The UK Financial Conduct Authority (FCA) published its Annual Report and Accounts for 2022/23 on 20 July 2023. The Annual Report sets out the FCA's progress and key achievements during the past year. In addition, it provides valuable insight for firms into the current enforcement and supervisory trends, and potential areas of focus in the coming year which should help inform your horizon scanning for internal audit.
In this article, we discuss what we think are the key takeaways to help spot emerging enforcement and supervisory trends, and in particular where the FCA sees developing areas of potential "serious harm". As broad overarching topics, the FCA remains focused on the prevention of financial crime, setting out how it is using its powers to restrict access to the market for those firms that do not have sufficiently robust AML controls, and describes its supervisory activities focusing on sanctions systems and controls in regulated firms. It also describes emerging work being conducted in the anti-fraud space. We will discuss each of these below.
In terms of supervisory focus, the report also describes the measures being taken in respect of consumer protection, most notably the implementation of the customer duty (which came into force on 31 July 2023), which sets out further expectation for firms in how they treat their customers. Consumer protection was also bolstered by a continued focus on financial promotions and the new financial promotions authorisation framework.
As is naturally the case, an increased supervisory focus on a particular known "issue" is almost always a precursor to enforcement action. Where the FCA conducts targeted reviews of particular problem areas, in particular where these are linked to thematic reviews of firms operating in the relevant portfolio, it will of course consider whether failings identified during the course of the review identify serious potential breaches of rules or principles which have or may cause consumer detriment or damage to confidence in the market.
As such, when horizon scanning and considering areas of focus for internal audit, firms ought properly to consider whether any of the following may be relevant.
The FCA's priority with respect to sanctions is ensuring that authorised firms have effective systems and controls in place to be able to monitor and comply with UK sanctions obligations, and this jurisdiction for systems and controls should be something that regulated firms consider in addition to OFSI jurisdiction. With Russian controls now firmly in place for most firms, and with potential further requirements in respect of China on the horizon, we would recommend that firms conduct a health check to ensure that they are able to meet expectations. We anticipate enforcement action in this space for those that do not, particularly given the expectations set out post thematic review.
We are likely to see a significant increase in FCA's enforcement action against illegal crypto activity and a step-up in compliance obligations for crypto firms once they are brought under broader FCA supervision from 8 October 2023 when new financial promotions rules come into effect. The FCA has already indicated a specific focus on ensuring that crypto firms have adequate AML and counter-terrorist financing measures in place. We recommend that firms involved in crypto activity ensure that they are familiar with the FCA's guidance on good and poor practice on AML and counter-terrorist financing when applying for FCA registration under the Money Laundering Regulations.
To keep up to date on the developments in the crypto space, take a look at the Dentons Crypto Bytes podcast series and our recent article: Crypto crime: what's next?
In the last year alone, the FCA's scanning of websites resulted in 1,882 warnings being issued, an increase of 34% from 2021 (when the number of warnings was 1,410). 8,582 financial promotions were withdrawn or amended in 2022 which is 14 times more than the year before.
Although the FCA only used its powers to ban a financial promotion twice in the past year (as opposed to the promotion being amended or withdrawn by the firm), this use of data and innovative tools appears to be increasing the FCA's ability to intervene where online scams are detected. This in turn should help the FCA achieve its consumer protection objective. We also note that in enforcement action where misleading financial promotions are involved, this is being pursued as a standalone regulatory (and potentially criminal) offence, and we anticipate an increase in investigations opened against both the producer of the promotion and the approver.
The FCA has also contributed to the Online Safety Bill, which is currently at its final stages in the House of Lords. A priority for the FCA was ensuring that "priority illegal content" and "paid-for advertising" fraud offences fell within the scope of the Bill. If the Bill is passed with the FCA's changes, platforms such as search engines and social media platforms will need to actively take steps to prevent people being exposed to fraudulent content. This will require such firms to continue to develop their anti-scam detection framework and put in place proactive gateway controls to prevent the platforming of unapproved or misleading financial promotions, or risk potential liability. This would support the work the FCA has already been carrying out with some of these platforms on a voluntary basis to reduce the risks of consumer harm. It will be interesting to see whether the FCA seeks to flex its enforcement powers in this space.
