Financial services claims - insuring the FCA’s discretion

In October 2024, the Court of Appeal held that the Financial Conduct Authority (FCA) can compel firms to give redress to their clients, even absent any strictly legal claims on the part of those clients, as a condition for being permitted to continue their regulated financial services business.

In other words, the regulator can put the following choice to regulated firms: pay client redress as we order - or shut up shop.

This judgment is highly relevant to financial lines insurers. The cover provided under insurance policies is, generally speaking, for the indemnification of legal liabilities. Redress payments that are imposed as a matter of a regulator’s discretion will not ordinarily fall within the scope of cover, but in theory may be covered depending on the precise terms of any coverage extensions in place.

This is an ever-growing area of risk that financial lines insurers and their policyholders will want to manage prudently.

Background

The FCA is the UK financial services regulator. BlueCrest Capital Management (the Respondent) is an FCA-regulated investment fund manager.

In September 2021, the FCA sought to impose a requirement on the Respondent – as a condition for it to have continuing permission to carry out its regulated financial services activities - that it pay redress to its clients for the alleged failure to manage conflicts of interest fairly. The value of this redress was estimated at more than USD 700 million.

In doing so, the FCA relied on the Financial Services and Markets Act 2000 (FSMA), which gives it the power to impose requirements on firms as a condition of granting permission for them to carry out regulated activities, in accordance with the FCA’s statutory objectives. One such objective (under s.1C of FSMA) is “securing an appropriate degree of protection for consumers.” The Respondent referred the matter to the Upper Tribunal. 

As a matter of law, a breach of an FCA Principle (as opposed to one of the more specific Rules in the FCA Handbook), causing an individual to suffer loss, does not give rise to any actionable claim by that individual.

Accordingly, the Respondent argued that the FCA did not have the power to compel it to offer redress to its clients – under the threat of otherwise withdrawing its regulatory permissions - unless the clients would have actionable legal claims against it, including the elements of breach of duty, causation and loss.

The Upper Tribunal ruled that the FCA did not have the power to impose such a redress requirement. The FCA appealed to the Court of Appeal (the Court).

A Wide Measure of Regulatory Discretion

Applying the language of FSMA, the Court held that the FCA does have the discretion to impose the payment of redress to clients as a condition of firms’ continued regulatory permission, even when the clients themselves would not have any actionable legal claim. The Court stated that it was:

“neither surprising nor objectionable that the FCA, as the specialist and expert regulatory body, should be afforded by Parliament a wide measure of subjective discretion in seeking to achieve the defined statutory objectives.”

The scope of the FCA’s discretion is wide, even extending to conduct beyond the scope of the firm’s regulated activities. The court stated:

“If an authorised person has engaged in inappropriate but not illegal behaviour outside the regulated activity workspace, such as rudeness or bullying which has caused distress or inconvenience, the FCA might rationally take the view that some redress was required if the person were to continue to be regarded as a fit and proper person.”

Equally, the redress that the FCA may impose is not limited to the remedies that a court of law could order. The only limits on the FCA’s discretion are therefore the same limits that apply to the exercise of power by all public authorities, e.g. the FCA’s powers must be exercised rationally, and for the purposes for which they were given under FSMA.

Five Means of Redress

The Court outlined the overall structure of client redress under FSMA, and, in light of this judgment, it is clear that there are now five principal “means of redress”:

1. Legal claims by the affected clients against firms directly, for damages in respect of any losses caused by breaches of the FCA’s Rules (under section 138D of FSMA).
2. The Financial Ombudsman Service (FOS) has the power to determine complaints that fall within its jurisdiction (e.g. by consumers or small businesses), subject to a maximum award currently of £430,000.
3. The courts or the FCA can require firms to pay “restitution” in respect of profits gained or losses caused as the result of breaches (under sections 382 and 384 of FSMA).
4. The FCA has the power to order firms to implement “consumer redress schemes” to provide redress to consumers who have suffered loss further to any “widespread” or “regular” breaches (under section 404 of FSMA).
5. As is apparent from this case, the FCA can also force firms to pay redress to one or more of their clients, as a condition of continued regulatory permission.

Comment

The Court of Appeal considered the precise wording of FSMA, and concluded that there was no reason to imply limitations on the scope of the FCA’s powers that are not expressly set out in the statute.  It is to be hoped that the FCA will exercise its newly confirmed discretion with restraint.

Together with the FOS’s existing expansive jurisdiction to order firms to make payments according to what it considers is “fair and reasonable in all the circumstances of the case”, even absent any strictly legal claims, financial services redress risks losing the predictability and certainty intended to be provided by strictly legal rules and precedents.

That may then lead to costs and inefficiencies being borne by firms and their customers across the financial services market more broadly – e.g. in the form of higher prices.

The FCA should not therefore lose sight of its statutory objective (under s. 1EB of FSMA) to promote the international competitiveness and growth of the UK economy. This objective needs to be appropriately balanced with the objective of protecting financial services customers in any particular case.

This judgment highlights that, while breaches of the FCA’s broad Principles are not directly actionable by individuals who suffer resultant losses, such breaches may lead to the imposition of redress by the FCA or the courts – whether as a condition of continued regulatory permission or alternatively as “restitution” orders under the relevant FSMA provisions. Principles-based regulation (as opposed to more specific rules-based regulation) therefore continues to take on increasing significance, in the day-to-day conduct of business by regulated firms, their regular supervision by the FCA, and also in the regulator’s imposition of disciplinary enforcement measures and client redress.

Redress imposed at the FCA’s discretion, when there would not otherwise be any legal liability, is a growing area of risk. Financial lines insurers are best placed to help their policyholders manage and transfer these risks by offering suitably tailored cover. But the risks of insuring losses that do not correspond to the time-honoured categories of existing legal liability – including actual proof of causation and the quantum of loss - should not be underestimated. Prudent underwriters should therefore cautiously consider the terms of any proposed extensions of cover intended to indemnify losses arising from the wide measure of the FCA’s discretion.