Regulatory update: Q2 2018

Christopher Bond, Chartered MCSI, outlines key regulatory changes in the finance sector in the past quarter. The regulatory updates outlined below were originally published in the Q2 2018 print edition of The Review

From the editor

The world threatened to stop when the updated Markets in Financial Instruments Directive (MiFID II) started in January 2018. Thanks to massive preparations by firms and flexibility from the FCA, it didn’t. But much remains to be done on detailed implementation. And now there is a new challenge – the General Data Protection Regulation (GDPR), which started 25 May. A simple change on the surface but very time consuming in the detail. These two events have obscured a raft of other regulatory changes which this section describes for senior managers to confirm what their compliance departments should be doing. EU General Data Protection Regulation
GDPR was implemented on 25 May 2018. The next ‘elephant’ after MiFID II. It affects both wholesale firms (anti-money laundering (AML) individual information and staff lists) and retail (customer and staff) data. Some impacts – using data for marketing, including adviser lead lists, without specific consent are now illegal; the difficulty in identifying all individual data held on a firm’s different servers and employees’ computers; deciding whether you and your outsource providers are a ‘controller’ or ‘processor’; putting in place data processing governance, risk assessment, policies and procedures, eg, so that breaches can be notified to the regulator within 72 hours, training, systems tools and templates, and monitoring all of this.

Firms with branches and overseas head offices or outsource providers have complications. The FCA has indicated a thematic review of cyber protection by firms (“One of the things that is coming very fast on our to do list is resilience and cyber risk and appropriate protection of data”).

Comments were for insurance but likely to be applied to the retail investment sector in future. The Facebook data furore and the search of Cambridge Analytica’s offices by the Information Commissioners’ Office are indicative here.


It is clear that many firms and the regulator continue to struggle with implementation. Problem areas include: regulatory reporting; best execution; the portfolio 10% value drop rule (which platforms, stockbrokers and model portfolio managers firms are interpreting differently); the historic figure of past performance used in Key Information Documents; how to disclose fees and charges to retail and institutional clients (again different practices) and what is ‘research’, eg, trade ideas; how the inducements rules apply to ‘minor non-monetary benefits’ and whether if managers absorb research costs, they will increase fees to clients. The FCA is also struggling with transaction reporting (increased from 20 million to 30 to 35 million reports daily).

There is a change of tone on forbearance for late firms - Andrew Bailey, CEO of the FCA, said: “To be clear, it is not our intention to offer forbearance; we expect firms to comply with their obligations. But we thought it important to confirm that we would not use our enforcement powers in a disproportionate manner”. There is no sign yet of any follow up thematic review though research costs are the most likely area for one.


The conditional agreement on a transitional period is likely to encourage some firms from implementing their contingency plans. The Bank of England has issued guidance that ‘passporting’ will continue during it. However, the European Central Bank (ECB) says that this depends upon the Brexit final agreement (where there is disagreement on whether access should depend on the EU’s judgement on continuing equivalence (EU), or permanent unless rules diverge (UK). This leaves firms in a dilemma, particularly since the ECB has said that new licence applications for EU entities by UK firms must be made by June this year. A key issue for asset management is whether some EU countries, particularly France and Germany, will take a strong position on refusing EU entities’ ability to delegate investment management to UK firms (the Investment Association estimates that the UK manages £2.6tn of non-UK assets, including £900bn from Ireland and Luxembourg).The French AMF said: “When we give authorisation to new managers, we need to be sure that there are enough people to control the delegation”). There are similar wonders about ‘back-to-back’ trades between EU and UK entities, UK insurance companies writing policies for EU entities, and for all firms, concerns about bringing in EU nationals to the UK. Donald Tusk, European Council President, has said that a Canada-style free trade agreement is not consistent with mutual recognition of financial services.


The trend towards this is becoming irreversible with the UK government, regulator and large and small financial firms joining in. Some examples:

  • The FCA is taking its regulatory ‘sandbox’ global – and separately has signed a ‘bridge’ agreement with Australia for mutual recognition of fintech standards.
  • Big high street banks such as Barclays and RBS are offering incubators to fintech firms to provide future services to it.
  • They (and others) are promoting robo advice.
  • ‘Real’ robo advisers are ‘marching in’ using artificial intelligence.
  • Financial advisers are using machine learning to analyse large amounts of data to provide investment advice to clients.
  • Wholesale firms are driven towards fintech, particularly in executing trades (to meet new ‘best execution’ requirements), transaction reporting within milliseconds and recording electronic trades.
  • Even regulators are using it in their investigations of firms’ marketing materials (machine learning is “five times better” than random searches for finding “language that merits referral to enforcement”– US SEC).
  • Most importantly of all, big tech is partnering with big banks to provide bank accounts to users (eg, Amazon and JPMorgan), and stock exchanges and clearing houses grow increasingly concerned that big tech will provide infrastructure to firms (eg, using blockchain to settle trades). A fascinating parallel discussion is taking place on how big tech should be taxed. The EU, including the UK, is considering a tax based on revenues rather than profits; the US (where big tech is based) is resisting this.
Regulation of cryptocurrencies

