Nicholas
Clayton looks at the much-feared Financial Services and Markets Act, known as
N2, and its impact on managers
Regulation
is a necessary part of life in many areas of business. The aim is to protect employees,
the public, consumers, the environment and even the Government. In the
financial sector, the corsets of regulation have been cranked tighter and
tighter in recent years, to the extent that some suggest that this vitally
important contributor to the British economy is being strangled – or at least
being made uncompetitive.
The
boom in financial markets through the 1980s and the increasing enthusiasm for
investment matters among consumers (often based on inaccurate information and
poor understanding) led to a number of high-profile disasters. But our
financial systems were not unregulated. A number of self-regulatory
organisations existed, as well as a legislative structure to provide control,
including the Financial Services Act 1986. So why was a new Act necessary?
The
background
Think
back to 1997, when several financial scandals had been exposed. The opinion
among commentators and many in the City was that the powers of the existing regulators
were inadequate; some had doubts about the effectiveness of self-regulation,
and there was inconsistency between the regulatory principles applied in
different sectors.
Financial
markets had become more complex and interrelated. The traditional boundaries
between insurance and banking and investment services were blurred, and the
activities of many firms spread across all three. But the old regulators
existed to monitor particular financial services or product groups – in other
words they were no longer a good fit. Furthermore, they did not all have the
same legal status: self-regulatory ones had power by the consent of their
members while others had power based in various pieces of legislation.
Consumers also had different rights and degrees of protection for different
financial products and services.
The
arrival of N2
This
tangle clearly needed to be sorted out by a new regime. The Financial Services
Authority – which had evolved from the Securities and Investment Board as a
result of the 1986 Act – would become the sole regulator for almost all
financial services firms in the. In the first phase, the FSA became responsible
for banks and investment business. There then followed a lengthy period of
planning, drafting and consultations within the financial sector which resulted
in the Financial Services and Markets Act (FSMA), passed in 2000 to come into
force at a date in 2001 known as ‘N2’.
In
the year leading up to N2, it acquired an almost mystic aura of fearful
anticipation, which ended with the stroke of N2 itself at the witching hour of
midnight on 30 November 2001. Was the apprehension justified? What did the FSMA
mean in practice? What are the powers of the FSA now that N2 has passed? What
does FSMA mean for managers? Do they need to bother about it?
The
FSA’s powers
The
FSA can authorise firms and approve individuals; gather information and conduct
investigations; intervene to stop a firm’s activities or limit them. Unlike
previous regulators, the FSA can prosecute for certain offences such as insider
dealing, market manipulation and money laundering, and it has the power to
impose fines for failure to comply with FSA rules or principles. As regards
individuals, the FSA can require a wide range of people to be ‘approved
persons’ before allowing them to do their jobs, and it can stipulate the
responsibilities of senior management in the firms it authorises.
The
FSMA sets out the kinds of financial activity that are to be regulated
(‘regulated activities’) and the authorisation requirement that determines who
may perform those activities in the UK (‘authorised persons’ – firms or
individuals). Authorisation may be by direct permission of the FSA or as a
result of having a right to conduct business under EU law. Authorised firms are
required to conduct their operations in line with the FSA Handbook of Rules and
Guidance (and remember they can be penalised for failure to comply).
An
important section of the handbook contains high-level principles for
businesses, which state the fundamental obligations of an authorised firm and
the standards by which it must do business. It sets criteria to ensure that
only ‘fit and proper persons’ are engaged in ‘controlled functions’ in
authorised firms. A controlled function is one that:
–
enables the person to exercise a significant influence on the conduct of the
firm’s affairs (as relating to a regulated activity such as its investment
business ñ not managing the car pool, for instance)
– involves dealing with customers of the firm in a manner substantially relating
to a regulated activity
– involves dealing with the property or assets of customers
What
might this mean for your managers?
If
a  manager performs a controlled
function as employee of an authorised person (firm), he or she need to be
approved by the FSA. In relation to investment business – Â for example in a regulated investment firm –
approval is needed by all directors and most senior managers, in addition to
the individuals who control assets and deal with customers. Across the
financial services sector, individuals who need to be approved include research
analysts, corporate financiers, fund managers, investment advisers, most
traders, and people selling certain types of investments.
