Hot Topic. Stand out for the right reasons Financial Services Risk and Regulation. The FCA releases its 2018/19 Annual Business Plan

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1 April 2018 Stand out for the right reasons Financial Services Risk and Regulation Hot Topic The FCA releases its 2018/19 Annual Business Plan Highlights FCA s latest business plan builds on existing initiatives, indicates new areas of focus and consolidates key themes. Firms should consider the impact of the wide ranging cross-sector themes. The sector-specific priorities give a good indication of the FCA s 2018/19 focus. While Brexit challenges the FCA and firms alike, the regulator is expecting a busy agenda for the year. The FCA published its Annual Business Plan on 9 April Consistent with previous years, the FCA highlights areas of concern which cut across all firms, before detailing sector-specific initiatives. This year, the FCA focuses on the impact of Brexit, both on itself and on firms. The resource required by the FCA to respond to Brexit has resulted in an aggressive reprioritisation of its agenda. This is indicative of the challenge of Brexit which will be echoed by many firms rather than a change of stance by the regulator. Following a number of years of big 'implementation' exercises from MiFID II to Guaranteed Asset Protection (GAP) insurance reforms to PRIIPs the FCA is evolving its approach to assess how these topics have been implemented. We are expecting to see the FCA engaging with firms on culture and governance to assess the drivers of behaviour and their potential to cause harm. It is also continuing with a number of existing initiatives from the extension of SM&CR, to reporting on the mortgage market study, to concluding its initial work on general insurance distribution chains. But there are also new items. The FCA has announced new market studies, confirmed its intention to undertake further work on fund liquidity and may extend the role of Independent Governance Committees. Against this backdrop, and the FCA's changed approach to supervision of some previously flexible-portfolio firms, there are clearly many challenges for firms this year. In this hot topic we summarise the FCA's proposed activities, discuss the potential impact for firms and steps they should be taking.

2 Cross-sector themes The FCA notes that the UK s withdrawal from the EU will account for a significant proportion of its work and resources between now and beyond Brexit in March Prominent workstreams here include providing technical support to the UK Government during negotiations, ensuring there is an appropriate model for authorising and supervising EEA firms and working with regulated entities to understand their operations in a post-brexit environment. More traditionally, the FCA identifies seven crosssector priorities. These will drive the FCA s planned activities. The cross-sector priorities will be familiar as they have been commonplace in the regulatory environment and are noted as follows: 1. Firms culture and governance 2. Financial crime (fraud and scams) and antimoney laundering (AML) 3. Data security, resilience and outsourcing 4. Innovation, big data, technology and competition 5. Treatment of existing customers 6. Long-term savings and pensions and intergenerational differences 7. High-cost credit. These priorities span the seven sectors regulated by the FCA. Firms should pay attention to the plans for their sector bearing in mind that they may also be influenced by the seven cross-sector priorities. They should also consider potential indirect implications. For example, a focus on vulnerable customers in highcost-credit may have implications and learnings for other credit participants. Firms relying on outsourcing arrangements (often to unregulated providers) for the delivery of critical services should note that this is a significant area of focus, given some of the recent public issues faced by third party providers. As a result, the FCA intends to increase its understanding of outsourced services and core infrastructure provision across sectors, with particular emphasis on service providers that support many firms. To this end the FCA plans to undertake several pieces of thematic and firm-specific work in this area. Rapid advances in technology and innovation have the potential to profoundly affect not only business models but create customer detriment. The use of data is one area highlighted by the FCA. With GDPR high on all firms agendas, the FCA confirmed that it is updating its MoU and interacting with the Information Commissioner. Each of the sector plans also have key points which are noted below. The CoE has identified those areas that are new or changed developments, or those that continue with existing work, which firms may be more familiar with. Wholesale financial markets The FCA plans to publish its Approach to Market Integrity in 2019, to help firms understand their roles in promoting clean, fair and effective markets as well as clarifying the way the FCA aims to police these markets. As well as looking at firms adherence to the new MiFID II rules, the FCA also plans to undertake examination of the impact of shifting a greater proportion of trading activity onto organised trading venues. In particular, it will seek to establish whether a reduction in OTC trading has had an impact on liquidity, and if this could be harmful. Another consequence of the regulatory-driven shift to a greater proportion of trading being conducted on organised venues is a greater reliance on market infrastructures. The FCA plans to look at firms operational resilience in this respect, examining firms ability to manage risks stemming from both traditional operational outages as well as cyber-attacks. MiFID II represented a significant implementation challenge for firms, so predictably a lot of the FCA s focus in wholesale markets will be on areas affected by those new rules, which went live at the beginning of Best execution, payment for order flow and research unbundling are all earmarked by the regulator as areas of focus. It will look at how firms are complying with these rules but also whether the rules are working as intended. The FCA notes that the transaction reporting regime has been expanded under MiFID II. It plans to continue to monitor markets using this data, but with a particular focus on the fixed income, currency, commodity and non-standard derivative markets. MiFID II brought the FCA new tools to tackle algorithmic and high-frequency trading. While it plans to look at firms adherence to new standards, it also intends to focus on doing more to develop its understanding of the use of trading algorithms. Building on progress in reforming primary markets, the FCA plans to monitor firms adherence to its new rules on managing conflicts of interest in producing connected research. The FCA s wider work on examining the effectiveness of primary markets identified three other areas for future focus: the future structure of the UK listing regime; the provision of patient capital to companies that require long-term investment; and retail access to debt markets. But and reflecting a broader trend for the regulator the FCA says that as elements of these topics are based on powers from EU legislation, progress will be dependent on the outcome of EU withdrawal negotiations. 1 Hot Topic Financial Services Risk and Regulation

