Appendix 3: response from the Financial
Service Authority (FSA)
1. We welcome the Committee's report on Local
Authority Investments. In this memorandum we respond to those
conclusions and recommendations which are relevant to the FSA.
In particular we describe the framework, set out in the Financial
Services and Markets Act 2000 (FSMA), which underpins our regulation
of certain services provided by FSA-regulated firms to local authorities.
2. Given the events that led the Committee to
undertake this inquiry, we understand that your main concern centres
on the decision by local authorities to place deposits in Icelandic
banks and on the advice that local authorities received to make
this decision. As we explain in this memorandum, advising on deposits
is not a regulated activity and therefore we do not monitor the
activities of regulated firms in this area.
3. We understand from paragraphs 119 and 120
of your report that you believe that we were seeking to be deliberately
unclear in our answers to your questions and that you also believe
that we were not discharging our regulatory duties under FSMA.
You ask that the FSA take a more active role in the regulation
of treasury management advisors and conduct an investigation into
the services they provide.
4. For the reasons explained in our earlier memorandum
to the Committee and the further answers that we provided, the
application of FSMA regulation to the activities with which the
Committee's inquiry was concerned is limited, and not straightforward.
For this reason it would not be appropriate for the FSA to carry
out the investigation, recommended by the Committee, of the services
provided by local authority treasury management advisers. An investigation
of this kind by the FSA would be appropriate only if the FSA's
scope were extended to cover many more of the activities in question.
This would be a matter for Government to decide. In those circumstances
we would, of course, seek to address the concerns you raise.
5. For future reference, if the Committee would
like further written or oral evidence from us before they finalise
a report, we would be happy to provide it.
Regulation of Treasury Management Advisers (Paragraph
120 and 121)
6. The Financial Services Authority (FSA)
should take a more active role in the regulation of treasury management
advisers. The evidence which we have examined has raised concerns
about potential conflicts of interest and questions as to whether
there are any financial transactions between treasury management
advisers and brokers that might compromise the independence of
advice being given to local authorities. There is a strong case
for a full investigation by the FSA of the services provided by
local authority treasury management advisers. We recommend that
such an investigation be carried out as soon as possible. (Paragraph
120)
7. Our examination of the role of treasury
management advisers in the Icelandic debacle has raised wider
questions about their influence on local authorities' treasury
management practice. First, there is confusion, and perhaps some
deliberate ambiguity, about what services they offer. It is clear
to us that some local authorities believed that they could place
reliance on their treasury management advisers in a way that some
of the treasury management advisers themselves now seek to argue
was misguided. Second, there is concern about the independence
of treasury management advisers that may be part of companies
that will benefit from the investment decisions of the local authorities
that they advise. Third, there is a lack of clarity about the
extent to which local authorities can assume that treasury management
advisers are properly regulated. While local authorities must
ultimately take responsibility for their investment decisions,
a range of regulatory and advisory bodies appear to us to have
been complacent in their approach to the role of treasury management
advisers. The Audit Commission, CIPFA and the FSA must all re-examine
the role and reliability of treasury management advisors and their
discharge of duties of care for local authorities in managing
this aspect of treasury management. (Paragraph 121)
Legal position
8. The activities for which FSA authorisation
is required (regulated activities) are set out in legislation
- the Financial Services and Markets Act 2000 (Regulated Activities)
Order 2001. Changes to the definition of regulated activities
are therefore a matter for HM Treasury and Parliament. Firms conducting
regulated activities in the UK must apply to the FSA for authorisation,
and we are responsible for regulating only those firms that we
authorise. It is important to note that firms which we authorise
commonly carry out a range of activities, only some of which we
regulate; we explain below the relevance of that principle to
this case.
9. Treasury management departments within local
authorities do not require authorisation by the FSA. In line with
the overall approach set out in paragraph 8, whether a separate
organisation providing services to a local authority to assist
it in its treasury management requires authorisation by the FSA
depends on whether that activity is a regulated activity as defined
by FSMA. In that context the following points are important:
a) A deposit by a local authority is not a regulated
deposit under legislation.
b) Moreover, advising on deposits is not a regulated
activity. Therefore advising a local authority to place its deposits
with a particular bank is not a regulated activity.
c) Equally, carrying out deposit-broking services
(for example, arranging for a client's money to be invested in
deposits with particular banks) is not a regulated activity.
d) Broadly speaking, advising on buying and selling
government or private sector debt securities requires authorisation
if the advice relates to specific transactions. Broader strategic
or generic advice (for example 'we recommend that you invest in
sterling denominated debt securities') are not regulated activities.
e) Broking and arranging activities in relation
to these investments are also usually regulated activities.
10. Broadly, our rules do not apply to activities
that are not regulated activities. However, if non-regulated activities
(for example, advising on deposits) are conducted alongside regulated
activities (for example, advising on investments), certain FSA
rules (such as the suitability rules referred to below) apply
to the nonregulated activities as well as the regulated activities.
11. As others have pointed out in their evidence
to the Committee, many of the rules governing regulated activities
derive from the Markets in Financial Instruments Directive (MiFID).
