ICTD3720106 Advanced Certificate in Compliance Assignment Question Submission Date 30 May 2011

I confirm that this assignment represents my own work and where quotations and/or ideas have been utilised from other sources these have been acknowledged and referenced accordingly. Your Chief Executive has asked you to prepare a Briefing Paper for the Board that: a) Sets out what impact this change in regulatory structure will, or could potentially have, upon the financial services industry in the UK . (50 marks) b) Identifies what actions or activities might be required by your firm in preparation for this change. (50 marks) Total 100 marks

Introduction The financial services industry in the UK is an important part of the UK economy and has seen a huge amount of changes over the past couple of years. Over the past few years it has seen a financial crisis in the banking sector and the UK economy has been in recession following a global economic downturn. We also have had a change of government, with the new Conservative and Liberal Democrat coalition government representing a major political shift in comparison to the previous Labour administration. Throughout this time the UK financial services industry has been overseen by the UK s independent regulator the Financial Services Authority (FSA). In June 2010 the Chancellor of the new Conservative/Liberal Democrat government announced the decision to replace the

FSA with two new regulators. This paper outlines some of the major changes that this represents, and the impact that these changes will or could have on the financial services industry in the UK . It will also explore the actions or activities that RESPONSE may need to take in preparation for the change, which should be completed in 2012.

The FSA & Current regulatory structure The Financial Services Authority is the UK s financial services regulator. It is an independent organisation from government and works closely with HM Treasury and the Bank of England. The FSA was formed was formed in 1997 when the chancellor of the then new Labour Government announced plans to reform the way the UKs financial services industry was regulated. In the past the UK financial services industry was largely self regulating. The Financial Services Action (FSAct) had introduced a basic regulatory framework in the mid 1980s. There were a number of regulatory bodies in existence, the Securities and Investments Board (which would later become the FSA), and a small number of Self Regulatory Organisations (SROs) and Recognised Professional Bodies (RPBs). Despite this attempt to introduce regulation in the UK marketplace, the structure was widely considered to have failed in its aim to ensure that investors were protected. The rules introduced under the regime were seen as too detailed and prescriptive, meaning companies found that disproportionate resources were required to comply with rules, and consumers found it difficult and confusing if things went wrong and they sought redress. In 1997 when the FSA was formed, the government also announced the replacement of the FSAct, and this happened in 2000 with the creation of the Financial Services and Markets Act (FSMA). Over the years the FSA has evolved its approach to regulation, and has gained more power, expanding to include regulation of Mortgages and General Insurance products in 2004/05.

Current regulatory framework The FSA operates as the UK single regulator, independent from government. Its overall aim is to promote efficient, orderly and fail markets and to help retail customers achieve a fair deal (1) has four statutory objectives:

Market confidence maintaining confidence in the UK financial system. Financial stability contributing to the protection and enhancement of the stability of the UK financial system. Consumer protection securing the appropriate degree of protection for consumers. The reduction of financial crime reducing the extent to which it is possible for a regulated business to be used for a purpose connected with financial crime

In order to achieve its statutory objectives, the FSA has moved towards a more principles based approach to regulation. That is, that instead of working to a set of prescriptive rules, which many firms may find overly burdensome and which would try and impose a one size fits all solution onto a wide variety of different firms offering different products and services, the FSA would regulate with a set of principles: - firms can then analyse the principles and objectives set-out by the regulator and asses what needs done to meet these in practice. This gives the regulatory framework more flexibility and prevents the FSA becoming too involved in the day to day running of business. The cost of regulation, which must be borne by the industry is reduced, and the competitiveness of the UK s financial services industry is not stifled by an over restrictive regulator. The FSA has eleven high level principles for business that are laid out in the FSA Handbook. The FSA has the power to authorise individuals to carry out regulated activities and it is required under the conditions of the FSMA to monitor authorised individuals and firms for compliance with the conditions of the act. Responsibility for the actions of firms lies with senior management, who must ensure that responsibilities have been assigned within the organisation and that adequate controls to meet the rules, principles and objectives are in place. The FSA takes a risk based approach to supervision, seeking to put the most resources on the supervision of firms whos activities present the greatest risk to the achievement of the FSA four statutory objectives. The level of supervision, and contact with the FSA will vary from baseline monitoring through returns to the FSA for low risk organisations, to regular on-site visits from the FSA in the case of medium to high impact firms. Supporting the Rules and Principles of regulation, the FSA has moved more recently to focus on not just principles, but outcomes as well. Outcomes typically support rules that are in place as a result of UK or EU legislation, but can also support one or more of the 11 high level principles, for example, the FSAs Treating Customers Fairly (TCF) initiative which delivers a set of six desirable consumer outcomes in support of a number of the principles for business. This is a key move firms must demonstrate, not only do they operate within the rules and following principles as laid out by the FSA, but also that they are achieving the desired outcomes for consumers.

Changes Following the financial crisis of recent years, the FSA recognised a need to make a number of changes, including taking steps toward a more proactive, not reactive, outcomes-based supervision (2) Following political change, the new coalition government announced changes to the regulation of financial services in the UK. In February of this year (2011), the FSAs chief

executive, Hector Sant wrote to the CEO of all regulated firms confirming that the FSA would be replaced in two years by with the creation of two new regulatory bodies:

the Prudential Regulation Authority (the PRA); the Consumer Protection and Markets Authority (the CPMA).

