FSA's Retail Risk Conduct Outlook - new areas forconcern?Guidance on new BriberyAct PublishedThe UK's Bribery Act 2010 comes into force on

the 1st of July this year. At the end of last

month the Ministry of Justice released a 45-

page guidance for commercial organisations

impacted by this new

act, together with a

9-page quick start

guide. This welcome

guidance seeks to

clarify many of the

areas of concern,

namely the treatment

of joint ventures,

corporate hospitality,

bribery within the

supply chain, and

activities of

"associated persons". It also states that, should

any of the infringements be committed by an

employee or agent, the existence of adequate

anti-bribery procedures in that organisation

would be considered favourably as defence

against penalties. Key statements were - that

an organisation was not necessarily liable for

any bribery within a supplier simply on the

basis that it was receiving that supplier's

goods, - also that genuine hospitality and

promotional expenditure was not necessarily

banned. The guidance laid down six key

principles in the creation of adequate

procedures: proportionality, top level

commitment, risk assessment, due diligence,

communication and monitoring/review. It also

clearly stated that procedures were not

needed where there was very little risk of

bribery being committed on behalf of the

organisation.

Nick Gibson, Chase Cooper’s Director of Compliance Solutions discusses:the FSA’s first Retail Conduct Risk Outlook — emerging risks andpotential concerns

The FSA published its very first Retail Conduct Risk Outlook on 28th February.

Most of the retail industry is already coming to the end of its decision-making process in

terms of new business models to meet the requirements of the Retail Distribution Review,

so the article provides some interesting reality checks.

The outlook is interesting less for its analysis of current issues - including payment

protection insurance and sales of structured products and deposits to retail

investors - but more for what it tells us about the FSA's likely activities going

forward. This forward-looking element is split between emerging risks (where

there is already evidence of poor conduct by firms) and potential concerns, which

is the FSA's own crystal ball gazing based on their

assessment of the environment.

FSA regulated firms, from retail banks to

independent financial advisers, should be

methodically reviewing their current and proposed services

and activities in those areas described by the FSA as emerging

risks to assure themselves that they are operating to an adequate standard, as FSA will

certainly be looking at them itself. We look at some key issues.

FSA's Retail Distribution Review (RDR)

Many of the emerging risks described implicitly arise from the imminent implementation of

the Retail Distribution Review, and the changes to firms' business models that arise from it.

As an aside, it is interesting to note that Barclays has already declared its intention to exit

the business of advising retail customers on investments through its branch network - the

Barclays Financial Planning division - apparently due to low levels of customer

activity and increasing regulatory costs.

A clear risk is that firms may be seeking to minimise cost and maximise

recurring income streams ahead of RDR go-live, through a variety of

mechanisms, to cushion themselves against the new regulatory

environment. Examples are:

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CHASE COOPER

continued on page 2

IN THIS ISSUE OF metric

● SEC probe Chinese firms

● ERM Discussion Drafts

● Singapore targets CRAs

● Vickers Report released

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§ Accepting large commissions offered by providers who are seeking

to maximise market share, resulting in unnecessary product churn

from the investor's viewpoint;

§ Increasing the amounts of trail commission charged on current sales;

§ Maximising commission generation ahead of selling the firm or

exiting the market;

§ Leveraging inconsistency between levels of commission on

equivalent products packaged in different ways, leading to the

possibility that firms will favour products offering a higher

commission but delivering similar results;

§ Using third party investment platforms to facilitate advice and

administer client portfolios (about half of all new investor money

now is placed through platform services) which only view a limited

range of investment products, thus risking unsuitable advice.

The FSA acknowledges inconsistencies between firms' terms of

business and platform services provided, and a lack of clarity around

the platform charging model towards the investor.

It is not remotely surprising that this should be the case, given that the FSA

has effectively unilaterally changed the retail advice business model within

the industry. However, in the light of this new reality, actions to maximise

income and shareholder value to ensure survival and prosperity by firms in

the retail financial services sector could have some unforeseen

consequences: a business model that is unacceptable to the FSA is likely to

cost the owners more than the revenues generated or safeguarded.

