Tag Archives: conduct risk

FSB Resolute on Reducing Misconduct Risk

Boardroom

In May 2015 the Financial Stability Board (FSB) agreed a work plan on measures to reduce misconduct risk, covering:

  1. reforms to incentives to reduce misconduct;
  2. improved global standards of conduct in the fixed income, commodities and currency (FICC) markets; and
  3. coordination of reforms to major financial benchmarks

The FSB objective is to strengthen the resilience of the financial system by raising expectations for, as well as awareness of, good practice standards of behaviour and conduct across markets and market participants.

Their message is clear: “Ethical conduct, and compliance with both the letter and spirit of applicable laws and regulations, is critical to public trust and confidence in the financial system”.

The FSB also believes misconduct is relevant to prudential oversight given its potential to affect the safety and soundness of a particular financial institution; an obvious step considering the scale of fines already levied on financial institutions and indeed future pay-outs provided for under stress tests.

Earlier this week, the FSB provided an update in its second report: Measures to reduce misconduct risk.

The role of incentives in reducing misconduct.

  • The FSB will develop and consult on supplementary misconduct-related guidance for existing compensation standards and recommendations for consistent national reporting and collection of data to address misconduct by end-2017
  • In parallel, the Working Group on Governance Frameworks will take stock of efforts to address misconduct and will potentially develop a supervisory toolkit or guidance for strengthening such governance frameworks

Improving standards of market practice.

  • The International Organization for Securities Commissions (IOSCO) will publish a final report of its Market Conduct Task Force in January 2017, including a detailed regulatory toolkit for wholesale market conduct regulation
  • The Foreign Exchange Working Group of the Bank for International Settlements (BIS) will issue its complete Global Code of Conduct for the Foreign Exchange Market and adherence mechanisms in May 2017

Reforming financial benchmarks.

  • The FSB will issue a final progress report on Reforming Major Interest Rate Benchmarks by end-2017
  • IOSCO is also assessing the degree of implementation of the Principles for Financial Benchmarks by benchmark administrators operating in IOSCO jurisdictions and by end-2016, will finalise guidance on the content of the statements of compliance that administrators are expected to publish

Next Steps

The FSB will publish a third progress report on its misconduct work plan in advance of the next G20 Leaders’ meeting in July 2017. Meanwhile, where does that leave Boards of financial institutions?

The answer is simple – the conduct agenda is not going away!

In fact the reversal of regulatory focus, from producers to customers, is in many ways a reasonable and overdue change, recognising customers’ real needs.

This conduct approach explicitly requires producers to turn their own compliance lenses inside out, or more accurately outside in, after decades of introspection and self-certified assurances.

For the Board this means taking appropriate steps to prevent, stop and/or remedy conduct failures. But directors can only do this if they are in touch with “what actually happens” day-to-day in their firm.

The Board emphasis needs to shift from econometrics to include greater engagement and more observation for directors to be satisfied that governance arrangements will safeguard their firm against customer detriment, a breakdown of market integrity and/or a distortion of competition.

Some questions the Board might consider:

  1. Does each member of the Board understand and distinguish between behavioural risk and conduct risk; biases and behaviours; risks and uncertainties? Does the Board understand collective and individual responsibilities, documenting them and exercising governance at a level that regulators expect? Is it adequately addressed under SMR?
  2. Has the Board established a working definition of conduct risk in the firm that is in line with latest best practice in the subsector? Is this evident in customer and business strategies?
  3. Who on the Board has direct authority over strategic response to customer complaints? How does the firm use conditioning (rewards/sanctions) to promote best conduct with customers? What corrective actions are available against persistent ‘rule-gamers’? How have these been used?
  4. What is the Board’s process for keeping up to date its definition of ‘acceptable and expected behaviour’ in the firm? How are personal expectations of staff behaviours and attitudes changing? What methods are used to track external changes in expectations?
  5. Is each member of the Board satisfied that the firm has identified and engaged with conduct risk within the overall risk framework, not merely as box-ticking, and to a standard that will satisfy the regulator?
  6. What forms of regular analysis does the Board commission to validate its claims to good conduct? (such as customer feedback, trends in enforcement, peer-provider comparison)
  7. In what practical ways does the firm put “customers at the heart of its business” and promote behaviours that consistently support this across all product and service lines?
  8. How does it make explicit its risk decision process in designing products and services to balance profit with due care for customers? Can it demonstrate equal concern for new and existing customers, and over the whole life and range of products and services?
  9. Which qualitative and quantitative indicators does it see as most effective in shaping how the firm engages with conduct risk? (For example: how incentives are affecting staff behaviour in practice; rates of change in fraud, absenteeism, staff retention, complaints or frequency of account closures)
  10. How does the Board identify business activities with the greatest behavioural risk? Who on the Board has the primary task of focusing on behavioural risk exposures? How does the Board hold executives and managers to account for the resulting conduct risks?
  11. For every fine paid by the firm, what is the true cost sustained by the time other costs are taken into account including restitution payments, professional fees, staff displacements, re-hiring and placating investors?
  12. How does the Board inform itself about “What Actually Happens” in the customer-facing functions of their firm? Does it take governance comfort from conventional checklists of compliance and financial transaction data, or do you use newer forms of insight such, as a behavioural lens or conduct analysis?

The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinions, position, or policy of Berkeley Research Group, LLC or its other employees and affiliates.

Compensation & Misconduct in Banking

FinTech brg

On 10 May 2016 the Financial Stability Board (FSB) hosted a round table on compensation practices to share experiences and lessons on the use of compensation tools to address misconduct in banks.

Senior executives responsible for risk and remuneration functions at 22 large internationally active banks and officials from the FSB Compensation Monitoring Contact Group (CMCG) participated in the round table.

Key takeaways  

The round table considered the processes for governing and applying compensation and related risk management tools to help better identify, mitigate and redress misconduct risk.

Participants also explored challenges related to use of current tools, including differences in their application among jurisdictions and also discussed the relative importance of compensation tools compared to other approaches to handling misconduct.

Participants believe that compensation tools are just part of the toolkit used in reducing the risks of misconduct; some banks advocated more (principle-based) dialogue between firms and supervisors on the full set of tools used to manage talent and culture with a focus on:

  • promoting good behaviours including effective use of compensation tools
  • enhancing individual accountability at all levels of the organization
  • providing guidance on what “good behaviours” look like

Participants indicated that there has already been significant change with most firms recognising that compensation and conduct are directly linked.

Furthermore firms are increasingly looking to actively manage conduct via compensation tools:

  • ex ante (explicit performance targets and encouragement of positive behaviour) and
  • ex post (ensuring appropriate consequences for poor behaviour)

More generally, banks are focused on turning values into actions and ensuring that lines of business “own” conduct risk; at most banks, codes of conduct set the framework for expected behaviour and are supported with explicit expectations for roles and responsibilities.

Banks pointed to the importance of “tone from the top” in signalling where to place the balance between performance and customer and counterparty interests while recognising the importance of long-term relationships with all customers. They noted however, that to be effective and to actually change culture and values, a holistic approach to culture, conduct, and employee development and reward systems must be developed, all of which takes time.

A number of banks requested more guidance from regulators on “what good looks like” and welcomed initiatives such as round tables to share examples of better practice. Notwithstanding this, they also emphasised the importance of allowing time to embed existing regulations.

Without doubt, regulators are holding boards accountable for culture and in this context the role played by rewards in driving behaviours. This is a key issue for the Remuneration Committee and in particular it’s Chair.

The real challenge for directors and senior executives is to understand “what actually happens” on a day to day basis in their firms. Econometrics provide only partial answers. Increasingly boards will need to evidence observed behaviours and the steps taken to prevent, stop and/or remedy conduct failures; including how their observations link back to reward systems.

The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinions, position, or policy of Berkeley Research Group, LLC or its other employees and affiliates.