The Prudential Regulation Authority will be a part of the Bank of England, and will be responsible for promoting the stable and prudent operation of the financial system through regulation of all deposit taking institutions, insurers and investment banks. (3) The Consumer Protection and Markets Authority will be responsible for regulation of conduct in retail, as well as wholesale, financial markets and the infrastructure that supports those markets. The CPMA will also have responsibility for the prudential regulation of firms that do not fall under the PRAs scope. (3)

Change to Twin Peaks regulation This new form of regulation overseen by PRA and the CPMA has been referred to as a twin peaks supervision. The responsibilities of the new regulators as described, ensure that the four regulatory objectives, as required by the FSMA can be met. The PRA fulfilling objectives of market confidence and financial stability and the CPMA delivering consumer protection and reduction of financial crime. The changes have been begun to be delivered by the FSA, starting on the 4th of April 2011 when their Supervision and Risk business units were replaced with a Prudential Business unit (PBU) and a Consumer and Markets Business Unit (CMBU). The FSAs current chief executive, Hector Sants, will be the chief executive of the PRA, as well as the PBU. The government has also announced the the chief excecutive of the CPMA will be Martin Wheatley, who will also be the head of the CMBU. These initial internal re-organisations that the FSA have undergone only represent a first step on the road to becoming two separate regulators (3). Further details of the new regulatory structure will emerge over the coming months.

Impact on the financial services industry in the UK . Immediate impact/long term impact/not there to prevent failure

The immediate impact of these changes may not be felt, as there will be a period of transition. The FSA have already started making the changes in their management structure. They plan to ensure there is a smooth transition between one regulator toward the new twin peaks structure. In the immediate future changes to the way that capital resources are calculated means that firms will need to hold more of their annual income in reserve capital than before. In the long term there a likely to be changes to the way in which the new authorities regulate, and the level of interaction with the regulator that some firms may expect. The CPMA will identify firms needing closer scrutiny using a risk model. Due to the events of the last few years in terms of the economic crisis, it has been recognised that the FSAs has not always been effective in the past. In response to this the CPMA will aim to minimise the amount of consumer detriment and is likely to scrutinise more closely firms with a lower risk threshold than the FSA would have. There is also the posibility that more firms may be allowed to fail in the future, as the PRA has recognised that regulatory culture should not operate under a zero failure regime.

Impact of changes on RESPONSE Although much of the final structure and the exact working of the new authorities remains to be seen there are a number of was in which the changes might affect RESPONSE as an organisation. As an outsourcer we are in a slighlty different position to other firms, in that the new regulatory bodies and the rules that they set out are less likely to affect us than they will firms such as the clients we provide contact centre services for. As with the current regulatory framework, REPSONSE does not design, market or provide financial services directly to any consumers, however we do provide front line staff who will act as a point of contact for both sales and service enquiries on behalf of those firms, and as such we are ourselves an FSA regulated organisation. Depending on our future activities for clients we may be required to hold a larger percentage of RESPONSEs annual income in reserve. The basic requirement for a firm which does not hold client money at present is wither 2.5% or 5000GBP, whichever is greater. This could potentially mean that RESPONSE will need to hold more funds in reserve. RESPONSE should take action now and ensure that extra funds can be made via our banking arrangements with the firms parent organisation. Our compliance team is responsible for ensuring that regulations are adhered to and conduct

monitoring to see that checks are in place at all appropriate levels. Our compliance staff may require further training on the subject of the new regulatory bodies, any new legislation that comes into force to underpin the new regulatory structure and changes to the principles or outcomes demanded by regulators or new or updated rules that may be put in place. Whilst formal training may not be necessary across all areas of the revised regulatory structure, time and resource must available to enable the compliance team to keep abreast with legal an regulatory changes, as well as industry reaction and best practice responses to the changes imposed. RESPONSE must ensure that our compliance staff receive training to an appropriate level, based on the level of change that takes place within the industry. Our compliance staff will be key in ensuring communication of regulatory objectives with the wider business is of good quality, and that we can influence good compliance behaviours within the organisation. Consideration will need to be given to the training of staff dealing with regulated financial service clients. The correct level of responsibility and training will have to be re-assessed for each job profile, from front-line advisor to Senior Operations Managers. This will require scheduling considerations: time for sometimes large numbers of staff to undergo awareness training. Some staff members will require more detailed training and may be required to demonstrate understanding via a measure of competence. The compliance team will be an important tool in the training and awareness program, having been prepared with technical knowledge from the training and awareness activities they have undertaken (as outlined above). Compliance will seek to support the roll out of any new rules or guidance by integrating them into our processes in a way that meets the business' needs, and allows us to incorporate compliance behaviours into our business culture. Under the current and future regulatory frameworks, Senior management have ultimate responsibility in ensuring the that we operate under a compliant framework. Our senior management team must also receive training in the changes to the regulatory structure and how it affects their roles and responsibilities as a controlled function within the organisation. Provision must be made for the professional provision of this training, and as in previous years it is recommended this training be outsources to an accredited firm. Finally we should prepare for the possibility that we will require more interaction with the regulator than at present. Currently RESPONSE is monitored by regular returns to the FSA, however in the future these may increase in complexity, may require further disclosure than at present and will take more time and expertise to complete. We are also more likley to fall under direct scrutiny from the regulator.

References and Quotes (1) About the FSA/Aims and objectives at www.fsa.gov.uk

(2) 13 December 2010 Speech by Hector Sants, Chief Executive, FSA Reuters Newsmakers (3) Letter to CEO's from Hector Sants 7-2-2011 www.fsa.gov.uk The supervisory approach of the Prudential Regulation Authority

19 May 2011 Speech by Andrew Bailey, Executive Director, Bank of England www.fsa.gov.uk