The FCA sets out its approach to authorising international firms

The FCA has published a consultation paper, CP 20/20, in which it sets out the approach it intends to take with international firms that require, or will require, authorisation to carry on regulated activities in the UK. Such firms have a choice between incorporating a UK company or establishing a branch in the UK.

While the authorisation process for a UK incorporated entity is well-trodden, the FCA sees heightened potential for risks with branches and therefore is aiming to produce guidance on how such risks should be mitigated and its approach to authorisation of international firms in general. It has in mind, in particular, the anticipated influx of authorisation requests when firms exit the UK’s Temporary Permissions Regime (TPR) – although the CP is relevant for any international non-EEA firms operating (or intending to operate) in the UK via a branch.

The note below looks in some detail at the various comments the FCA makes and steer that it gives. The CP, though, raises a number of issues which affected firms should start to think about now, particularly those firms looking to identify the most appropriate exit route from the TPR when the time comes.

Among these firms will want to consider:

• what activities they intend to carry on in the UK, whether these activities are regulated and whether it will be possible to carry on such activities from a UK branch (see “Does this affect me?” below for further details on this);
• the broader implications for the rest of the firm that result from FCA authorisation. The FCA makes it clear that authorisation applies to the whole firm, not just the UK branch, and firms will want to consider the implications of one entity being subject to two regulatory regimes. (see “What will authorisation mean for the rest of the firm?” below); and
• whether any risk mitigants required by the FCA or limitations/conditions on the firm’s permission profile would be unduly restrictive.

We expect international firms will welcome the flexibility offered by the FCA, although further clarity will be needed before firms can make any final decisions.

What’s new?

CP 20/20 sets out how the FCA intends to deal with international firms that require, or will require, authorisation. The CP contains no proposals for changing the existing rules or minimum authorisation standards. In fact, the FCA congratulates itself that the approach it has taken to date to the authorisation and supervision of international firms has been “appropriate and proportionate”.

So why has the FCA published the CP?

The FCA is anticipating a significant increase in the number of international firms which will be looking for UK authorisation. This is because, once the EU withdrawal transition period ends on 31 December 2020, EEA firms which currently operate in the UK under the passporting regime (and who have not taken advantage of the TPR) will no longer be able to do so and (in broad terms) will need either to become FCA-authorised or cease performing regulated activities.

Ahead of this increase, then, the FCA thought it worthwhile to set out, in a public document, how it approaches the authorisation and supervision of international firms and the factors it takes into account when making its decisions.

So, the CP will have widespread relevance for such firms, not least in helping them understand what expectations the regulator will have of them when they exit the TPR – at that point, firms have to decide whether to apply for FCA authorisation as a UK branch or a newly incorporated subsidiary, consider alternative options (such as exemptions under the Regulated Activities Order or becoming an appointed representative), seek to rely on the Financial Services Contract Regime to service pre-existing contracts or cease its regulated activities in the UK.

(The FCA has previously announced that the TPR window will re-open on 30 September 2020. For more information on the TPR, see our earlier update from 2018 here. Note that the terms 'no Brexit' or 'hard Brexit' now mean should a trade agreement not be reached before 31 December 2020 – but the overall principles of how and when the TPR would be used remain the same.)

What happens next?

The consultation period for CP 20/20 closes on 27 November 2020.

The FCA then intends to publish a final document in which it will explain its general approach to international firms.

Does this affect me?

The CP is relevant to international firms that require FCA authorisation (as a result of carrying on regulated activities in the UK), including:

• EU / EEA firms that have notified the FCA of their intention to join the TPR (or intend to do so) and will need to be authorised on exiting the TPR; and
• non-EU / EEA international firms that are already authorised in the UK or have applied – or intend to apply - for authorisation.

On the other hand, it doesn’t apply to certain types of firm (set out in para 1.6 of the CP). These include:

• firms which don’t need to be authorised in order to operate in the UK (for example, if they’re relying on the Overseas Person Exemption under the Regulated Activities Order);
• AIFMs – after the transition period only firms with a UK registered office can be authorised to manage an AIF in the UK;
• depositaries, trustees and managers of UK authorised funds (including UK UCITS) – such entities need to be incorporated, and their affairs administered, in the UK; and
• benchmark administrators.

The reference to ‘AIFMs’ above, though, could lead to some difficulties in interpretation – especially in the context of EEA UCITS becoming AIFs under the UK’s post-transition regime - and is an area which might benefit from additional clarity in the FCA’s final guidance.

Take, for example, the position of the UK branch of a Luxembourg UCITS ManCo, which carries on portfolio management for a Luxembourg UCITS.

Following the end of the Brexit transition period on 31 December 2020, the Luxembourg UCITS will become an AIF and only firms with their registered office in the UK will be able to obtain permission to manage an AIF.

While you could argue that portfolio management is a “UK MiFID” activity (which would allow the branch permission to carry on portfolio management etc), the fact that the client is an AIF (for UK purposes) could make the branch the UK AIFM of an AIF (the Lux UCITS), especially if risk management was carried on from the UK. In which case, these activities couldn’t be carried on from a UK branch.

Finally, dual-regulated firms will also need to check what the PRA has said about branches of international banks / insurers.