In itself, this is a significant governance risk for firms: how do senior

management or proprietors mitigate the risk that all of the initiatives

adopted to meet the RDR and carry on in business, as a package, are

not sufficiently focused on ensuring that the clients' best interests

continue to be served? Have senior management taken a step back

and looked at the new business model from soup to nuts?

IFA Networks

A further risk generated in part by the RDR is a lack or downgrading

of systems and controls within IFA networks. Smaller firms may be

seeking to reduce overheads by becoming appointed representatives

of an adviser network. At the same time, existing networks are, in

common with the rest of

the industry, seeing

falling business levels

due to the adverse

economic environment.

Some are adopting a

strategy of increasing

numbers of appointed representatives to sustain income levels,

together with increasing product sales and moving into more

complex investment products.

The FSA is concerned that fast expansion at a time of falling business

will put strains on the systems and controls used to manage the

network, as those charged with control try to manage more people,

learn new products, and cope with a greater volume of sales. All this

seems self-evident, but network firms need to show that they

recognise the risk and take steps to mitigate it.

Remuneration Issues

Remuneration issues are always an area of concern, particularly where

there are explicit links

between remuneration

and the achievement of

sales targets: the FSA is

concerned that firms

operating such targets

are not devoting enough

effort to oversee the

suitability of such sales given the clear conflict of interest faced by the

sales staff.

Whilst it is interesting that the FSA describes this as an emergent risk

- the conflict between sales levels and related incentives has always

been with us - it can only be that the economic environment makes

achievement of targets more challenging, increasing the risk that

sales advisers will act inappropriately to achieve targets.

Customer Risk Profiling

Investment risk profiling for customers is also an emerging area of

concern, likely to lead to customer detriment. Simply, if the risk

profile is inaccurate or incomplete, there is a high chance that advice

and sales based upon it will be unsuitable.

More than half of unsuitable investment files reviewed by the FSA

failed on the point of the portfolio not meeting the risks the

customer was willing and able to take. This appears to include a

recognition that an unduly conservative portfolio selection fails the

customer by reducing their opportunity for income and capital

gain. The FSA is - not unreasonably - expecting a reasonably

precise calibration between the consumer's expressed risk

appetite and the advice or portfolio constructed for them.

This is increasingly challenging at a time when customers seek the

unrealistic objective of minimal risk for high returns, leading firms to

consider more highly-structured products (which they themselves

may not understand in depth) in an attempt to satisfy their clients.

In response to this key issue, the FSA released guidance in January

2011 on assessing suitability, underlining that firms often fail to

collect comprehensive information - an example given is the client's

tolerance for loss - or misinterpret the information collected through

vagueness and a lack of clarity in the collection process, resulting in

unsuitable outcomes. The main thrust is that firms should ask very

clear questions in order to get precise information that enables them

to provide specific advice that they can demonstrate is in the

customers' best interests.continued on page 3

A business model that is

unacceptable to FSA is

likely to cost the owners

more than the revenues

generated or safeguarded.

met

ricMore than half of unsuitable

investment files reviewed by

the FSA failed on the point

of the portfolio not meeting

the risks the customer was

willing and able to take.

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3

What should firms be doing?

Taking a step back, and looking across the piste of the proposed new

business model to seek to ensure that:

§ The business model for the new environment, when looked at as a

whole, will continue to serve the best interests of customers;

§ The information held about customers is sufficiently clear and

precise to enable the provision of suitable advice, neither

overshooting nor undershooting the client's risk appetite;

§ Risks inherent in new products and in using platform services are

properly understood and communicated internally; and

§ That the control environment does not lag behind the business

environment, and that the systems and controls for managing the

risks inherent in all of the client-facing processes (whether in a

single firm or a distributed network) remain sufficiently robust to

mitigate the risk of negative outcomes for clients.

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New ERM draft standards issuedDiscussion drafts developed by the Enterprise Risk Management

(ERM) Task Force of the Actuarial Standards Board (ASB) are now

available for comment. The two documents are titled "Actuarial

Professional Standards for Risk Evaluation"

and "Actuarial Professional Standards for

Risk Treatment." Both drafts are contained

within the document, Actuarial Standards of

Practice for Enterprise Risk Management.