SEC “Cybersecurity is one of the greatest risks facing the Financial Services Industry”

SEC

Mary Jo White, Chair of the U.S. Securities and Exchange Commission (SEC), delivered a Keynote Address Investment Company Institute 2016 General Meeting in Washington, DC on the 20th May

The Commission is the primary regulator of the mutual fund industry which is comprised of 8,131 mutual funds with approximately $15 trillion in assets held by 54 million U.S. households as of March 2016.

White advised that the current and future health of the markets and the financial security of investors depend on the success of both its regulatory efforts and how well the industry participants do their jobs as fiduciaries and responsible leaders of the marketplace.

She highlighted 3 significant areas of regulation for the asset management industry:

  • controls on conflicts of interest;
  • a robust registration, reporting and disclosure regime; and
  • controls on specific fund portfolio composition risks and operational risks

Looking to the future, White highlighted disclosure effectiveness and ETFs as key areas of focus for the SEC. She also highlighted a number of areas where the sector must take the lead.

White believes a key challenge for the industry is the risk in using technology and service providers. She stressed the importance of firms ensuring that a fund is adequately prepared to promptly and effectively respond to risks that may be triggered by service providers and its own use of technology, including implementing alternative and reliable means to satisfy the fund’s regulatory requirements.

Cybersecurity is a particularly critical element of this challenge – as I have said before, cybersecurity is one of the greatest risks facing the financial services industry.  Cyber risks can produce far-reaching impacts, and robust and responsible safeguards for funds and for their investors must be maintained”.

The Commission has been very active in drawing attention to the issue and examining and enforcing the rules it oversees in respect of cybersecurity. Its regulatory efforts are focused primarily on ensuring that our registered entities have policies and procedures to address the risks posed to systems and data by cyber-attacks.

While no one can prevent all disruptions from cybersecurity events, you should consider the full range of cybersecurity risks to your funds and consider appropriate tools and procedures to prevent breaches, detect attacks and limit harm”.

BRG recently undertook a Cybersecurity Preparedness Benchmark Study. The study examined six main areas:

  • Leadership
  • Information Governance
  • Risk Management
  • Essential Protection
  • Incident Response and
  • Security Culture

For financial services, BRG partnered with the Institute of Operational Risk.

The results of the Benchmark will be released shortly.

For further information, please contact:

USA:                      Faisal Amin         famin@thinkbrg.com

UK/EMEA            Tony Moroney  tmoroney@thinkbrg.com

The views and opinions expressed in this article are those of the authors and do not necessarily reflect the opinions, position, or policy of Berkeley Research Group, LLC or its other employees and affiliates.

FCA stresses mortgage affordability, competition and innovation

FinTech brgJonathan Davidson, Director of Supervision retail and authorisations at the Financial Conduct Authority (FCA), delivered a keynote speech at the Building Societies Association Annual Conference.

Davidson stated that the FCA has a keen interest in strategy:

  1. strategic factors which shape the landscape
  2. resulting strategies and the business models
  3. how business models create a sector that works well for consumers

He acknowledged some of the strategic questions the building society sector is dealing with, namely:

  • the digital challenge,
  • the growth of challenger banks
  • the economies of scale of the large banks

Davidson also shared some of his thoughts on how the FCA approaches interventions that have an impact on building societies and their respective strategies and business models:

  • The FCA expect firms to have their customers at the heart of how they do business; how they develop products and services and how they treat customers.
  • Promoting competition is not just about preventing market share dominance; it’s about ensuring that building societies and other firms have the opportunities to reach consumers and grow.
  • Innovation if not managed appropriately they can lead to serious risks that can prove existential to individual firms and taken to their extreme could potentially affect a whole market; affordability and responsible lending rules serve to prevent the return of the irresponsible lending practices pre-crisis and so protect the strategically important mortgage market.
  • The FCA is concerned as to what will happen to borrowers in the event of a rate rise; over a million borrowers have never seen an interest rate rise.
  • FCA recognises the importance of meeting the financial services needs of older consumers; it will publish a series of recommendations in 2017.
  • The FCA mortgage market study will also look at consumers’ ability to make effective choices and whether the tools available such as price comparison websites, best buy tables or interactions with advisers, do in fact effectively help customers source the products that best meet their needs.

