Financial Services Act 2021

Schedule 2: Prudential regulation of FCA investment firms

Part 1: New Part 9C of the Financial Services and Markets Act 2000

540. Section 143A defines what is and is not an FCA investment firm. This is for the purpose of ensuring that the new rules apply to the appropriate range of FCA investment firms, and not investment firms designated by the PRA or exempt investment firms.
541. Section 143B, subsection (1) relates to the interpretation of other terms in Part 9C of FSMA.
542. Subsection (2) gives powers to HM Treasury to further specify by regulations the meaning of "on a consolidated basis", "group", of "parent undertaking" and of "subsidiary undertaking".
543. Section 143C, subsection (1) details the prudential requirements on which the FCA has a duty to make rules for FCA investment firms. These prudential requirements relate to capital and liquid assets, exposure to concentration risk, reporting, public disclosure, governance arrangements and remuneration policies. Taken together, these are the key prudential requirements relevant to investment firms. Paragraphs (a), (e) and (f) of this subsection are all requirements relating to the risks in subsection (2).
544. Subsection (2) specifies the types of risks relevant to the setting of these prudential requirements. These risks are self-explanatory. This subsection covers the risks posed by FCA investment firms (to consumers and to the integrity of the UK financial system) and risks to which they are themselves exposed. HM Treasury has a power to add to the list of risks.
545. Subsection (3) specifies that FCA investment firm rules can be imposed on investment firms at a range of levels of an FCA investment firm’s organisational structure. Subsection (3)(e) explains that the rules may make provisions by referencing the CRR, an instrument made under the CRR, and the law of the United Kingdom which was relied on immediately before IP completion day to implement the capital requirement directive. This is because concepts within the CRR may still be relevant for the purpose of making FCA investment firm rules. This is also the case in relation to section 143D(4)(e) in relation to rules made for parent undertakings. The remaining elements of subsection (3) are self-explanatory.
546. Section 143D specifies the duty on the FCA to make prudential rules in relation to parent undertakings, authorised under FSMA, of FCA investment firms for the purpose of complying with group prudential requirements. This duty is engaged only when the FCA chooses to exercise its general rule-making power under section 137A of FSMA. This section also introduces the FCA’s new duty to make rules for unauthorised parent undertakings where necessary or expedient for advancing the FCA’s operational objectives, which are set out in sections 1C, 1D and 1E of FSMA.
547. Subsection (2) specifies the types of risks relevant to the setting of these prudential requirements. These are risks posed by FCA investment firms, parent undertakings of FCA investment firms and by FCA investment firms belonging to a group (to consumers and to the integrity of the UK financial system), and risks to which FCA investment firms are themselves exposed through their parent undertakings. HM Treasury has a power to add to the list of risks. Subsection (4) reflects section 143C(3). Subsection (5) extends sections 137A(6) and 137A(7) of FSMA to the rules made for unauthorised parent undertakings. Subsection (6) disapplies the prohibition in s.137A(6) of FSMA to allow the FCA, in making rules, to modify the CRR or instruments made under it. Subsection (7) applies section 137H of FSMA where the FCA makes rules relating to non-authorised parent undertakings of FCA investment firms. This will allow remuneration provisions in employment contracts issued by non-authorised parent undertakings in breach of rules to be voided, and payments made under the void provision to be clawed back. Subsection (8) will give HM Treasury the power to direct the FCA to consider whether the remuneration policies of those non-authorised parent undertakings comply with the regulator’s rules. HM Treasury will be obliged to consult with the regulator before issuing them with a direction to undertake a review. Subsection (9) applies s.141A FSMA to the exercise of the FCA’s power under s.143D(3). Subsection (10) is self-explanatory.
548. Section 143E gives the FCA powers to make rules in relation to parent undertakings (whether authorised or not). Subsections (1) and (2) set out that the FCA is not generally required to make rules where a group includes a UK credit institution or a PRA-designated investment firm, but it may do so. Subsection (3) allows the FCA to make rules to require parent undertakings to disclose information about the group’s branches or subsidiaries outside the UK. Subsections (5) and (6) specify that section 143D(4) and (6) of FSMA also apply to rules made under this section, and section 143D(5), (7), (8) and (9) applies to rules made under this section applying to non-authorised parent undertakings as it applies to rules made under section 143D(3).
