40 Minute Briefing

1. 40 Minute Briefing • Domestic reform: • The first 100 days of the new regime • Jonathan Herbst - Partner • Katie Stephen -Consultant • Sonya Zywko - Senior Associate • Norton Rose Fulbright LLP • 3 July 2013

2. Today’s agenda • What happened to the Handbook? • The new philosophy: How the FCA is using the new threshold conditions and objectives • The end of certainty? • Themed visits • Events driven work • The world of enforcement Domestic reform: The first 100 days of the new regime

3. Nuts and bolts: What happened to the Handbook? • Minimalist approach: Made sense given the timescales • Approach taken by the FSA prior to cut-over: • Designate provisions to be carried forward in the new regime • Make changes to certain provisions that did not involve policy changes • Make more substantive changes to align the new Handbooks with the provisions of the Financial Services Act 2012 • FSA statutory obligation under section 155 FSMA to consult on changes: Several consultation papers published in particular CP12/26 concerning changes to approved persons regime • Final changes to the Handbook set out in PS13/5 Domestic reform: The first 100 days of the new regime

4. Nuts and bolts: What happened to the Handbook? • At cut-over FSA Handbook split into FCA and PRA Handbooks: Note a combined view can be found on FCA website • Interpretation of both Handbooks: • Purposive interpretation of the rules • If Handbook provision goes beyond the FCA’s or PRA’s powers or responsibilities, it is to be interpreted as applied by that regulator to the extent of that regulator’s powers and regulatory responsibilities only Domestic reform: The first 100 days of the new regime

5. The evolution of the new Handbooks • FCA and PRA can amend their Handbooks subject to public consultation: Sections 138I and 138J FSMA • PRA will conduct a review of its Handbook and intends to replace it with a rulebook: • Unclear at the moment how much the rulebook will differ from the Handbook • But guidance material in the rulebook will be strictly limited and other types of material (e.g. procedure manuals and information on how the PRA will act) will be published separately • Important to bear in mind the PRA Approach document: Firms expected not to merely meet the letter of the rules nor game them but maintain sight of the overriding principle of their safety and soundness and act accordingly Domestic reform: The first 100 days of the new regime

6. The evolution of the new Handbooks • FCA will be reviewing the way it presents rules and guidance: • Journey to FCA confirms that FCA is reviewing the way that non-Handbook guidance (e.g. letters to firms) can be used as an effective tool for firms: A major issue over the last few years • Financial Services Act 2012 provides for the FCA and PRA to make threshold condition codes: • Not published so far but FCA has COND and PRA has set out information in its Approach documents Domestic reform: The first 100 days of the new regime

7. The new philosophy: The twin pillars • Regulatory objectives: • A lot of work within FCA on competition objective: Competition within financial services in interests of consumers in regulated financial services and markets • Must insofar as possible advance consumer protection and integrity objective to promote effective competition • Unclear yet how policy will be shaped in this area but questions already much more focussed for firms on competition issues • Note also the distinction between this and competitiveness of the UK: Now there is just a sustainable growth have regard to • Innovation is a discretionary have regard to as part of the competition objective Domestic reform: The first 100 days of the new regime

8. The new philosophy: The twin pillars • Threshold conditions: • FCA threshold conditions for FCA authorised firms: Effective supervision, appropriate resources and business model threshold conditions being used to the full • FCA threshold conditions for PRA authorised firms: Effective supervision and appropriate non-financial resources and business model • Key point is the breakdown of the compliance versus commercial distinction in the new world • Ties closely into forward looking regulatory intervention and product regulation Domestic reform: The first 100 days of the new regime

9. A further word on effective supervision • FCA effective supervision threshold condition: • New threshold condition encompassing previous FSA close links condition • Covers all circumstances including the nature and complexity of the firm’s regulated activities, the complexity of its products and the way in which the business is organised • Appropriate non-financial resources: • PRA solely responsible for assessing dual regulated firm’s financial resources under its prudent conduct threshold conditions • Appropriate interpreted as meaning sufficient in terms of quantity, quality and availability • Includes any systems, controls, plans or policies that the firm maintains, any information that the person holds and the human resources that the firm has available • Assess whether firm able to comply with SYSC and other applicable systems and controls requirements • FCA may consider the impact of other members of the firm’s group on the adequacy of its resources Domestic reform: The first 100 days of the new regime

