The FCA and Covid-19 preparedness: what should authorised firms be doing?
In the statement it makes clear that regulated firms must have contingency plans for the outbreak and that it expects firms to:
- assess operational risks;
- ensure that they are able to continue to operate effectively; and
- take steps to serve and support their customers.
The FCA stated that it expected firms to take all reasonable steps to meet their regulatory obligations, noting that these included the need to enter orders and transactions into systems promptly, use recorded lines and for staff to have adequate compliance support. The FCA further stated that it would have no objection to firms operating from backup sites or with staff working from home if firms were able to meet the required standards when doing so.
Perhaps unsurprisingly, therefore, the FCA does not give any public guidance to firms making difficult, potentially binary, decisions over the coming weeks between service continuity and compliance with systems and controls and market abuse obligations.
Key points for FCA regulated fund managers to consider
- Can the firm support its existing trading activity if the Covid-19 outbreak worsens significantly?
- Will services to customers be maintained at an appropriate level?
- How practicable is it for services currently provided from a central location to be provided by staff working from home?
What is the risk to fund managers of not preparing fully?
The FCA directs firms to “take all reasonable steps to meet their regulatory obligations” which are steps that are proportional to the nature, scale and complexity of the business.
A firm may argue that Covid-19 has created an emergency situation so that it would be reasonable for the firm knowingly to incur breaches, where this is necessary to ensure positive outcomes for customers, act in their best interests and treat them fairly. This is especially the case where a firm may feel that its duties to customers require it to continue to provide services even if the firm cannot comply with technical requirements imposed by the FCA.
The FCA handbook contains a provision governing “emergency” but sets out strict conditions that enable a firm to disregard an FCA rule if an emergency arises. The emergency would have to make compliance with the rule impracticable, outside of the firm’s control and not avoidable having taken all reasonable steps.
While Covid-19 is not therefore a general excuse to ignore FCA rules, our view is that the FCA is very unlikely to take action against a firm that can demonstrate it has weighed up the risks carefully and done its utmost to comply, but ultimately placed its customers’ interests at the heart of its decisions on what to do. Firms should however seek advice on the governance and mitigants they put in place to address any consequent rule breaches along with any Principle 11 notifications they may need to make as a result.
Operational effectiveness considerations
- Has the firm identified any areas where trading volumes or withdrawals of investments may be much higher than normal, counterparty risk may increase or there may be some other operational or financial stress placed on the firm as a result of market volatility created by Covid-19?
- What analysis has the firm done on the effect of Covid-19 on its service providers, particularly those providing critical or important outsourced operational functions and those in countries where there is a high incidence of Covid-19?
- What strategic, operational and investment decisions is the firm taking in response to this disruption, what scenario testing has it undertaken and how is it documenting these decisions and tests?
- What special governance arrangements has the firm put in place, including the designation of an individual senior manager who is responsible for the firm’s response to Covid-19?
- To the extent that the firm has a dedicated FCA supervision team, has the firm contacted the team to highlight any business services that may be at risk as a result of disruption caused by Covid-19 and how the firm is addressing these risks?
- To the extent that the firm does not have a dedicated FCA supervision team, has the firm considered whether it needs to make a notification under Principle 11 (Relations with regulators) or otherwise to the FCA on the disruption which Covid-19 may cause to the firm and how the firm is addressing this disruption?
Client protection and market integrity considerations
- Will staff working remotely be able to enter orders and transactions promptly into the firm’s trading and other systems to ensure good client outcomes and an orderly market?
- Will the firm’s systems and controls for monitoring and recording the discharge of conduct of business obligations, such as those related to best execution and generating best execution reports, be effective in covering the activities of staff working remotely?
- Has the firm tested whether staff working remotely are likely to increase the firm’s cyber security and financial crime risks and are its systems and controls effective in safeguarding client data and access to client and firm assets to which remote staff may have access?
- Are the firm’s market abuse surveillance systems and controls as effective for monitoring the decision-making and trading activities of staff working remotely and ensuring that it can make suspicious transaction reports with respect to such activities?
- Is the firm able to discharge its duty to record or copy telephone and electronic communications of staff working remotely, noting the need for consistency with its policy on the use of privately owned equipment?
- Where the firm has transaction reporting duties, is it able to discharge these duties effectively with respect to transactions executed or transmitted by staff working remotely?
- Will the firm’s systems and controls for monitoring counterparty exposures and gathering other data for the purpose of monitoring the adequacy of regulatory capital capture the activities of staff working remotely?
Reasonable steps and emergency?
The FCA directs firms to “take all reasonable steps to meet their regulatory obligations”. In the context of Covid-19 these would be steps that are commensurate with the nature, scale and complexity of the firm’s business that the firm can demonstrate are designed to identify and mitigate operational risks, ensure the firm's effective operation and are taken to serve and support their customers.
In our view the FCA handbook provision on “emergencies” must be read in this light. On the one hand, this provision is strict in its exposition of the conditions for an emergency allowing a firm to disregard an FCA rule if an emergency arises which:
- makes it impracticable for a firm to comply with a particular rule in the handbook;
- could not have been avoided by the firm taking all reasonable steps; and
- is outside the control of the firm, its associates and agents (and of its and their employees).
The handbook allows this only for so long as: (a) the consequences of the emergency continue; and (b) the firm can demonstrate that it is taking all practicable steps to deal with those consequences, to comply with the rule, and to mitigate losses and potential losses to its clients (if any). The handbook requires the firm to notify the FCA as soon as practicable of the emergency and of the steps it is taking and proposes to take to deal with the consequences of the emergency.
In this respect, the notion of compliance being “impracticable” for the purpose of reliance on the emergency provisions is similar to the doctrine of impossibility. The emergency provision, itself, is a type of codified necessity, reliance on which would require clear and unambiguous support.
The FCA notes in its guidance on the emergency provision that “an action is not practicable if it involves a person going to unreasonable lengths.” It is not enough, therefore, that compliance with the FCA rule in question is very inconvenient; it must be impossible or very close to impossible.
This is consistent with the very high bar imposed under the statutory framework for rule waivers and modifications under Financial Services and Markets Act 2000. In any event (and pending the end of the 2020 Brexit transitional period), this framework cannot apply to any rule which is derived from European Community (EC) law. The FCA has no discretion formally to waive rules such as those on telephone recording which are derived from EC law.
On the other hand, we would not expect a firm which wilfully causes significant detriment or loss to clients as a result of service interruptions to be viewed sympathetically by the FCA if it runs the argument that it had no choice and it was compelled to avoid incurring any technical rule breaches. Where firms make those difficult choices over the coming weeks it will be important for decision-making to be documented in detail and to demonstrate that everything reasonable was done to mitigate the risks.