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Prioritising prudence and conduct in a regulated market

A STRING of fresh scandals – including mis-selling and Libor-rate fixing – have raised questions over the financial industry and the way it operates. As a result, the regulator is adopting a renewed vigour to fulfil its pledge and create orderly markets that prioritise good governance.

With the regulator seeking to create a more controlled industry that prevents another financial crash, there is a heightened focus on examining the conduct of both financial institutions and the approach of executives when it comes to creating prudent financial markets. Just weeks into 2014 and the Financial Conduct Authority (FCA) had already announced that Standard Bank has been fined £7.6m for anti-money laundering (AML) controls and the Co-Operative Bank is facing an investigation for its £1.5bn capital shortfall.

Research by the London School of Economics reveals that the world’s biggest banks have already paid out approximately £143bn in “conduct costs”. Yet the FCA’s focus on good conduct is only going to intensify as financial institutions face additional fines and compensations for failing to exhibit anything but “exemplary behaviour”.

A joint approach
The regulators are already starting to impose stricter sanctions on individuals who are reckless with clients’ money and assets. In the year ahead, it is likely that the FCA will introduce new measures, including criminal charges and clawing back bonuses or pensions, to make the impact of non-compliance even more severe on individuals responsible for breaches of governance.

However, the FCA is no longer alone. Moving forwards, where conduct is under review by the FCA, the Prudential Regulation Authority (PRA) will be following closely behind as the regulators seek better integration of “conduct” and “prudent reviews”.

To prove compliance and demonstrate how firms are introducing control frameworks centred round prudence and good conduct, the regulators are demanding even more granular reporting from organisations. In particular, the FCA wants to understand where capital sits, how client assets are being handled and what protections are in place in the event of a failure, at all times. In addition, the regulators want reassurance that firms understand customer needs and are developing a proposition that ensures firms are delivering the right level of service and contact at all times.

Delivering this information will require many banking organisations to invest in core modern banking infrastructures that bring together different feeds from legacy systems. Once again, financial institutions will need to change the way they operate and move away from siloed systems to meet tougher regulatory requirements, fulfil the competing demands of different stakeholders and return to growth and profits as quickly as possible.

Better capitalisation
The FCA is also placing more emphasis on organisations’ financial stability and highlighting the importance of good governance in preventing the level of global contagion seen since the financial crash. The regulator has long been committed to creating better-capitalised banks so that organisations avoid the temptation to engage in the bad behaviours brought about by a shortfall of capital. However, it is likely to introduce new preventive measures to avoid further instances emerging.

Over the next year, it is likely that firms who fail to meet capital adequacy requirements and institute simple financial controls will be banned from taking on new business as the regulatory regime continues to be dictated by the desire to protect customers’ assets. As a result, the industry will see smaller players exit the market as they struggle to meet demands for better integration of “conduct” and “prudence” practices – with many being forced to become closed-book businesses, face acquisition or simply cease to exist.

Since the FCA was introduced as the governing body, it has already got tough on compliance. However, the ongoing emergence of new breaches in financial controls should act as a warning that the regulator has not yet finished the transformation. Over the next year, fines will continue to get bigger and more individuals will be held accountable as the FCA and PRA aim to create a closely regulated market. The real challenge will be creating a viable marketplace that protects customers’ assets but also allows competition to exist.

Jim Muir is director of AutoRek

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