On 23 September 2020, the FCA published a consultation (CP 20/20) on its general approach to international firms providing or seeking to provide financial services that require authorisation in the UK, which will result in finalised guidance. The Guidance will not apply to firms that would operate as payment service or e-money providers.
The Guidance will be similar to that published by the PRA in Supervisory Statements on its approach to the authorisation and supervision of branches of international banks and international insurers (SS1/18 & SS2/18).
The FCA sets out some general considerations which will be key to its approach to international firms seeking authorisation:
Minimum standards for authorisation:
Firms that wish to be authorised in the UK need to meet the minimum standards in the relevant “threshold conditions” that apply to all firms.
Subsidiary or branch:
Whilst international firms have a degree of choice regarding the legal form of their UK presence – subsidiary or branch – in both cases, where an authorisation is sought, the authorisation covers the whole entity, including its UK and overseas offices, and the FCA expects it to have an establishment or physical presence in the UK.
Firms operating from branches will also often demonstrate a high degree of interconnectedness between their UK and international establishments so the FCA must have comfort over the jurisdiction where the firm is incorporated, and how the arrangements in that jurisdiction affect the ability of the firm to meet the relevant minimum standards for authorisation e.g. the comparability of relevant home state regulation, wind-down plans and whether the home state has implemented and complies with relevant global standards.
Further, where a firm intends to provide some services to UK customers from overseas (i.e. anywhere other than a UK establishment), the FCA will seek to ensure that it can effectively supervise services provided to UK
customers in this way. The FCA will also be alive to the particular risks of harm and how these might be mitigated, e.g. business conducted from outside the UK may not be covered by the Financial Services Compensation Scheme.
In terms of substance, the FCA states that it will “typically not suffice if a firm’s local presence has little or nothing more than a UK registered address. In addition, we will need assurance that the personnel (including management and decision-making structures) and the systems and controls (taking into account any offshore or outsourcing dependencies) are adequate for the firm’s UK activities to be effectively supervised“.
The FCA states that it would “typically expect senior managers who are directly involved in managing the firm’s UK activities to spend an adequate and proportionate amount of their time in the UK to ensure those activities
are suitably controlled“, while recognising that individuals at an international firm who have responsibilities for the UK branch that are purely strategic may not be based in the UK. The FCA also expects individuals responsible for the day-to-day management of the UK branch activities to have sufficiently independent decision-making powers and to exercise independent challenge over strategic decisions that affect the wider firm. This approach to substance appears to be less prescriptive than that which is developing in the EU.
Where relevant the FCA also assesses whether the UK operations are appropriately financially resourced by the firm as a whole, to avoid the risk that the firm cannot meet any legal and regulatory obligations arising from the operations of the branch.
Ability to supervise:
The FCA pay particular attention to the extent to which they are able to supervise the conduct of the firm’s UK business, with reference to the complexity of the firm’s regulated activities, products and how the business is organised. Effective supervision includes being able to access relevant information, monitor on an ongoing basis and make regulatory interventions to respond to specific harms or events.
In considering how effectively it can supervise the firm in the context of its wider operations, the FCA assesses the degree of cooperation between the FCA and the home state supervisor – including the existence of cooperation agreements and the ability to exchange confidential information.
The FCA would assess the firm’s business model and consider whether the firm’s strategy for creating value is implemented in a sound and prudent manner, and in the interests of the consumers it serves.
Systems and controls:
Any firm authorised to operate in the UK must also have appropriate systems, controls and human resources. The FCA will consider the role and accountability of senior management (and the ability to comply with SMCR). Outsourcing arrangements should not impair the quality of the firm’s governance and internal controls and the FCA’s ability to supervise it.
In its overall assessment of an international firm against the relevant minimum standards the FCA proposes that it would consider the firm’s potential to cause harm (‘risks of harm’) and the level of these risks. In the CP, it sets out 3 potential risks that are more relevant for international firms, especially those operating from branches:
1) Retail harm
Protection for the UK office’s retail customers, through redress and supervisory oversight for example, could be less effective, especially if the international firm becomes insolvent or exits the UK (‘retail harm’).
Examples given by the FCA of harms that could occur with an international firm include where:
a. The firm is solvent, but refuses to make payment of redress, and has insufficient assets in the UK to satisfy such claims. In such circumstances:
- The FSCS would be unable to pay any compensation in circumstances where the firm is simply unwilling – rather than unable – to pay its redress liabilities.
- The consumer may have to seek enforcement action in the firm’s home state, which may be complex, expensive, and time-consuming.
- The firm may take defensive action to resist enforcement, such as by seeking judicial declarations or anti-suit injunctions in the courts of its home state. It may also seek to dissipate any assets it may have in the UK.
- It may be more difficult for UK regulators to take effective action. For example, if a fine is levied, but the firm refuses to pay, the foreign court may refuse to enforce the payment of the fine on the basis that the fine is the sovereign act of a foreign state.
b. The firm is insolvent, and so cannot make full payment of redress. Under these circumstances, where the firm is subject to home state insolvency laws, then:
- Consumers with FSCS protected claims who are eligible will be able to claim compensation from the FSCS up to the relevant limits. However, this is not possible for certain claims that are not FSCS-eligible, such as – in general – those relating to consumer credit or loan-based crowdfunding or where customers pursue their claim themselves where their claim exceeds FSCS limits.