10. Business model analysis • FCA • FCA will look at a firm’s business model to ensure it meets the needs of consumers when it considers authorising it • Firms applying for authorisation or to vary their permissions will be assessed against FCA threshold conditions, one of which is the Business Model Threshold Condition (BMTC) • BMTC will demonstrate the importance that the FCA will place on a firm’s ability to put forward an appropriate, viable and sustainable business model, given the nature and scale of business that they intend to carry out • FCA will expect firms to: • Demonstrate adequate contingency planning in their business model • Make clear how their business model meets the needs of the client • Provide clear information, with evidence of how they will meet BMTC • FCA will recommend refusal at an early stage where it is not satisfied that a firm meets, or will continue to meet, BMTC • FCA is consulting on how it will apply BMTC • PRA • PRA’s supervisory approach will include business model analysis of firms it regulates • The analysis will include an assessment of where and how a firm makes money, the risks it takes in so doing, and how it funds itself. Firms will be assessed at the level of the firm or the sector as appropriate • PRA will aim to understand a business model’s sustainability and vulnerabilities. Vulnerabilities might include: • Unsustainable expectations of growth • Heavy reliance on an inflexible structure of net interest income, with consequent exposure to a low interest rate environment • Concentrated funding sources which may dry up in stressed circumstances • Significant consequences following a change in credit rating • For those firms posing greater risk to the stability of the financial system, the analysis will be more detailed. It will include a review of the drivers of profitability, risk appetite, performance targets and underlying assumptions, and a firm’s own forecasts and their plausibility • If the PRA believes that mitigating measures alone cannot adequately reduce material risks to the safety and soundness of the firm, it will require the firm to change its business model Domestic reform: The first 100 days of the new regime

11. The end of certainty? - Themed visits • The key message: • Certainty on the cycle of visits and communications has gone: FCA will be pre-emptive and tough and firms can expect much more challenge • Reminder of FCA firm categorisation: • C1 and C2 to be fixed portfolio firms with a nominated supervisor • C3 and C4 to be flexible portfolio supervised by a team of sector specialists and no nominated supervisor: A lot of firms have or are losing their supervisor • The FCA three pillar supervisory approach: • Firm Systematic Framework (FSF), event-driven work and issues and products • FSF assesses the firm’s conduct risk and aims to answer the question: Are the interests of customers and market integrity at the heart of how the firm is run? • Fewer supervisors allocated to specific firms means more flexibility to assign resources to pillars 2 and 3 • Issues and products: Sector risk assessment which provides an assessment of the conduct risks across a sector • The reality of sector risk assessment is that firms without supervisors never know when the theme arc light may shine on them Domestic reform: The first 100 days of the new regime

12. Practical reality of themed visits • Regulator will identify an area about which it has concerns or wishes to find out more: Areas may be identified by supervisors, policy work, or by looking at trends in complaints • Objectives of a themed visit: Identify good practice, address identified risks or determine the scale of risks identified from intelligence or surveillance • In reality, tight timing for documentation requests and visit shortly after that: Appears designed to stop “creation” of documentation • Message is to do proper trend analysis and have documentation and people ready at any time: Dawn raid prep is a good comparator Domestic reform: The first 100 days of the new regime

13. Practical reality of themed visits • Key issue for firms is to avoid 166 or disciplinary action: • Much more commercial focus with linkage to the new business model threshold condition: Firms need to be clear how their business model meets the needs of clients and customers • The focus on approved persons • Already seen results in investment managers ABC/AML, conflicts and transition management visits • A new NRF product: The Complete Themed Visit Response Domestic reform: The first 100 days of the new regime

14. The twist in the tail: Lessons from event driven work • The official position: • SUP 1A.3.4 definition: Dealing with problems that are emerging or have crystallised, and securing customer redress or other remedial work (e.g. to secure the integrity of the market) where necessary • Covers everything from deals where there has been a problem to whistleblowing allegations to spikes in reported complaints at a firm • FCA Business Plan 2013/14: • Delivering consumer protection FCA moving from a reactive approach to a more proactive one • Complex Event-Driven Crystallisation Team aims to resolve issues quickly and decisively • The reality: • Vital for firms to consider Principle 11 and breach notifications carefully as they may trigger referral to crystallisation team • A firm without a supervisor may suddenly find itself the subject of a lot of attention • Even for firms with supervisors the old world in which the supervisor was in control is largely gone: Other forces at work within FCA which have key input on outcomes Domestic reform: The first 100 days of the new regime