People
who were already registered with the former regulators such as IMRO, the SFA or
PIA ceased to be registered at N2, but mostly became ‘approved persons’ under
the new regime. Firms worked with the FSA to apply new approval by
‘grandfathering’. Some people no longer needed to be approved, but many others
– senior managers, for example – needed approval for the first time. This
process has affected about 180,000 people in the majority of financial services
firms across the UK. Those new to the regime are the managers who perform
so-called ‘significant influence functions’:
Governing
functions
1
Director
2 Non-executive director
3 Chief executive
4 Partner
5 Director of unincorporated association
6 Small friendly society
7 Sole trader
8 Apportionment and oversight
9 EEA investment business
10 Compliance oversight
11 Money laundering reporting officer
12 Appointed actuary
Systems
and control functions
13
Finance
14 Risk assessment
15 Internal audit
Significant
management in
16
Designated investment business
17 Other business operations
18 Insurance underwriting
19 Financial resources
20 Settlements
Three
principles relating to general management
Principle
5: An approved person performing a significant influence function must take
reasonable steps to ensure that the business of the firm is organised so that
it can be controlled effectively. Breaches would include:
–
failing to apportion responsibilities for all areas of the business under the
approved person’s control
– failing to review the competence, knowledge, skills and performance of staff,
despite evidence that their performance is unacceptable
– giving undue weight to an individual’s financial performance when considering
his or her suitability for a particular role
– allowing managerial vacancies, which put at risk compliance with the firm’s
regulatory obligations, to remain without arranging suitable cover.
Principle
6: An approved person performing a significant influence function must
exercise due skill, care and diligence in managing the business of the firm.
Breaches would include:
–
failing to inform him- or herself adequately about the affairs of the business
– failing to supervise and monitor individuals to whom responsibility has been
delegated
– delegating responsibility without reasonable grounds for believing that the
delegate had the necessary capacity/competence/seniority or skill to deal with
the issue.
Principle
7: An approved person performing a significant influence function must take
reasonable steps to ensure that the business of the firm complies with the
regulatory requirements imposed on that business. Breaches would include:
–
failing to take reasonable steps to monitor compliance
– failing to inform him- or herself adequately about the reasons for regulatory
breaches
– failing to ensure that procedures and control systems are reviewed and, if
appropriate, improved after a regulatory breach.
The
FSA may take action against an individual who is personally responsible for
breaking a principle or rule, if their action was deliberate or their behaviour
was below the standard that would be reasonable in the circumstances – and this
could include allowing someone else to break a rule or principle if your
manager knew what they were doing and had the power to stop them.
The
FSA’s options include telling your manager or your firm to take corrective
action, issuing a private warning, public censure or even financial penalties
which have no upper limit. If the conduct is judged sufficiently serious, the
FSA can withdraw approval, which means that the individual can no longer work
in a controlled function. Appeals can be made to the Financial Services and
Markets Tribunal.
So
N2 has proved almost as sinister as some feared. Overnight, many managers
acquired serious responsibilities and the threat of dire sanctions for failure.
It is entirely possible to be penalised for the wrongdoing of subordinates down
the line in specialist areas that a generalist administrator/manager had
previously trusted to the skilled practitioner.
From
the point of view of a communications consultancy such as Information Transfer,
the coming of the FSMA is a classic challenge in communication. Before N2, the
need was to raise awareness among all management levels. Subsequently, it was
to provide detailed explanation of the rules and principles that people would
have to observe.
It
is also vital to ensure that appropriate training is provided and supplemented
by clear, well-structured guidance and reference materials. And to build FSMA
training into induction programmes for new starters as well as part of personal
development plans.
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The
most fearsome ghouls can be overcome if you know how they work and what you
must do to deal with them. In the case of N2, this means good communication and
effective training
Nicholas Clayton is a founding partner at
the Cambridge-based communication and training consultancy Information Transfer          Â