I need to be FCA authorised - what will the FCA look at?

The FCA will ordinarily authorise UK branches of international firms if they (a) meet the general authorisation requirements (see, for example, the FCA’s approach to authorisation guidance and, in particular, the threshold conditions) and (b) have good risk mitigation in place.

(a) Do I meet the authorisation requirements?
When considering whether to grant authorisation to a UK branch of an international firm, the FCA will assess the firm against its minimum standards and general expectations, for example:

• effective supervision
  is the firm capable of being supervised effectively? Will the FCA, for example, have access to relevant information? Will it be able to conduct ongoing monitoring and /or effective regulatory interventions?
• active place of business
  does the firm have an active place of business in the UK? If its presence is little more than just a UK registered address, this will ‘typically not suffice’.
• home state jurisdiction
  what’s the home state jurisdiction of the firm? How comparable are its regulations, its wind-down plans, its prudential regulation etc? How far does it implement (and comply with) relevant global standards? How good is its cooperation with the FCA (for example, when it comes to exchanging confidential information)?
• appropriate financial and non-financial resources
  the FCA will consider both outsourcing by the firm as well as the extent to which a branch relies on services from other locations of the firm.
• Senior Management and Certification Regime
  How far can the firm comply with the SM&CR? The CP notes that this regime applies proportionately to international firms with a UK branch, but also points out that the FCA would “typically expect senior managers who are directly involved in managing the firm’s UK activities to spend an adequate and proportionate amount of their time in the UK to ensure those activities are suitably controlled.”
• decision-making structures
  Are the branch’s adequate? The FCA expects individuals who are responsible for the day-to-day management of the UK branch activities to have sufficiently independent decision-making powers and to exercise independent challenge over strategic decisions that affect the wider firm.

(b) How do I mitigate against risks of harm?
While the FCA will also consider risks which are relevant to the firm’s specific sector and business model, the CP outlines three broad areas of potential risk which three FCA identifies as being ‘particularly relevant’ for international firms performing regulated activities from a UK branch:

a. Retail harm

Where an international firm conducts regulated activities with UK retail customers there is a risk that those customers will not be able to obtain full redress under the relevant UK rules since this may depend on the cooperation of the international firm’s head office or, where the firm is insolvent, the position of UK consumers under the home state’s insolvency rules and/ or the FSCS.

Because the FCA has noted that such cases are more likely where the firm exhibits factors such as:

• inappropriate sales practices resulting from poor governance
• inadequate disclosure of product information
• inadequate conflict management
• systems and controls flaws
• failure to hold adequate professional indemnity insurance and capital to meet liabilities

it pays close attention to these when assessing any firm for authorisation, but notes the increased risk posed by international firms.

b. Client assets harm

Where an international firm safeguards client assets from a UK branch or holds client money, it will usually need to comply with UK client asset rules (in particular, CASS) while it is a going concern. Any mismatch between UK protections and the laws in the firm’s home state could have a negative impact on the protection the client receives.

For example, if the firm becomes insolvent, protections offered under CASS may not apply (or may not apply fully) if the insolvency is administered in line with the home state’s laws.

As there is little harmonisation in insolvency law at an international level, when it comes to assessing what harm could be caused in particular situations, the FCA is likely to consider:

• whether the rights of UK clients to their assets would be recognised under the insolvency regime in the firm’s home state;
• whether client assets will be segregated from the firm’s general estate at the point of insolvency; and
• whether client assets safeguarded from the UK branch would be distributed in a timely fashion.

c. Wholesale harm

The FCA will also consider the risk that could originate from the firm’s overseas offices to UK markets in which the UK branch operates.

Common factors which would tend to increase the risk of “wholesale harm” include:

• where the products or services that the firm offers in the UK market are not readily substitutable;
• where the firm occupies an important position in the UK market; and
• where the firm interconnectedness to other firms in the industry, so risk in the system would be amplified rather than reduced.

Firms will need to demonstrate to the FCA how they intend to mitigate these risks - section 4 of the CP sets out a number of ways in which these risks could be mitigated and firms which may be affected by the CP should spend time in analysing these.

When deciding to authorise a UK branch, the FCA can also impose limitations to or conditions on the firm’s permission profile in order to mitigate risks. If the FCA is not satisfied that risk can be adequately mitigated by the international firm operating via a branch but could if the relevant activity was undertaken through a UK entity, the FCA can ‘invite’ the firm to apply for authorisation on that basis.

What will authorisation mean for the rest of the firm?

The FCA makes it clear that authorisation will cover the whole firm (including its UK and overseas offices) and identifies that this may have an impact on services provided by the firm to UK clients from outside the UK. International firms will also want to know what this means for FCA oversight of the whole firm and may be concerned that establishing a UK authorised branch will result in it being subject to two (potentially divergent) regulatory regimes. The CP refers to effective supervision of the firm and cooperation with home state regulators but there is limited indication from the FCA as to how this would play out in practice, although it is clear that the FCA’s primary focus will be UK customers and the integrity of the UK market. Indeed the FCA itself is concerned with jurisdictional differences, the potential for overlap between UK and home state regulations and how this would affect the FCA’s ability to take certain actions against international firms.