Supervision

Part

REC Recognised Investment Exchanges and Recognised Clearing Houses

Chapter

Supervision

Printed on: 09/11/2024

Rulebook at: 01/07/2005

REC 4

Supervision

REC 4.1

Application and purpose

01/12/2004

Application

REC 4.1.1

REC 4.2, REC 4.3 and REC 4.5 apply to UK recognised bodies. REC 4.4 and REC 4.6 to REC 4.8 apply to all recognised bodies. REC 4.8 applies to applicants for recognition as a recognised body.

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Purpose

REC 4.1.2

This chapter sets out the FSA's approach to the supervision of recognised bodies and contains guidance on:

(1) the arrangements for investigating complaints about recognised bodies made under section 299 of the Act (Complaints about recognised bodies) (REC 4.4);
(2) the FSA's approach to the exercise of its powers under:

(a) section 296 of the Act (FSA's power to give directions) to give directions to recognised bodies (REC 4.6);
(b) section 297 of the Act (Revoking recognition) to revoke recognition orders (REC 4.7);

and the procedure to be followed in those cases and where the FSA decides to refuse an application for recognition as a recognised body (REC 4.8); and
(3) the FSA's approach to, and procedures for, the exercise of its powers under sections 166 and 167 of the Companies Act 1989 to give directions to UK recognised bodies in relation to action under their default rules (REC 4.5).

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REC 4.1.3

The FSA's general approach to supervision is intended to ensure that:

(1) the FSA has sufficient assurance that recognised bodies continue at all times to satisfy the recognition requirements and other obligations imposed by or under the Act; and
(2) the FSA's supervisory resources are allocated, and supervisory effort is applied, in ways which reflect the actual risks to the regulatory objectives.

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REC 4.1.4

In applying these principles of risk based supervision to the supervision of recognised bodies, the FSA has had particular regard to the special position of recognised bodies under the Act as well as to its general duties set out in section 2 of the Act (The FSA's general duties).

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REC 4.1.5

More information on the supervision of UK recognised bodies is given in REC 4.2 and REC 4.3. More information on the supervision of overseas recognised bodies is given in REC 6.

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REC 4.2

The supervisory relationship with UK recognised bodies

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REC 4.2.1

The FSA expects to have an open, cooperative and constructive relationship with UK recognised bodies to enable it to have a broad picture of the UK recognised body's activities and its ability to meet the recognition requirements. This broad picture is intended to complement the information which the FSA will obtain under section 293 of the Act (Notification requirements) or under notification rules made under that section (see REC 3). The FSA will usually arrange meetings between the Markets Division and key individuals of the UK recognised body for this purpose. The frequency and nature of these meetings may vary in accordance with the risk profile of the UK recognised body.

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REC 4.2.2

UK recognised bodies are likely to develop and adapt their businesses in response to customer demand and new market opportunities. Where such developments involve changes to the way the UK recognised body operates, they are likely to involve changes to the way it satisfies the recognition requirements and other obligations in or under the Act.

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REC 4.2.3

The FSA expects a UK recognised body to take its own steps to assure itself that it will continue to satisfy the recognition requirements and other obligations in or under the Act when considering any changes to its business or operations.

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REC 4.2.4

However, the FSA also expects that UK recognised bodies will keep it informed of all significant developments and of progress with its plans and operational initiatives, and will provide it with appropriate assurance that the recognition requirements will continue to be satisfied.

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REC 4.3

Risk assessments for UK recognised bodies

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REC 4.3.1

Information is needed to support the FSA's risk based approach to the supervision of all regulated entities. Risk based supervision is intended to ensure that the allocation of supervisory resources and the supervisory process are compatible with the regulatory objectives and the FSA's general duties under the Act. The central element of the process of risk based supervision is a systematic assessment by the FSA (a risk assessment) of the main supervisory risks and concerns for each regulated entity.

