Under the Financial Services and Markets Act 2000 (FSMA) no one in the United Kingdom can carry on financial services activities (known as regulated activities) unless they are authorised by the FSA or they are exempt.
The majority of law firms are able to rely on an exemption in Part XX of FSMA. These are described as exempt professional firms and are able to carry on those activities known as exempt regulated activities. Exempt professional firms are not regulated by the FSA. They comply with the SRA Financial Services (Scope) Rules 2001 in the Specialist Services section of the SRA Handbook.
A small number of law firms—currently 64—provide mainstream financial services to their clients. These law firms are known as authorised professional firms (APFs). APFs are authorised by the FSA to conduct these activities but they are partially regulated in the conduct of the activities by the SRA.
Because they are dually regulated, these APFs are entitled to some carve-outs from compliance with the FSA Handbook of rules and regulations. Significant aspects of this carve-out include:
compensation arrangements—APFs do not contribute to the Financial Services Compensation Scheme and comply with the SRA Compensation Fund Rules;
rules on holding client money—APFs are exempt from many of the FSA's Client Assets Rules and comply instead with the SRA Accounts Rules 2011;
professional indemnity insurance—APFs are required to have in place indemnity which complies with the SRA Indemnity Insurance Rules (SIIR).
In common with the majority of law firms APFs can also conduct incidental financial services. These are known as exempt regulated activities when undertaken by law firms which are not APFs. When APFs undertake such activities they are described as "Non-mainstream Regulated Activities" (NMRA). When APFs carry out such activities they are required to comply with the SRA Financial Services (Conduct of Business) Rules 2001, in the same way as exempt professional firms, plus a limited number of FSA regulations which are only relevant to authorised firms when they carry out NMRA.
The purpose of this consultation is to seek views of the future treatment of APFs. The issues that have triggered the need for this review are described below, as are three options that the SRA has identified as possible solutions. The SRA invites comments on these issues and the options.
Two issues have led to the publication of this consultation:
- the position in respect of SRA-authorised alternative business structures,
- the position of other APFs regulated by the SRA.
The SRA is a licensing authority for alternative business structures (ABSs). The SRA believes that the scope of its regulation of ABSs should extend only to reserved and non-reserved legal activities and any other activities that are subject to conditions imposed on the ABS licence. The SRA does not intend to licence activities that are not legal services. This position has been made clear since at least 2009. Its basis for this decision reflects its commitment to regulating in the public interest. The SRA does not believe that authorising an entity to provide services in respect of which it has little experience or expertise is in the public interest.
This means that the SRA will not be authorising the mainstream regulated activities of ABSs ("ABS APFs"). These activities will be regulated by the FSA, and such ABSs will need to comply with the FSA Handbook. The SRA will have no oversight role of such activities which will be separate from the SRA-authorised business.
A consequence of this is that ABS APFs will not have the benefit of the carve-out from the FSA Handbook requirements which are currently enjoyed by other APFs regulated by the SRA. The SRA believes that it is not appropriate for one regulator's requirements and protections to cover the risks presented by another regulator's area of coverage.
However, the SRA has been concerned that this would lead to a gap in regulatory protection for customers of such businesses. It has therefore been in discussion with the FSA. The FSA has altered its own regulatory requirements to ensure that the ABS APFs must comply with all pertinent requirements of the FSA Handbook and will not be entitled to rely on the carve-outs granted to other APFs as described in paragraph 7. The FSA's requirements are stated in their policy document PS 11/17 (PDF 4 pages, 300K) published on their website.
This decision means that there is currently regulatory inconsistency between ABS APFs and other law firms that are SRA-authorised APFs. This is because the latter continue to have the benefit of the carve-outs from the FSA Handbook as they are regulated by the SRA and subject to compliance with the SRA Handbook regulatory requirements.
Although this is a small percentage of the regulated community, this carve-out and the different treatment of ABS APFs and other APFs is inconsistent with SRA strategy that there should be a common approach in regulatory arrangements for all entities authorised and regulated by the SRA.
The SRA also believes that such carve-outs are no longer appropriate in any event. It has the potential to create the position where the SRA Compensation Fund is exposed to risks which are not derived from reserved legal activities or non-reserved legal activities and puts the SRA in a position where it is extending compensatory protection to activities which it does not authorise. The Law Society negotiated this concession in 2001, prior to the establishment of the SRA or the introduction of the Legal Services Act 2007. As such, the SRA does not believe this is now an appropriate or sustainable position to choose to maintain.
Do you agree with the overall approach to the issues identified in this consultation?
Which of the options would you favour?
Do you agree with the SRA's interpretation of the risk issues?
Do you have any comments on the costs and benefits of the various options, and the indicative cost-benefit analysis which accompanies this consultation?
Are there any other comments you wish to make?