549. Section 143F requires the FCA to publish a list of all of its Part 9C rules.
550. Sections 143G and 143H introduce new accountability requirements for the FCA (taken together, these two sections will be referred to as ‘the accountability framework’). The accountability framework reflects the increased responsibility given to the FCA for setting prudential requirements for investment firms which is granted to them through this Act and provides structure to its rule-making power. It ensures the FCA considers additional policy priorities that HM Treasury has identified as relevant to the IFPR, and which are not currently captured within the FCA’s statutory obligations. It also aims to increase transparency of how these policy priorities will impact rulemaking by the FCA through the reporting requirement.
551. Section 143G requires the FCA to have regard to a new list of matters specified in this section when making Part 9C rules. When having regard to the likely effect of the FCA’s Part 9C rules on these matters, the FCA should consider both their positive and negative effects. Subsections (3) and (4) include a further matter for the FCA to consider when making Part 9C rules – the effect of these rules on equivalence decisions specified as relevant by HM Treasury, including decisions made by the UK, and for, the UK by any international jurisdiction. The Government retains responsibility for international relations, which includes equivalence arrangements between the UK and other international jurisdictions. Therefore, the matter of equivalence is treated differently to the others, with a requirement for the FCA to consult HM Treasury in this area. The Government has been clear that financial services equivalence will be judged on outcomes and therefore the FCA’s considerations of equivalence will follow this.
552. Section 143H imposes a new obligation on the FCA when it a) publishes consultations on draft Part 9C rules and b) makes final Part 9C rules. In both these scenarios, the FCA will be required to publish an explanation of the way in which having regard to the new matters listed in section 143G(1) has affected their draft or final rules. When the FCA makes final Part 9C rules, it must also publish a summary of their purpose. This is intended to increase transparency about FCA rulemaking when it implements prudential rules for investment firms and any further material updates to this regime.
553. Section 143I sets out the situations in which the accountability framework in sections 143F and 143G does not apply. Subsection (1) notes that the accountability framework does not apply where the FCA makes Part 9C rules following a direction or recommendation given by the Financial Policy Committee (FPC) of the Bank of England. This is because the FPC has an existing secondary objective to support the economic policy of the Government, and so they are already required to consider public policy priorities set by the Government.
554. Subsection (2) is self-explanatory.
555. The accountability framework is intended to apply on an ongoing basis, including to material rule changes where the FCA updates Part 9C rules in the future. Subsections (3), (4) and (5) exempt immaterial modifications to these rules from the accountability framework.
556. Section 143J allows the FCA to require two or more FCA investment firms, who are subsidiaries of the same parent undertaking with its head office outside the UK, to secure the establishment of a parent undertaking with its head office within the UK. Such a requirement may be imposed when the FCA determines that the third country supervision of the parent undertaking does not impose requirements which have equivalent effect to Part 9C rules.
557. Section 143K allows the FCA to impose, vary or cancel additional requirements on parent undertakings which are not authorised under FSMA, either on its ‘own initiative‘ or on the application of a parent undertaking. This mirrors the existing powers the FCA has for authorised parent undertakings under section 55L FSMA. The FCA’s own initiative powers may only be exercised by the FCA to address the risks in section 143D(2) where it is desirable to do so in order to advance any of its operational objectives.
558. Section 143L relates to the form and manner of applications of unauthorised parent undertakings for the imposition or variation of additional requirements under section 143K.
559. Section 143M imposes an obligation on the FCA to determine an application under section 143K.