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REC 4.3.2

For each UK recognised body, the FSA will conduct a periodic risk assessment. This assessment will take into account relevant considerations including the special position of recognised bodies under the Act, the nature of the UK recognised body's members, the position of other users of its facilities and the business environment more generally.

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REC 4.3.3

The risk assessment will guide the FSA's supervisory focus. It is important, therefore, that there is good dialogue between the FSA and the recognised body. The FSA expects to review its risk assessment with the staff of the UK recognised body to ensure factual accuracy and a shared understanding of the key issues, and may discuss the results of the risk assessment with key individuals of the UK recognised body. If appropriate, the FSA may send a detailed letter to the body's chief executive, chairman or both with proposals for further action or work to address particular concerns or issues and seek their comments on the risk assessment.

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REC 4.4

Complaints

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Recognised body's arrangements

REC 4.4.1

Recognised bodies may receive complaints from time to time from their members and other people, both about the conduct of members and about the recognised body itself. A UK recognised body will need to have satisfactory arrangements to investigate these complaints in order to satisfy the relevant recognition requirements (see REC 2.15 and REC 2.16).

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The FSA's arrangements

REC 4.4.2

The Act does not provide a mechanism for appeals to the FSA from decisions by recognised bodies in relation to complaints. However, the FSA is required by section 299 of the Act (Complaints about recognised bodies) to have arrangements to investigate complaints (called relevant complaints in the Act) which it considers relevant to the question of whether a recognised body should remain recognised as such. This section describes aspects of the FSA's arrangements for investigating relevant complaints.

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REC 4.4.3

Where the FSA receives a complaint about a recognised body, it will, in the first instance, seek to establish whether the complainant has approached the recognised body. Where this is not the case, the FSA will ask the complainant to complain to the recognised body. Where the complainant is dissatisfied with the handling of the complaint, but has not exhausted the recognised body's own internal complaints procedures (in the case of a complaint against a UK recognised body, including by applying to that body's complaints investigator), the FSA will encourage the complainant to do so.

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REC 4.4.4

The FSA will not usually consider a complaint which has not, in the first instance, been made to the recognised body concerned, unless there is good reason for believing that it is a relevant complaint which merits early consideration by the FSA.

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REC 4.4.5

When it is considering a relevant complaint, the FSA will make its own enquiries as appropriate with the recognised body, the complainant and other persons. It will usually ask the recognised body and the complainant to comment upon any preliminary or draft conclusions of its review and to confirm any matters of fact at that stage.

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REC 4.4.6

The FSA will communicate the outcome of its review of a relevant complaint to the complainant and the recognised body, but will normally only discuss any action which it considers the recognised body should take with the recognised body itself.

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REC 4.5

FSA supervision of action by UK recognised bodies under their default rules

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REC 4.5.1

UK recognised bodies which, under their rules, have market contracts are required to have default rules enabling them (among other things) to take action in relation to a member who appears to be unable to meet his obligations in respect of one or more unsettled market contracts. The detailed recognition requirements relating to the default rules are set out in REC 2.17.

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REC 4.5.2

The default rules are designed to ensure that rights and liabilities between the defaulter and any counterparty to an unsettled market contract are discharged, and for there to be paid between the defaulter and each counterparty one net sum. The Companies Act 1989 contains provisions which protect action taken under default rules from the normal operation of insolvency law which might otherwise leave this action open to challenge by a relevant office-holder.

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REC 4.5.3

The Companies Act 1989 also gives the FSA powers to supervise the taking of action under default rules. Under section 166 of the Companies Act 1989 (Powers of the FSA to give directions) (see REC 4.5.4 G), the FSA may direct a UK recognised body to take, or not to take, action under its default rules. Before exercising these powers the FSA must consult the recognised body concerned. The FSA may also exercise these powers if a relevant office-holder applies to it under section 167 of the Companies Act 1989 (Application to determine whether default proceedings to be taken) (see REC 4.5.9 G).

