Prevention or prosecution – what now for the FCA?

Since his appointment as head of the UK's newly created Financial Conduct Authority (FCA) in September 2011, Martin Wheatley has often had to act more like a sheriff in a Wild West town than a run-of-the-mill regulator, confronted as he was by a UK financial sector which appeared to have let its ethical standards reach an all-time low. 

After four years of cracking heads and handing out some eye-watering fines to leading City of London institutions, Mr Wheatley made few friends in the industry. Famed for his bluff demeanour and tough stance toward misbehaviour, he was very much suited to the task in hand. However, in July this year he was informed by George Osborne, the UK’s chancellor of the exchequer, that he would soon have to hand in his spurs. The general consensus is that the UK Treasury now wants someone who can foster a more cordial, and less combative, working relationship with the industry 

September 12 will be Mr Wheatley’s final day at the FCA, and many expect his departure to mark a shift at the organisation from prosecution to prevention of misconduct. “In a way, this change is a natural thing, and would have happened with or without [Mr Wheatley's] departure,” says Paul Sharma, a managing director at London-based financial consultancy Alvarez & Marsal, and a former director of the FCA’s forerunner, the Financial Services Authority. “If the issuance of heavy fines is a sign of success for an enforcement agency in its early years, having to continue that kind of approach in the medium to long term would be a sign of failure because it would indicate that industry behaviour isn’t improving.” 

For Mr Sharma, Mr Wheatley’s exit may have the odd effect of both delaying and speeding up the change. “There will probably be a quiet period during the interregnum between [Mr Wheatley] and his successor, but when the new person is on the job, I expect work on prevention to begin in earnest,” he says.

Kiss and make up 

So, might there soon be a slightly cuddlier FCA, one content to place its arm around the industry and guide it toward better behaviour, rather than smack it around the head? There has certainly been a lot of smacking on Mr Wheatley’s watch. For instance, the cumulative fines levelled at leading banks for manipulating the London Interbank Offered Rate (Libor) and the WMR/Reuters foreign exchange benchmark run into many billions of pounds. 

Michael Ruck, formerly an advanced associate lawyer at the FCA and now a senior enforcement lawyer at legal firm Pinsent Masons in London, believes that the shift away from strong enforcement will not be as significant as many in the industry hope. “Enforcement and investigations will always be a major part of the FCA’s job. What people also often forget is that a large portion of the FCA’s punitive actions over the past few years, particularly with regard to benchmark fixing, has been mirrored or driven by regulatory agencies outside the UK. The FCA will be keen to maintain a consistent international approach to these issues,” he says.

If FCA enforcement does not slacken off per se, it may be rerouted to the sort of everyday action it took before the big targets of Libor and foreign exchange manipulation came into view. If these high-profile fines are taken out of the picture, the sum of money levied against the industry by the FCA in 2014 was lower than normal. These large investigations have sucked resources away from more ordinary projects, a flow that should reverse itself in time. “What we will probably see is actually a larger number of enforcement cases, covering a wider number of areas, but each will be smaller in size,” says Mr Sharma.

FEMR continues 

One area that is likely to be business as usual is the Fair and Effective Markets Review (FEMR). Mr Wheatley was a driving force in its creation, and will continue to serve on the review board in an advisory capacity after he leaves the FCA. Established in June 2014, the FEMR assessed the functioning of wholesale markets in the UK, and made an array of policy recommendations to prevent misbehaviour and promote competition in its final report in June this year.   

“Clarifying and strengthening market practices remains a critical part of rebuilding public trust in the industry, and reform of the markets remains high on the global agenda. The FEMR was driven by senior figures at the Bank of England and the FCA, and looks set to continue to be a key focus for both organisations. Many recommendations have either already been implemented or the legislative change is [on the way],” says Omar Ali, UK head of banking and capital markets at EY.

These recommendations focus in particular on improving standards in fixed-income, currencies and commodities trading units, and their implementation process will be a key area of discussion for the Bank of England at its open forum in November. “Regardless of who’s driving the FEMR, responsibility lies with the industry, policy-makers and regulators alike,” says Mr Ali. 

Prevention before cure 

A renewed focus on prevention will allow the FCA to nudge the City of London in certain directions, rather than set up roadblocks. It already has several tools for this task, such as the temporary intervention powers that allow the agency to restrict or prevent the use of a product prior to a full consultation if it is deemed to pose a significant risk to consumer safety. It can also intervene to improve competition levels within a specific market. 

One area in the retail space where these competition powers have been used is payday lending. Providers of this service have been accused of taking advantage of customers who fail to pay back on time by slapping them with exorbitant interest rates. “The FCA has had to fast track changes in this sector due to obvious public pressure. Payday lenders will be forced to redesign their products to provide more competition on arrears charges and other penalties, rather than just speed of access to cash. We’re likely to see a lot more of that in other sectors, too. It’s a preventative approach that puts competitive pressure on products for the benefit of consumers,” says Mr Sharma. 

Generating a wholesale cultural shift that produces better behaviour will be harder, though. In conjunction with the Bank of England’s Prudential Regulatory Authority (PRA), the FCA implemented a series of new rules that, in Mr Wheatley’s words, will “embed personal accountability into the culture of the City”. These include a 'senior managers regime' that will make key members of staff in banks, building societies and investment houses accountable to regulatory bodies for any misconduct that occurs within their field of responsibility. Firms will have to have these key appointments approved by the FCA, and will have to demonstrate that their fitness and propriety is assessed on at least an annual basis. There is also the 'certification regime' that applies to other, less senior staff with important roles, such as those who submit benchmark data. 

“The FCA’s work on an improvement in culture should be made easier by the improvements in its market intelligence, thanks to the introduction of new trade reporting regimes. These will help it spot problems early on and prevent systemic misbehaviour,” says Mr Sharma. Many of the industry processes that were the source of major ethical breaches, such as benchmark submissions, have now also been brought under greater regulatory control.   

Turf war? 

One of the first tasks confronting the new head of the FCA may be to keep other regulatory tanks off its lawn, as talk grows of the PRA being more closely integrated into the Bank of England and endowed with extra enforcement powers. On a policy level, it is recognised that there may be times when the PRA and FCA have an interest in investigating the same alleged misconduct. Protocol states that in these circumstances both regulators must consult each other to determine who gets the job, or whether both can participate. If there is a tussle for the right to investigate, the FCA does not hold too strong a hand. “Given that the PRA has the backing of the 300-year-old Bank of England, there can only really be one winner if the FCA finds itself in this kind of turf war,” says Mr Sharma. “The Bank of England always gets what it wants.”

Mr Ali at EY believes these concerns are overblown, but that the FCA is in danger of losing prominence if it does not work hard to get the industry back on side. “The FCA’s voice will remain strong, in part due to its clear statutory remit over conduct and competition, and because the sheer range of firms it regulates makes it a very significant regulator for the industry as a whole. But its future success and legacy does depend on its ability to reconnect with the industry, while ensuring the progress made over the past few years is not undermined,” he says.