What do the product intervention powers of the UK financial conduct regulator look like?

In brief

Written by Senior Regulatory Counsel Michael Mathieson and Partner Matthew McLennan

If you have been following the Financial System Inquiry, you will not have missed the idea of giving the Australian Securities and Investments Commission (ASIC) additional 'product intervention' powers. These powers exist in the UK. What do they look like? This question is more relevant than ever right now, as the Financial Conduct Authority (the FCA) is about to use its temporary product intervention power for the first time.

Rule-making power

The FCA is authorised to make such rules applying to the organisations and people it regulates 'as appear to the FCA to be necessary or expedient for the purpose of advancing one or more of its operational objectives'. Its operational objectives relate to consumer protection, competition and market integrity.

This power is extremely broad. It is essentially a plenary power to legislate in relation to financial conduct matters. It brings to mind the very broad standard-making powers conferred on APRA in relation to prudential matters. (As an aside, the conferral of these powers on regulators can be troubling to anyone who values representative democracy and the separation of powers.)

The FCA's power can be used to intervene in the manufacture and distribution of financial products. Rules of this kind are 'product intervention rules'. If contravened, the rules may provide for a relevant agreement or obligation to be unenforceable, for money or other property to be recovered or for compensation to be paid.

The power can also be used to make rules prohibiting people from being remunerated in a specified way. It is difficult, and perhaps troubling, to imagine ASIC having the power to legislate its preferred set of FoFA provisions.

Requirement for public consultation

Before making a rule, the FCA must publish a draft for public consultation and it must have regard to any submissions it receives. The draft rule must be accompanied by an explanatory statement and, in some cases, a cost/benefit analysis.

The requirement for public consultation does not apply if the FCA considers that the associated delay would be 'prejudicial to the interests of consumers'. Nor does the requirement apply if the rules are 'temporary product intervention rules'.

Temporary product intervention rules

Temporary product intervention rules are product intervention rules made by the FCA where it considers that it is 'necessary or expedient' not to go through public consultation. This is a less demanding test than the general test (mentioned earlier) under which the associated delay must be 'prejudicial to the interests of consumers'. The trade-off (for the FCA) is that temporary product intervention rules cannot operate for more than 12 months. Further, they cannot be re-made once they have expired (although this does not prevent the FSA from making a permanent product intervention rule, if the conditions for doing so are fulfilled).

A policy statement (PS13/3) has been issued in relation to the FCA's use of temporary product intervention rules. The policy statement says:

Rules may range from requiring certain product features to be included, excluded, or changed, requiring amendments to promotional materials, to imposing restrictions on sales or marketing of the product or, in more serious cases, a ban on sales or marketing of a product in relation to all or some types of customer.

In exercising its power to make temporary product intervention rules, the FCA's main consideration is whether 'prompt action is deemed necessary'.

The policy statement sets out a 'governance process' for making temporary product intervention rules. In essence, an internal working group submits a proposal to a senior executive committee which then decides whether to put the proposal to the FCA board for final decision.

There are concerns about the use (and potential abuse) of the power as well as about the risk of challenge to an exercise of power. The FCA noted:

Some respondents [to the consultation on the policy statement] raised specific concerns about the risk of challenge if the FCA does not gather enough evidence before it acts. [Temporary product intervention rules] will be subject to the same forms of challenge as the other rules the FCA makes. The FCA will be subject to proportionate evidential standards, and will need to satisfy itself it has enough evidence to decide whether to make a TPIR. In considering this we expect a court to take into account the fact that Parliament intended these measures to allow prompt, temporary intervention.

When was the last time ASIC told a court what it expected the court to do?

The FCA's response to concerns that the power could stifle product innovation was that 'not all innovation is necessarily beneficial'. Its response might tend to reinforce the concerns.

Firing the first shot

On 5 August 2014, the FCA announced that it would use its temporary product intervention power for the first time, by restricting firms from distributing contingent convertible securities (CoCos) to the mass retail market from 1 October 2014. From that date, CoCos will only be able to be distributed to professional, institutional and sophisticated or high net worth retail investors. The FCA will consult on permanent rules later this year.

The FCA said:

Contingent convertible instruments (commonly known as CoCos) are hybrid capital securities that absorb losses when the capital of the issuer falls below a certain level. They are risky and highly complex instruments ...

The FCA's concerns about hybrid securities in particular, and complex products more generally, are shared by ASIC. In November 2011, ASIC issued a warning to consumers about hybrid securities (11-270MR) and its recent preoccupation with complex products is well-illustrated in REP 384 and REP 400.

ASIC's second round submission

There has been a lot of discussion of 'regulatory tools' and ASIC's second round submission to the FSI makes it clear it wants the FCA's 'toolkit'. ASIC is at pains to point out, quite correctly, that intervention in how financial products are distributed, marketed and designed in Australia is not new. However, to date this intervention has been largely by way of legislation and, according to ASIC, legislative processes are 'too slow and cumbersome'. ASIC specifically mentions the CoCos situation in the UK.

ASIC says that if its toolkit is expanded it will invariably choose the 'least interventionist tool' that is appropriate for the problem at hand. The question is whether the FSI, the Government and the Parliament are ready to take the step of delegating to ASIC the power to control how Australians can invest their money.