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REC 4.5.4

The Companies Act 1989: section 166

The FSA may issue a "positive" direction (to take action) under section 166(2)(a) of the Companies Act 1989:

Where in any case a [ UK RIE ] or [ UK RCH ] has not taken action under its default rules - if it appears to [the FSA ] that it could take action, [the FSA may direct it to do so,

but under section 166(3)(a) of the Companies Act 1989:

Before giving such a direction the [ FSA ] shall consult the [ UK RIE ] or [ UK RCH ] in question; and [the FSA ] shall not give a direction unless [the FSA ] is satisfied, in the light of that consultation that failure to take action would involve undue risk to investors or other participants in the market,

The FSA may issue a "negative" direction (not to take action) under section 166(2)(b) of the Companies Act 1989:

Where in any case a [ UK RIE ] or [ UK RCH ] has not taken action under its default rules - if it appears to the [ FSA ] that it is proposing to take or may take action, [the FSA ] may direct it not to do so.

but under section 166(3)(b) of the Companies Act 1989:

Before giving such a direction the [ FSA ] shall consult the [ UK RIE ] or [ UK RCH ] in question; and the [ FSA ] shall not give a direction unless [the FSA ] is satisfied, in the light of that consultation that the taking of action would be premature or otherwise undesirable in the interests of investors or other participants in the market.

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REC 4.5.5

The FSA's view is that the exercise of these powers will only be justified in exceptional circumstances. The most likely case in which the FSA would consider exercising them is if there were a need to coordinate action by different UK recognised bodies because, for example:

(1) the likelihood of a default may not be apparent to all UK recognised bodies; or
(2) there was a need to avoid premature default action by one UK recognised body; or
(3) significantly different settlement prices had been fixed by different UK recognised bodies.

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REC 4.5.6

Under section 166(6) of the Companies Act 1989, a negative direction cannot be given if, in relation to the defaulter, either:

(1) a bankruptcy order or an award of sequestration of the defaulter's estate has been made, or an interim receiver or interim trustee has been appointed; or
(2) a winding-up order has been made, a resolution for voluntary winding-up has been passed or an administrator, administrative receiver or provisional liquidator has been appointed;

and any previous negative direction will cease to have effect on the making or passing of any such order, award or appointment.

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REC 4.5.7

Under section 166(5) of the Companies Act 1989, a negative direction may be expressed to have effect until a further direction is given, which may either be a positive direction or a revocation of the earlier negative direction.

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REC 4.5.8

Under section 166(7) of the Companies Act 1989, where a UK recognised body has taken action either of its own accord or in response to a direction, the FSA may direct it to do or not to do specific things subject to these being within the powers of the UK recognised body concerned under its default rules. However, the FSA cannot give such a direction unless it is satisfied that this will not impede or frustrate the proper and efficient conduct of the default proceedings.

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Section 167 of the Companies Act 1989

REC 4.5.9

Where, in relation to a member (or designated non-member) of a UK RIE or a member of a UK RCH:

(1) a bankruptcy order; or
(2) an award of sequestration of his estate; or
(3) an order appointing an interim receiver of his property; or
(4) an administration or winding-up order; or
(5) a resolution for a voluntary winding-up; or
(6) an order appointing a provisional liquidator;

has been made or passed and the UK recognised body has not taken action under its default rules as a result of this event or of the matters giving rise to it, a relevant office-holder appointed in connection with the order, award or resolution may make an application to the FSA under section 167 of the Companies Act 1989 (Application to determine whether default proceedings to be taken).

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REC 4.5.10

The effect of an application under section 167 of the Companies Act 1989 is to require the UK recognised body concerned to take action under its default rules or to require the FSA to take action under section 166 of the Companies Act 1989 (see REC 4.5.4G).