15. Enforcement: 100 Days • Priorities • Penalties • Process • Publication Domestic reform: The first 100 days of the new regime

16. So what is new? The place? Domestic reform: The first 100 days of the new regime

17. So what is new? The people? • FSA Director of Enforcement Tracey McDermott • FCADirector of Enforcement Tracey McDermott Domestic reform: The first 100 days of the new regime

18. So what is new? The public face? Domestic reform: The first 100 days of the new regime

19. FCA Priorities 2013/14 • Themes • Focus on consumers • Culture • Principles • Credible deterrence • Senior management • Hot topics • LIBOR • Market abuse • Unauthorised business • Financial crime controls • Mis-selling • Client money and assets • Complaints handling Domestic reform: The first 100 days of the new regime

20. FCA Priorities 2013/14 • Thematic reviews feed into enforcement • Banks’ control of financial crime risks in trade finance • Mobile phone insurance • Motor legal expenses insurance • Claims handling • Product governance • Mortgage arrears handling procedures Domestic reform: The first 100 days of the new regime

21. Senior management • Credible deterrence: • 55 individuals (over £5m fines, 43 prohibitions and 13 criminal convictions) • 38 firms (£418m fines) • Knowingly concerned (Cummings, Thiam) • No comfort in a crowd (Thiam) • If in doubt, disclose: • to the regulator (Thiam, Final Notice, Censure) • to the board (Burns, Decision Notice, £154,800) • to shareholders (Willford, Decision Notice £100,000) Domestic reform: The first 100 days of the new regime

22. Mis-selling • Drivers of behaviour • Product focus • Actual or potential: • Sesame £6,031,200, Principles 3 and 9 • JP Morgan £3,076,200, Principle 3 Domestic reform: The first 100 days of the new regime

23. Client Assets and Complaints Handling • Client Assets • XCap: £120,000, Principles 3 and 10 and CASS • Horn Express: Censure (£136,687), Payment Services Regulations Complaints Handling • UBS: £9.45m, mis-selling and complaints handling • Lloyds: £4.315m, PPI complaints handling • Co-op: £113,300, PPI complaints handling Domestic reform: The first 100 days of the new regime

24. Penalties • March 2010 – new penalty regime • When the new regime applies: • “Gravamen of misconduct” • Majority of misconduct • Revenue not always indicative of harm: • Client asset cases: daily average of balances • Listing rules cases: average market capitalisation • Forecasts • Lead time Domestic reform: The first 100 days of the new regime

25. Process • Decision Notice reasons • Challenging the regulator • PRA Domestic reform: The first 100 days of the new regime

26. Publication of Decision Notices • Arch Cru: September 2012 • Grounds: • Serious reputational harm • Risk to families from disgruntled investors • Adverse effect on civil proceedings • But… • Lack of evidence • Press comment • Court papers publicly available • No “cogent evidence of disproportionate damage” Domestic reform: The first 100 days of the new regime

27. Publication of Decision Notices • Burns: May 2013 • “Possibility” of severe damage vs “significant likelihood” • Burden not discharged due to: • Uncertainty of future business • Prospects of revival • Financial impact “not such to leave her insolvent or destitute” • Cogent evidence needed to outweigh strong presumption that publication should be permitted Domestic reform: The first 100 days of the new regime

28. Publication of Decision Notices • Christopher Willford: June 2013 • Judicial Review • Private at first instance • Not at Court of Appeal • Public interest in open justice • Judicial review brings matter into public forum Domestic reform: The first 100 days of the new regime

29. Publication of Warning Notices • Background • “Greater and earlier transparency” • RDC to decide if publish: CP12/37 • How power will be used: CP13/8 • What will be published? • s.391(1)(c) “appropriate” • Statement • Caveats • Not sanction Domestic reform: The first 100 days of the new regime

30. Publication of Warning Notices • Process • 14 days • RDC decision • Unfairness • “Clear and convincing evidence…suffer a disproportionate level of damage” e.g. • materially affect physical or mental health • disproportionate loss of income or livelihood • prejudice criminal proceedings Domestic reform: The first 100 days of the new regime

31. Enforcement Summary • Different face, different focus? • “Tough and meaningful action” • Earlier public exposure Domestic reform: The first 100 days of the new regime

32. Contact details Domestic reform: The first 100 days of the new regime

33. Phoenix Domestic reform: The first 100 days of the new regime