Financial Services Seminar Successfully negotiating the new conduct risk agenda. Peter Snowdon Partner Norton Rose Fulbright LLP 5 May 2016

Transcription

1 Financial Services Seminar Successfully negotiating the new conduct risk agenda Peter Snowdon Partner Norton Rose Fulbright LLP 5 May 2016

2 Programme Registration 2: Session Regulatory priorities and horizon scanning The FCA Business Plan examined Being prepared: horizon scanning of key topics Session Spotlight on key conduct issues Whistleblowing Individual accountability lessons learned from the Senior Managers Regime Recent individual enforcement cases Break Session Conduct risk, behaviour and culture Defining conduct risk Behavioural aspects of conduct risk Closing

3 Conduct Risk How do we continue to examine conduct risk? 3

4 Regulatory priorities and horizon scanning Imogen Garner Partner Norton Rose Fulbright LLP 5 May 2016

5 1 What is conduct risk? 2 Identifying conduct and the focus on conduct so far 3 Drivers of conduct 4 FCA outlook for 2016/17 5

6 What is conduct risk?

7 What is it? Firms Markets Customers 7

8 Who does it apply to? All firms regulated by the FCA: Banks Asset Managers Brokers Custodians Clearing houses Others Consumer credit Insurance Payment services 8

9 How does it arise? Inherent factors A range of inherent drivers of conduct risk interact to produce poor choices and outcomes in financial markets. These drivers are a combination of supply-side market failures (e.g. information problems) and demand-side weaknesses (e.g. inbuilt biases), which are often exacerbated by low financial capability among consumers. Environmental factors Long-running and current economic, regulatory and technological trends and changes are important drivers of firm and consumer decisions. Structures and behaviour Structures, processes and management (including culture and incentives) that have been designed into and become embedded in the financial sector, allowing firms to profit from systematic consumer shortcomings and from market failures. All these factors create an ethical drift. This leads to poor conduct which in turn creates risk associated with conduct of employees 9

10 Focus on conduct

11 Focus on conduct so far Journey from the FSA to FCA FCA Business Plans 2014/15 and 2015/16 Conduct Risk Briefing by Robert Taylor Wholesale Conduct Risk speech by Tracey McDermott Conduct risk more articulated in the retail market, but TCF principle expanded into professional sphere pre-crisis. Conduct regulation hard-wired into FSA rules which moved to FCA Handbook. Firms behaviour, attitudes and motivations must be about good conduct A Both business plans stressed an emphasis on Conduct Risk and identified it as a key risk to the FCA s goals and objectives. 2014/15 focus was on wholesale conduct risk and thematic reviews were focused on investment banks and asset managers. 2015/16 focus was on the culture in firms and ensuring change came from the top. B Highlighted the importance of trust and the industry earning the trust of individuals. Additionally, discussed inherent risks that are faced in the industry including anti-money laundering and Politically Exposed Persons. Sustainability was also highlighted as an inherent risk. C Provided a comprehensive list of questions firms should ask themselves to identify conduct risk and define conduct risk in their own business. Highlighted the FCA s role in conduct risk how to work with the industry on solutions to rebuild reputation and embed change to ensure they identify risks and individuals are held accountable. D 11

12 Drivers and measures

13 Drivers of conduct FCA Risk Outlook 2014 highlighted a number of drivers of risk Drivers of risk Inherent factors Information asymmetries across all markets Environmental developments Economic and market environment including the risks in the global and UK economy Policy and regulatory environment Biases made by consumers and mental shortcuts Technological developments The complexity of financial products Gaps in consumers financial capabilities Conflicts of interest Culture and incentives Market structure 13

14 FCA Business Plan

15 FCA Business Plan 2016/17 Risk outlook Increasing the accountability of individuals as demonstrated by the extension of the SM&CR. Further proposals to strengthen individual accountability in Fair and Effective Markets Review Regulatory Focus Firms cultures remain a central focus and as a key risk to markets. Culture can be a driver and a mitigator of conduct risk. 15