The UK’s 44 building societies approved £57.8bn in new lending in 2015; some 395.3k new mortgages giving them a 26% market share. At the end of 2015, they held mortgages with a value of £265.2bn; 21% share.

Retail savings balances increased by £10.4bn and at the end of 2015 building societies held savings balances of £246.6bn; 18% share of the UK market.

The BSA believes that as customer owned organisations, that its member firms genuinely have their customers at the heart of their businesses. Intuitively this sounds right, however, it equally raises the bar for boards and senior executives to ensure their firms consistently achieve “good customer outcomes”.

Strong product governance is a prerequisite, not just at the point of sale but throughout the life of the relationship with customers/members. With huge quantities of mortgages being written on short-term fixed rates, the moment of truth will be the re-pricing of mortgages on roll-over.

The views and opinions expressed in this article are those of the authors and do not necessarily reflect the opinions, position, or policy of Berkeley Research Group, LLC or its other employees and affiliates.

Insurance Supervisors concerned about FinTech

Bank Reg

The International Association of Insurance Supervisors (IAIS) represents insurance supervisors and regulators from more than 200 jurisdictions in nearly than 140 countries.

Its Secretary General, Yoshihiro Kawai, outlined IAIS’s position with regards to FinTech in its recent newsletter.

For Kawai, FinTech presents both a significant opportunity and a threat.

It is giving rise to new business models, applications, processes and products. These could have a material effect on financial markets and institutions and the provision of financial services”.

IAIS focus has been on financial inclusion. It acknowledges that FinTech, in particular mobile or online based sales, has already contributed to a significant increase in insurance sales in some emerging markets.

New technology enables insurers, intermediaries and other financial service providers to customise products and marketing material”.

“However, more opportunities and fewer barriers do not automatically mean better market or customer outcomes and can also give rise to conduct of business risk”.

IAIS believes there are risks when products are sold online or using digital platforms without appropriate advice:

  • Unauthorised insurers could sell insurance to a wide range of customers across borders
  • The growing importance of data leads to risks to privacy protection and data security
  • Sophisticated cyber-attacks may lead to customer data being stolen, manipulated or destroyed

IAIS also recognises that FinTech developments pose substantial supervisory and regulatory challenges.

Kawai acknowledges that both insurance regulation and insurance supervisors need to adapt, foresee potential risks and act in a timely and appropriate manner to pre-empt emerging risks of FinTech.

Kawai concludes that IAIS Members should be well informed and prepared. He rightly points to conduct of business risks. Boards and senior executives of insurance firms need to ensure their products and services are based on real customer needs. Ensuring good customer outcomes is key.

The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinions, position, or policy of Berkeley Research Group, LLC or its other employees and affiliates.

 

Boards ultimately have responsibility for Sales Incentives and Customer Outcomes

 

FinCoNet, the International Financial Consumer Protection Organisation, has published its Report on Sales Incentives and Responsible Lending, outlining key findings on the topic.

It is no real surprise that sales incentives are a key driver of both culture and behaviour towards consumers. Key findings of the report include: Continue reading Boards ultimately have responsibility for Sales Incentives and Customer Outcomes

Catching the Careless Nudists: New ways to predict problem behaviour (Part 2)

iStock_000012107875XLargeWe would all like to think that our offices are full of positively motivated people, yet the reality is that some of our staffs behave in various ways that do not conform to expected good behaviour. Each individual’s behaviour is constantly adjusted due to both positive and negative reinforcement. Behavioural economics may simply confirm some of our suspicions at a surface level, but it also adds deeper insights. For example… Continue reading Catching the Careless Nudists: New ways to predict problem behaviour (Part 2)