust, resilient, collaborative retail payments services, rules and standards for the benefit, and meeting the evolving needs, of all users";
• the NPSO should be a company limited by guarantee with its initial members/guarantors being the current members of the payment systems which are to be consolidated (it is anticipated that the guarantor group will be expanded going forward to reflect other relevant stakeholders);
• there should be a staged transition of responsibilities to the NPSO from the operators;
• all decision-making powers in relation to the NPSO should rest with the board, to comprise 50% or more independent directors and no "member appointed" directors (although there would be a general right for members to vote on re-appointment of directors of NPSO); and
• the funding model (based primarily on transaction fees) should give the NPSO the ability to both build-up surplus funds (for re-investment) and seek capital funding for specific development projects, allowing funding decisions to be made independently of members by the NPSO Board.

The response of the PSR and BoE

The PSR and the Bank of England published a letter which welcomed the report, set out their expectations of next steps and extended the remit of the PSODG to establish the NPSO corporate entity and oversee the initial stages of the implementation plan. 

Following the decision of the CMA, the PSODG is now aiming to have responsibility for the execution of the implementation plan handed over to the NPSO by the end of July 2017, with a consolidated entity substantially completed by the end of 2017.

This is an update to an interview with Charles Buckworth which was published by Lexis®PSL on 6 June 2017

• the new chapter containing product governance rules ("PROD") requires product manufacturers and distributors to take into account the 'end client' and build appropriate information sharing systems into the supply chain.  (We note that there was a minor change: the deletion of the guidance in PROD 3.2.12G on target market assessment which the FCA has stated that firms can find instead in this ESMA paper )
• the new suitability rules, in relation to which the FCA has confirmed that the (new) COBS 9A – applicable to MiFID business - will not be changed from the draft version
• The rules on client agreements will be those set out in the draft rules. These require firms to enter into a basic written agreement with professional as well as retail clients, and this must be done for each investment service or ancillary service

In relation to the FCA's inducement rules it was more of a mixed picture. As proposed:

• The existing RDR ban on advisers from accepting inducements in relation to advice on retail investment products to retail clients will continue

• The ban on accepting inducements will be extended to firms which provide independent or restricted advice or portfolio management services to retail clients, preventing them from accepting and rebating monetary benefits to such clients

• The new rule that only non-monetary benefits can be accepted in relation to advice on retail investment products - not just those falling under MiFID II – will come in

  However:

• the FCA will consult again on the proposal to apply the inducements ban more widely to a firm's business of providing advice (and not just in relation to specific personal recommendations); and

• Finally, the FCA will not extend the ban on receiving and rebating monetary benefits (other than 'minor non-monetary benefits') in relation to services to professional clients

The policy statement, which stretches to over 1000 pages, includes chapters on a variety of topics including: client assets; inducements; complaints handling; client categorisation; disclosure requirements; independence; client agreements; and product governance.

However, despite its length and the wealth of material contained within the statement, in the overview chapter the FCA highlighted the following as being "points of particular note":

• Inducements in relation to research – now applying to collective portfolio managers;

• Client categorisation – revised for local authorities opting up to professional client status;

• Best execution – no longer applying to AIFMs;

• Appropriateness – continuing the FCA's stance that collective investment undertakings other than UCITS, NURS and investment trusts are "neither automatically non-complex nor automatically complex" (!); and

• Taping – no longer required for all investment services and activities in relation to corporate finance business. Other amendments, such as allowing some firms to take a note, also added.

Following this announcement, the FCA has confirmed that it will hold off on implementing changes to conduct rules for CFD firms, which it had originally proposed in December 2016 (CP16/40).  However, the FCA clarified that if ESMA's decision is delayed, the FCA intends to implement its own conduct rules for UK CFD firms in the first half of 2018.

In addition, the FCA also announced the results of its review into the appropriateness assessments conducted by CFD firms when on-boarding retail clients, which followed its Dear CEO letter of February 2016.  The FCA identified five key areas of concern:

• inadequate assessments of prospective clients' knowledge of CFDs;

• insufficient consideration of prospective clients' previous transactional experience;

• inadequate risk warnings to prospective clients who fail appropriateness assessments;

• failure to evaluate whether failed applicants should be allowed to make CFD transactions in any event; and

• poor oversight, weak controls and inadequate management information in CFD firms.

  These concerns echo the FCA's 2016 Dear CEO letter, demonstrating the lack of improvement that the FCA has found in the industry's treatment of retail clients. As a result, the FCA is encouraging firms to assess their policies and procedures, and to pay particular regard to MiFID II (which also takes effect on 3 January 2018).

The FCA published its interim report in November, setting out the FCA's provisional view on the way competition works for asset management services, the resulting outcomes for investors and its proposed remedies to address the identified issues.

Key findings

Having considered the feedback it received the FCA has now confirmed that the following key findings set out in the interim report are to be final:

• Price competition is weak in a number of areas of the sector;
• Despite a large number of firms operating in the market there was evidence of sustained, high profits over a number of years;
• Investors are not always clear what the objectives of funds are;
• Fund performance is not always reported against an appropriate benchmark; and
• There were concerns about the way the investment consultant market operates.

Remedies

The FCA has decided to take forward a package of remedies, which it believes, will make competition work better in the asset management sector and will protect those least able to actively engage with their asset manager. The FCA believes that these remedies will lead to the UK asset management industry being a more attractive place for investors and so improve the relative competitiveness of the UK market.

These remedies fall in to three broad areas.

• Provide protection for investors who are not well placed to find better value for money – to do this the FCA intends to:
  • strengthen the duty on fund managers to act in the best interests of investors and use the Senior Managers Regime to deliver individual focus and accountability;
  • require fund managers to appoint a minimum of two independent directors to their boards;
  • introduce changes to improve fairness around the management of share classes and the way in which fund managers profit from investors buying and selling their funds. 
• Drive competitive pressure on asset managers – to achieve this the FCA will:
  • support the disclosure of a single, all-in-fee to investors;
  • support the consistent and standardised disclosure of costs and charges to institutional investors;
  • recommend that the DWP remove barriers to pension scheme consolidation and pooling;
  • chair a working group to focus on how to make fund objectives more useful and consult on how benchmarks are used and performance reported.
• Improve the effectiveness of intermediaries – to achieve this the FCA will:
  • launch a market study into investment platforms;
  • seek views on rejecting the undertakings in lieu of a market investigation reference regarding the institutional advice market to the CMA;
  • recommend that HM Treasury considers bringing investment consultants into the FCA’s regulatory perimeter.

The implementation of the remedies will take place in a number of stages.

Additionally the FCA has published a separate consultation paper alongside the final report setting out its proposals in relation to fund governance, risk-free box profits and share class switching. The FCA is also consulting on its provisional view to reject the undertakings in lieu of a market investigation reference of investment consultancy services .

The FCA's existing powers to impose a financial penalty or publicly censure a person or its officers and prohibit an officer from holding a management role at a relevant person or payment service provider will continue.

The FCA is consulting on its proposals to apply the same factors it currently does when deciding the level of sanction imposed for breaches of MLR 2017. It also proposes that no settlement discount will be available for cancellations of authorisation or registration and for permanent prohibitions.  Feedback to the consultation is expected to be published next month.

Comment

The FATF is due to visit the UK in February / March 2018, 10 years after its last visit, to assess the effectiveness of the UK's system. FATF recently issued new international standards which were put into place in the EU's AML and counter terrorist financing framework by the Fourth Money Laundering Directive and Fund Transfer Regulation, and led to MLR 2017 in the UK. Its visit is therefore likely to be a driver for the FCA to bring a number of money laundering or other financial crime related enforcement cases ahead of the visit in order to demonstrate that the UK is taking steps to tackle the issue.