3 How to tackle regulated firms engaging in activity that sits outside the perimeter has been a conundrum for the FCA in recent years spot FX being a prime example. Last year the regulator proposed to formally recognise some industry codes of conduct as a means of addressing this concern. It plans to issue a policy statement on this later in 2018, which is likely to contain measures to further encourage the industry to self-regulate in such areas. Financial crime is one of the FCA s cross-sector priorities, but it looks as though wholesale markets are in line for special attention. The regulator plans to conduct a thematic review examining the impacts of money laundering in capital markets in 2018/19. The FCA plans to continue to work with the BoE and industry on replacing LIBOR. The FCA plans to cease the requirement for firms to submit to LIBOR after the end of 2021, when it will be replaced with a reformed version of SONIA. Investment management and retail investment Investment managers experienced a significant hump of activity last year, with the culmination of several large implementation projects such as MiFID II, combined with the focus of the FCA through the Market Study and proposed extension of the SM&CR. This year, the focus will be slightly different, if not necessarily reduced. The FCA will continue to engage on PRIIPs implementation, signalling that it may issue additional UK-specific guidance similar to its previous statements on potentially misleading performance scenarios. Its stated commitment to working with EU regulators indicates that it will strive to minimise discrepancies in implementation but there are wider Brexit implications if the UK begins to deviate materially from a wider EU approach. The FCA is triggering new initiatives on topics that have been simmering in the background for some time. Globally, regulators have been scrutinising the liquidity management of open-ended funds and the FCA will be proposing rules this year. The FCA signalled a very balanced approach in a 2017 discussion paper, avoiding major structural changes (such as limiting the range of funds that could be open-ended) in favour of increased stress testing and disclosure. Any rules proposed this year will likely to be broadly consistent with the discussion paper, but may reflect recent IOSCO recommendations. An area where the regulator appears to be taking a more aggressive stance is retail investment in complex products, specifically exploring permanent interventions in the binary options and contracts for difference markets. Also, the FCA will look at tightening its authorisation regime for firms providing advice on complex products and more broadly subjecting investment advice in this area to increased supervisory scrutiny. The announcement of an impending review of roboadvice indicates that the FCA remains focused on the implications of technological innovation in the asset management market. Perhaps even more significantly, the FCA will be publishing a review of passive investment more broadly. While active management seemed to be in the FCA s cross-hairs during the market study (until its approach was tempered in the final report), it s clear that the regulator remains concerned that both investment modes of passive and active management pose specific risks. A review indicates that regulatory interventions may be considered at some point. The regulator appears to be looking to get the balance between investor protection and innovation right. As a result, the regulator will be conducting a review of RDR and FAMR. While it's unclear at this stage what the direction and scope of this review will entail, any significant changes to either regime would be an important development for the industry. The FCA has been pursuing a multi-year market study and competition and governance review of the asset management sector. The upcoming year will see the FCA finalising rules on use of objectives and benchmarks as well as publishing additional consultations on disclosure. Notably, the FCA may also look to expand the market study remedies to encompass with-profits and unit-linked funds. The market study had already expanded its reach last year by triggering a separate study on investment platforms, and the FCA will look to publish it interim report this year. Continuing its emphasis on governance from last year's business plan, the FCA will also be finalising its extension of SM&CR rules to all FSMA firms over the summer. Retail lending Across retail lending, the FCA proposes a number of activities focused on the mortgage and consumer credit sectors. The latter has been, and continues to be, a strong area of focus. It also reflects the FCA s ongoing focus on potential harm to more vulnerable and less financially resilient customers. While noting developments in standards across the consumer credit market since taking over regulation in 2014, the FCA highlights particular concerns in the debt management sector around the quality of debt advice and the long term sustainability of some business models. More broadly, high-cost credit is identified as a crosssector priority in the Plan. The FCA notes that harm caused by these products tend to disproportionately affect vulnerable consumers, and that as part of its ongoing work into the sector it will look at solutions designed to increase the choice and availability of 2 Hot Topic Financial Services Risk and Regulation