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REC 4.5.11

The procedure is that the FSA must notify the UK recognised body of the application and, unless within three business days after receipt of that notice, the UK recognised body:

(1) takes action under its default rules; or
(2) notifies the FSA that it proposes to take action forthwith; or
(3) is directed to take action by the FSA under section 166(2)(a) of the Companies Act 1989;

the provisions of sections 158 to 165 of the Companies Act 1989 do not apply in relation to market contracts to which the member or designated non-member is a party or to anything done by the UK recognised body for the purpose of, or in connection with, the settlement of any market contracts.

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REC 4.6

The section 296 power to give directions

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REC 4.6.1

Under section 296 of the Act (FSA's power to give directions), the FSA has the power to give directions to a recognised body in order to secure its compliance with the recognition requirements or other obligations in or under the Act.

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REC 4.6.2

The FSA must also give a direction to a recognised body if it is directed to do so by the Treasury under section 308 of the Act (Directions by the Treasury).

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REC 4.6.3

The FSA is likely to exercise its power under section 296 of the Act if it considers that:

(1) there has been, or was likely to be, a failure to satisfy the recognition requirements or there has been a failure to comply with any other obligation in or under the Act which has serious consequences;
(2) compliance with the direction would ensure that the recognition requirements, or other obligation in or under the Act, were satisfied; and
(3) the recognised body is capable of complying with the direction.

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REC 4.6.4

Under section 298(7) of the Act (Directions and revocation: procedure), the FSA need not follow the consultation procedure set out in the rest of section 298 (see REC 4.8), or may cut short that procedure, if it considers it essential to do so. The FSA is likely to consider it essential to cut short the procedure if, in the absence of immediate action, there would be:

(1) a serious risk of substantial losses to investors, particularly private customers; or
(2) a serious threat to market confidence or to the stability of the financial system; or
(3) a serious risk of money laundering or other serious financial crime.

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REC 4.7

The section 297 power to revoke recognition

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REC 4.7.1

Under section 297 of the Act (Revoking recognition), the FSA has the power to revoke a recognition order relating to a recognised body.

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REC 4.7.2

The FSA will revoke a recognition order if:

(1) it is directed to do so by the Treasury under section 308 of the Act (Directions by the Treasury); or
(2) the recognised body has asked the FSA to revoke the order.

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REC 4.7.3

The FSA will usually consider revoking a recognition order if:

(1) the recognised body is failing or has failed to satisfy the recognition requirements or other obligations in or under the Act and that failure has or will have serious consequences; or
(2) it would not be possible for the recognised body to comply with a direction under section 296 of the Act (FSA's power to give directions); or
(3) for some other reason, it would not be appropriate for the FSA to give a direction under section 296.

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REC 4.7.4

The FSA would be likely to consider the conditions in REC 4.7.3 G (2) or REC 4.7.3 G (3) to be satisfied in the following circumstances:

(1) the recognised body appears not to have the resources or management to be able to organise its affairs so as to satisfy the recognition requirements or other obligations in or under the Act
(2) the recognised body does not appear to be willing to satisfy the recognition requirements or other obligations in or under the Act; or
(3) the recognised body is failing or has failed to comply with a direction made under section 296 of the Act or
(4) the recognised body has ceased to carry out regulated activities in the United Kingdom, or has so changed the nature of its business that it no longer satisfies the recognition requirements in respect of the regulated activities for which recognised body status is relevant.

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REC 4.7.5

In addition to the factors set out in REC 4.7.4 G, the FSA will usually consider that it would not be able to secure an overseas recognised body's compliance with the recognition requirements or other obligations in or under the Act by means of a direction under section 296 of the Act, if it appears to the FSA that the overseas recognised body is prevented by any change in the legal framework or supervisory arrangements to which it is subject in its home territory from complying with the recognition requirements or other obligations in or under the Act.