More widely, it is no secret that the FCA expects its new approach to investigations to lead to more investigations being opened (see speech by James Symington, Director of Investigations). Its expanded toolkit in relation to AML and countering the financing of terrorism will give it more scope to take investigatory action for potential breaches. The emphasis of the above powers on the accountability of senior managers also suggests that the regulator's focus is likely to be on bringing cases against individuals. In that context, the consultation  paper provides some helpful guidance on the approach the FCA might take in deciding when to use its powers, for example by outlining the factors to be taken into account in determining the level of fine.

The complexity of chess and sheer number of possible positions and moves presented a huge challenge to programmers.  As recently as the 1970s chess computers were very weak players.  In 1976 Eliot Hearst of Indiana University, a master level chess player and professor of psychology noted that "the only way a current computer program could ever win a single game against a master player would be for the master, perhaps in a drunken stupor while playing 50 games simultaneously, to commit some once-in-a-year blunder".  The idea of a computer being stronger than the human world champion would have seemed absurd.

By the early 1980s, however, computers had become average players and by the late 1980s they could win against master level players.  Then in 1996 world champion Gary Kasparov, considered one of the strongest human players in history, lost a game to IBM's dedicated chess-playing supercomputer Deep Blue, albeit while winning the overall match.  In a rematch the following year, however, he was defeated by an upgraded version of the supercomputer that scored a narrow match victory which would have seemed impossible 20 years earlier.

Chess programs continued to become more and more sophisticated and efficient and now, another 20 years on, anyone can download a smartphone app that would comfortably be capable of beating the human world champion.

Is the field of financial advice following a similar trajectory with the rise of robo-advisers?  Robo-advice, the provision of financial advice with minimal human intervention by reference to mathematical rules or algorithms, has been around as a concept for almost a decade but has become a particular buzzword in recent years.  In the FCA's 2016 Financial Advice Market Review Final Report, for example, the FCA was enthusiastic about the use of "mass-market automated advice models" and it subsequently established an Automated Advice Unit to assist firms in implementing robo-advice solutions.  Encouraged by the FCA's attitude, many firms have been developing and launching robo-advice offerings over the last twelve months and these are becoming more and more an accepted tool for the provision of advice.

To date, robo-advice offerings have tended to focus more on the less complex end of the financial advice spectrum.  The FCA's enthusiasm for robo-advisers stemmed largely from concerns about an 'advice gap', situations where consumers (particularly those with limited assets) are unable to get advice and guidance on a need they have at a price they are willing to pay.  The FCA has therefore seen robo-advisers as a way of providing quick and inexpensive advice primarily in relation to lower value or less complex scenarios.  Robo-advice is still in its infancy and is generally not yet at the stage where it can provide sophisticated advice in relation to complex circumstances.  Certain external factors are also slowing the spread of robo-advice.  For example, recent research sponsored by ING suggests that the majority of the public remains uncomfortable with the idea of automated advice and this attitude will take time to change.  In addition, PI Insurers may feel, by necessity, that they need to take a relatively cautious view in relation to new and untested technology.  Firms implementing robo-advice solutions may therefore face increased insurance premiums, which is a further potential brake on innovation.

For the foreseeable future then, it appears that human advisers have no need to be concerned.  Robo-advice is in the process of automating only one part of the wider industry and even then at a relatively restricted pace.  But what about the longer term?  If we make the reasonable assumption that advances in robo-adviser technology are inevitable does that mean that robo-advisers will one day become so sophisticated and accepted as to render human input redundant?

Returning to the analogy of chess, the strongest players today are often considered so called 'centaurs', where a sophisticated program and a strong human player work together in collaboration.  Such players are considered to be stronger than either computers or humans playing alone as it appears that human input still improves overall performance, regardless of how strong computers become.  Similarly, perhaps financial advice will one day see a situation in which collaborative human and AI input produces the best possible overall outcome for customers.  If so, the role of the human financial adviser looks to remain central to financial advice no matter how capable robo-advisers become, while the overall standard of advice will only improve.

The review began in April 2016, and assessed 1,142 pension and investment advice files from 656 firms. Overall the review's findings were very positive but it still found three main issues:

    1. Disclosure - Initial disclosure by some firms was found to be unacceptable. In particular, firms were disclosing an hourly charging structure without approximating their time, and firms used charging structures with a wide range of fees;

    2. Replacement business - Some firms recommended that customers give up valuable guarantees without good reason, and customers were given solutions containing additional costs which appeared to outweigh any benefits gained; and

    3. Risk profiling and mapping to investment solutions - Firms used their risk profiling tools too stringently – without considering or mitigating the limitations of the tool. Firms also recommended solutions which did not match the risk that some customers were willing or able to take.

Interestingly, the FCA also found that firms with 25 or more advisers performed better than smaller firms, both in providing suitable advice and in providing sufficient disclosure to customers. 

The FCA has announced that it intends to resolve the problems observed with a communication programme throughout 2017 and into 2018 which shall provide further clarification of the FCA's expectations and start a dialogue with firms about how best to make improvements.

This review shall be repeated in 2019 to measure the success of the communications plan, as well as the implementation of new rules under MiFID II, PRIIPs and the IDD.

The FCA's choice of a communication programme gives it a broad scope but also shows a lighter touch – likely due to the overall positive findings of the review. By communicating examples of good practice and giving firms a chance to improve their own practices, the FCA highlights its expectations that firms approach compliance in a mature and cooperative manner. Whether such an approach is successful in changing practice within the sector will be evident in the 2019 review.

What is DLT and blockchain?

An ordinary ledger is maintained by a central authority and individuals must communicate with this authority to update the ledger. A distributed ledger on the other hand gives all participants in a network an identical copy of a ledger. This ledger can then be updated according to the rules of the network to reflect the transactions being undertaken.

Blockchain is the principal form of DLT. It collates records into "blocks" and links them using a unique signature. Each time a block is created it links to the previous, creating a chain. These blocks cannot be retrospectively altered therefore all information in each block is transparent, traceable and cannot be edited.

Discussion paper

The FCA's discussion paper focuses on the risks and benefits of DLT in the following areas:

• Governance and technology resilience;

• DLT and distributed data;

• Recordkeeping and auditability;

• Smart contracts (which RPC have previously blogged about); and

• The use of digital currencies to deliver financial services.

DLT, and blockchain in particular, maintain distinct advantages in recordkeeping and auditability and when distributing data.

In recordkeeping and auditability, the FCA highlights new commercially available options for owners of securities. An "auditable, transparent and fully verifiable electronic election" system can be used to track shareholder votes which could reduce proxy votes and empower individual investors. It can also be used to keep an accurate, up-to-date register of members which can be particularly useful for public companies.

Distributing data, particularly in the reinsurance market, can be improved by DLT. DLT can be used to validate contract versions by storing it, with other useful information, in each block. It can enable automated claims settlement through smart contracts. DLT can also improve data quality and transparency to facilitate the identification of participants in reinsurance contracts and retrocedants thereby highlighting risks and making it easier to avoid 'risk spirals'.

Comment

Notwithstanding its 'technology neutral' approach, the FCA is keen to promote technologies which it considers will improve the financial services sector. To that end the FCA has highlighted DLT as a technology which promotes transparency and which can help to make financial services more efficient. The FCA also perceives that DLT can ensure that evidence can be more easily gathered, will be more trustworthy and more easily traceable thereby making the job of the regulators easier.

N, an FX and payment services provider, banked with RBS.  In October 2015, RBS suspected some of N's accounts of containing the proceeds of crime, and duly made a suspicious activity report to the National Crime Agency (the NCA).  RBS decided to terminate its banking relationship with N and obtained consent under POCA from the NCA to return funds to N (but not to third parties).  Faced with such a drastic threat to its business, indeed a potential death-knell, N managed to find alternative banking facilities, but sought orders from the court requiring RBS to make certain payments from N's accounts to third parties.  The NCA opposed the orders.  However, the court noted that the NCA was willing for the money to be returned to N, which the court thought indicated that the funds were unlikely to be the proceeds of crime in fact.