- Consumers whose claims are not FSCS-eligible or who pursue their claim themselves where their claim exceeds FSCS limits may have to prove their debts under the foreign court’s insolvency procedures and the laws of the
home state. This may add significant complexity, expense, and delay to the enforcement action. If the firm is heavily insolvent, the additional expense may further reduce the funds available for unsecured creditors, to the point that it is uneconomic for the UK consumers to pursue their redress.
- If consumers with non-FSCS eligible claims have already taken steps to secure redress in the UK before the firm became insolvent, they may need to start afresh under foreign insolvency proceedings.
The FCA is aware that harms may be exacerbated where a firm subsequently decides to provide some services from its home state establishment rather than its UK branch / subsidiary as , for example, FSCS protections may not apply.
The FCA gives examples of potential mitigating factors, including where:
- the home state regulator could obtain compensation from the firm;
- the level of prudential scrutiny and supervision applied to the firm in its home state provides comfort;
- the extent of any ongoing monitoring of recovery and wind-down plans (where relevant), and the degree to which UK authorities may be involved in the recovery and planning process; and
- reputational damage that might arise were the firm not to compensate UK customers.
2) Client assets harm
The UK rules that protect client money or custody assets safeguarded through the UK office and the home state insolvency regime which become applicable if the international firm fails may not be aligned. This misalignment could negatively impact the outcome for UK clients (‘client assets harm’).
If an international firm safeguards client assets from a UK branch, it will generally be required to comply with UK rules on the protection of client assets while the firm is a going concern (in particular, the CASS rules). However, in insolvency, it is probable that a UK branch will be subject to the insolvency regime and procedures of the international firm’s home state. There is little harmonisation of insolvency law at an international level. An insolvency practitioner appointed in the home state may not be in a position to observe UK protections when distributing assets – clients for whom assets were safeguarded under CASS could even have to prove their claims as creditors rather than beneficiaries to property.
The FCA expects international firms to have considered the risks to client assets and how to address them. One possibility that credit institutions can consider is to hold money that would otherwise be classified as client money as a deposit under the ‘banking exemption’ set out in CASS 7.10.16R of the FCA Handbook. For custody assets, in some cases, ensuring assets are registered in a manner consistent with both home and host state laws may be sufficient to mitigate the harm depending on the insolvency law position in the relevant jurisdiction.
Another possible option an international firm could consider is to structure its arrangements so that client assets are not safeguarded from its UK branch, to the extent that doing so would better protect custody assets. The firm may wish to choose to conduct the custody asset activity from an establishment in the home country (such as the firm’s headquarters) where the home state provides its own protections. Or the firm may wish to arrange
for the client to appoint another person who has the appropriate permissions to act as its custodian in the UK (with the firm possibly retaining a mandate over the custody account so that it can still service the client’s transactions). Establishing a UK-incorporated subsidiary is another possible option for the international firm to consider, where this could ensure that there is consistency in the treatment of client assets in the UK between the safeguarding regime that applies during the life of the firm and the law that would apply in an insolvency.
The FCA will expect reassurance as to how assets safeguarded by a UK branch would be treated if the firm entered into insolvency proceedings. This could include seeking legal advice on the specific circumstances of the firm and its proposed UK branch in the context of the insolvency regime of its head office’s jurisdiction, and assessing the implications of its recovery and wind-down plans (or resolution plans where relevant) on the customers of the UK branch. When assessing whether these harms can arise in particular situations, questions that the FCA is likely to consider include:
- Recognition of property rights: Will UK clients’ rights to their assets be recognised under the home state insolvency regime? Will the segregation of client assets from the firm’s general estate at the point of insolvency be respected?
- Client interaction with home state insolvency: Will UK clients be treated in a way commensurate to UK expectations when exercising a claim to their client assets?
- Effectiveness of home state insolvency process: Will client assets that were safeguarded from the UK branch be distributed in a timely fashion? What influence, if any, will the FCA or other UK authorities have over the protection of clients of the UK branch?
3) Wholesale harm
Shocks or risks that originate from the international firm’s overseas offices could, in some circumstances, be more difficult to detect or prevent and could be passed easily to its UK office, affecting the stability and integrity of the UK markets in which it operates or to which it is connected (‘wholesale harm’).
The FCA identifies 3 common underlying factors that it believes can increase a firm’s ability to impact
UK markets, and so its potential to cause harm in them, include:
- a lack of substitutability of the products and services that the firm offers in the UK market(s) where it operates;
- the firm occupying an important position in the UK market, for example where it has significant market share in a niche market or otherwise has significant influence; and
- the firm being interconnected to other firms in the industry, and spreads and amplifies risks in the system rather than reducing or absorbing them.
The FCA notes that the solo-regulated international firms that it regulates would be less likely to reach a scale or scope that could cause market disruption or other related harms that undermine market integrity – in SS1/18.
Where this risk arises, the FCA considers that relevant mitigants might include, for example, the level of supervisory cooperation; the prudential regime the firm is subject to; and the credibility and quality of its wind-down planning.
EEA firms that have notified their intention to enter the UK’s Temporary Permissions Regime (TPR) will be allowed to continue their UK business within the scope of their current permissions for a limited period after the transition period ends, if they meet the conditions to enter and remain in the TPR, while they wait to be called by the FCA to submit their applications for full UK authorisation. The notification window for entering the TPR reopens on 30 September 2020.
If an EEA firm does not notify for a temporary permission or does not obtain a permanent authorisation, it may be able to rely on the Financial Services Contract Regime to continue to service pre-existing contracts in the UK until they expire.states