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REC 4.8

The section 298 procedure

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REC 4.8.1

A decision to:

(1) revoke a recognition order under section 297 of the Act (Revoking recognition); or
(2) make a direction under section 296 (FSA's powers to give directions); or
(3) refuse to make a recognition order under section 290 (Recognition orders);

is a serious one and section 298 of the Act (Directions and revocation: procedure) sets out a procedure (see REC 4.8.9 G) which the FSA will follow unless, in the case of a revocation of a recognition order, the recognised body concerned has given its consent (see section 297(1)) or, in a case where the FSA proposes to make a direction under section 296, it considers it is essential not to follow, or to cut short, the procedure (see REC 4.6.4 G and REC 4.8.7 G).

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REC 4.8.2

The FSA's internal arrangements provide for any of these decisions to be taken at an appropriately senior level.

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REC 4.8.3

In considering whether it would be appropriate to exercise the powers under section 296 or section 297 of the Act, the FSA will have regard to all relevant information and factors including:

(1) its guidance to recognised bodies;
(2) the results of its routine supervision of the body concerned;
(3) the extent to which the failure or likely failure to satisfy the recognition requirements or other obligations in or under the Act may affect the regulatory objectives.

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REC 4.8.4

In considering whether or not to make a recognition order, the FSA will have regard to all relevant information and factors, including its guidance to recognised bodies and applicants and the information provided by applicants. Details of the application processes and other guidance for applicants are set out in REC 5 and (for overseas applications) REC 6.

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REC 4.8.5

The procedures laid down in section 298 of the Act are summarised, with the FSA's guidance about the actions it proposes to take in following these procedures, in the table at REC 4.8.9 G.

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REC 4.8.6

Before exercising its powers under section 296 or section 297 of the Act, the FSA will usually discuss its intention, and the basis for this, with the key individuals or other appropriate representatives of the recognised body. It will usually discuss its intention not to make a recognition order with appropriate representatives of the applicant.

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REC 4.8.7

Under section 298(7) of the Act, the FSA need not follow the procedure in section 298 in relation to giving a direction under section 296, when it considers it essential not to do so. Guidance on the circumstances in which the FSA will usually act in this way is given in REC 4.6.4 G.

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REC 4.8.8

Under section 290(6) of the Act, the FSA need not follow the procedure in section 298 in relation to a refusal to make a recognition order if (under section 307) the Treasury has not given its approval for the recognition order to be made. Further guidance is given in REC 5 and REC 6 (for overseas applications).

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REC 4.8.9

Key steps in the section 298 procedure

The FSA will:

Guidance

(1)

give written notice to the recognised body (or applicant);

The notice will state why the FSA intends to take the action it proposes to take, and include an invitation to make representations, and the date by which representations should be made.

(2)

take such steps as it considers reasonably practicable to bring the notice to the attention of the members of the recognised body or of the applicant, as the case may be;

The FSA will also notify persons individually (as far as it considers it reasonably practicable to do so) if it considers that the action it proposes to take would affect them adversely in a way which would be different from its effect on other persons of the same class.

(3)

publish the notice so as to bring it to the attention of other persons likely to be affected;

(4)

receive representations from the recognised body or applicant concerned, any member of the recognised body or applicant, and any other person who is likely to be affected by the action the FSA proposes to take;

The FSA will not usually consider oral representations without first receiving written representations from the person concerned. It will normally only hear oral representations from the recognised body (or applicant) itself or of a person whom it has notified individually, on request.

(5)

write promptly to any person who requests the opportunity to make oral representations if it decides not to hear that person's representations;

The FSA will indicate why it will not hear oral representations and the FSA will allow the person concerned further time to respond.

(6)

have regard to representations made;

(7)

(when it has reached its decision) notify the recognised body (or applicant) concerned in writing.

(8)

(if it has decided to give a direction, or revoke or refuse to make a recognition order) take such steps as it considers reasonably practicable to bring its decision to the attention of members of the recognised body or applicant and to other persons likely to be affected.

The FSA will usually give notice of its decision to the same persons and in the same manner as it gave notice of its intention to act.

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