The NCA appealed, essentially seeking a declaration that the orders were wrong in law but not trying to set aside the orders.  The Court of Appeal agreed that the orders should not have been issued.

While the Court of Appeal was not willing to go quite as far as holding that the court had no jurisdiction to grant orders of this nature (as the NCA had argued), it accepted that the statutory regime should prevail, except in exceptional circumstances, which had not been present here.

Such changes are set to bring the EU financial sanctions regime into line with breaches of UK and EU terrorist asset freezing regimes.

What offences have increased penalties?

The following offences have increased penalties:

• Offences for contravening or circumventing financial prohibitions;
• Breaches of licence terms;
• Obtaining a licence under false pretences;
• Reporting obligations; and
• Failing to comply with information requests.

What are the new penalties?

The penalty has increased from two years to seven years for more serious (indictable) breaches of sanctions.

The penalty has increased from three months to a "relevant maximum" for less serious (summary) breaches of sanctions. This "relevant maximum" is currently six months in England and Wales, twelve months in Scotland and six months in Northern Ireland.

The "relevant maximum" increases to twelve months in England and Wales once section 154(1) of the Criminal Justice Act 2003 comes into force. Whilst this section has existed, unenacted, since the last labour government, the Justice Select Committee have recently created a report which advocating its enactment.

Comment

Last month, the Office of Financial Sanctions Implementation (a Treasury department) was granted, under the Policing and Crime Act 2017, a range of powers giving them enforcement powers and the ability to impose new monetary penalties. In addition, the same legislation increased the imprisonment terms for financial sanctions, and applied both Deferred Prosecution Agreements and Serious Crime Prevention Orders to some financial sanctions offences.

An in-specie contribution is the transfer of property, shares or other assets into a pension instead of cash.  An in-specie contribution does not involve the sale/purchase of the asset but a transfer of legal ownership.

If an in-specie contribution falls within HMRC's criteria, the pension administrator can claim basic rate tax relief and the member can claim any tax relief above the basic rate in a process known as relief at source.  Broadly for every £80 contributed there is usually a top up of £20 tax relief from HMRC.  The relief is claimed on a monthly basis by the SIPP / SSAS provider.

What are the criteria?

HMRC has had in place guidance on in-specie contributions since 2009.  It provides that a member must first create a legally binding debt which the pension scheme is required to collect.  A member does this by first notifying the specific monetary amount of its proposed contribution to the scheme. 

Once the legally binding debt has been created, at that point an asset can be used to meet the debt rather than cash.  The asset must be transferred at open market value and this usually requires an independent valuation from a qualified valuer.  The asset is then re-registered into the names of the pension scheme trustees.  The transfer is subject to stamp duty and capital gains tax. 

Tax relief can be claimed once the process is complete and this can result in over and underpayments dependent on the valuation at the time of completion (which may have changed).  If there is an underpayment the member has to top up the contribution with cash and if there is an overpayment the scheme will purchase the remainder of the asset and make a cash payment to the member which will not benefit from tax relief.

What’s the current fuss about?

In early 2016 HMRC changed one of its forms to require SIPP and SSAS providers to separate out cash and in specie contributions in their claims for relief at source.  Following the form change, HMRC demanded further information and documentation from a number of SIPP providers and in the meantime withheld all tax relief (on both cash and in-specie contributions).  It is understood after a recent freedom of information request that HMRC has refused tax relief on in-specie contributions to 34 SIPP and SSAS providers.

The basis for HMRC's stance is unclear.  However, the available anecdotal evidence indicates that the reason for HMRC's position arises out of concerns that firms are not following HMRC's guidelines.  In particular, (1) when valuing assets, (2) the nature of type of assets transferred into schemes and (3) whether the transfer of the assets was a pre-ordained transfer?

What's the potential tax issue?

The dispute over whether or not tax relief is available revolves around the word "paid" – contributions must be "paid" under relevant tax legislation and HMRC appears to be arguing that "paid" means cash and nothing else.

If HMRC challenges the application of tax relief to in-specie contributions it could go back to 2009 with claims for not only the relief but penalties and interest.  If tax relief was not available this gives rise to a couple of issues:

(1) Unauthorised payment and scheme sanction charges

These tax charges would apply in circumstances where a pensioner has taken too much tax free cash as a result of dis-applying the tax relief.  For example, a pensioner who thought their pension pot was worth £100,000 with tax relief could have taken 25% in tax free cash – i.e. £25,000.  However, if the tax relief did not apply such that the pension pot was worth £90,000, then the available tax free cash would reduce from £25,000 to £22,500 leaving tax charges on the difference of £2,500.

(2) Repayment of tax relief claimed at source

For example, a promised contribution of £8,000 met by way of an in-specie contribution said to be worth £8,000 but in fact worth £4,000, would have created artificial tax relief of £1,000.  This is because the 25% tax relief on £8,000 is £2,000 when in fact the tax relief should only have resulted in a saving £1,000 being 25% of £4,000.  The difference between being £1,000.

Are there implications beyond SIPPs and SSASs?

Yes, contributions to some final salary schemes have been made by in-way of specie contributions on which the company receives corporation tax relief.  There is no available anecdotal evidence that HMRC is challenging corporation tax relief at the moment but the relief is claimed annually rather than monthly and so this problem may not have been investigated by HMRC.

What's happening at the moment?

The Association of Member-directed Pension Schemes met with HMRC in Autumn 2016 in an attempt to resolve the situation. 

However, the position remains unresolved with several pension providers having instructed lawyers to fight attempts by HMRC to claw back tax relief on certain pension scheme contributions.  HMRC was separately raising information requests with SIPP providers.  There is talk of a potential test case to resolve the issue, but at the moment members, providers and advisers in this area are left in limbo.

The comments made by Mr Griffith-Jones highlight the apparent conflicting policy approaches being adopted by the Regulator that on the one hand wants to encourage alternative technological developments through the likes of the Regulatory Sandbox and Innovation Hub and on the other hand want to ensure the regulation of services provided in an electronic format remains fit for purpose.

The concerns raised about the "greying" of the distinction between advice and guidance are made against the backdrop of the HMT's consultation on the changing definition of advice which concluded last month. We will have to see whether the Chairman of the Regulator's recent comments have had any bearing on the proposed rules implementing MiFID II requirements which are due to be published later this year.

Interestingly, there was also a reference in Mr Griffith-Jones speech to, "Artificial Intelligence puts the pooling of risk via insurance under pressure as individual odds become increasingly forecastable". It remains to be seen how "forecastable" such risks can be calculated however it goes without saying that robo-advice undoubtedly creates a potential systemic mis-selling risk.  Mark Carney recently noted "robo-advice and risk management algorithms may lead to excess volatility or increase pro-cyclicality as a result of herding, particularly if the underlying algorithms are overly sensitive to price movements or highly correlated" (see his speech here).

As we too have noted before this is a view shared by the European Banking Authority who identified in their Discussion Paper released at the end of 2015 that the increase in automated technology results in a significant number of consumers transacting in the same way which can potentially create a "herding risk" resulting in a volume of complaints – or "systemic or recurring problems". One risk is therefore that technology services cross the bridge from providing guidance to more bespoke advice which could result in a wide-scale problem if not properly managed from the outset.

What happened?

In August 2000 the Claimant – Paul Denning - instructed Alexander Forbes Financial Services Limited (AF) to provide advice in relation to the transfer of his final salary benefits.  AF recommended that the Claimant transfer his final salary benefits to a personal pension plan with Scottish Equitable (the First Transfer).  AF continued to advise the Claimant and in February 2007 recommended a further transfer to a "Phased Unsecured Income Plan" (the Second Transfer).

In August 2008 the Claimant instructed the defendant – Greenhalgh Financial Services Limited (GFS).  It was common ground between the parties that the Claimant did not instruct GFS to review the First Transfer.  GFS' engagement letter and accompanying Fee Agreement provided that GFS was not authorised or qualified to give legal advice and referred to arranging future transactions for the Claimant. However, GFS were given a folder containing AF's advice in relation to the First Transfer. 