16 FCA Business Plan 2016/17 Firms proactively identify the risks their strategies, business models and cultures present and address these risks Firms ensure strategy and business model is aligned with firm values Firms and senior managers can explain principles of good conduct Firms proactively identify and address issues when things go wrong Firms should develop a culture of accountability FCA aims for firms culture and governance Increased trust in financial services 16

17 Retail conduct areas of focus The stated FCA aim is that the industry is known for the highest standards of conduct towards consumers. However, regulatory action in the face of conduct failures can focus activity disproportionately on short-term goals or impose restrictions which prevent firms innovating and adapting. The FCA is moving focus towards self-reinforcing behaviour in order to make a permanent change for the better. New expectation that consumer credit firms should continually re-assess whether the right products are being pitched at the right consumers. Doing the right thing should become part of the DNA of all firms. 17

18 Wholesale conduct There is no longer thought to be a clear divide between retail and wholesale markets: Risks caused by poor conduct can be transmitted between markets, what may start with wholesale relationships often affects retail consumers. Poor wholesale conduct is never a victimless act simply because it takes place between sophisticated market participants as inevitably there is a consumer at some point in the chain. FCA accepts that the overall caveat emptor principle should continue to apply to wholesale markets. However, misconduct in wholesale markets can have a much wider impact on the integrity of, and trust in, markets than a narrow interpretation of the principle of caveat emptor may suggest. The FCA intended to take a more assertive and interventionist approach to risks caused by wholesale activities. A key aim of the FCA is to ensure that wholesale markets are clean, fair, effective and competitive, and that consumers, whether retail or wholesale, enjoy an appropriate level of protection from risks arising from their exposure, either directly or indirectly, to wholesale activities. 18

19 Risk Outlook for 2016/17 Conduct Focus Regulatory focus is increasing the accountability of individuals Legacy systems, cyberattacks and organisational resilence Firms culture remains a central focus The Fair and Effective Markets Review and financial crisis both demonstrate that fundamental change is needed in the market. Senior Managers & Certification Regime (SM&CR) is being extended to all FSMA firms. The FCA and PRA are consulting on detailed rules and guidance, learning from implementation of the SM&CR for banks. A lack of technological resilience among many firms exists, particularly due to complexity as systems have evolved over time. The need for firms to balance investment in innovation with maintaining existing systems and infrastructure as well as a lack of IT expertise at board level are some of the reasons this area continues to present significant challenges. Culture remains a key driver of significant risks in every sector and the root cause of high-profile and significant failings. It impacts on individual behaviours which in turn affect day-to-day decisions and practices in regulated firms. Culture can be a driver, and mitigator, of conduct risk. Conflicts of interest still driving risk Vertical integration in the context of wholesale banking. 19

20 Priorities for 2016/17 Priority Pensions Financial Crime and Anti-Money Laundering Wholesale financial markets Advice Innovation and technology Firms culture and governance Treatment of existing customers Fair treatment for consumers, stronger competition and a market that meets consumer need Better, proportionate and more efficient AML controls and consumers who are better able to avoid scams Strong controls which protect market integrity and ensure clean, efficient and effective markets Affordable, professional advice to meet consumers changing and complex needs Resilient systems and new sources of competition Strong culture and governance which helps competition and consumers alike Effective competition, a fair deal and greater transparency for long-standing customers 20

21 Conduct risk & Financial Crime and AML risk Firms need appropriate AML procedures in place Firms are de-risking and no longer offering services to those with higher money-laundering risk. May mean firms are acting contrary to clients best interests and therefore a potential conduct risk. Risk-based approach does not mean that banks should deal generically with whole categories of customers or potential customers Consideration from the FCA as to whether firms de-risking strategies could lead to consumer protection and / or competition issues. Proportionality is key Conduct risk can also originate from employees not carrying out KYC procedures correctly and ignoring AML checks. 21

22 Conduct risk & firms culture and governance risk The FCA highlights a top down approach to conduct risk, and in particular the implementation of the SM&CR. Reality is that this means the FCA expects to see Compliance feature on board agendas. Senior managers and executives should be actively involved in both Compliance and reforming conduct. The SM&CR will bring in further personal accountability. Expectation in the industry is that personal liability for CCOs in particular would increase, however it is likely this will occur for all senior managers. CCOs can play a key role in advising other senior managers about how to manage their own personal regulatory risk. 22