4 alternatives. It is clear the spotlight is very much on this sector and clients will need to be prepared for the outputs of the FCA s review. The FCA also confirmed a new market study into the role of information shared by credit ratings agencies. With market studies potentially changing competitive drivers in markets, this is likely to have wider implications for all lending. As part of the post implementation review of the transfer of consumer credit from the OFT to FCA in 2014, the FCA is reviewing retained provisions of the Consumer Credit Act. This must be completed by 2019 and is a large amount work for FCA and for firms. The FCA has also committed to delivering further findings on remuneration and commission models in Pensions and retirement income The FCA is further increasing its focus on pensions and retirement income issues in 2018/19, with more emphasis on this sector than in the FCA s 2017/18 business plan. The FCA will focus on understanding the magnitude of consumers under-saving for retirement and intends to issue an occasional paper later this year. The FCA will also collect and act on data from firms with pension transfer permissions to assess practices across the market, before issuing a policy statement. This has been driven by concerns that some firms are exploiting consumers lack of knowledge of pension products when advising them to transfer out of defined benefit schemes. The findings will be incorporated into a package of remedies as part of the Retirement Outcomes Review final report which we will hopefully see by Christmas. As a general point, FCA notes the growth of more technology-enabled pension distribution. The FCA sees this as beneficial to consumers but potentially challenging for people with limited access to technology. Balancing technological developments with access remains part of the FCA s approach. The FCA intends to produce a strategy with the Pensions Regulator to enable stakeholders to understand the FCA s role in the pensions sector; combatting pension scams; and publish a feedback statement on competition in non-workplace pensions following its February 2018 discussion paper. The FCA will place particular emphasis on unsuitable advice and the sale of unsuitable products this year which aligns with other sectors such as the asset management sector. Retail banking The FCA recognises that retail banking is integral to everyday life and will seek to understand how changes to the sector will affect consumers and industry participants. The priorities for the retail banking sector focus primarily on continuing existing initiatives implementing changes designed to reduce consumer detriment. The FCA will seek to develop a payments sector strategy by identifying key players and emerging trends and enhancing supervision of electronic money and payment institutions. The technological changes facing payments will also be considered as part of developing the strategy. A consultation on Financial Services Register policy proposals will be launched by summer 2018 supporting the regulator s work on culture and governance. Additionally, consultations on measures for arranged and unarranged overdrafts will be used to reduce consumer harm regarding highcost credit. Newly regulated Account Information /Payment Initiation Service Providers will be supervised to develop the FCA s understanding of these business models. The retail banking sector has been subject to major regulatory changes over the past two years and this year s business plan continues along that same path. Firms must implement ring-fencing rules by 2019 and the FCA will assess their preparation by reviewing data security controls, outsourcing arrangements, risk management, IT plans and governance effectiveness. Similarly, the FCA will support the delivery of PSD2 to ensure compliance with regulation and identify the potential for consumer detriment. A review of remuneration will push the FCA s culture and governance agenda while awareness campaigns for PPI and fraud, in conjunction with the Pensions Regulator, will continue as will efforts to improve competition in the current accounts and cash savings markets. More broadly, the FCA will seek to understand the impact of technology and innovation on the traditional retail banking business model. 3 Hot Topic Financial Services Risk and Regulation

