Written by Anna Davis and Jad Soubra
On 19 July 2022, the FCA published its quarterly perimeter report. The report describes various issues surrounding what the FCA does and does not regulate and the action it is taking in response, recognising that harm can occur where new products and services sit outside of the Perimeter (and therefore the FCA's powers are extremely limited). Here we outline some of the pertinent issues raised within the report, from the Appointed Representatives regime to cryptoassets.
Firm business models
Amongst others, the FCA sets out specific concerns in relation to the following models:
- Appointed Representative (ARs): The FCA is concerned that the risks to consumers, including mis-selling, from the current regime are too high. For example, principals generate 50% to 400% more complaints and supervisory cases than other directly authorised firms. Changes to the AR regime are currently under consultation and the FCA has confirmed it expects to publish a consultation response and final rules later this year.
- Outsourcing / third party service providers: The regulator has reported that over last three years, between 2018 and 2021, 23% of operational incidents reported to the FCA involved third parties, making this the top root cause of such incidents. Additionally, the FCA expressed concern over many firms relying on the same third parties (such as cloud service providers) and the potential systemic risks this can pose to the UK financial sector. Jointly with the PRA, the FCA published a discussion paper (DP3/22) in June 2022 on this topic and confirmed that further steps, informed by stakeholder feedback, will be taken once the Financial Service and Markets Bill receives Royal Assent.
- General Insurance: The FCA notes that there has sometimes been uncertainty as to whether certain contracts should be classed as insurance. Whilst some firms have structured their products to take them outside the perimeter, the regulator considers that those products should be regarded as insurance. Two main concerns the FCA has in relation to this are:
- Insurer’s discretion to pay out: Insurance requires a provider to undertake to pay money or provide a corresponding benefit to a recipient. In some contracts, the provider claims to have absolute discretion not to pay out. However, the FCA notes that this may include circumstances where the discretion can be considered to have no real content or to be an unfair term. In such cases, the regulator’s view is that the contracts should properly be categorised as insurance.
- Warranties: In response to firms claiming that their warranties are mainly service contracts providing repair services with a minor indemnity element that pays benefits if the product is lost or damaged, the FCA has clarified that it believes many of these contracts artificially describe the repair services and, on a more detailed analysis, are really contracts of insurance.
The FCA is investigating what further action it could take to give both the industry and consumers greater clarity about its position on these types of products, which could potentially include amendments to its perimeter guidance on insurers (PERG 6) and enforcement action.
- Firms supervised under the Money Laundering Regulations (MLRs): The FCA has expressed concern over the powers it has in relation to Annex I Financial Institutions (FIs) that are not authorised under FSMA but supervised by the regulator under the MLRs. The level of powers which the regulator currently has makes it difficult to apply a more intensive supervisory regime, a concern which the FCA outlined to the Treasury in May 2021. In response to this, in June 2021 the Government announced proposals to grant the regulator greater powers to collect information and take action against FIs to ensure they have robust AML policies and procedures as required by the MLRs – these powers ensure there is parity with the crypto regime within the MLRs.
The FCA has set out the following area of perimeter concerns in this sector:
- Consumer Investments Strategy- some of the most serious harm continues to come from investments outside the perimeter and from investment scams.
The rising cost of living and current negative real returns across most mainstream investments, could encourage some consumers to invest in higher risk investments and fall victim of scams.
Unregulated Collective Investment Schemes - UCIS are high risk investments and cannot be promoted to the general public in the UK. Despite this, the FCA has seen evidence that UCIS are being unlawfully promoted to ordinary members of the public. Firms thinking of establishing these investment opportunities or offering them to the general public need to consider whether they meet the definition of a CIS/AIF.
Mass-marketing of high-risk investments to retail consumers - High-risk investments continue to be marketed to retail consumers. FCA has limited powers over many issuers of high-risk investments as issuing an investment product is often not carrying out a regulated activity. However, marketing these investments is generally subject to the financial promotion regime, unless an exemption applies. In January 2022, FCA published a Consultation Paper on strengthening the financial promotions rules for high-risk investments, including cryptoassets. Final rules are due this summer.
Exemptions in the Financial Promotion Order - unauthorised persons still frequently rely on exemptions in the Financial Promotion Order (FPO) involving ‘high net worth’ and ‘sophisticated’ investors (‘the exemptions’) to market high-risk investments. Promotions made under these exemptions do not have to comply with the FCA's financial promotions rules, including with the requirement to be clear, fair and not misleading, and with our mass-marketing bans. The FCA recognises that some of the criteria for the exemptions to apply have not kept pace with market changes and are out of line internationally. There is also no requirement for firms to check that consumers meet the relevant criteria and some investors who do not meet these tests are being ‘pushed’ through them, often by unregulated firms. The Treasury is consulting on reforming these exemptions.
New Regulatory Gateway (s21 Gateway) - currently, any authorised firm can approve the financial promotions of an unauthorised firm, regardless of their expertise or experience of the relevant market. FCA has seen instances of firms approving financial promotions without properly understanding the product or service and so being unable to properly ensure that the promotion meets our standards. On 22 June 2021, the Treasury confirmed it intends to introduce a new regulatory gateway (a ‘s21 gateway’) for firms approving financial promotions for unauthorised persons. This s21 gateway means the FCA will assess whether the authorised firm has the necessary competence and expertise to act as a s21 approver before they can approve financial promotions for unauthorised persons.
- Marketing of CFDs and other high-risk derivative products - There are problems with the marketing of contracts for difference (CFDs) and other high-risk derivative products to retail clients. Concerns the FCA has identified include firms encouraging clients to trade with entities in third country jurisdictions rather than their UK business, and the use of introducers and affiliates who may be carrying out unregulated activities.
Overseas persons exclusion (OPE)
The OPE is available to an overseas person who carries out certain regulated activities in the UK without requiring authorisation, so long as the person does not do so from a permanent place of business maintained in the UK. The FCA has noted that, despite technological advances which have significantly changed the way activities can be carried out in the UK without a permanent place of business in the market, the OPE has remained largely unchanged. The regulator is working closely with the Treasury to address this and launch a consultation which will consider whether further oversight and regulatory powers are needed for the OPE regime to address any deficiencies in regulatory oversight. The FCA believes that greater information requirements and powers along with greater visibility and oversight of firms using the OPE would be beneficial and the overseas perimeter would benefit from greater clarity about when a regulated activity is being carried on in the UK.