Before GFS had completed their initial review of the Claimant's financial position, the Claimant complained to AFS and then to FOS about the Second Transfer.  Before FOS his complaint expanded to include the First Transfer. FOS rejected the complaint in relation to the First Transfer on the basis a complaint was out of time. 

The Claimant subsequently issued proceedings against GFS alleging that they should have identified and raised with the Claimant his claim against AF so that the claim could have been made in time for limitation purposes.

What happened in the proceedings between the Claimant and GFS?

The essence of the Claimant's case on duty was that it was obvious that any advice to transfer from a final salary pension scheme was negligent; GFS had a copy of AF's advice on the First Transfer and this was enough to have put them on notice of a claim against AF which they should have raised with the Claimant.

The Claimant adduced expert evidence supporting his position and relied on the decision in Credit Lyonnais v Russell Jones & Walker [2002].  This case was in the context of a solicitors' negligence claim where the Court found the solicitors responsible for a failure to advise on the time critical nature of a payment required under a break clause in circumstances where it had been instructed to advise on the exercise of the break option.  In the decision, Justice Laddie used an analogy with a dentist to explain circumstances where a professional's duty may extend beyond the terms of their retainer: "… If a dentist is asked to treat a patient's tooth and, on looking into the latter's mouth, he notices that an adjacent tooth is in need of treatment, it is his duty to warn the patient accordingly…".

In the claim between GFS and the Claimant, Justice Green set out the features of the Credit Lyonnais which in his view led to a finding that the solicitors owed a duty beyond their retainer in that case: (1) the totality of the information required by the professional to give the advice it was alleged should have been provided was before the professional concerned, (2) the issue overlooked was one which was patent on the facts of the instruments being reviewed and it became evident from the performance by the retainer, (3) the matter that should have been advised upon was something for which the professional was being paid and would not entail "extra work", (4) the dentist analogy highlights the sort of matters that the professional should assume a responsibility to advise upon and (5) Credit Lyonnais is not supportive of the proposition that, in cases where the professional reads documents that he is not asked to read and he discovers a risk to the client upon reading those documents, the professional assumes a duty to advise the client of that risk.

In applying these principles, Justice Green found that the relevant facts for GFS and the Claimant were (1) GFS' retainer was prospective, (2) GFS was never asked to advise on the First Transfer, (3) GFS was not equipped with sufficient information to advise on the First Transfer, (4) GFS was never paid to advise on the First Transfer, (5) there was no commercial or factual connection between the First Transfer and the advice GFS was asked to give and (5) the advice it is said GFS should have provided was in large part legal in nature and this was carved out of their engagement letter. As a result, the claim was struck out.

Take away

The case highlights the importance of an adviser's retainer which the Court will look to in the first instance when considering whether or not an adviser owed a duty to advise on a particular issue.  The decision also provides comfort to professionals that, even if they are provided with lots of information and issues arise when reviewing that information outside of their retainer, provided the engagement terms are sufficiently clear and concise, the professional will not necessarily owe a duty to advise on those wider issues.

In a world of ongoing adviser charges and the need – emphasised by the FCA's current suitability review – to demonstrate ongoing suitability, we can expect further divergence between the legal position on the one hand and the regulatory position, probably adopted by FOS, on the other.

What’s the story?

In August 2009, a Canadian company (then called Griffiths) agreed to pay a Maryland company called Ambassade du Tchad LLC ("Embassy of Chad") US$2m if Griffiths were awarded certain oil concessions in Chad.  Ambassade du Tchad was owned by the Chadian ambassador to the US.  In September 2009, that agreement was replaced by another, in the same terms, with a Nevada company, called Chad Oil Consultants LLC.  This company was owned by the wife of the Chadian ambassador.  On the same day, Mrs Saleh, who was the wife of another senior Chadian diplomat in the US, the ambassador's wife and a former religious teacher of the ambassador's children subscribed for 4 million shares in Griffiths at a cost of C$800.

In January 2011, Griffiths was awarded two oil concessions in Chad.  Shortly before the contracts were signed in February 2011, the agreed sum of US$2m was paid to Chad Oil Consultants. 

In July 2011, Griffiths, then under new management, started investigating the payment to Chad Oil Consultants.  It reported itself to the Canadian authorities and in January 2013, it pleaded guilty in Canada to corruption and was fined C$10.4m.

The Canadian authorities then planned to seek forfeiture of the shares issued to Mrs Saleh, the ambassador's wife and the former religious teacher of the ambassador's children on the basis that the shares were bribes.  However, in April 2014, the Canadian authorities dropped the case for reasons unknown and the Canadian court issued an order which included the statements:

• "it…appear[s] that [Mrs Saleh] is innocent of any complicity in any indictable offence that resulted in the…seizure of her shares in [Griffiths]…" (in a recital); and

• the order was to be "construed as a judgment in rem, in that the…shares issued…[to Mrs Saleh]…are neither crime related proceeds nor offence related property, but were at all times from the date those shares were issued to her, continuously and beyond the date of this Order/Judgment, her property lawfully acquired by her" (as part of the order).

  Why would the UK Serious Fraud Office get involved?

  In the meantime, Griffiths was floated on the London Stock Exchange and then acquired by Glencore plc in July 2014.  The amount paid for Mrs Saleh's shares was £4.4m.  However, after Glencore had paid the purchase price to Griffiths' registrars based in England, but before it was paid on to Mrs Saleh, the SFO obtained a property freezing order over the purchase price.  This was on the basis that the money was recoverable property for the purposes of the Proceeds of Crime Act 2002 (POCA), ie, property obtained through conduct that was a crime in the UK, or would be a crime if it occurred here.  In this case, the alleged unlawful conduct was the events in 2011 in the US and Canada which the SFO alleged amounted to a series of corrupt transactions. 

  Mrs Saleh applied to discharge the order, on the basis that the order of the Canadian court precluded treating the money as recoverable property under POCA.

  Did the Canadian order trump the property freezing order?

  No, said Mrs Justice Andrews at first instance (Saleh v Director of the Serious Fraud Office [2015] EWHC 2119 (QB)), and now the Court of Appeal has agreed with her.  The Court of Appeal saw the two issues as:

• Was the Canadian order final and conclusive on the merits?

• Was the Canadian order a judgment in rem so as to bind the SFO (rather than a judgment in personam, which would bind only Mrs Saleh and the Canadian prosecutor)?

  "On the proper analysis, it was in fact neither" found the Court of Appeal.  It relied on the fact that the Canadian judge had not heard any evidence on the facts or submissions on the relevant law and the Canadian prosecutor had not agreed the order (although he had not opposed the granting of it).  Further, even if the order was a judgment in rem, it established only that Mrs Saleh had good title to the shares and could confer good title on a sale – it did not prevent the SFO from making arguments as to the circumstances in which that title was acquired and therefore whether the proceeds from the sale of the shares were recoverable property under POCA.

  The next instalment

The FCA has regulated P2P lending – or 'loan-based crowdfunding' – since 1 April 2014. As such, P2P platforms must presently comply with core elements of the FCA Handbook, including the FCA Principles and relevant conduct of business rules.

However, current regulatory obligations upon P2P platforms are by design less stringent than those affecting other financial services firms. In particular, platforms active before April 2014 have been allowed to operate under interim FCA permissions, pending a successful application for full authorisation – and even fully authorised platforms need only meet limited minimum capital requirements. Unadvised investors also currently lack recourse to the FSCS.

This 'light touch' approach arguably suited the first generation of P2P platforms, which were essentially matchmakers between lenders and borrowers. Of concern to the FCA, however, is that some platforms' business models now increasingly resemble those of asset managers or collective investment schemes – creating a risk of 'regulatory arbitrage' where platforms operate like traditional financial institutions, but are not subject to the same controls.

