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Introduction to Compliance

Background

The word compliance is derived from the verb 'to comply', which means, 'to act in accordance with the rules'. In the context of financial services, it therefore refers to the need for those organisations that transact regulated activities to abide by the terms of the Financial Services and Markets Act 2000 (FSMA) and to act in accordance with the rules of the Financial Services Authority (FSA), the independent supervisory body established under the FSMA as the sole regulator of the financial services industry.

The rules cover nearly all sectors within the financial services industry, including banking, insurance, investment management and securities, and apply to a vast network of financial institutions, offering a multitude of financial services and products, who have to comply with them.

Regulated companies normally have a compliance department, headed by a Compliance Officer, whose role is to develop policy and practices that ensure all obligations and regulations are adhered to, as well as ensuring that no conflicts of interest arise within the organisation. This person is also responsible for maintaining the company's relationship with the FSA.

Some organisations also have to comply with the rules of other regulatory bodies. These include bodies that have had regulatory powers conferred on them by the FSA, such as the London Stock Exchange, in recognition of its role as a Recognised Investment Exchange, and other voluntary associations, for example, the General Insurance Standards Council, whose members agree to comply with a self-prescribed code of conduct.


Why regulate?

The primary reason all industries, from utilities to food and including financial services, are regulated, is to protect the consumer.

In the financial services industry, regulation aims to address the potential problem of the knowledge gap between financial experts who sell products and less informed consumers who buy them. It is difficult for the average consumer to properly understand the financial position of those institutions in which they are considering investing, partly because the market is so complex, and partly because it requires, time, information, skill and experience to make the best decisions. Regulation aims to ensure that the advisor helping people make those decisions is doing so as effectively as possible and in the best interests of the consumer.

In addition, many financial products are of a long-term nature, which makes after-sales service an important consideration. “Conduct of Business” regulation (which covers the standards that financial advisers must adhere to when conducting business with their customers), protects customers by forcing firms to maintain service levels throughout the length of a contract.

Financial services regulation also seeks to protect the industry against financial crime, as well as against a systemic failure of the economy, should one institution fail and cause a contagion effect, resulting in other failures. This is a concern that is particularly relevant for banks.

Regulation also works to minimise anti-competitive and monopolistic behaviour, as, without it, the size of some well-established financial organisations could act as a barrier to entry for smaller organisations, with larger companies using economies of scale to stifle competition and restrict choice for the consumer, leading to high prices.

It should be noted, however, that while regulation is in place to protect the consumer, firms pass on the costs of compliance to the consumer in the form of higher prices.


Current regulation

The main legislation that acts as the legal basis for financial services regulation is the Financial Services and Markets Act 2000. The FSMA received royal assent in June 2000 and was implemented on 1 December 2001, a date commonly known as "N2". It established the FSA as the sole regulator of the financial services industry, replacing the previous structure of SROs and RPBs and, as the FSMA came into force, much of the financial services legislation previously in place was repealed, including the FSAct.

Companies and individuals falling under the jurisdiction of the Act, who therefore require authorisation from the FSA in order to transact business include:

  • Banks
  • Building societies
  • Insurance companies
  • Investment and pensions advisers
  • Friendly societies
  • Credit unions
  • Lloyds
  • Stockbrokers
  • Fund managers
  • Derivatives traders
  • Professional firms offering specific investment services

A small number of bodies are exempt from authorisation:

  • Bank of England
  • European Central Bank
  • Central banks of the European Economic Area countries
  • Various government bodies

Virtually all financial products are regulated under the FSMA including deposit taking, debentures, futures, stocks and shares, unit trusts, investment trusts, collective investment schemes, open-ended investment contracts, gilts, individual savings accounts, life assurance, pensions, disability insurance and funeral plan contracts. Mortgages and general insurance (for example home and motor insurance) were also included under the FSMA from mid-2004 (section 6 refers).

The FSMA has provided the FSA with a full range of statutory powers, including the power to authorise, supervise, investigate and discipline authorised persons, to prosecute unauthorised market participants under civil law, and the right to 'recognise' investment exchanges and clearing houses. It has also made provision for the FSA to control financial promotions, as well as the regulation and marketing of collective investment schemes, and introduced a new market abuse regime. The Act established the Financial Services and Markets Tribunal and laid down the framework for the Financial Ombudsman Service and the Financial Services Compensation Scheme.

Under the provisions of the Act, the FSA has developed detailed rules and guidance, with which all authorised persons carrying on regulated activities must comply. The FSA Handbook, which documents all rules in place, is made up of a number of Sourcebooks, covering specific areas of regulation including;

  • High Level Standards
  • Business Standards (including Conduct of Business regulation)
  • Prudential regulation
  • Market Abuse
  • Money Laundering
  • Training & Competency

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