The purpose is to share the work done to

date and to collect input from interested parties. Comments are

requested by June 15th, and are welcome from all interested

parties, including non-ASB members. The drafts can be viewed at:

www.actuarialstandardsboard.org m

SEC probes Chinese firms listing in the USAFollowing a series of accounting scandals, the US SEC has launched

a fraud investigation into Chinese companies buying into quoted US

companies. The target for this investigation is those firms that have

gained US listings by reverse mergers into

existing publically quoted, but possibly

dormant, US companies. Since the beginning of

2007 there have been over 600 such mergers

with a quarter of these coming from Greater

China. There is concern that companies are

carrying out these mergers with the express purpose of raising

capital on US exchanges and that the overseas companies are often

already in financial difficulties and that their mergers may have

been based on inadequate or, at worst, falsified accounting

records. In the past few weeks, the SEC has suspended trading on

two organisations, China Century, a media company, and

Chianjiang Mining and New Energy. In both these cases the US

auditors of these companies had resigned saying they were unable

to verify the sources of accounting details. m

Coming up in Issue 4 of metric,

Tony Blunden, Chase Cooper's

Head of Consulting discusses:

‘KRIs: Finding the right way’. A

considerable number of firms are

still finding key risk indicators a

difficult task. During a recent

Chase Cooper Risk Breakfast

there was a lively discussion on KRIs and attendees

were surveyed on their current state of development.

The article will look at a straightforward methodology

for identifying KRIs and their controls. In addition,

the result of the survey will be published.

met

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Singapore proposalto regulate creditrating agenciesThe Monetary Authority of

Singapore (MAS) has released

a consultation paper on proposed regulation of credit rating

agencies (CRAs). The MAS proposes that CRAs be licensed

under the Capital Markets Services (CMS) licensing regime,

and "Providing credit rating services" be added as a regulated

activity. Licensees who carry on the business of providing

credit rating services will be required to comply with existing

requirements that apply to all CMS licensees. The proposal,

which aims to promote the quality and integrity of rating,

strengthen CRA independence and investor protection, and

enhance protection of information, is based on the IOSCO

Code of Conduct Fundamentals for CRAs.

The European Union has already introduced new CRA licensing

requirements and the US has extended existing licensing

regulations. Hong Kong consulted on new CRA rules in 2010

and these are expected to take effect in June.

m

Chase Cooper StrategicCompliance BreakfastBriefings are held each month and

are free to attend. Breakfast is provided.

For more information visit www.chasecooper.com.

Recent briefings addressed the FSA’s changed Client Money

and Assets regime, and what firms should be doing in the face

of FSA’s more aggressive approach, coupled with the new re-

quirements for client money oversight, reporting, and diversi-

fication of client money deposits. In April we reviewed the

sometimes controversial Bribery Act 2010 following the Treas-

ury’s guidance in March, particularly the new corporate obliga-

tions, with a view to taking some of the fear and heat out of

responses to the new Act earlier in the year. We looked at the

practical steps necessary for a risk-based and proportionate

approach based on the guidance – whilst still being able to

take clients to Twickenham.

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The Financial Stability Board (FSB) has publishedthe detailed national responses to an FSB surveyon the implementation of the latest G20recommendations which was conducted inSeptember 2010. The responses formed theprogress report on implementation submittedto the G20 Seoul Summit in November 2010.

The Hong Kong Monetary Authority hasreleased a further supervisory policy (LM-2) onsound systems and controls for liquidity riskmanagement. These are based on the LiquiditySound Principles release by the BIS inSeptember 2008.

Hector Sants, the FSA's CEO,has sent out an update onFebruary's plans to transferprudential supervision ofbanking and insurance to threebodies - a subsidiary of theBank of England, the PrudentialRegulation Authority, and theFinancial Conduct Authority.This announces theachievement of the firstmilestone - the replacement ofthe current Supervision andRisk business units with aPrudential Business Unit (PBU)and a Conduct Business Unit (CBU).

The much awaited report from the IndependentBanking Commission (the Vickers Report namedafter Sir John Vickers, its chairman) was releasedApril 11th. It makes recommendations on howthe retail banking business of UK banks is to beisolated from their investment banking armsand recommends that the retail banking armscarry an extra regulatory Tier 1 capital obligationof 3% taking them to a minimum of 10%. It alsomakes recommendations on how bondholdersshould bear responsibility for bank losses.However the report falls short of proposingcomplete separation of the investment andretail banking businesses and does not specifyhow the bondholder losses will beimplemented. The reaction seems to be relieffrom the banks and dissatisfaction for thosewho saw this report as a way to significantlyrestructure the banking industry.