23 Conduct risk & innovation and technology focus IT and new technology can impact on business models and strategies as well as assist in areas such as Compliance Cyber risks are multi-faceted and must not simply be left to the IT function. The PRA and FCA for the first time, took concurrent enforcement action against three banks in the RBS group with a total fine of 62m being levied. The PRA stated that action had been taken because the proper functioning of IT risk management systems and controls should be an integral part of a firm s safety and soundness. Recent high profile cyber-attacks and data leaks should bring the issue of resilience into the minds of firms. Employees can play an instrumental role in protecting information and reporting on weaknesses in infrastructure. RegTech is a focus for the FCA, as it should assist in reducing regulatory burden on firms. CCOs are already looking at adopting more innovative approaches and solutions which have had differing levels of success in different firms. Integration into the current infrastructure and appropriate investment are the key challenges being faced. 23

24 Conduct risk & FCA supplementary work streams Focus on sustainable regulation Ever increasing change in regulation means Compliance Officers are often facing regulatory fatigue and overload. Increasing costs from a staffing perspective. Good Compliance Officers assist in forming good culture, but are limited in number in the market, meaning the human resource cost increases. FCA is focusing on reviewing whether aspects of rules are outdated or are no longer effective in advancing statutory objectives, which suggests that there may be some recognition by the regulator of regulatory fatigue. However, the implementation of MiFID II/MiFIR and MAR is likely to create further work for Compliance. 24

25 Horizon scanning

26 Our Technical Resources Regulation Tomorrow Pegasus Banking Reform - Our Guide to Banking Reform 26

27 Conduct risk, behaviour and culture Lisa Lee Lewis and John Higgins Regulatory Risk and Compliance Unit 5 May 2016

28 1 Recap - why does conduct risk remain a focus? 2 Defining conduct risk 3 How robust is your compliance risk framework ask yourself 5 key questions 4 How the FCA supervises conduct risk 5 Interplay between conduct and culture 6 Behaviour and culture 28

29 Recap - why does conduct risk remain a focus?

30 Why does conduct risk remain a focus? Retail Product governance failings: PPI misselling (April 2015: largest fine of 20,678,300) Wholesale LIBOR / EURIBOR (April 2015: largest fine of 227,000,000) Principle 3 failings: Adequate risk management (December 2015: fine of 6,038,504) Not managing conflicts (February 2015: largest fine of 17,607,000 and compensation payment of 132,000,000) Financial Crime failures (November 2015: fine of 72,069,400) Failure to handle PPI complaints (June 2015: fine of 117m with 710m set aside for redress) Oversight failures by an individual (February 2016: Individual fined 51,600) Forex (May 2015: fine of 284,423,000 ) CASS failures (April 2015: fine of 126,000,000) Market Abuse Systems failures (February 2016: fine of 1,200,000) Reporting failures (April 2015: largest fine of 13,285,900) 30

31 Defining Conduct Risk

32 Defining Conduct Risk The European Banking Authority has defined conduct risk as: The current or prospective risk of losses to an institution arising from an inappropriate supply of financial services, including cases of willful or negligent misconduct (19 December 2014 EBA Guidelines on common procedures and methodologies for the supervisory review and evaluation process) An FCA spokesperson said that: it will always turn on the circumstances of a firm, their operations and activities. Firms need to make a judgment about the conduct risks they face and how they might mitigate these 32

33 Defining Conduct Risk Thomson Reuters 2015/2016 Conduct Risk Report confirmed that: 43% of Globally Systemically Important Financial Institutions (G-SIFIs) have not defined conduct risk in 2015, down from 74% in 2014 For non G-SIFI firms, 64% of firms still do not have a separate working definition of conduct risk, down from 81% in