560. Section 143N clarifies that if the FCA proposes or decides to refuse an applicant, the FCA is under the obligation to notify the applicant appropriately (either through a warning or a decision notice).
561. Section 143O relates to the FCA’s exercise of its powers under section 143K without an application from an unauthorised parent undertaking. Section 143O imposes an obligation on the FCA to notify by written notice the unauthorised parent undertaking when the FCA proposes or exercises its own-initiative powers under 143K. Subsection (4) sets out what the written notice must cover.
562. Section 143P explains the unauthorised parent undertaking’s rights to refer matters which relate to section 143K to the Tribunal.
563. Section 143Q makes provision where requirements are imposed under section 143K which prohibit the disposal or dealing of the unauthorised parent undertaking’s assets, or require assets (including those of customers) to be transferred to a trustee approved by the FCA. Under subsection (7), a person will commit a criminal offence if assets held by a trustee are released or dealt with without the consent of the FCA.
564. Section 143R aims to ensure that managers of parent undertakings of FCA investment firms which are not authorised under FSMA are fit for the role they occupy, by requiring non-authorised parent undertakings to ensure managers are of sufficiently good repute, and have the appropriate knowledge, skills and experience.
565. Section 143S relates to prohibition of individuals performing an activity in relation to unauthorised parent companies. It sets out the scope of prohibition orders, which the FCA is given power to make, should an individual not possess the appropriate knowledge, skills and experience described in section 143R.
566. Section 143T sets out how the FCA may issue a warning notice – in cases where the FCA proposes to make a prohibition order – or a decision notice – in cases where the FCA decides to make a prohibition order – to an individual.
567. Section 143U sets out that a recipient of a prohibition order can apply to have their prohibition order changed or revoked. The FCA must inform the applicant of its decision in the appropriate way (either by written notice, warning notice or decision notice).
568. Section 143V specifies that if an individual breaches a prohibition order, they have committed an offence. Subsection (2) specifies the penalty for committing the offence. Subsection (3) specifies that if an individual took all reasonable precautions and exercised due diligence to avoid committing the offence, this is a defence.
569. Section 143W relates to disciplinary measures for unauthorised parent undertakings. It sets out the extent of disciplinary powers at the FCA’s disposal should an unauthorised parent undertaking breach a provision of Part 9C rules, a requirement imposed under section 143K or section 143R and section 143S(6).
570. Section 143X specifies the procedure for disciplinary measures against unauthorised parent undertakings. It sets out that the FCA must issue a warning notice and if it decides to take action must issue a decision notice to individuals, as well as specifying the required contents of the warning notice or decision notice.
571. Section 143Y relates to the statement of policy for penalties under section 143W, including with respect to the issuance, and the amount, of penalties; and the matters the FCA must have regard to when setting out its statement.
572. Section 143Z specifies the procedure for the statements of policy under section 143Y and is self-explanatory.

Part 2: Further amendments of the Financial Services and Markets Act 2000

573. Part 2 of Schedule 2 makes further amendments to FSMA to ensure that matters relating to disciplinary, enforcement and other procedures work as intended in law.

Part 3: Transitional provision

574. Part 3 of Schedule 2 concerns rules made, and consultations conducted prior to the provisions in new Part 9C of FSMA coming into force. It specifies that the FCA may fulfil its duty to make rules for FCA investment firms through existing rules, and that these existing rules are not retroactively subject to the accountability framework described in sections 143G and 143H. After this Schedule comes into force, the FCA must publish a list of such rules and a statement which explains how the FCA has considered the risks in sections 143C(2) and 143D(2) as well as the matters in section 143G(1) and the likely effect of the rules on equivalence decisions, when determining that such rules should be Part 9C rules. The FCA may also rely on consultations conducted prior to the commencement of Part 9C. Paragraph 21 specifies what counts as a relevant equivalence decision and paragraph 22 sets out that the carbon target described in section 143G(1) applies to Part 9C rules made after 1 January 2022. Paragraph 23 is self-explanatory.