In this respect, developments in the P2P lending sector identified by the FCA include:

• Pooling of credit risk – including through 'reserve' or 'provision' funds, where a proportion of investment return is set aside in order to reimburse investors following anticipated future defaults. In the FCA's view, this practice may blur the line between P2P lending and asset management, and can generate a false sense of security where the risks which remain are not adequately explained to investors.

• Maturity mismatches – where lenders can withdraw money more quickly than borrowers are required to repay loans. As the FCA observes, this bears some resemblance to traditional banking business, but is not subject to equivalent regulatory requirements (for example, regarding capital adequacy).

• Cross-investment – where one P2P platform facilitates investment in loans formed on other platforms, creating an increasing degree of interconnectivity between P2P platforms (and therefore systemic risk).

Whilst the FCA's review continues, last month's report highlights several areas where the regulator has already identified sufficient potential for consumer detriment to warrant possible rule changes. Subject to further consultation, the FCA proposes to introduce restrictions on cross-investment and, given the increasing complexity of P2P lending, to strengthen the rules requiring firms to implement 'wind-down plans' in case platforms fail. The regulator also proposes to introduce more prescriptive rules regarding the content and timing of risk disclosures to potential investors, in response to concerns that some investors are not sufficiently aware of the risk factors associated with P2P lending.

The European Banking Authority (EBA) Chair, Andrea Enria, has recently appeared before the European Parliament's Committee on Economic and Monetary Affairs (ECON).  The purpose of the hearing was to enable the EBA to update ECON on its work to deliver the 11 mandates conferred under Payment Services Directive ((EU) 2015/2366) (PSD2) with the focus of the hearing's discussions being on the EBA's approach to developing Regulatory Technical Standards (RTS) on strong customer authentication (SCA) and secure communications (SC).In his introductory statement to ECON, Mr Enria explained that, in developing the RTS, both the EBA and the European Central Bank (ECB) had to make difficult trade-offs between competing demands. He described the challenges faced by the EBA and ECB in this regard as "formidable".

The EBA published the draft RTS for consultation in August 2016. Mr Enria explained that since the consultation closed, the EBA has been assessing responses. To date, the EBA has identified approximately 260 distinct concerns and requests for clarifications. It intends to assess the strength of the arguments relating to each concern, with a view to deciding whether the correct trade-offs were made when developing the draft RTS for consultation. When it publishes and submits the final RTS to the European Commission in early 2017, the EBA intends to publish a very extensive feedback table, providing feedback to the responses received and making clear the EBA's assessment of whether or not each request has led it to amend the RTS.

However, Mr Enria also explained that a large number of the 260 requests related to PSD2 itself and how to interpret its provisions, rather than to the draft RTS. It was made clear that the EBA considers it was not for it to take a view on these issues and therefore the EBA is currently discussing with the Commission how best to communicate clarifications of this kind.

Of those concerns, which were focussed on the RTS, Mr Enria did briefly address the three concerns which ECON has previously raised:

• The monetary thresholds proposed in the draft RTS.

• The communication interface and direct access.

• The exemptions to SCA.

However further detail on how the EBA proposes to address these concerns will be provided in the new year when the EBA intends to submit the final RTS. Interestingly the EBA expects to miss, by about a month, the original deadline of 13 January 2017, which is set out in PSD2.  It considers that this is delay acceptable to ensure that the RTS are fit for purpose, support PSD2's objectives and ensure the EBA delivers its mandate.

As a result of the views expressed in FAMR, the FCA has decided to carry out a fundamental review of how the FSCS is funded. The FCA says it is looking to review the funding structure of the FSCS to ensure that it acts as a back stop, not a first line of defence and that there is sufficient funding to compensate claimants who are entitled to receive compensation.

The FCA is looking at a range of options to try and establish a change in how the FSCS is paid for and the level of protection it provides to consumers.  It is asking for comments on the following proposals:

• Whether PII could cover more claims.
• If there should be product provider contributions towards the costs of claims.
• Including Lloyd's of London in the retail funding pool.
• Changing the funding classes.
• The introduction of risk-based levies.

In addition to gathering views on how the FSCS should be funded, the FCA is asking for comments on extending the FSCS's remit.  The FCA is considering whether compensation limits should be increased in respect of claims relating to investment provision and the intermediation of life, pension and investment products.  It also seeks views on whether cover should now be afforded for loan-based crowdfunding and financial promotions.

The FCA's review, which involved a sample of 200 firms, followed up on 'isolated issues' that the FCA had seen in the course of its reactive supervisory work.  Primarily the review looked at whether the policies that firms had purchased  complied with the requirements in the Prudential sourcebook for Mortgage and Home Finance Firms (MIPRU), though the review also considered how effectively the general insurance (GI) PII market was functioning.

The FCA's key findings included the following:

• There is sufficient breadth within the GI PII market to provide choice and consequently firms were able to obtain cover.
• Firms were able to obtain cover for high levels of indemnity.  However. the FCA did find that in a small number of cases, firms did not have the minimum level of cover required under MIPRU, or had a policy excess greater than that permitted.
• The FCA was concerned that policies often contained exclusion clauses the effect of which could be to reduce the scope of the cover below that required by MIPRU. These related to four broad types of exclusion clauses (the suitability of the insurer, unrated insurers, non-admitted insurers and insurer insolvency).
• There were significant numbers of policies which had inadvertent gaps in coverage or inaccuracies.  The FCA concluded that this indicated that the policies had not been subject to appropriate review by the firms. These included exclusion clauses drafted too widely, and a lack of clarity about the scope of cover for Financial Ombudsman awards and the activities of appointed representatives that a firm might have.

Whilst the FCA is proposing to engage with the sector it also made clear that it expects all affected firms to consider the findings of this review.  In particular, the FCA made clear that it expects all GI intermediaries that were not part of the review to review their PII policies to ensure that they meet MIPRU requirements, and the FCA expects insurers and managing general agents, which provide PII to GI intermediaries, to review their products against the findings of the report.

The ESMA guidelines set out a non-exhaustive list of legitimate interests of issuers for delaying the disclosure of inside information.  The guidelines also list situations in which the delay of disclosure of inside information is likely to mislead the public.

The FCA has notified ESMA of its intention to comply with the ESMA guidelines (the FCA has also indicated that it will comply with ESMA guidelines on market soundings (ESMA/2016/1477)).

In amending DTR 2.5, the FCA is proposing to follow the approach it has previously used when implementing the Market Abuse Regulation. It proposes to delete FCA Handbook material that conflicts with or duplicates the ESMA guidelines and to cross-refer to the ESMA guidelines where appropriate. The FCA is proposing that within DTR 2.5 the reader will be signposted to the ESMA guidelines, which will ensure that if the list is added to in the future the handbook will not need to be amended.

The consultation closes on 6 January 2017.

However, it seems that the current government has little time for "George Osborne's baby" citing concerns that the proposed secondary market would not keep consumers "properly protected".

In a statement released earlier this week the government explained, "It has become clear that creating the conditions to allow a competitive market to emerge could not be balanced with sufficient consumer protections."

The government's change of heart has not gone unnoticed; during yesterday's PMQ's the Economic Secretary to the Treasury was questioned on the reasoning for the decision. The Economic Secretary to the Treasury stated that having consulted "extensively" to "establish whether people would be able to get a good deal", the government has decided "we are not taking this policy further".

The government's decision to scrap its proposal for a secondary annuity market has been labelled "a U-turn".  However it arguably did not require physic powers to forecast that the proposals might not materialise.  The proposals faced their fair share of critics from both the industry and the regulator. Notably one service provider said that they would play no part in the secondary annuity market and the FCA'S consultation on the proposals released in April this year identified that it could lead to "significant risk of poor outcomes for consumers".

