On 4th September 2007, the FSA published a Policy Statement (07/16) in which it describes the role of industry guidance, and set out the process by which it will grant confirmation for specific guidance and the confirmation criteria which must be met before any FSA confirmation will be granted.
The Policy Statement examined
This Policy Statement explains the changes that the FSA has made to its original proposals contained in its Discussion Paper 06/5. For example, the FSA now intends to tighten up its policy by limiting the endorsement of industry guidance to FSA confirmation only. It will also submit to the Financial Services Consumer Panel all guidance that it considers will have a significant consumer impact. The FSA has also decided that industry guidance will have a confirmed status for three years only after which the confirmation will be revoked unless a request is received to review and renew it.
The FSA also explains that its confirmation of industry guidance will mean that it will then regard firms following the confirmed guidance correctly as having complied with any relevant Handbook rule. However, the Authority will not treat any failure to comply with such guidance as indicative of a rule breach, since in many cases there will be more than one way to skin the cat, i.e. to comply with the industry guidance concerned. The FSA also comments on the practical effect of confirmation in an enforcement context, indicating that, where a rule breach is established, the industry guidance will be relevant potentially to any enforcement action. The FSA may then use it in the ways set out in Chapter 2 of the Enforcement Guide.
The FSA’s policy on industry guidance is to take effect immediately. Those bodies wishing to seek confirmation of their guidance are therefore urged to contact the FSA at an early stage in their work. Other than for certain of the guidance recently published by MiFID Connect, the FSA does not propose to apply its confirmation retrospectively to existing industry guidance. The FSA will also review its industry guidance confirmation process in the first quarter of 2010 as part of a post-implementation review of this process.
The FSA will not monitor firms’ use of confirmed industry guidance, nor will it expect the trade and professional bodies providing the guidance to monitor or enforce its compliance themselves. In PS 07/16 the FSA states that it will not require industry bodies to plug regulatory gaps, nor to answer firms’ queries on their confirmed guidance, nor will it place pressure on the trade and professional bodies to produce any guidance at all!
The Policy Statement thus makes it clear that the FSA will not take action against firms that have complied with the confirmed industry guidance. Firms will therefore enjoy the so-called “sturdy breakwater” level of protection against FSA disciplinary and enforcement action. They will not be protected, however, from any civil action brought by third parties (for example, their depositors, customers or counterparties).
Verena Ross, the FSA’s Director of Strategy and Risk is reported as having said:
“Trade associations and others have for many years provided guidance on regulatory matters for their members. This new formalised system involving FSA confirmation will contribute towards the move to principles-based regulation, allowing us to focus on the main principles to be achieved. Industry guidance will give firms help and advice on ways of complying with FSA principles and high-level rules, in a way that should not only stimulate flexibility and innovation but also tailor the advice to different sectors.”
The Policy Statement also responds to feedback from the industry and consumers. It also confirms that the FSA will continue to produce its own guidance on its own rules. However, the Policy Statement notes that: “Where we do provide it, the emphasis will be on regulatory outcomes rather than detailed processes and will consist of guidance (Handbook) and supporting material (e.g. case studies).”
The FSA intends to ensure that the rules it makes will not depend on the existence of industry guidance for their implementation. The Authority will state clearly where compliance with confirmed industry guidance will take a firm beyond the FSA's own regulatory minimum standards.
The FSA has also undertaken to answer queries on its own rules and guidance, although not, as mentioned above, on any confirmed industry guidance. It expects the guidance providers to do the following:
· to ensure that their guidance is kept up-to-date and relevant, and that the FSA is notified of any changes;
· to be proactive in requesting FSA confirmation;
· to work with other trade bodies, if required, to develop guidance; and
· to ensure that the guidance is free and publicly available.
It is noteworthy that a relatively small number of the respondents to the earlier FSA Discussion Paper (06/05) disagreed entirely with the principle of industry guidance. Some suggested that it was the FSA's own responsibility and duty to provide guidance on its rules, not that of the trade bodies. One has a certain sympathy with that point of view, as at first blush, the notion of such guidance appears to be little more than a form of regulatory "buck-passing" - almost an attempt to reintroduce self-regulation into the regulatory process under FSMA by the back door in fact, without any authority from Parliament to do so. The creation of a second tier of regulation was another anxiety expressed by a minority of the respondents. The FSA responded to this by stating that it firmly believed that industry guidance was a useful tool to help firms meet their regulatory requirements.
On the question of whether trade bodies, which lack the FSA’s statutory immunity, will they lay themselves open to legal action, the Authority believed that there was no greater legal risk of this in the case of guidance providers in respect of industry guidance than already existed. “However, we would anticipate that guidance providers will insert any disclaimer they regard as necessary to protect themselves”, the FSA concluded as it appeared to back-track on the need for statutory immunity.
So far, the only industry guidance that the FSA has actually confirmed under this new "principles-based" approach has come from MiFID Connect. Three of MiFID Connect’s guidance documents on compliance with MiFID – on outsourcing, suitability and appropriateness, and investment research have now been approved by the regulator, although the guidance on MiFID’s perhaps more important best execution and conflicts of interest requirements have not received such confirmation. Indeed, the guideline on conflicts of interest by MiFID Connect appears to have been relegated to an information memorandum only. In this context, it is now worth noting some other aspects of the MiFID Connect guidelines in more detail.