In the past year, the FCA suspended listings of instruments on 34 occasions and there were 54 instances of clarificatory statements to the market after contact from the FCA. Further, three enforcement actions were brought against firms for failures in market abuse systems and controls.
One of the most significant market abuse enforcement actions from the past year involves Carillion Plc. The FCA proposed total fines of £870,200 for three of its former directors and, had Carillion not been in liquidation, it would have faced a penalty of £37.9 million. Among other failings, Carillion recklessly published misleading announcements and did not reflect significant deteriorations in its expected financial performance.
FSMA 2023 repeals the retained EU law for financial services with the aim of delivering a smarter regulatory framework more tailored to the UK. Now is a good time for financial services firms to prepare and consider how their current business practices may need to adapt as the new regulatory framework is implemented. For example, various changes have been proposed to the UK Listing Rules to encourage competition and improve the choice for investors. We recommend firms consider any potential changes that may be beneficial for them, such as the proposed more permissive approach to dual class share structures or the removal of compulsory shareholder votes and shareholder circulars for significant transactions, and include these in their horizon scanning.
For example, FSMA 2023 gives the FCA powers to ensure the reasonable provision of cash access services across the UK. The FCA is currently developing rules and guidance in anticipation of these new powers. It intends to pay particularly close attention to branch closures planned in areas where there are fewer cash access alternatives, such as post office services, as well as areas with significant indicators of potential customer vulnerability. While most firms look to technology to innovate and create new products, it is important to be mindful of all groups of customers and their respective needs when it comes to financial services.
To prepare for the changes brought about by FSMA 2023, take a look at the following series of articles providing you with a helpful overview of the Act.
The trend of enhanced authorisation scrutiny is also seen in the cancellation of the authorisation of 627 firms that failed to meet the FCA's minimum standards or could not evidence that they were currently or intending to shortly exercise their permissions (the "use it or lose it" principle) in 2022 – a 30% increase from 2021. The implementation of the "use it or lose it" initiative highlights a shift in direction in authorisation scrutiny. In previous years, obtaining permissions on a precautionary basis by firms was commonly accepted. However, since "use it or lose it", firms are required to proactively review their regulatory permissions and prove that they are carrying out the regulated activities they are permitted to or face losing this permission with the FCA's ability to cancel permissions 28 days after an issued warning. Firms may also be aware with the rollout of the new Economic Crime Levy, which applied from April 2022, that a firm with unused or unnecessary permissions may find itself caught by the Levy where it holds permissions for activities caught by the Money Laundering Regulations. This will of course have a negative financial consequence for firms, compounded by the fact that the Levy is assessed on a firm's total income in the UK for both regulated and unregulated activities and not only on income generated from activities falling within the Money Laundering Regulations. We would recommend that, as part of horizon scanning, compliance officers consider a regular review of firms' held permissions and whether these are required for current or planned activities.
Following the collapse of the Silicon Valley Bank in the US (which impacted its UK operations) and the continuing economic pressures affecting businesses, it is expected that the FCA will use the baseline to closely monitor firms subject to financial, or other, stress which may lead to failure.
The FCA is currently considering feedback on the consultation and plans to publish a policy statement in Q3 2023. With the FCA aiming to embed ESG considerations in all aspects of its regulatory activity, businesses across different financial services sectors need to consider their approach to ESG issues.
We are closely monitoring the increased regulatory scrutiny on ESG. For example, in June, together with our European colleagues, we published a podcast exploring the impact that ESG has on the insurance sector.
If you would like to discuss any of the matters which arise in this article, please reach out to a member of our team.