As usual, the Risk Outlook sets out the key conduct risks that the FCA believes may cause it problems in the coming year, while the Business Plan sets out the FCA’s regulatory actions. Both are a useful heads-up on what the FCA is worried about and what it proposes to do, so it is the closest any firm will get to a free gift from the regulator.
A useful starting question is to ask why the FCA goes to the effort of publishing these documents in the first place.
The answer lies in the FCA’s expectations on conduct risk. The term ‘conduct risk’ has never been formally defined, but I suggest the clue is in the name – Financial Conduct Authority. To put it in context, regulators worldwide have been blamed for their failure to prevent the financial crisis of recent years, but the FCA well knows it is not easy for an organisation of a few thousand people to police the entire UK financial services industry.
They cannot be everywhere, even if it sometimes seems that they are.
Whether you agree with the principle or not, conduct risk is the FCA’s expectation that firms must regulate themselves. The FCA has statutory objectives to make the markets work well, and deal with consumer protection, market integrity and the promotion of competition.
The FCA’s own risks come from failing to meet these objectives – with chief executive Martin Wheatley hauled before the Treasury select committee for a dressing down.
So they want firms to share the objectives with them to avoid that happening. Put more alluringly, the firms that do pay attention to conduct risks can expect to have an easier time in dealing with the FCA, at least compared with those that do not.
This year’s publications highlight a number of risks that might have an impact on the market for financial advice. Top of the list are retirement products. There are risks arising from the challenges around judging the suitability of different decumulation options. There is no mention of the chancellor’s recent Budget announcement, but that can surely have made the picture even more challenging for consumers.
The FCA is worried about risks from complex, opaque and overpriced products. In addition, marketing material or product labelling might highlight certain product features, creating spurious differences between products that are fundamentally designed to serve the same need. Barriers to exit are also a concern, preventing consumers from exiting a product that has become unsuitable for them. All of these will be concerns for product providers, but advisers will need to be on top of the risk to consumers, as well.
There is also a risk that terms and conditions for financial products may be excessively complex, making it difficult for consumers to understand what they have bought, and possibly obscuring important information necessary to compare different products, costs, risks or exclusions. This is a risk for product providers, but the adviser ‘sniff test’ is also relevant: do not recommend products unless you are sure you understand them.
There are concerns about consumer borrowing, whether secured or unsecured. A rise in the property market could lead to mortgage underwriting standards slipping – there may be affordability problems for consumers who assume interest rates will always be close to zero.
An economic recovery and a return of the ‘feel good factor’ may lead to unwise borrowing fuelled by unwise lending. This is an area that will be front and centre for the FCA as it takes on responsibility for consumer credit.
Technology is another risk. This is not just a problem for large banks whose payment systems might fail. All firms need to understand the technology risks they are running and, in particular, properly oversee any third-party firms to which technology solutions are outsourced.
There is also a risk perceived with back-books of legacy products, where providers may be relying on inertia to avoid providing benefits that are reserved for new customers. Advisers will need to be alert to their customers who might be holding products in this category – while at the same time avoiding the accusation of churning. Staying in the regulator’s good books in this area will come down to good record-keeping.
The FCA also raises a conduct risk in terms of firms’ culture and controls. The key to culture lies in firms’ internal systems and controls, making sure that all employees in the firm have a clear idea of what is expected of them and that they are measured against that expectation. The cultural tone must be set from the top of the organisation, with the firm’s leadership making a judgment on the acceptable balance between profit and risk.
There is nothing inherently wrong with firms taking risks – without risk there is indeed no return, and the FCA is aware of that. But if greater risk is to be taken, the risk management controls need to be enhanced to manage it. The FCA must now (by law) assess a firm’s business model. It is important that firms assess the risks that their operations may cause to consumers, market integrity or competition. Firms should have a handle on that before the FCA attempts its own judgment.
The most significant two risks for financial advisers are not explicitly mentioned in the Risk Outlook. That may seem odd but both of them are really what the risk eggheads would call ‘control failures’, rather than risks. They are suitability of advice and financial crime.
On suitability, it remains crucial to maintain records to prove why specific advice was appropriate to the consumer. On financial crime, money-laundering checks are vital. There are established standards for both these areas, but the number of disciplinary cases on both suggests consistent attention is needed.
So, what should a financial adviser do with the Risk Outlook? I can imagine all sorts of answers, but as already mentioned, the Outlook provides a heads-up on the FCA’s concerns.
All firms should analyse the risks to see whether they are valid to the firm’s business. Indeed, firms should look beyond the FCA’s publications and examine the risks that arise generally from its business – for example, the nature of its customers and the products it engages with.
For those risks that seem plausible, the next stage is to try to assess how big the problem is. After that comes the difficult question of how to deal with the risk. And this process of identification, assessment and mitigation needs to be regularly reviewed. The process needs to be proportionate – no-one expects a small firm of financial advisers to have a risk-management system equal to Barclays. But clearly the FCA expects to see something.
It made that clear in its recent publication, The FCA’s Approach to Supervision, where it said: “The theme… 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”.
Ashley Kovas is head of funds at Bovill, the financial services regulatory consultancy
Key points
* The Financial Conduct Authority has published its annual Risk Outlook and Business Plan.
* The FCA is worried about risks from complex, opaque and overpriced products
* All firms should analyse the risks to see whether they are valid to the firm’s business.