The proposal will see the code of conduct rules (also referred to as COCON) apply to standard NEDs in relevant authorised persons (RAPs) (that is, banks, building societies, credit unions and dual regulated investment firms) and insurance firms (that is, firms defined as Solvency II firms in the FCA Glossary).  For the purpose of CP16/27, "standard NEDs" means those NEDs who are not subject to regulatory pre-approval under the senior managers regime for RAPs, or the PRA's senior insurance managers regime and the FCA-revised approved persons regime for insurance firms.

The FCA has stated that "Applying COCON to standard NEDs will help raise standards of conduct for these individuals and, by placing additional duties on them, aims to reduce the risk of future misconduct and mis-selling." This commentary is quite significant because it touches on the new Rule 4, which requires staff  to "pay due regard to the interests of customers and treat them fairly".  Rule 4 is one of the most significant differences between the new Code of Conduct and the previous Statements of Principle and Code of Practice for Approved Persons.

If, as seems likely, the FCA goes ahead with this proposal, standard NEDs will find themselves tackling the same issues facing NEDs who are already within the regime; how do you discharge your duties under these new more customer-centric conduct rules?

The deadline for comments is 9 January 2017.

What we do know is that the road to Brexit is complex and Art 50 of the Lisbon Treaty envisages a two year (or more) process for a member state to leave the EU. Although Article 50 has never been previously invoked we know that nothing will change overnight and the status quo will prevail until the finer details of 'Brexit' have been considered and mapped out.

Whether fund managers will now look to Luxembourg, Ireland or other European funds markets remains to be seen. And the evidence is currently unclear as to whether sponsors will be more reluctant to raise new funds until a degree of certainty has been reached over the UK's role in Europe.

We recently hosted a British Venture Capital Association (BVCA) breakfast at our London office at which soundings were taken from both the BVCA and a number of private equity fund sponsors on the expected impact of Brexit. During the coming weeks, we will be liaising with the BVCA of which we are a sponsor. Going forward, the BVCA will take a central role in lobbying the UK government to protect the interests of the UK's fund management industry, for instance by seeking to maintain the UK's passporting rights.

The consultation is open to individuals and organisations until 25 October 2016 with implementation of the allowance expected in April 2017.

It is envisaged that consumers will be able to use up to £500 of their pensions, tax free, to pay for regulated advice on their pension arrangements, before they reach the minimum pension age. There is no suggestion that the 25% tax-free lump sum available when consumers turn 55 will be affected.

Whilst the Government has a framework in mind the consultation is to fine tune exactly what the parameters will be.

Some of the questions raised in the consultation are:

• The age at which the allowance should be available to consumers.
• How many times consumers may use the allowance (recognising that consumers' circumstances change over time).
• How to maximise awareness of, and access to, the allowance.
• The scope of the advice that the allowance can be used for.

Consumers with defined contribution pensions will be able to use the allowance, but those with defined benefit pensions will not. If consumers have both, then they are likely to be able to use the allowance to obtain advice on their pension arrangements as a whole.

The introduction of pension freedoms and automatic enrolment in workplace pensions are two key factors that have exacerbated the impact of the widening advice gap. The pension advice allowance is intended to ease access to advice for the less wealthy by making advice more accessible and affordable.

Although there is a question mark over whether £500 is enough, there are more serious concerns. Will the introduction of the allowance attract fraudsters, particularly if consumers are permitted to use it multiple times? One anticipated safeguard is to ensure the payment goes directly from the pension fund to the adviser - but that won't stop fraudsters impersonating an authorised person or unscrupulous firms charging for little or no useful advice.  It is not clear whether, or how, a successful balance can be struck between affording sufficient access to the allowance and limiting the scope for scams.

The new capital adequacy rules introduce a change to the FCA formula for calculating the minimum capital requirements for SIPP providers.  The new formula is based on the value of assets the SIPP provider has under administration and the number of SIPPs that are invested in any part in assets the FCA classifies as "non-standard".  The old capital adequacy rule calculated the minimum capital needed based on the equivalent of a SIPP operator's expenses for 13 weeks.  The new rule requires an increased amount of capital.

The definition of "non-standard" assets hit the headlines last year when the FCA initially included commercial property in the definition (albeit this was later changed).  "Standard" assets include physical gold bullion, national savings and investment products, bank account deposits, DFM portfolios provided the underlying assets are also "standard assets" and units in regulated collective investment schemes.  "Non-standard assets" can include any standard asset if it cannot be valued or sold/realised in 30 days. Typical non-standard assets include unlisted company shares and unregulated collective investment schemes.

The new formula was announced by the then FSA in November 2012 and so SIPP providers have had time to make appropriate arrangements to ensure that they have adequate capital in place.  The FSA said at the time of the announcement that it expected 20% of SIPP providers would be unable to meet the new requirements and the result has been a consolidation in the market.  Some firms have already increased charges in order to cover the new capital adequacy requirements.

The change will impact SIPP providers holding "non-standard assets" and it is going to be difficult for SIPP providers to mitigate this position in circumstances where some "non-standard" assets include closed funds and so there is no option for members to encash the investment, mitigate the increased capital adequacy requirements (and potentially a charge) and purchase a standard asset.

The change is not only important for the SIPP market but also for advisers who, as part of their due diligence, should be looking at whether or not a SIPP provider meets the capital adequacy rules before making a recommendation to transfer funds to a specific SIPP. 

No doubt the change will also be seen by many as the FCA's way of discouraging SIPP providers from permitting members to invest in "non-standard" assets; or perhaps what the FCA considers to be "undesirable" assets.

The FOS endorses vigilance and knowledge-sharing to combat the issue stating "it’s essential that everyone with an insight shares that insight". Given the FOS' engagement on the front line of customer complaints, it is well-placed to monitor and assess such trends as they develop.

In pursuit of further insight, it is worth taking another look at the complaints made to the FOS in the last year and how the FOS has dealt with these complaints (as published in the FOS' annual review of the April 2015 / April 2016 financial year).

Key figures

1. 340, 899 new complaints were investigated (3.5% more than last year)

    

2. 438,802 complaints were resolved (2.14% less than last year)

    

3. On average, 51% of complaints were upheld (4% less than last year)

    

4. The FOS operated a costs base of £257.9m (6.78% more than last year)

    

5. 56% of complaints related to PPI (7% less than last year)

    

6. 31% of complaints related to banking and credit (7% more than last year)

    

7. 9% of complaints related to other insurance (same as last year)

    

8. 4% of complaints related to investment and pensions (same as last year)

    

The figures show that the FOS spent more money but resolved fewer complaints than last year. Even with the increase in new complaints, the total increase (including resolved and new complaints) was only 0.3% against a total costs increase of 6.78%. The FOS calculate this as an overall "unit cost" per case of £586 against last year's unit cost of £536.

Given that the FOS' experience of complaints has now developed significantly over the last 15 years, it is surprising that the unit cost per case has increased. One might expect the FOS' costs to have reduced, particularly as the make-up of complaints is very similar to last year.

Trends

1. PPI

In March 2016 the FOS reached a total of 1.5 million complaints about PPI (which is half of all complaints received since the FOS was set up in 2001). The wave of PPI complaints has slowed but remains by far the largest cause of complaints made to the FOS. In fact, the biggest spike in complaints this year was caused by the FCA consultation regarding a potential 15 year time limit on PPI complaints. It is likely that PPI complaints will continue to dominate the FOS' capacity for some time.

2. Business complaints by sector

In terms of the businesses complained about, 72% of the new complaints were directed at banks and 10% at general insurers. Just 3.5% of complaints were directed at insurance brokers, 2% at mortgage intermediaries, and 1% at IFAs. As banks sold the majority of policies that are the subject of PPI complaints, the PPI trend is strongly influencing these figures.

In terms of financial products complained about, there are several clearer trends based on recent developments. Complaints about payday loans increased by 178% and complaints about packaged bank accounts increased by 107%, both products having received considerable negative press coverage in the past year or so.

In relation to pensions and investments, the number of complaints relating to Personal Pension Plans (PPPs) has increased by 23% since the pension freedoms came in last year. PPPs are now the largest single contributor of complaints in this area.