Broadly, under this legislation, the FSA is not allowed to set
more stringent rules than those in MiFID, including the rules
referred to in paragraph 12 and 13.
12. If the firm gives regulated advice to any
client, the suitability rules will apply: broadly, a firm must
take reasonable steps to ensure that the advice it gives its client
is suitable for that client.
13. Generally, local authorities are 'professional
clients' under the rules set by MiFID. The scope of a 'professional
client' is determined by MIFID and our rules reflect the MIFID
requirements. MiFID provides a lower standard of protection for
professional clients. A regulated firm is entitled to assume that
a professional client has the necessary level of experience and
knowledge to understand the risks involved in the transaction
when assessing the suitability of advice being given. So if advice
is given to professional clients, the regulated firm is entitled
to assume that the client is financially able to bear any related
investment risks. Professional clients do not have access to the
Financial Ombudsman Service.
14. The Committee also expressed interest in
what information the FSA makes available to local authorities
about regulated firms and their activities. All firms regulated
by the FSA are listed in our Register, which is publicly available
on our website. FSMA sets out what we must include on the Register
of regulated firms (for example the name of the firm, the regulated
activities the firm holds itself out as able to provide, a suitable
business address for the firm and the name of any approved persons
carrying out controlled functions in the firm). FSMA also requires
us to include other information that we deem appropriate for the
public record. Under this heading we include any publicly available
disciplinary history of a firm or individual and the regulatory
history of a firm or individual for the benefit of consumers and
market participants.
The FSA's supervisory approach
15. For the reasons explained above, we do not
regulate much of the activity carried out by the firms which provide
services to local authorities. To the extent that we do regulate
activities they carry out, we take a risk-based approach, taking
into account the risk posed to the market and to consumers by
the firm's regulated activities.
16. Where firms form part of a wider group (for
example; Sector Treasury Services Ltd is a small firm which is
part of the Capita Group Plc. Butlers is the trading name of a
division of ICAP Securities Ltd), we supervise them as part of
the group. The extent to which we focus specifically on individual
firms within the group depends on their size and their risk profile
within the group. In their own right, Sector and Butlers are significantly
below the size threshold to warrant a risk assessment. However,
as they are both part of wider groups, we take their business
into account when we carry out our risk assessment of the wider
group.
17. Sterling Bank and Arlingclose Ltd are small
independent firms, not part of a wider group. We do not routinely
carry out risk assessments of these firms but instead we monitor
the information (covering, for example, financial position, volume
of business, number of complaints received) which we require firms
to submit to us regularly.
Conflicts of interest
18. The FSA takes potential conflicts of interest
within firms very seriously. Principle 8 of the FSA Principles
for Business states 'A firm must manage conflicts of interest
fairly, both between itself and its customers and between a customer
and another client'. The FSA Handbook develops this principle
in detailed systems and controls rules which prescribe that firms
must (i) identify conflicts of interest, (ii) manage those conflicts
to prevent them from harming their clients interests, and (iii)
in the case that conflicts can not be managed, firms must disclose
them to their clients. Compliance with this Principle and our
rules is monitored through our risk assessment process.
19. The FSA also regularly undertakes thematic
supervisory work across a range of authorised firms in a number
of areas, including conflicts of interest. The main objective
of this thematic supervisory work is to promote good practice
across particular industry sectors of the firms we regulate and
to pinpoint and remove bad practice.
Review of Treasury Management (Paragraph 156)
20. We seek reassurance that regular meetings
at an appropriately senior level are held between the Audit Commission,
the local authority associations, CIPFA and CLG to ensure that
the treasury management system is kept under review. We also recommend
that these meetings include links with the financial regulatory
bodies—the Financial Services Authority and the Bank of
England—to ensure consistent and up-to-date information
is passed onto these bodies. (Paragraph 156)
21. There is a well-established framework for
such communication: the Capital Programmes Working Party (CPWP).
This is a forum for the discussion of capital finance, treasury
management, accounting and all related issues. Its members are:
the Department for Communities and Local Government (DCLG); HM
Treasury; other Government departments interested in local government
capital spending; the Local Government Association; London Councils;
CIPFA; the Audit Commission; the National Assembly for Wales;
the Scottish Executive. We understand that the Capital Programmes
Working Party (CPWP) already fulfils the Committee's expressed
desire for regular meetings between these groups. We also understand
that the DCLG is considering, with HM Treasury, how best to establish
links between the CPWP and the FSA.
Regulatory scope
22. As we have explained, the extent of our jurisdiction
over the activities with which the Committee is concerned is very
limited. It would therefore not be appropriate for us to take
a more active role in the regulation of treasury management advisers.
Decisions to extend our jurisdiction to cover other activities
relating to advice given to local authorities are a matter for
Treasury. The Government's recent White Paper on financial services
does not propose any changes in this area. We would like to assure
the Committee that we will continue to be active in our supervision
of the firms where we have responsibility for their conduct of
business.
- Finally, if the Committee has specific evidence
that FSA-regulated firms have not complied with the applicable
regulatory standards in carrying out FSMA regulated activities
for local authorities, we would invite you to send it to us so
that we can look into it.
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