FSA turns up the heat on conduct

FROM APRIL 2012 the Financial Services Authority (FSA) splits into ‘twin peaks’ so that regulated firms get two sets of supervisors before its two business units – Prudential and Conduct – become the Prudential Regulation Authority and the Financial Conduct Authority. Any hope FDs might have had that the operational complications of moving to a new model might dull regulatory momentum will have been dashed in recent weeks. The flurry of announcements and press briefings shows that when Lord Turner talks of taking a ‘drains up interest’ in how firms are making their money and ensuring good business conduct, he means it.

Lord Turner’s view which is echoed in the FSA’s Business Plan, is that firms’ senior management and boards must get more engaged in the conduct agenda. The message to firms is to get with the programme and that foot dragging will not be allowed to survive in the ‘new world’.

‘Conduct risk’ is in regulatory speak, all about the risk of a firm behaving in a way which delivers bad outcomes for customers. While already high on the FSA’s agenda, it will be higher still on the new Financial Conduct Authority’s agenda. The clue being in the name.

The problem for firms and their financial directors is that the recently released Retail Conduct Risk Outlook highlights 48 risks, with 16 new risks alone since 2011, covering just about all financial services firms and business. Only 3 risks from last year have been relegated but even here the FSA says that does not mean these are areas that firms can ignore.

The 48 risks are a heavy duty list, ranging from complex products such as structured investments, through reward and business models, via how firms are responding to regulatory and legal change such as RDR and Solvency II, to cost cutting and the search for business. A headache for business and compliance directors.

But FDs should be worrying about these retail conduct issues too, and about the conduct of their firm in general, as the regulatory spotlight is increasingly on all aspects of a firm’s behaviours. The FSA’s recent censure of HBOS, highlights how business strategy and aggressive growth, coupled with control and incentivisation weaknesses contributed to HBOS’s failure.

But for its taxpayer backing, it would have been hit with a fine of as much as £100 million due to its conduct in the lead-up to the financial crisis. Coutts has now been hit with a fine of £8.75mn for anti money laundering failures which also go to how the firm has conducted itself.

It is crucial therefore that FDs and their boards understand just how important their firms’ behaviours are to the FSA and the new regulatory bodies which will replace it.

This should also alert FDs to three strategic issues which their firms should consider. These are: Business model fragility; Innovation scepticism and Integration. Each presents their own challenges.

The regulator’s focus on getting conduct risk prevention embedded in firms is starting to impact on business models But what the FSA does not sufficiently acknowledge is how in a market of shrinking margins, organisations will make the kind of returns on which they have built their business, based their budgets, and set their shareholder expectations while at the same time being fair to customers. Or put another way, will firms want to offer the products in the first place and what will this mean for their business models?

Secondly there is the matter of innovation. From the broadside launched at the City by Lord Turner, Chairman of the FSA, in media interviews earlier this month and at the Treasury Select Committee the prevailing FSA view is clear. In the FSA’s eyes innovation is sometimes just needless complication to create products to drive increased revenue, and hence another risk.

Without a touchstone on what is good and bad innovation, many firms are going to struggle in prioritizing. The trouble is the FSA probably does not see itself as obliged to give them a clue on that. They just want them to take action. There is a touch of ‘just do it’ about this.

How they do this is the final issue. Effective tackling of business conduct issues requires firms to take a new cross functional and integrated approach, bringing together compliance, product development, business modeling and reward. Tone from the top and norms of behaviour and values comes into it, but it requires hard-coding into the way the firm works. Traditional technical views of risk have to be supplemented with a more strategic and outward looking risk and customer management capability.

This is taking firms into new territory. One where traditional vertical organisational structures and attitudes don’t make this easy.

FDs and their boards must start having the necessary strategic debates to make this cross functional approach happen. And, where some firms are trying to find a way through via digital innovation and transformation, they need to build in management of conduct risk to avoid transforming themselves into just being more efficient at making old mistakes – at least from the regulator’s point of view.

The sooner a firm starts to grapple with this, the sooner they will make real in-roads on the conduct risks that the FSA is highlighting in firms and for customers. The FSA has thrown down the gauntlet. It expects financial directors and their boards to pick it up.

Sandra Quinn is an associate director at Capgemini Consulting. A former senior regulator, she was previously director of people risk at Lloyds Banking Group, and interim chief executive of the National Fraud Authority. Sandra is also managing director of Quinnity