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What happened?

Sector Views is an analysis published annually by the FCA that looks at changes in the regulated financial environment and how these affect consumers and market effectiveness. The recently published Sector Views 2020 provides an overview of the key financial sectors based on data available at mid-2019. To save you time, we’ve reviewed the FCA’s sector-by-sector commentary and summarised some of the regulator’s key concerns and observations below.

Technology and P2P firms

Rapid innovation and change have raised questions about whether new firms’ have adequate controls in place to safeguard client funds and prevent their systems from being misused to facilitate fraud and/or financial crime.

The FCA is concerned about social media advertising of – and easy access to – high-risk investments and credit products.

Outsourcing to specialists may increase resilience and security, but some third-party providers may have less stringent security, controls and oversight.

Wind-down arrangements

The FCA has already seen examples of how inadequate wind-down arrangements can cause losses for consumers and it has begun enforcement action as a result. If P2P firms cannot achieve an effective run-off or transfer of business, consumers could suffer significant harm. This is particularly true if they have invested in more speculative or illiquid asset classes such as property development. They may not recover all of their investments, and any recovery could be delayed if the wind-down is disorderly.

Payments firms

Regulatory changes have enabled many new firms to enter the payment services sector and grow rapidly. But consumers can suffer harm if they select products that are not protected by regulation – or if firms fail to comply with regulations. The regulations are complex, and consumers could suffer harm if they have not understood whether Section 75 or Financial Services Compensation Scheme protections apply to innovative products such as digital wallets. The FCA continues to monitor and take action on firms’ financial promotions to ensure they comply with the relevant restrictions.

Safeguarding

If payment firms fail to safeguard customer funds adequately, consumers can suffer financial losses when a firm fails in a disorderly manner. The problem is compounded if safeguarding failures coincide with prudential weakness, or if firms act outside the scope of regulation. These concerns have prompted the FCA to take a pre-emptive approach to supervising these firms.

Peer-to-peer providers are facing challenging trading conditions. Prominent property development P2P platform Lendy recently became the largest firm in the sector to enter administration, with potentially serious implications for confidence in this nascent market.

Claims management companies

Since the FCA assumed responsibility for regulating the claims management sector on 1 April 2019, 953 such firms have registered with the FCA for temporary permission and will now need to apply for authorisation to continue their activities.

General insurance firms

Well-publicised cases of non-financial misconduct in the London Market raise questions about the culture at firms in the wholesale insurance sector.

Product oversight

The FCA has seen instances of poor value products, including poor claims outcomes, in personal lines and SME classes. It has also seen long distribution chains and weak product oversight leading to poor value for customers. Longer chains may also slow the pace of innovation, as adopting new ideas requires coordination between all parties in the chain.

EU withdrawal

The UK’s withdrawal from the EU poses a risk to contract continuity. Firms are restructuring their operations to reduce disruption to customers, for example by setting up new European entities to service EU business. They also need to ensure that these contracts remain valid at the end of the transition period. This could require amending or ‘repapering’ them. Brokers will need to ensure registration is valid in the relevant jurisdictions and ‘repaper’ terms of engagement where necessary. Both brokers and insurers will need to consider GDPR during this process.

Pensions advisers

Unsuitable DB-DC transfers remain a significant source of harm. The cost for consumers of getting this wrong can be very high, as they are giving up valuable guarantees and will then need to manage longevity and investment risks for themselves. The FCA has also identified the potential for significant harm from unsuitable retirement income advice.

Investment firms

Product suitability

The sale of unsuitable or fraudulent high-risk products is the FCA’s main concern in this sector. Risky investments have been directly targeted at consumers, leaving them more exposed to risk. The FCA recently addressed this harm by issuing a temporary product intervention on the marketing of speculative mini-bonds to most types of retail customers.

New requirements for disclosures on costs and charges have had a significant effect on investment firms. These should ensure best execution for retail investors, enhanced investor protection and suitability reporting, increased transaction reporting, and the unbundling of investment research costs. This has led many firms to review and update aspects of their distribution models.

The FCA has intervened to address harm in the retail CFD sector by restricting how firms market, distribute, and sell these products to retail consumers. Prior to this, there were an estimated 800,000 active client accounts holding a total of £1.5bn in client money. The FCA estimated that retail clients were losing £1.07bn per year trading these products. Following the introduction of leverage limits and other investor protection measures, total losses for retail clients of UK firms fell by £77m between August and October 2018 alone. The FCA estimates that the final rules will save retail consumers between £267m and £451m annually. Retail consumers are still at risk, however, and should be alert, as some CFD firms are encouraging retail clients to opt up to ‘elective professional status’ or contract with affiliated third-country firms to circumvent leverage restrictions.

Asset Management Market Study

The FCA Asset Management Market Study found weak price competition in several areas of the industry, no clear relationship between charges and performance, and a lack of transparency and clarity on pricing and quality. This means investors struggle to assess which products and services are most appropriate for them. It can also mean investors do not switch when a fund no longer meets their needs. Poor standards of governance were also found. Several regulations have come into force in the past two years aimed at reducing this harm. These include remedies developed as a result of the Market Study as well as MiFID II and PRIIPS.

Specific issues identified include poor governance and oversight of outsourced functions, insufficiently resilient legacy IT systems with poor cyber security, and a lack of contingency plans for service disruptions caused by outsourced service providers. The FCA has a comprehensive programme of work in place to reduce harms resulting from a lack of operational resilience.

The value assessments which authorised fund managers must publish for UK authorised funds, as part of the Asset Management Market Study remedies, are currently being worked on across the industry. Firms are considering seven factors around costs, performance, quality of service, and fairness. Submissions will be made from early 2020. Challenges include how to present firms’ findings, and the potential need to move investors in share classes with higher charges to ones with lower charges. The FCA expects to do some follow-up work with firms once they have published their value assessments.

The FCA continues to monitor the pricing and quality of custody and investment administration services. Its main concerns are around weak client money and assets controls and governance, weak depositary oversight of authorised fund managers, and operational resilience.

Investment Firm Review

The FCA expects to implement the Investment Firm Review in 2021. This will introduce a new prudential regime for investment firms. Investment firms were previously subject to the same prudential requirements as more systemic financial services providers. The new regime is aimed specifically at investment firms and takes more proportionate account of how far investment firms can cause harm to clients and to the markets in which they operate.

How can we help you?

Our specialist team can provide effective guidance and assistance with any aspect of the FCA’s supervision of firms or any of the issues mentioned above. To find out more, email info@thistleinitiatives.co.uk or call now on 0207 436 0630.