Complaints about Self-Invested Personal Pensions (SIPPs) and Small Self-Administered Schemes (SSASs) also increased by 14%. Three quarters of these complaints were about advice to invest in Unregulated Collective Investment Schemes (UCISs), a trend that will be evident to those dealing with claims against professionals and their insurers.

3. How complaints are being made and dealt with

Almost half of complaints continue to be made through claims management companies, but once the complaints relating to PPI and packaged accounts are removed, this drops to 5%.

The FOS has improved its speed in resolving complaints, 66% of complaints being resolved within 3 months. This may come as a surprise to those dealing with long-running FOS complaints on behalf of professionals and their insurers. However, this is explained by the fact that complaints relating to pensions and investments are by far the most likely to be referred to an ombudsman, considerably lengthening the decision time for complaints against insured professionals.

The FOS review states that only 1% of complaints involved redress of over £75,000. However, the most common redress outcome, applied to 41.5% of complaints, involved "telling the business the basis or formula on which they should pay compensation". This redress method often necessarily results in awards of well over £75,000, casting significant doubt on the relevance of these figures.

Summary

As part of the rules implemented following the RDR all retail investment advisers have had to obtain the relevant professional qualifications and hold a Statement of Professional Standing (known as a 'SPS') since 2013.

The FCA considers Miss Parry fabricated two SPSs to hide the fact she was not qualified to provide investment advice to retail customers.  Miss Parry only admitted her misconduct towards the end of the FCA's investigation in 2015 and is now banned from performing any regulated activity.

Mark Steward's comments on the announcement leave us in no doubt that the regulator will not hesitate in penalising such dishonest behaviour in order to ensure consumer protection and maintain market integrity:  "Miss Parry's behaviour demonstrates clear disregard of those standards and her duty to be honest with the FCA. We will not tolerate this sort of behaviour'.

In short – don't blag it to the regulator.     

The recent alert identifies that the FCA has noticed a growing number of cases in which firms have failed to take adequate control over the advice they have provided to their customers. The alert notes that this issue is most prevalent in pension transfer cases.

The FCA has highlighted that there have been cases where firms are presented with pre-completed Fact Finds from introducers where it appears that there has been insufficient review of the introducers' assessment of a customer's financial circumstances. The FCA is clearly concerned that in some cases advisors never meet their ultimate client raising questions as to whether a sufficiently thorough analysis of a client's needs and circumstances is undertaken.

The alert also touches on the issue of what happens when advisors are met with insistent clients. The FCA refers to one of the "warning signs" as being when consumers approach advisors with a "pre-determined investment in mind". However, the update provides no tangible explanations as to what advisors should do in the circumstances where a client may have already made-up their mind.

A further issue of concern is that the FCA considers that some advisors are relying upon over-simplified advice processes which can also result in a pre-determined recommendation to the customer. Advisors face a practical balancing act between ensuring they meet their regulatory requirements whilst ensuring their business models' remain viable given the increasing burden of regulatory costs.

The FCA also raises the specific practical concern that some less scrupulous introducers may be using firms' Firm Reference Number (FRNs) to obtain customers' policy information which they would not have otherwise been provided. This is clearly unwarranted behaviour by the introducers; however whether advisor firms should be considered at fault is a separate issue.

The alert highlights the challenges advisors are facing to ensure they remain compliant with their regulatory requirements following the pension freedom changes. So how can a firm ensure that it meets its regulatory requirements when advising upon pension transfer cases? The FCA's alert has offered some limited advice on what advisors need to keep in mind when accepting business from introducers which is often a way advisors receive business to transfer monies into a SIPP.

The key points to take away from the alert are:

1. To ensure that thorough due diligence is carried out of the introducers with whom advisors deal;
2. To ensure that advisors properly understand products they recommend and take adequate due diligence steps as appropriate, and
3. To ensure that advisors retain their independence in providing advice to the ultimate client

The FCA's alert regarding due diligence will come as no surprise to the vast majority of advisors who are well familiarised with their due diligence requirements. Rather, the concern remains that some less scrupulous advisors may perhaps seek to take advantage of the 'advice gap' by targeting those clients who are unprepared to incur the cost of instructing more reputable advisor firms.

Following the recent announcement and alert it is clear that pension transfer cases remain a topic of focus. We will have to wait and see whether this week is similarly busy for the FCA's news team!

What will the new methodology look like?  The FCA has not yet announced when the Consultation Paper will be published, maybe to build up some hype and anticipation within the industry in the meantime! Until then it will not be clear what precisely the FCA's concerns are and whether this means a more or less favourable calculation or just something different. However, it is anticipated that one of the main issues for the consultation will be whether the recently updated assumptions that should be used to calculate redress remain fit for purpose. Following the sweeping changes to the pension freedom rules in April of last year it is arguable that the Financial Ombudsman Service's (FOS') current methodology is based on outdated assumptions. Advisers will no doubt also have their own thoughts as to the suitability and complexity of the current assumptions. It is hoped that any changes to the methodology will at least provide some much needed certainty on the topic.

The announcement raises further queries as to what will be the position in the interim period between now and any final conclusion (not due until spring 2017). The FCA says that they expect firms in some cases to offer a provisional redress now and then provide a subsequent further redress calculation once the outcome of the consultation is known. This is unlikely to appeal to many firms given the cost often involved in carrying out the calculations if it could be wide of the actual redress given to the complainant. This is an area of uncertainty and firms should draw complainants' attention to the FCA's wording in the recent announcement to explain the inevitable delay to their complaint being dealt with.

How will FOS deal with pension redress cases in the interim period?  Will firms effectively be paying interest on any awards whilst the FCA makes their mind up as what changes are necessary?  These questions are also left unanswered

In April 2008, Glenn Maud guaranteed a loan made to his company Propinvest Group Ltd by the Libyan Investment Authority (LIA).  Propinvest Ltd defaulted and by February 2014, Mr Maud owed the LIA £17.6m.  As a precursor to bankruptcy proceedings, the LIA then made a statutory demand for the money owed.  Mr Maud applied (albeit rather late) for the statutory demand to be set aside under the Insolvency Rules, on the grounds that payment under the guarantee would contravene EU sanctions on Libya (Regulation (EU) No 204/2011, implemented in the UK by the Libya (Asset-Freezing) Regulations 2011).

Although there was also detailed consideration as to whether a statutory demand amounted, for the purposes of the sanctions, to a "claim" (which the LIA could not bring) and whether Mr Maud should have sought a licence from HM Treasury to pay under the guarantee, the crux of the case was the effect of Article 5 of Regulation (EU) No 204/211 which reads:

"Article 5

4. All funds and economic resources belonging to, or owned, held or controlled by the following on 16th September 2011:

(a) Libyan Investment Authority…

and located outside Libya on that date shall remain frozen."

The judge in the first instance had found that the guarantee represented "funds", and payment of the guarantee would involve dealing with it in a way that would result in a change of character of the guarantee and enable the LIA to use the funds, in contravention of Article 5(4).  Mr Maud could not, therefore, pay under the guarantee without a breach of sanctions and the judge set aside the statutory demand.

The Court of Appeal disagreed.  Its view was that the Regulation should be read to give effect to the underlying Security Council resolutions.  Those resolutions, after some relaxation of sanctions following the overthrow of Colonel Gaddafi, were intended to allow the LIA to deal with assets outside Libya acquired after 16 September 2011 and to allow it to obtain new assets free of sanctions.  It found that the payment of debts arising under a guarantee was to be characterised as making new funds available rather than dealing with existing, frozen, assets.  That was permissible under the sanctions.  Accordingly, the statutory demand was reinstated. 

Pity the poor compliance officer trying to work out whether a given transaction breaches sanctions or not!