Reports from Washington indicate that the USauthorities are divided on the list of US SIFIs(systemically important financial institutions).The US Fed and the Treasury favour a list limitedto only the major US global banks whilst theFDIC wish to include large hedge funds, insurersand asset managers. Institutions in questionhave launched a major lobbying action to avoidbeing designated as SIFIs claiming it would addto their costs and lock up capital.

ASYMmetricAL

There has been a lot in the press about the possibilities of banks moving away from the City of

London. This would be as a consequence of the UK Coalition Government's plans to increase

the restrictions on banks in the areas of remuneration, to impose levies on banks' balance

sheets, and, critically, to look at breaking up large bank's into separate investment and retail

banks. This last threat has caused major banks such as Barclays, HSBC and Standard Chartered

to issue veiled threats that they may consider moving their reporting base to another country.

Whilst the mayors of New York and Paris say they would welcome the large British banks,

would governments feel the same. After all, who would then bail them out following another

crisis? The recent Vickers Report has also played down the threat – whilst still leaving the door

open to regulatory restructuring of banks. It is also a given fact that moving headquarters, and

regulatory oversight, of a global bank is no easy operation. Ignoring logistical and regulatory

problems, there are reputational questions - what will existing depositors and investors do?

What will be the reaction from both London or losing financial centres? There

could be reputational impact and, this being difficult to quantify, is a risk that no

bank wishes to run.

But regulatory inconsistencies are of serious concern to financial institutions. In

the years leading to the last financial crisis, the first 8 years of the 21st century,

there was a consistency in global financial regulation - although the criticism that

it did not work could be valid. Basel II was on the way to being adopted in a

globally consistent manner - the US was lagging but the view was that they

would have come into line. Sarbanes-Oxley was being adopted by most large

global corporations and was seen as a global best practice for many companies

who were not otherwise bound by this US regulation. And IFRS with its mark-to-

market principles was well on the way to being a global standard for all

accounting disclosures.

All this has now changed. Although Basel III has global approval from regulators, there are a

significant number that have suggested that its implementation will have regional variations,

both in implementation and in the recognition of capital components. The USA has come up

with a new set of rules - the Dodd-Frank Act, a massive piece of legislation with new standards

and new supervisory agencies to monitor these standards. This will occupy the attention of US

banks for many years to come and the impact on foreign companies quoted on US exchanges

(the means by which they were drawn into Sarbanes-Oxley compliance requirements) remains

to be seen. The global roll-out of IFRS has been set back by criticisms, amongst which

are that mark-to-market makes the accounts excessively volatile. In addition to these

potential inconsistencies, there are national differences in the regulatory treatment of

hedge funds - the UK being at odds with the rest of Europe who wish these to be more

tightly regulated - and in the wish to restrict the remuneration and bonus packages of bankers

- here the UK is considered one of the hawks.

Whereas the first decade of this century was marked by a collaboration and consistency

between the regulators of the major financial markets, this second decade looks like it is

moving towards a free-for-all market with each country aiming to satisfy its national

requirements and the wishes of its voters. Given the situation, can one blame banks, and bank

shareholders, for considering moving their head offices to those cities that will allow them the

greater freedom and the larger profits? Surely it is time for the G20 to come up with some

agreement on regulatory consolidation - or are we into the era of regulatory arbitrage, and

increased regulatory risk?

Early this month the UK's House of Lords Committee on Economic Affairs released a vitriolic

criticism of the auditing profession in regards to its failure to play a part in preventing the last

financial crisis. Recommendations included the

encouragement of increased competition and that risk

committees audit the auditors. Could this be an additional area

of arbitrage? Auditor arbitrage?

The back page, sometimes critical view from the Editor

RegulatoryNEWS

m

HECTOR SANTS, current ChiefExecutive of the FSA and ChiefExecutive designate of the PRA

metric is published byChase Cooper.web: www.chasecooper.comemail: editor@chasecooper.comm

etric