MiFID Connect Guidelines
The British Bankers' Association (BBA) has provided the secretariat for MiFID Connect. The guidelines are documents developed by a group of eleven UK-based trade association, of which the BBA is one, to help their members to better understand some of the more novel or difficult parts of MiFID. Indeed, some commentators would say that almost all of MiFID is difficult to understand. The subjects covered were chosen by the members of the associations themselves as the areas where they felt they needed the most assistance although they do not replace the need for legal advice in specific cases. The three confirmed MiFID Connect guidelines are on suitability and appropriateness; investment research; and outsourcing. All these guidelines can be accessed from the MiFID Connect website.
It is to be regretted that the three MiFID Connect guidelines mentioned above do not have the pan-European authoritativeness of an interpretation by the European Commission or by the UK regulator of rules made by the Financial Services Authority itself. They have, however, been confirmed by the FSA and were developed by the more representative of the many trade associations for the financial services firms operating in the UK. They have also benefited from a review by the Financial Services Consumer Panel.
The FSA confirmation gives them what the regulator has described as mentioned above as a "sturdy breakwater" status. This appears to mean that, although no firm is obliged to follow them, the FSA will take compliance with the guidelines into account when it carries out supervisory or enforcement action in relation to a firm. Generally speaking this sort of guidance is not currently available anywhere else in the EU and in that respect it is to be welcomed.
As to the information memorandum on conflicts of interest, this does not enjoy any particular regulatory status. It simply provides information on conflicts of interest which firms may find useful to take into account when implementing MiFID. Following the information memorandum will not, however, provide any protection for a firm. Unlike the three guidelines mentioned above, the information memorandum has not had the benefit of any FSA review and policy input.
What do the MiFID guidelines seek to achieve?
The guidelines are high level in nature. They are not intended to cover all the detailed variations which might be relevant in different market sectors or for different types of firm. They are intended to supplement the FSA's rules and any FSA guidance which relates to the topic in question. In most cases, the FSA rules for the guideline topic implement the relevant MiFID provisions that apply without any major change to the legislative text. Generally speaking, the FSA itself has, rather unhelpfully, not given much guidance on the subjects to which the guidelines relate. Further, in some cases a trade association which covers a particular market sector may provide supplementary information on that sector. This is, however, likely to be the exception rather than the rule prior to 1st November 2007, in the BBA’s view.
The guidelines seek to give practical suggestions that firms may wish to consider when implementing the relevant MiFID requirements. So, for example, the outsourcing guideline makes suggestions about the controls that a firm might wish to consider putting in place both at the outset of outsourcing and to monitor the outsourcing arrangements.
The guidelines have also been developed with a view to ensuring that the implementation of the MiFID requirements can be carried out in a flexible and sensible manner retaining as much scope to adjust to the needs of different business models. This is very welcome.
Why were the particular topics chosen by the trade bodies that comprise MiFID Connect?
Suitability and appropriateness was chosen because the appropriateness concept was completely new and had no counterpart in the existing FSA rulebook, and suitability was an existing concept in the FSA rulebook and it was important that consideration was given to the extent to which MiFID may have affected the existing FSA requirements. In contrast, investment research was chosen because there was considerable uncertainty about how both MiFID and the Market Abuse Directive (MAD) affected the existing FSA rulebook requirements. The MiFID Connect guideline is an update of the existing BBA/International Capital Market Association/London Investment Banking Association guideline relating to the recently superseded COB 7.3. It is important, in this context, to remember that the guideline is quite narrow in its scope and that there are a range of other rules relating to investment research which it does not cover because it is focused only on the MiFID requirements. For example, the guideline does not cover the application of the MAD.
The outsourcing guideline was chosen because there was a need to have a common approach to outsourcing which embraced both the Capital Requirements Directive and MiFID requirements. The existing FSA rulebook requirements applied equally to banking and securities firms and there was a wish to ensure that this continued with two new pieces of European legislation being implemented.
Conflicts of interest was chosen because this was a particularly contentious topic politically and because MiFID was modifying some of the existing requirements. It is unfortunate that merely an information memorandum has resulted. This is an area where the regulatory rules, the principles of the law of fiduciaries and the express contractual provisions commonly contained in client engagement agreements frequently conflict with one another in practice.
Best execution was another topic which regulated firms wanted considered. Associations such as the BBA had successfully lobbied for additional clarifying interpretation at an EU level on best execution from the European Commission and the Committee of European Securities Regulators. As a result of this it was decided, rightly or wrongly, that a MiFID Connect high-level guideline was not required on this topic.
These guidelines are effective from 1st November 2007. The FSA's confirmation of them is valid for three years provided that there are no legal changes meanwhile. MiFID Connect will carry out a review of the guidelines at some time within that three year period.
Conclusion
One is drawn to conclude that it is in the area of conflicts of interest that most work still remains to be done. It seems unlikely that either the FSA or the trade and professional bodies will rise to the challenge of resolving the conflicts that will exist between their own rules and the general law.
Martin Day
Financial Services Team
Farrer & Co
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