In its new supervisory model, the FCA has clearly flagged a shift towards a pre-emptive and judgement-based approach to training and competence. Its brief is now to focus on “outcomes”.
This entails achieving appropriate customer or market outcomes and the highest ethical performance from customer-facing staff. In simple terms, it refers to one thing: conduct.
Regulators around the world are giving the management of conduct risk the highest level of priority. Crucially, however, there is no universally agreed definition of conduct risk. Indeed, the FCA has acknowledged that it does not have a master definition. I believe this is a deliberate policy. Why?
The FCA says conduct risk profiles are unique to every firm, making a one-size-fits-all approach impossible. Achieving appropriate customer, market and behaviour outcomes is dependent on a culture that sees these interests as paramount. This approach enforces and reinforces appropriate behaviour, standards and outcomes by embedding a top-down compliance culture.
This new model applies to all regulated firms, not just those in the retail sector. Yet there is a misconception in areas of the wholesale banking, investment banking and investment management sectors that this regulation does not apply to them. In a sense, however, it is even more important. At least the retail sector has relatively prescriptive frameworks surrounding T&C and conduct; other sectors are left to follow guidelines.
If T&C, conduct policy and process fail to deliver compliant client, market and behavioural outcomes, the FCA will – under its judgement-based approach – deem the firm in question to be failing to comply.
Drivers of conduct risk
The three main drivers for conduct risk are:
■ Inherent factors, such as information asymmetries, biases and inadequate financial capability;
■ Structures and behaviours, such as ineffective competition, culture and incentives and conflicts of interest;
■ Environmental factors, such as economic, regulatory and technological changes.
The FCA will focus its reviews on how firms adjust their strategic business models; whether they balance prudential soundness and profitability with good consumer outcomes; and the alignment of market performance expectations and underlying fundamentals. The foundation for every firm is to:
■ Assess the business model strategy and structure to ensure it is putting the interests of the customer and the integrity of markets centre stage;
■ Ensure that it has a culture that promotes sound outcomes; appropriate oversight and governance around the design and innovation of products and services; the promotion of consumer confidence by taking an active role in ensuring the integrity of the markets; and transparency.
This is all rather conceptual (and perhaps intentionally vague). So, how should these concepts translate into practice?
The most important challenge is to create a culture that puts integrity and trust at the heart of all business activity. It is critical to embed processes and controls that identify and deal efficiently with conduct risk, maintaining appropriate audit trails and records.
The FCA assesses culture through factors such as how firms respond to and deal with regulatory issues; what customers experience when they buy products or services; how a firm designs its products; the manner in which decisions are made or escalated; the behaviour of the firm and its staff in markets; the remuneration structures; and, ultimately, how a firm engages in and drives these areas of conduct and ensures that they comply.
In order to do this, the compliance, risk and HR departments must define with the board what is acceptable, including the levels of conduct expected in the environments in which the firm operates.
The second-biggest challenge is making this happen: setting benchmarks and expected levels of delivery; designing suitable training and monitoring its success; and identifying and remedying any shortfalls.
Neil Herbert is director of HR Comply