The regulators disagree on whether these (such as bitcoin) should be regulated. The Japanese Financial Services Authority has done so. This has contributed to a market boom in it and others such as XEM, but it has been blamed for failing to supervise two large crypto platforms/ custodians (MountGox and Coincheck) which have collapsed through fraud. Regulators are aware of investor demand and are caught between allowing this and the risk of fraud and their use for the dark web. The European Banking Authority is cautious about regulating them, preferring to ban banks from supporting them. Mark Carney says they need to be “isolated, regulated or integrated” into regulation. “The time has come to hold the crypto-asset ecosystem to the same standards as the rest of the financial system. Being part of the financial system carries enormous privileges, but with them great responsibilities”. However, global regulators have decided to take no action for now. The FCA has also warned against fraudsters encouraging individuals buying cryptos. The Bank for International Settlements is concerned that its relationship with mainstream finance (eg, listing on the CME Exchange or opening accounts with banks such as Barclays) will cause systemic risk. The jury is out on whether they should continue without regulation, heavily regulated, for links with conventional finance prohibited or simply banned. The UK Treasury has announced the establishment of a ‘task force’ to “harness the benefits of this technology while guarding against the risks it poses” (perhaps a prelude to regulation). Investment managers are also having to understand how they work, and to consider whether they are becoming a mainstream investment. Bitcoin has halved in value from approximately £15,000 to £7,500 recently.
Financial Ombudsman ServiceHere are some figures showing its growth and why its funding is likely to change. Ten years ago the FOS had 350 staff and handled 20,000 cases. Today there are 4,000 staff handling 500,000 cases. Much of this is from Payment Protection Insurance (PPI) claims, but there is an important shift in its use. In the past it was the ultimate resort for unsettled claims; now it is the first port of call for both firms (through rejecting claims) and unhappy clients. After PPI claims finish, this shift will remain. The good news is that complaints against advisers fell 16% in H2 2017 (816 against 966 in H1 2017). Of these new complaints, 34% were upheld against 43% in the previous six months. However, a landmark judgment held a network responsible for the fraudulent activities of its appointed representative.

Firms' culture

Andrew Bailey has again focused on the culture of regulated firms as a current priority, but the FCA has learnt its influence on firms’ culture is only partial: “The question is not whether to focus on the individual or the broader organisational system. It is about examining the influences surrounding the individual, be it peers, managers, leaders, incentives, goals etc, and how aligned these factors are”. Interestingly, Barclays Audit Committee has “observed that the issues arising from unsatisfactory audits indicated that there was still work to do in embedding the required level of control consciousness across the group and ensuring that control exceptions were highlighted clearly in management reporting”. The latest Banking Standards Board survey of bank employees finds that 27% would still not speak out about a colleagues’ bad behaviour – for fear of trouble and futility of resulting action.


The media storm resulting from the publication of gender pay gap figures continues. There is a significant gap between the average bonus of men and women in finance. In some cases, eg, Goldman Sachs in the UK, it is as much as 67%, although only 36% on salaries. Goldman Sachs said: “Comparison of the average pay of all men at the firm compared with the average pay of all women at the firm, reflects our current reality that there are more men than women in senior positions in our organisation” this leaves the question of why, and also whether women get paid less than men in the same role. (Interestingly, HMRC figures show that the gap between investment income for women compared with men increased 150% between 2011/12 and 2015/16 from £9.6bn to £24 bn – one suggestion for this is that men get paid more earlier and without interruption). Andrew Bailey has thrown his weight behind this movement and has said that diversity in financial services firms can help improve culture, prevent ‘groupthink’ and poor customer outcomes.
Bank regulation