34 How robust is your conduct risk framework ask yourself 5 key questions

35 Five key questions 1. How is conduct risk identified within your business? 2. Who has been assigned responsibility for managing conduct? 3. What support is in place to improve the conduct of business? 4. How does the board and executive committee gain oversight of conduct? 5. Do firms have any perverse incentives or other activities which undermine work done to improve conduct? 35

36 1. Identifying Conduct Risk within your business The FCA expects firms to go to the root of the poor conduct and connect high level definitions to the day-to-day running of the business. The main challenges are setting out the firms key values and identifying what constitutes conduct, and what is more interlinked to operational factors and market structure. Important to note that a number of the same failings occurred in the LIBOR and FX benchmark rigging cases, which could be down to market structure or market wide ethical drift. Can staff identify the key values of the firm and behaviour which is contrary to this? 36

37 2. Assigning responsibility for managing conduct Conduct management needs to go further than being a responsibility which is assigned to one department Conduct management should be in the context of the culture as a whole. There is an element of self-regulation by employees, but there should be clearly apportioned oversight. FCA are expecting a top down approach, so senior managers are key, however teams on the front line have a greater understanding of the day-to-day running of the business and should understand their responsibilities. The senior managers of the firm need to understand how to make employees feel responsible for managing their own conduct and influencing other employees conduct in the day-today running of the business. Training has an important role to play, but good culture also needs to be developed. 37

38 3. Support Mechanisms Remuneration should support good culture, rather than rewarding or incentivising actions contrary to firm culture. Product and business approval committees should be robust and representation from the control functions should feature on these committees. Training and induction programmes should support a good culture within the firm, but be proportionate to the size and scale of the business. Escalation / whistleblowing policy and procedure should be in place to allow employees to voice their opinions internally and externally. The FCA has a whistleblowing mechanism. Do your employees have the right motivations and support in place to report poor conduct? 38

39 4. Gaining oversight of the conduct of the organisation The board and executive should be receiving information relating to conduct as well as other facets of the business and then evidencing how they take this information into account in their decision-making. Conduct issues should feature on board agendas but conversations need to go further and boards need to take conduct implications into account in every strategic decision. Firms should recognise that senior management decisions have just as big an impact on the way business is conducted as the behaviour and decisions of those who report to them. Strengthened accountability through the SM&CR so more oversight and understanding of conduct issues will be required. The FCA is focusing on the tone from the top so this will be an area of strong focus when conducting supervisory activity 39

40 5. Perverse incentives It requires the firm to question their incentive structures and put themselves in the shoes of the employee to ask: Why has the employee been promoted? Is it for behaviour that is contrary to firm culture or behaviour that could be seen as bad conduct? The FCA stresses that there needs to be industry wide improvement as individuals move all the time regulatory references under the new SM&CR will aim to stop bad apples moving from firm to firm. Culture and conduct are two sides of the same coin 40

41 How the FCA supervises conduct risk

42 The FCA supervision framework how is conduct risk supervised? The FCA supervision framework is built around three Pillars designed to deliver different aspects of supervision. Each pillar touches on conduct risk Issue based supervision (Pillar 3) (Also known as thematic work) addresses specific conduct risks across a sector Proactive individual firm supervision (Pillar 1) assesses whether a firm is run in a way that results in the fair treatment of customers through identifying and addressing the drivers of conduct risk at firm level Event supervision (Pillar 2) addresses significant crystallising or crystallised conduct risks at firm level, e.g. Libor and Forex investigation work 42

43 10 principles The FCA s supervisory approach is built on 10 principles Ensuring fair outcomes for consumers and markets Being forward-looking and pre-emptive, identifying potential risks and taking action before they have a serious impact Being focused on the big issues and causes of problems Taking a judgement-based approach, with the emphasis on achieving the right outcomes Ensuring firms act in the right spirit, which means they consider the impact of their actions on consumers and markets rather than just complying with the letter of the law Examining business models and culture, and the impact they have on consumer and market outcomes An emphasis on individual accountability, ensuring senior management understand that they are personally responsible for their actions Being robust when things go wrong, making sure that problems are fixed, consumers are protected and compensated, and poor behaviour is rectified along with its root causes Communicating openly with industry, firms, and consumers, to gain a deeper understanding of the issues they face Having a joined-up approach, making sure firms get consistent messages from the FCA 43

