Our Banking Litigation team has launched their new Banking Litigation Notes blog, focusing on the latest banking litigation developments of interest to financial institutions. The team’s first post highlights our recent briefing on the latest communication from the FCA and PRA to ensure firms are properly prepared for the transition from LIBOR to alternative interest rate benchmarks.
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Author: Hanne Gundersrud
The FCA and PRA have announced their second enforcement action in relation to outsourcing failures by the retail bank R. Raphael & Sons plc (“Raphaels“). The firm failed to manage its outsourcing arrangements properly, in breach of FCA Principles 2 and 3, the applicable provisions of Chapter 8 of the FCA’s Senior Management Arrangements, Systems and Controls sourcebook (“SYSC 8”), and PRA Fundamental Rules 2, 5 and 6. Raphaels received separate fines of £775,100 from the FCA and £1,112,152 from the PRA in respect of the breaches, resulting in a combined fine of £1,887,252. Raphaels agreed to resolve the matter with its regulators and therefore qualified for a 30% discount in the fines imposed by both regulators.
Authors: Jenny Stainsby, Vicky Man and Cat Dankos
While there have been other reviews1 into the near failure of the Co-operative Bank (“Co-op Bank”), on 6 March 2018, HM Treasury announced that it had directed the Prudential Regulation Authority (“PRA”) to conduct a further investigation, specifically focused on the prudential supervision of Co-op Bank between 2008 and 2013 with a view to reporting on any lessons learned and making appropriate recommendations (“the Review”). The review period covers a significant period for the Co-op Bank, including its merger with Britannia Building Society (“Britannia”) in 2009 and its withdrawal from the bidding process to purchase 632 bank branches from Lloyds Banking Group in 2013.
This is the first example of the use of a statutory power enacted in 2012 whereby the Treasury may require the PRA (or Financial Conduct Authority (“FCA”)) to investigate where it considers that it is in the public interest that the PRA (or FCA) should carry out an investigation into ‘relevant events’ and it does not appear to the Treasury that such an investigation has been or is being undertaken2. The Government had announced its intention to invoke this power in 2013, stating at that time that the review would not commence until the conclusion of all regulatory enforcement action relating to Co-op Bank.
With Treasury’s approval, the PRA appointed Mark Zelmer as independent reviewer to conduct the Review. Mr Zelmer’s report was published on 27 March 2019. In it, Mr Zelmer addresses the eight areas of investigation which were set out by HM Treasury; and provides eight recommendations. The PRA and the Bank of England’s (“BoE”) Joint Response was published on the same day and welcomed the report.
Many of the observations made in the report are unsurprising, and to a considerable degree, as acknowledged in the report itself, the shortcomings in supervision during the period of the review will have been addressed during the restructure of the UK regulatory regime in 2013. While a clear theme coming from the Review is the need to ensure ongoing compliance with regulatory and statutory requirements, there are a handful of forward-looking points from the Review and Joint Response of particular note:
- the Review draws particular attention to the importance of stress testing, and it seems likely that as stress testing methodology continues to evolve, it will do so with a particular eye to incorporating “the inherent uncertainty that would prevail as a stress scenario unfolds in real life”, the most recent ‘real life’ example to be included in stress tests being cyber stress tests;
- the Review considers various threats to the safety and soundness arising from technology, (for example, cyber-attacks), but notably draws out the potential impact of Open Banking on bank runs which may highlight for some firms the need to review both “early warning” detection strategies and crisis management preparedness;
- in the joint response, the PRA explains that it is considering whether to set either formal or informal asset encumbrance limits; should the PRA proceed with limits, this will have an impact on balance sheet calculations; and
- the Review also notes that the PRA said that it intends to assign firms’ senior managers (as designated under the Senior Managers and Certification Regime or “SMCR”) to be accountable for actions in letters to the largest UK deposit takers; the September 2018 letter on LIBOR transition is an illustration of this.
Below we consider in more detail some of the key recommendations, the BoE and PRA response, and implications for firms.
The UK FCA and PRA propose to implement the TPR if the UK leaves the European Union on 29 March 2019 without an implementation (or transitional) period, to ensure that EEA firms currently operating under an incoming passport (either from a UK branch or on a cross-border services basis into the UK) can continue to carry out regulated activities in the UK until they receive new direct authorisation by the UK regulators. For more information, please see our HSF briefing – UK Temporary Permissions Regime placemat
Almost a year after it was introduced, a key piece of UK domestic Brexit legislation has now been passed. The European Union (Withdrawal) Act 2018 (EUWA), which aims to provide a functioning statute book on the day the UK leaves the EU, completed its difficult passage through the UK Parliament and passed into law on 26 June 2018. Please refer to our briefing, “The UK’s new legal order post-Brexit: A new class of UK law” for a summary of the EUWA.