The review is targeted at the decumulation phase; this is the phase of converting assets held in a pension pot into a fund for a pensioner's desired lifestyle.  The review will focus on annuities, income drawdown, hybrid products and uncrystallised pension fund lump sum cash withdrawals.  Defined benefit pensions, equity release products and individual savings accounts fall outside the scope of the review. 

The FCA has been collecting data on a quarterly basis from a representative sample of pension and retirement income providers and this data is presented as the backdrop to the review.  The data for October to December 2015 provided that:

• more than half of consumers are staying with their existing pension provider;

• high numbers of consumers are entering into income drawdown products without the use of a regulated advisor, with 32% of reported draw down sales not associated with a regulated advisor, compared to 3% of sales in 2013 before the pension freedoms were introduced;

• a significant number of consumers were taking full encashment or making high rates of cash withdrawals from their pension savings; 52% taking full encashment, 29% drawdown and 17% annuities.

In light of these findings the FCA are concerned about the ability of consumers to make informed decisions and place competitive pressure on firms in light of increased choice and complexity and increased mass market access to high risk products.  These concerns were highlighted in the retirement income market study of March 2015 and the FCA considers that the data to date shows that these concerns have been borne out in practice.

Given these concerns the review is to look at four areas:

1. Shopping around and switching. The FCA has identified that consumers have been missing out on higher income by not shopping around for their retirement product which is a particular issue in relation to annuities. The aim of the review is to explore whether there is a more acute issue post pension freedoms in relation to consumers' ability to compare their options and shop around.

    

2. Non-advised consumer journeys. The introduction of the pension freedoms has introduced a greater degree of flexibility and also complexity for consumers, such that the decision about a retirement product is no longer a one off decision. The review is to study the non-advised consumer journey and assess whether consumers are inhibited or discouraged from making informed and impartial decisions.

    

3. Business models and barriers to entry. The report notes that the pension freedoms have opened up possibilities for firms to enter or expand into retirement income markets. The aim of the review is to understand the extent to which the critical mass of customers and/or customer acquisition continues to be a barrier for new entrants into the market.

    

4. Impact of regulation. The review also invites responses on whether or not FCA regulation is acting as a barrier to entry or expansion and the extent to which it disproportionately increases costs or deters innovation.

The deadline for responses is 31 August 2016 and the intention is for a final report to be published in the Summer of 2017.  This final report will follow the introduction of the lifetime individual savings account and the secondary annuity market which are both due to be introduced in April 2017.

On 14 July 2016 the FCA also published press releases in relation to (1) signposting pension guidance and (2) a new annuity comparator.

Most interesting was the annuity comparator press release which sets out the FCA's findings in relation to a proposed comparator designed to provide targeted information to consumers at the point of purchase and highlight the benefits of shopping around.  The FCA's findings indicate a positive response to the comparator and it is possible that the comparator will be introduced as part of a range of changes aimed at the areas the FCA has identified as part of the retirement outcomes review.

However, it is noteworthy that the highest number of complaints regarding pension freedoms related to delays in allowing individuals to access their pension funds. The FOS stated in the recent newsletter that "if we decide a pension provider caused unreasonable delays, we'll make sure their customer isn't worse off because of it". The newsletter provides no indication of what has been considered an "unreasonable" period of time. The FOS has also sought to put its own interpretation on the recent figures in seeking to identify that, as delays account for a smaller proportion of complaints than they do of enquiries, this suggests that the FOS has been proactively engaging with pension providers to help them understand the position. Readers may have their own views on this interpretation of the statistics. 

There are also passing comments on the difficulties advisors face when dealing with insistent clients in pension advice cases. The FOS notes "wanting to help a client who's set on using the new freedoms, while believing it isn't the best course of action in that client's individuals circumstances, is clearly a difficult position to be in". It will be of interest to see whether there is any tangible shift in the FOS' approach in dealing with insistent clients or whether such statements are merely token acknowledgments of the difficulties advisors face on this issue.

Perhaps the most telling figures from the FOS' newsletter are that the second highest number of complaints relate to individuals having to obtain financial advice before accessing their pension pots. The pension freedom rules require customers to obtain advice if they hold safeguarded benefits worth £30,000 or more. The much talked about "advice gap" has been one of the buzz words of the moment and it seems that the FOS has identified numerous complaints from customers in cases where they are either unprepared to pay for advice or are simply struggling to find an adviser who's willing to give them advice. 

We will have to wait and see whether the apparent deficit in advisors providing assistance to those customers with more limited means has the potential to create a risk for a minority of unscrupulous advisors targeting those customers who are unable (or unprepared) to seek advice.

In their business plan the FCA raises concerns that consumers may not be receiving "the most suitable advice" and advisers may "offer a limited range of products or have staff reward schemes that motivate sales over suitability". The recent call for suitability reports is evidence of the FCA's continuing commitment to improving the suitability of advice provided to consumers.

It is understood that the FCA will review a sample of case files selected from the data collected. It is also expected that they will enter into a dialogue with advisers with a view to producing guidance and template reports. This is a case of the FCA doing what it says it is going to do. In Drew's recent blog he commented that one of the recommendations arising out of FAMR was to improve suitability reports. FAMR found there to be considerable variety in the approach and format of suitability reports being used by IFAs prompting the FCA to look to provide firms with better guidance and template reports; which appears now to be the reason for the widespread request for suitability reports. 

According to their business plan the FCA wants to review suitability of advice in order to achieve "Affordable, accessible advice options that meet consumers' needs" and "Advice [that] is of appropriate quality and suitable for consumers' needs". This closely mirrors FAMR recommendations concerning affordability and accessibility of advice for consumers with the continuing attention on addressing the 'advice gap' which has become so prominent since the introduction of the pension freedoms.

Despite the good intentions, firms may be somewhat uneasy about the scrutiny. If any of the reports are considered to be sub-standard and led to unsuitable investments being sold to consumers, firms could be facing the prospect of past business reviews and/or redress payments. 

Concerns aside, reviewing real data and consulting with (some) advisers is promising; what is not known is how far the review, and in turn, any changes will go. Will there be an attempt to standardise suitability reports to the extent that there is a 'one size fits all' approach or will there be discretionary guidance? Will either result in changes in the current approach to advice? 

An area of real change and challenge is robo advice. It's as much of a current theme in the advice market as suitability but we don't know if the FCA's current review will directly address it. With such uncertainty and variety anticipated in the robo advice market it would seem to be a prime target for this review, as well as it being relatively well timed, particularly for those still refining their choice of robo advice format. Perhaps the FCA will defer until there is sufficient specific robo advice data to conduct a similar review to the current one.

Ultimately how a balance is to be struck between the delivery of suitable advice, affordability and accessibility is unclear. The FCA anticipates measuring the success of the review on changes in consumer satisfaction and consumer complaints data. Measuring success with consumer reaction is no bad thing but will fewer complaints be indicative of more suitable advice or more successful investments? 

Clearly suitability is high on the FCA's priority list and with its relevance to so many current topics we will be keeping a close eye on developments in this area. 

Now, less than a year later, the FCA is launching a review to ensure that the changes don't lead to another mis-selling scandal. The FCA's business plan for 2016/2017 (published on Tuesday) sets out 'pensions' as one of their top priorities and we can probably expect a heavy degree of involvement from the FCA in this area in the near future.

The FCA's business plan notes that people using pension freedoms to access cash or take drawdown presents different risks to those involved in taking an annuity. They also note an increased risk of people being targeted by fraudsters. 

The advisory market is caught between a rock and a hard place; the Government has opened up a whole raft of new options for consumers but the FCA seems eager to penalise advisors (and providers) who facilitate access to those options. It's not this blog's purpose for me to set out my personal views on whether freedom of choice should trump protection (but if you ever bump into me in EC3 I'd be happy to bore you with my thoughts). However, it is clear that the pension advice market will remain a difficult one. Advisors are faced with a difficult juggling act, trying to act in their customers' best interests on the one hand and trying to keep on the right side of the FCA on the other. 

As ever, watch this blog for any updates.