Conduct Risk – beyond the rulebook

Ashley Kovas, Head of Funds

27 March 2014

2

Risk that behaviour leads to ‘poor outcomes’

Product provider doesn’t understand its proposed new product

Product is mis-advised / mis-sold

Product provider doesn’t manage its ‘product lifecycle’

Financial crime takes place (money laundering / market abuse)

Bank’s lending practices are unfair

3

Agenda

What is conduct risk?

• Sharing the FCA objectives

• Dealing with the threshold conditions

• Understanding FCA supervision

• FCA Risk Outlook 2013

• Effective management

Managing conduct risk

• Managing conduct risk

• Assessing comparative risks – with examples

• Deciding who is responsible for conduct risk

Setting up your project

• Practical next steps in managing conduct risk

4

The spirit of the rules, not the letter

“One of the features of regulation historically was that it was all

about compliance. Were a particular set of rules followed?

Could a firm demonstrate and document that it had followed

those rules to the letter? This created a cottage industry out of

compliance – but did not necessarily lead to good outcomes.

Indeed, Oliver Wyman released a report last year talking about

firms’ ‘obsession’ with compliance, their tendency to follow the

letter of the law, rather than its spirit”.

Martin Wheatley, CEO, FCA

12 March 2013

5

An evolving customer focus

Treating

customers

fairly

Principles

based

regulation

Outcomes

focused

regulation

Conduct

Risk

6

Understanding the ‘drivers’

FCA

objectives

FCA

Supervision Risk Outlook

Threshold

conditions Management

7

Sharing the FCA objectives

FCA strategic objective

• Ensuring that the relevant markets function well

FCA operational objectives

• Consumer protection

• Integrity

• Competition

“We will focus on the most important issues affecting our

objectives.”

The FCA’s Approach to Supervision, March 2014

FCA objectives

8

The consumer protection objective

• Risk

• Experience and expertise

• Consumer responsibility

• Information

• Appropriate care – degree of risk

• Differing expectations

FCA objectives

9

The integrity objective

• Soundness, stability and resilience

• Financial crime

• Market abuse

• Orderly operation

• Transparency of price formation

FCA objectives

10

The competition objective

• Needs of different consumers; information

• Ease of access

• Ease of changing provider

• Market entry

• Encouraging innovation

FCA objectives

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Dealing with the threshold conditions

• Location of offices

• Effective supervision (including ‘close links’)

• Appropriate resources

• Suitability (‘fit and proper’)

• Business model

Threshold conditions

The threshold conditions give the FCA power to make judgements

about a firm’s future conduct and the outcomes it may create

– and take action against the firm

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The ‘suitability’ condition

Matters the FCA can consider in judging a firm’s suitability

• Firm’s connections

• Nature and complexity

• Affairs conducted in an appropriate manner

• Compliance with requirements imposed by the FCA

• Adequate skills and experience

• Sound and prudent

• Financial crime

Threshold conditions

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The ‘business model’ condition

• Sound and prudent

• Interests of consumers

• Integrity of the financial system

The firm’s business model (that is, the firm’s strategy for doing

business) must be suitable for a person carrying on the regulated

activities that the firm carries on or seeks to carry on.

Threshold conditions

14

FCA’s approach to supervision

FCA’s supervision categories:

• C1 – 11 major groups

• C2 – 120 groups

• C3 – 400 firms and groups

• C4 – 25,000 firms

The FCA cannot supervise all firms in the same way but have the

same expectations across all the categories

FCA Supervision

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The ten supervision principles

• Ensuring fair outcomes for consumers and markets

• Forward-looking and pre-emptive

• Focused on the big issues and causes of problems

• Judgement-based

• Ensuring firms act in the right spirit

• Business model and culture

• An emphasis on individual accountability

• Robust when things go wrong

• Communicating openly

• Having a joined-up approach

FCA Supervision

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Supervising what matters

We will be proactive in identifying potential risks to

customers or market integrity

Your culture underpins everything you do, setting the

tone for the behaviours you promote and reward

Your business processes, from product development

to complaints handling should be designed to give

customers what they need and meet their expectations

…effective systems and controls designed to identify

and deal with conduct risks, as well as effective anti-

money laundering measures

…we will pay close attention to the way they

implement consumer and market-focused values Governance

Systems and controls

Front line business

processes

Culture

Business model and

strategy

FCA Supervision

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Applying the same principles to all

“The theme running through all these areas is the focus

on consumer outcomes and market integrity. We will

consistently apply this in all our dealings with every firm,

no matter how big or small, and whether you are active

in retail or wholesale markets. You will see this new emphasis

in our sector-based work as well as your

firm-specific assessments.”

FCA Supervision

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Including culture in supervision

• Sectoral analysis and thematic reviews

• Regular baseline monitoring of regulatory returns

• Occasional routine tasks

• Four-yearly assessment

“The supervisory regime for many C4 firms is similar to the previous

regime under the FSA in terms of the intensity and type of

supervision. However, we are now looking at the culture and

practices of each firm to ensure you consider consumers and

market integrity in everything you do.”

FCA Supervision

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The FCA Risk Outlook 2013

Firms do not design products and services that respond to real

consumer needs or are in consumers’ long-term interests

Distribution channels do not promote transparency for consumers on

financial products and services

Over-reliance on, and inadequate oversight of, payment and product

technologies

Shift towards more innovative, complex or risky funding strategies or

structures that lack adequate oversight, posing risks to market integrity

and consumer protection

Poor understanding of risk and return, combined with the search for

yield or income, leads consumers to take on more risk than appropriate

Risk Outlook

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Effective management is integral

As part of Treating Customers Fairly, the FSA was concerned about

firms’ internal processes. These remain valid for Conduct Risk.

• Leadership

• Strategy

• Decision making and challenge

• Controls

• Performance management

• Reward

Management

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Managing conduct risk

Identify

Mitigate

Measure Monitor

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Assessing conduct risk

Impact

Strong Acceptable Needs

improvement

Weak

Controls

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The framework for managing conduct risk

Identify • FCA statutory objectives

• Management risks

• FCA Risk Outlook

• FCA Supervision

• Your own thoughts

Measure • Impact/probability

• Proxies for probability include

control effectiveness

Mitigate • Project based

Monitor • ‘Audit’ style

• Management information

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Assessing your conduct risks – examples

Major new IT system

Advisers may not

understand X product

Product lifecycle

Market abuse

Testing completed, parallel

running going to plan, minor

glitches

Residual

Culture has improved,

however several further cases

of unfairness identified

Awareness training completed.

Post-trade analysis process

enhanced

Review undertaken, action

items implemented

Mystery shopping results fallen to

8% unsatisfactory, advisers training

programme to complete this month

Residual

Residual

Residual

Residual Unfair lending practices

1

2

3

4

5

25

Assessing comparative risk

1

2

3

5

4

IT system

X product

Product lifecycle

Market abuse

Lending practices

Impact

Strong Acceptable Needs

improvement

Weak

Controls

1 4

2 5

3

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Deciding who is responsible for conduct risk

• What role does Compliance have?

• What is the role of senior management?

• Governance – conduct risk committee?

• Do you need a policy for conduct risk?

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Setting up your project

1. Agree your firm’s approach to managing and mitigating conduct risk

2. Consider all relevant drivers in identifying potential conduct risks

Functioning markets

Consumer protection

Integrity

Competition

FCA objectives

Business strategy

Culture

Front-line processes

Systems and controls

Governance

FCA supervision

Customers – who?

Products / services

Management

Financial crime

Risk Outlook

Additional factors

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…and crucially

Anything else I haven’t thought of

relevant to the statutory objectives

as they impact on your firm