Key impact on firms
The consultation is relevant to firms applying for FCA authorisation under Part 4A of the Financial Services and Markets Act 2000 (FSMA), who will need to meet the minimum standards for authorisation set out in FSMA – the "threshold conditions".
International firms that seek authorisation or registration under other regulatory regimes will need to meet the minimum standards set out in the relevant legislation that applies. For example, international e-money firms that need to be authorised under the Electronic Money Regulations 2011 will need to meet the conditions of authorisation or registration in those regulations. In the FCA's view, there will often be similarity between the threshold conditions in FSMA and the minimum standards in other legislation. As such, while this consultation focuses on the FCA’s expectations relating to the threshold conditions in FSMA, much of it may also be of interest for firms seeking authorisation under other legislation.
The FCA's expectations will impact international firms that do not have any UK presence but wish to be authorised to operate in the UK in future, such as those currently relying on an EEA services passport to serve UK customers cross-border. Firms that already have an establishment in the UK are likely to be less impacted.
The three risks of harm – retail harm, client assets harm and wholesale harm, as we explain below – are relevant for international firms needing authorisation and carrying out or intending to carry out the following activities:
- undertaking retail business;
- safeguarding client money or custody assets from their UK establishment; and
- undertaking business in wholesale UK markets in the UK.
Some of those international firms may need to make operational or financial changes to their businesses. Some may need to restrict or limit their businesses to activities that do not pose significant risks. Costs may include one-off costs from restructuring, for example from changing its systems or transferring its businesses to another firm, and ongoing costs from the relevant requirements that being authorised will entail. Some firms may choose not to enter the UK or may choose to reduce their existing UK footprint if they cannot adequately mitigate the risks they pose in a way that is commercially viable, which could affect competition.
While the scope of this briefing covers only the FCA's consultation, dual-regulated firms must also have regard to the Prudential Regulation Authority's (PRA) expectations regarding operational readiness for the Temporary Permissions Regime (TPR).
Minimum standards for authorisation
The minimum requirements that firms must meet to become, and stay, authorised are set out in Schedule 6 to FSMA – these are known as the "threshold conditions". The Threshold Conditions Sourcebook of the FCA Handbook (COND) contains guidance on the threshold conditions for which the FCA is responsible, and the FCA's Approach to Authorisation provides firms with further information f on how the FCA evaluates whether firms and individuals meet the threshold conditions.
In meeting these minimum standards for authorisation, there are additional factors that international firms will need to consider and address. These include, for example, the nature of their UK and overseas operations, their personnel or decision-making structures, and their systems and controls. As part of that assessment of international firms against the relevant minimum standards, the FCA also considers the firms’ potential to cause harms and the mitigation available. The following points describe some of the FCA's general expectations; while these points are particularly relevant to international firms operating from a UK branch, they may also be relevant for UK subsidiaries with overseas parents.
Nature of a firm's operations
- To effectively supervise a firm’s UK activities, the FCA expects the firm to have an active place of business in the UK. It will typically not suffice if a firm’s local presence amounts to little more than a UK registered address.
- In addition, the FCA will need assurance that the firm's personnel (including management and decision-making structures) and systems and controls (taking into account the nature of any offshore or outsourcing arrangements) are adequate for the firm’s UK activities to be effectively supervised. Where relevant the FCA will also assess whether the UK operations are appropriately financially resourced by the firm as a whole, to avoid the risk that the firm cannot meet any legal and regulatory obligations arising from the operations of the branch.
- The FCA will assess the degree of cooperation between the FCA and the home state supervisor, including cooperation agreements and the ability to exchange confidential information.
- The FCA will also consider the firm’s business model and assess whether the firm’s strategy for creating value is implemented in a sound and prudent manner, and in the interests of the consumers it serves.
Personnel and decision-making
- When considering the appropriateness of resources and suitability of the firm, the FCA will consider the ability of the firm to comply with the rules which give effect to the Senior Managers and Certification Regime (SMCR).
- The FCA would typically expect senior managers who are directly involved in managing the firm’s UK activities to spend an adequate and proportionate amount of their time in the UK to ensure those activities are suitably controlled. The FCA recognises that individuals at an international firm who have responsibilities for the UK branch that are purely strategic may not be based in the UK.
- The FCA expects individuals responsible for the day-to-day management of the UK branch activities to have sufficiently independent decision-making powers and to exercise independent challenge over strategic decisions that affect the wider firm.