Following the passing of the EUWA, HM Treasury, the Bank of England, FCA and the Payment Services Regulator (PSR) have each published statements on their approaches to their role in preparing for Brexit, a summary of which is set out here.
Today, 9 April 2018, the Prudential Regulatory Authority (PRA) has published its Business Plan 2018/19. The Business Plan sets out:
- An overview of the PRA’s responsibilities and approach;
- The PRA strategy;
- Business Plan 2018/19; and
- Budget 2018/19.
Alongside the Business Plan, the PRA has published:
- CP7/18 Regulated fees and levies: rates proposals 2018/19; and
- Letter from the Prudential Regulation Committee to the Chancellor, and its report on the adequacy of PRA resources and the independence of PRA functions.
In the summer, the PRA will publish its Annual Report for the year ended 28 February 2018. Continue reading
- Relevant to both solo- and dual-regulated firms, the report reflects the findings of both firm-specific and cross-firm reviews into algo trading undertaken in the run-up to MiFID II implementation.
- Within the introduction, the FCA lists relevant MiFID II requirements, noting that “firms should reference a number of pieces of legislation when developing algorithmic trading practices and procedures”.
- FCA sets out five key areas of focus and sets out its objective under each area; these are then used to structure the report’s examples of good and poor practices:
- Defining algo trading
- Objective: to ensure firms establish an appropriate process to identify algo trading, manage ‘material changes’, and maintain a comprehensive inventory of algo trading across the business
- Development and testing
- Objective: to ensure firms maintain robust, consistent and well understood development and testing processes which identify and reduce potential trading risks across trading algos prior to full deployment
- Risk controls
- Objective: to ensure firms develop suitable and robust pre- and post-trade controls to monitor, identify and reduce potential trading risks across algo trading activity
- Governance and oversight
- Objective: to ensure firms maintain an appropriate governance and oversight framework which demonstrates effective challenge from senior management, risk management and compliance on algo trading activities
- Market conduct
- Objective: to ensure firms appropriately consider the potential impact of their algo trading on market integrity, monitor for potential conduct issues, and reduce market abuse risks
Comment: The focus is very much on operating robust and sensible governance and controls, mitigating the risk to the FCA’s objective of enhancing market integrity. FCA has a clear expectation that regulatory requirements are prominently factored into product/process/strategy development process, including controls development, at an early stage.
PRA Consultation (CP5/18): Algorithmic trading
- The Consultation is relevant to dual-regulated firms subject to the rules in the Algorithmic Trading Part of the PRA Rulebook and Commission Delegated Regulation EU 2017/589.
- The draft SS would apply to all algo trading of a firm including in respect of unregulated financial instruments, e.g., Spot FX.
- The SS is structured in five sections; a summary of the proposals by section follows:
- A firm’s governing body should explicitly approve the governance framework for algo trading.
- A firm’s management body should identify the relevant Senior Management Function(s) with responsibility for algo trading.
- Algo approval process:
- A firm should have a robust approval process with clear scope and conditions for approval.
- Prior to granting approval, each algo should have assigned owners and have completed testing across all relevant parties (e.g., front office, risk management, other systems and controls functions).
- Testing and deployment:
- All algos and risk controls should be tested prior to deployment and subject to periodic re-validation.
- Inventories and documentation:
- Firms should create and maintain: comprehensive inventories of algos and risk controls; and documentation of each algo’s strategy and risk mitigants, kill-switch control procedures and the algo trading system architecture.
- Risk management and other systems and controls functions:
- A firm’s risk management (which is independent of the Front Office) and other systems and controls functions should have oversight of the risks of algo trading.
- The PRA expects those functions to have authority and expertise to challenge Front Office and to impose on algo trading whatever additional risk controls are necessary to effective risk management.
Comment: As with the FCA report, the PRA consultation is very focused on governance and controls. Firms may need to think about how they evidence that risk management/other systems and controls functions have the authority and expertise to challenge Front Office and impose additional risk controls.
The PRA has issued a draft Supervisory Statement, containing guidance on how Solvency II remuneration rules are to be applied (Draft Guidance). The Draft Guidance is, in certain respects, materially more onerous than may have been expected. In particular, it provides that firms must ensure that at least 40% of the variable remuneration of senior staff and other "risk takers" is deferred for at least 3 years, allowing all or part of the deferred element to be withheld.
Documents published over the summer provide some insight into how the PRA is supervising insurers. In particular, firms should be aware of a new version of the PRA’s “Approach to insurance supervision” (Approach Document) and of an update on the PRA’s continuing transition from its current Handbook to a new, more concise Rulebook (PS5/14). Continue reading
The FSA has published future versions of the Handbooks of the FCA and PRA, together with a Guide to how the Handbook rules have been designated,. The FSA Handbook has been split between the two new regulators to form two new Handbooks, although some rules have been adopted by both. The Handbooks will come into effect on 1 April 2013. Continue reading