44 Interplay between conduct risk and culture

45 Interplay between conduct risk and culture Conduct and culture go hand-in-hand FCA 2015/2016 Business Plan A firm s culture is the key driver behind the behaviour of those in it. In many cases, where things have gone wrong in a firm, a cultural issue is at the heart of the problem FCA 2016/2017 Business Plan Culture impacts individual behaviour which in turn affect day-today decisions and practices in the firms.culture is therefore both a driver, and a potential mitigator, of conduct risk 45

46 Behaviour and Culture

47 Why focus on behaviour? We want to see as an outcome is an approach where the interests of customers and the market are at the heart of your business Ultimately, unless doing the right thing becomes part of the DNA of all firms it won t happen Tracey McDermott, 7 April 2016 Too many examples can be provided to illustrate that poor conduct of and within financial firms can have great adverse impact on consumers and consumer confidence Steven Maijoor, ESMA Chair, June 2015 The culture of a firm includes its standards of behaviour PRA Statement of Policy, June 2014 Finance Companies confront risk posed by own staff Financial Times, March 2016 Banks staff not fully understanding negative risk behaviour will be punished despite earnings performance Financial Post, November 2015 City of London, black book is called for to track bad apple traders Financial Times, February

48 What makes corporate ethical failures happen? Trigger Event Corporate Failure Latent Risks 48

49 Lessons from First-Hand Experience Accept that even in the best ethically-led organisations, some trigger events will occur So we must ensure the organisation is resilient 49

50 Suffering organisational and cultural inertia? Are we guilty of Failure to Learn the hard lessons from past ethical and regulatory failures? Are our conduct and compliance programmes too narrow? Are our risk and compliance programmes really changing workplace behaviours? 50

51 Asking the right questions on culture? Does our risk management include an objective, empirical, evidence-based assessment of corporate culture and its risk impact? Does the board understand corporate cultures as experienced by people across the organisation and how they balance: Financial performance and ethical behaviour (triggering own failure) Getting the job done versus critical professional challenge and curiosity (recognising failure nearby) Have we objectively assessed the ethical intelligence of the senior leadership of the business? Do recruitment and progression embed ethical leadership capability as well as financial and operational leadership capability? Does talent development include ethical leadership? Does our ethics and compliance training and development go beyond technical content and / or resolution of well-signposted ethical dilemmas? 51

52 Understanding the corporate cultures Cultures not culture Culture is tangible and experiential How matters as much as What and Why matters as much as What 52

53 Ethical business needs ethically intelligent leaders Ethical Sensitivity (Connectedness, recognition and exploration) Willingness to Learn Ethical Intelligence 'EthQ' Moral Development Level Ethical Response (Taking action and setting standards) 53

54 Taking action Assess Ethical Leadership Capability Understand our Ethical and Cultural Profile Influence Behaviours Develop Ethical Leadership Capability 54

55 Influencing culture, behaviour, attitude Where things have gone wrong in a firm, a cultural issue is often at the heart of the problem Culture A firm s culture is an aggregate of the behaviours and attitudes of those in it Attitude Behaviour We can leverage psychology research and nudge practices 55

56 Changing culture A firm s culture is a key driver behind the behaviour of those in it. Where things have gone wrong in a firm, a cultural issue is often at the heart of the problem Action points: 1. Ensure that culture and conduct issues are a priority and a key issue on your board s agendas 2. Engage in conduct issues, including for example: probe high return products or business lines understand strategies for cross-selling products understand how growth is obtained ensure products are being sold to the customer segments they are designed for 3. Translate customer focus into cultural practices that drive how business decisions are made 4. Consider how your firm responds to consumer-related issues and problems as they arise 5. Define how individuals should behave 6. Ensure issues are escalated in an open way 7. Consider how remuneration and incentives are awarded 56

57 57 A reflection

58 Our Technical Resources Regulation Tomorrow Pegasus Banking Reform - Our Guide to Banking Reform 58

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