Systems and controls
- Where an international firm’s UK operations are dependent on services provided from other locations of the firm, the FCA will consider whether these arrangements could impair its ability to supervise the firm effectively.
Home state jurisdiction
- The FCA must have comfort over the jurisdiction where the firm is incorporated, and how the arrangements in that jurisdiction affect the ability of the firm to meet the relevant minimum standards for authorisation. For instance, to assess whether the UK operations are appropriately financially resourced by the firm and to avoid the risk that the firm cannot meet any legal and regulatory obligations arising from the UK operations, the FCA will take account of the comparability of relevant home state regulation, wind-down plans and whether the home state has implemented and complies with relevant global standards. This includes, for example, whether the specific activities that the firm wishes to carry out in the UK from a branch are prudentially regulated in its home state. The FCA will also take account of the supervisory cooperation with the relevant home state regulator(s).
- Where an international firm applies for authorisation, the whole firm must meet the minimum standards for authorisation and the whole firm, including its overseas offices, benefits from the permissions granted. If such a firm intends to provide some services to UK customers from anywhere other than a UK establishment, the FCA will seek to ensure that it can effectively supervise services provided to UK customers in this way. In doing so, the FCA will consider how much assurance it can take from its supervisory relationship with the firm’s UK establishment. For example, the extent to which the UK branch has oversight of activities provided to UK customers from overseas.
Choosing between branch and subsidiary
Without appropriate mitigation, certain potential harms could be more likely to occur where the regulated activities are undertaken by international firms from branches rather than through UK-incorporated subsidiaries. This is in part because it might be more complex for the FCA to take certain actions where international firms operate from branches. In addition, jurisdictional differences may be an issue. International firms operating from branches may be subject to regulation and supervision in their home state that also cover aspects of activities in UK branches, thereby overlapping with UK rules and supervision by the FCA. Insolvency proceedings relating to a branch may in some cases make protections of customers of that UK branch less effective.
To account for this, when assessing an international firm against the relevant minimum standards, the FCA will have regard to whether there is a heightened potential to cause harm from the activities being undertaken from a branch and whether the risks can be adequately mitigated. The FCA will also consider the nature and scale of the activities the international firm intends to conduct from outside the UK.
Risks of harm relevant for international firms
As part of that overall assessment of an international firm against the relevant minimum standards, the FCA considers the international firm’s potential to cause harm – the risks of harm – and the level of these risks. The FCA's consultation sets out three potential risks that are more relevant for international firms, especially those operating from branches.
Protection for the UK office’s retail customers, through redress and supervisory oversight for example, could be less effective, especially if the international firm becomes insolvent or exits the UK. In the FCA's experience, higher incidences of consumer harm resulting in complaints (which can lead to redress) are typically associated with recurring factors such as:
- poor quality of governance leading to inappropriate sales practices (including failing to establish customer needs, or conduct affordability checks);
- inadequate disclosure of product information resulting in consumers being unable to effectively engage with the product;
- inadequate management of conflicts of interest between how firms generate revenue and consumer needs;
- flaws in the design and implementation of systems and controls;
- failure to hold adequate professional indemnity insurance and capital to meet liabilities;
- inadequate arrangements to maintain technology resilience and cyber security; an
- failure to establish adequate controls to prevent financial crime such as scams.
International firms may pose increased risk relating to non-payment of redress. In addition, international firms are typically dependent on their head offices and other overseas offices, and the factors set out above may be exacerbated if these firms have not appropriately adapted their business to suit the UK market or regulatory requirements, or if the supervisory oversight of the relevant overseas offices is not sufficient. The FCA will pay more attention to the risk of these factors occurring and what assurances can be provided by the firm to mitigate them.
Client assets harm
The UK rules that protect client money or custody assets safeguarded through the UK office, and the home state insolvency regime which become applicable if the international firm fails, may not be aligned. This misalignment could negatively impact the outcome for UK client. When assessing whether these harms can arise in particular situations, questions that the FCA is likely to consider include:
- Recognition of property rights: Will UK clients’ rights to their assets be recognised under the home state insolvency regime? Will the segregation of client assets from the firm’s general estate at the point of insolvency be respected?
- Client interaction with home state insolvency: Will UK clients be treated in a way commensurate to UK expectations when exercising a claim to their client assets?
- Effectiveness of home state insolvency process: Will client assets that were safeguarded from the UK branch be distributed in a timely fashion? What influence, if any, will the FCA or other UK authorities have over the protection of clients of the UK branch?