There is an important international debate on whether the bank regulation (both prudential capital and limits on their trading risks) introduced in the post-crisis reforms should be maintained or rolled back. The rollback movement is strongest in the US, on the grounds that banks hold the key to economic growth – the rollback being achieved mainly through Trump appointing reform-friendly leaders to regulators rather than law change (although there is a draft law before Congress that would remove mid-sized banks from Federal Reserve oversight). Non-US regulators are likely to follow the US, given the size of their banks and to avoid giving them competitive advantages, and the EU has in any event diluted the global prudential standards to suit, eg, on exceptional treatment for non-performing loans (think Italy). Mark Carney frets that reducing prudential capital will increase systemic risk in systemically important banks. The ring fencing of large retail banks in the UK is proceeding with much work, cost and glitches (Barclays has court approval for its ring fencing plans). One consequence of prudential capital requirements and banks’ reduction in lending is the rise of direct lending to business and individuals by non-banks, such as asset managers, hedge funds, private equity and loan/deposit matching platforms – increasingly to sub investment grade borrowers on covenant-lite terms. (Internationally, shadow banking grew to approximately US$45tn in 2017 – 13% of total global financial assets.) Loan amounts have increased too – up to £300m for a single loan. The European Securities and Markets Authority (ESMA) recommended non-bank lenders be regulated as banks, but the EU Commission decided against it.
Asset management

The revolution in asset management is close, according to the CEO of Jupiter Asset Management, Edward Bonham Carter. “Is it a slow inert industry that has arguably been buoyed up by high profits? Yes. Is it an industry that is going to look very different in ten years’ time? Yes, with or without regulators.” He cites fintech and machine learning and a “substantial reduction” in headcount. This could lead to large reductions in management fees, where Fidelity is leading the way. There are more radical fee ideas – for example, Mercer proposes a new relationship between manager and client under which the manager would guarantee a rate of return, and keep any outperformance. Japan’s Government Pension Investment Fund agrees: “Without excess returns, their fee must be equal to that of passive managers with the same amount of asset size.” On a commercial level, big UK platforms and advice firm consolidators (such as AFH) are beginning to flex their negotiating power to reduce fund management fees.

Morgan Stanley has recently warned that the asset management sector had missed the opportunity of the bull market to restructure its cost base – it sees a 20% saving from automation, and a 10% reduction from outsourcing some operations. Peter Hargreaves has criticised the difficulties in starting new funds – “This is because if they [the adviser] buy it, they have to show that they have ticked all the boxes, and one of those boxes is track record. So, unless a fund manager has worked at a very big firm, and the track record has their name on it, they can’t do it”.

Private wealth advisers

  • Key Information Documents (KIDs) continue to be contentious, particularly their projection of future returns, which can run into thousands of per cent, based upon the past five years and what is a ‘complex’ product (regulator review at the end of this year). Firms adjusting to handing out KIDs before investment can be made; continuing confusion over 10% portfolio drop rule – who is responsible for warning the client if there is a discretionary fund manager (DFM) and adviser and platform involved?
  • Legal uncertainty of self-invested personal pension (SIPP) providers’ responsibility where client or adviser has invested in unregulated investments through unregulated introducers (possible under regulation).
  • A lot of work preparing for GDPR.
  • Many firms still not MiFID II compliant, eg, on disclosure of all costs and charges, providing venue execution information to clients (FCA priority); and in notifying clients of changes to terms and conditions. There is also an interesting report on firm supervision and enforcement from the FCA which states its expectation that firms will take the initiative in taking remedial action in compensating investors without waiting for a FCA investigation – “If firms and individuals fully account for any harm caused, including putting it right where there are reasonable grounds to do so, we will consider this when applying sanctions”. Conversely, failure to take action or cooperate with the regulator may lead to a heavier penalty.


The FCA is under great political pressure to slow down the rate of transfers from occupational pension schemes. So boundaries on what is “suitable” advice are constantly shifting – dangerous for firms. There has been lots of enforcement action in this space – more than 20 advisory firms on pensions have been restricted or banned. PI premiums for some pension transfer advisory firms have increased dramatically. An FCA survey suggests that 48% of individuals with advisers do not know what fees they are paying, and (unsurprisingly) 73% of those without advisers – is transparency the solution to financial illiteracy? As importantly, the rate of pension drawdown is reducing where advisers are involved – but the number of drawdowns without their involvement is increasing. (Many pension providers now insist upon adviser involvement on transfers, but not so many on withdrawals). The FCA’s latest policy statement for advisers retains the presumption that transfers are unsuitable unless shown otherwise, requires deep knowledge of the investor and describes what the “appropriate pension transfer analysis” should look like.

This article was published in the Q2 2018 print edition of The Review.  The print edition is available to all members who opt in to receive it, except student members. All eligible members who would like to receive future editions in the post should log in to MyCISI, click on My Account/Communications and set their preference to 'Yes'. 

Views expressed in this article are those of the author alone and do not necessarily represent the views of the CISI.

Published: 29 Jun 2018
  • Operations
  • Wealth Management
  • Compliance, Regulation & Risk
  • Change
  • cryptocurrency
  • Mifid II
  • GDPR
  • Brexit

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