5 General insurance and protection The FCA s priorities for the general insurance and protection sectors are fairness, access and value for retail customers, plus an effective wholesale market. The key drivers of potential harm are suitability of products, renewal pricing, mis-selling, low value products, operational resilience and cyber-crime. These risks are reflected in the initiatives included in the Plan. The only new insurance specific market-based initiative is an upcoming diagnostic project to assess claims inflation when motor insurers and brokers make referrals to claims management companies (CMCs). The work is said to give the FCA a flavour of the issues it will need to address when it takes over regulation of CMCs next year. Brexit remains an area of focus in the general insurance sector due to the high volume of crossborder general insurance business between the UK and EEA countries. The FCA notes that the potential loss of passporting rights has led many insurers to plan a restructure of their cross-border business, including through Part VII transfers and new firms setting up in the UK. This may increase firms complexity and result in changes to their business models which in turn might create a challenge for the FCA s supervisory work. There are few surprises regarding the FCA s areas of focus in the insurance sector. There are a number of usual suspects such as implementation of the IDD; the extension of SM&CR to insurers which is set to start on 10 December 2018; further work on understanding firms pricing practices and approach to product suitability; and focus on operational resilience and data security due to technological developments in the sector. The IDD is acknowledged as one of the most significant regulatory changes for the year ahead and the FCA intends to work with firms to ensure compliance. Some of the ongoing work could be affected by IDD rules, such as finalising diagnostic work on value in distribution chains, where FCA promises to look into the end-to-end relationships in a sample of distribution chains to identify the impact on value of insurance products and customer services. Vulnerable customers and access to insurance continue to be an area of focus. The FCA will publish a Feedback Statement on access to travel insurance this summer. More importantly the FCA will use this report as a springboard to understanding consumer s journeys better and work with industry to produce meaningful change for vulnerable customers. Treatment of existing customers is a cross sector priority that significantly affects the insurance sector. The FCA plans to conclude the first phase of diagnostic work on pricing practices, including how systems and data used by firms affect final prices and also scope work to formalise a debate on whether it needs to intervene to ensure future insurance pricing practices work well for customers. The FCA s ongoing work also includes evaluating the effectiveness of the FCA s 2015 rules on GAP insurance to see if they are improving competition and customer understanding; and publishing the FCA s interim findings on the wholesale insurance brokers market study by the end of 2018 including potential solutions to address identified concerns. Impact on firms The annual FCA business plan is a great opportunity for firms to take stock of the regulator s priorities for the coming year. Clearly the EU withdrawal is impacting both the regulator and firms, but there remains a range of post-implementation activity and new issues that firms need to understand. With the FCA arguably less focused on the implementation of very detailed specific regulations, the impact of regulation particularly sector-wide competition exercises may feel more strategic. Firms should consider not just the direct impact on their business, but also on competitors, and new entrants, the encouragement of which are a common outcome of the competition based agenda. 4 Hot Topic Financial Services Risk and Regulation

6 What do firms need to do? Overall, firms must: Review the cross-sector themes and priorities, relating them back to your business. Consider the relevant sector-specific priorities, in the context of your business and that of our competitors. Engage with the FCA on new initiatives at an early stage to articulate the potential impact on your business and your customers. PwC and the FCA are hosting a live webinar on 15 May 2018 with the FCA s Chris Woolard, Director of Strategy and Competition, and PwC experts giving their perspective. Please register here Your usual PwC sector team is also keen to discuss priorities for your firm. Contacts Sarah Isted Partner M: E: sarah.t.isted@pwc.com Andrew Strange Director M: E: andrew.p.strange@pwc.com Reginald Hanna Manager M: E: reginald.hanna@pwc.com This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors PricewaterhouseCoopers LLP. All rights reserved. PwC refers to the UK member firm, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see for further details JD-OS

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