Shocks or risks that originate from the international firm’s overseas offices could, in some circumstances, be more difficult to detect or prevent and could be passed easily to its UK office, affecting the stability and integrity of the UK markets in which it operates or to which it is connected. The common underlying factors that the FCA believes can increase a firm’s ability to impact UK markets, and so its potential to cause harm in them, include:
- a lack of substitutability of the products and services that the firm offers in the UK market(s) where it operates;
- the firm occupying an important position in the UK market, for example where it has significant market share in a niche market or otherwise has significant influence; and
- the firm being interconnected to other firms in the industry, and spreads and amplifies risks in the system rather than reducing or absorbing them.
These are not the only risks the FCA will consider when assessing individual firms – the FCA will also consider risks relevant to the firm’s sector and business model.
The FCA will determine if the international firm can offer sufficient mitigation to address the risk(s) of harm, considering mitigation of these risks on a case-by-case basis. The factors that follow are important in considering the mitigation of these risks.
Note that where the risk of harm cannot be adequately mitigated for an international firm applying to operate in the UK from a branch, but could be mitigated if that firm undertakes the relevant activity through a UK entity, the FCA may invite the firm to apply for authorisation on that basis to undertake the activity in the UK.
International firms planning to serve retail customers will need to demonstrate that they adequately mitigate the risk of retail harm. This may be more difficult for firms whose business and operational models show a higher propensity for causing harms to consumers. The FCA will consider the firm’s home jurisdiction to understand the comparability of redress rules and supervisory approach, consulting the home state regulator where appropriate, and will also consider the level of cooperation between the FCA and the home state regulator.
The FCA will also consider the relationship between the branch and its head office, to identify whether the FCA could gain additional assurance from how the branch is structured or resourced. This includes, for example, whether and to what extent:
- the branch has its own management in the UK or independent oversight as part of its governance structure, or is heavily influenced by executives at the head office;
- the systems and controls are well-suited to the operation of the branch in the UK (especially if they are derived from the policies and practices of the head office);
- the people exercising control functions (for example for compliance, audit and risk) have adequate UK regulatory or legal experience and knowledge of the UK market;
- the products and services that are developed by the head office or by other overseas branches are suitable for the UK market; and
- the conflict of interest and other relevant polices derived from the head office are sufficiently localised to ensure that expectations under UK laws and regulations are adequately met.
Client assets harm
International firms planning to safeguard client assets will need to demonstrate that they adequately mitigate the risk of client assets harm. The likelihood of this risk and mitigation measures depend on how home state laws treat client assets safeguarded under UK rules.
The FCA will consider the risk of harm for client money and custody assets separately. For example, one possibility that credit institutions can consider is to hold money that would otherwise be classified as client money as a deposit under the ‘banking exemption’ set out in Rule 7.10.16R of the Client Assets Sourcebook (CASS) of the FCA Handbook (as many such firms do already). In this situation the position of depositors in insolvency is likely to be more certain. For custody assets, in some cases, ensuring assets are registered in a manner consistent with both home and host state laws may be sufficient to mitigate the harm depending on the insolvency law position in the relevant jurisdiction.
If the FCA still has concerns after these considerations, one possible option an international firm could consider is to structure its arrangements so that client assets are not safeguarded from its UK branch, to the extent that doing so would better protect custody assets. The firm may wish to choose to conduct the custody asset activity from an establishment in the home country (such as the firm’s headquarters) where the home state provides its own protections. Alternatively, the firm may wish to arrange for the client to appoint another person who has the appropriate permissions to act as its custodian in the UK (with the firm possibly retaining a mandate over the custody account so that it can still service the client’s transactions). This could ensure that there is consistency between the safeguarding regime that applies during the life of the firm and the law that would apply in an insolvency.
Establishing a UK-incorporated subsidiary is another possible option for the international firm to consider, where this could ensure that there is consistency in the treatment of client assets in the UK between the safeguarding regime that applies during the life of the firm and the law that would apply in an insolvency.
International firms planning to provide wholesale financial services will need to demonstrate that they adequately mitigate the risk of wholesale harm. For most firms, this risk will be small, as they are unlikely to have the scale or scope to have an impact on wider market integrity. On a case-by-case basis, the FCA will consider the extent to which this risk of harm is likely to become real, as well as what mitigating arrangements are in place and whether they are adequate relative to the level of risk. Relevant factors include, for example, the level of supervisory cooperation, the prudential regime the firm is subject to, and the credibility and quality of its wind-down planning.