These days, when a firm has to follow things up after a visit from the UK's Financial Conduct Authority, the regulator is likely to ask it to write a letter attesting that it has completed all the follow-up tasks. This used to occur only after warning of enforcement. This is one way of offseting 'conduct risk,' which we examine in this article.

At the dawn of the FCA’s life in April 2013, there was much talk of ‘conduct risk’. Yet there are many in the wealth management and private banking industry who are still asking the question: what is conduct risk and what does it mean for my organisation?

In fact, the greatest challenge facing compliance and risk managers today is to try to settle on examples of conduct that are acceptable in the multiple market, investment and client sectors that the FCA regulates.
 
What is conduct risk?

Conduct risk is, in effect, the danger that the conduct of a regulated firm will hamper the FCA in its objective of making financial markets work well so that consumers receive a fair deal. This objective is encapsulated in 3 broad things that the FCA desires. It wants to see that:

• consumers obtain financial services and products that meet their needs, from firms they can trust;
• markets and financial systems are sound, stable and resilient, with transparent pricing information; and
• firms compete effectively, with the interests of their customers and the integrity of the market at the heart of their approach to doing business.

What does it mean for my organisation?

What does conduct risk really mean in practical terms for a regulated firm? If conduct risk is not simply another type of risk that has to be ‘ticked off’ by the compliance team, how should it be approached?

Here are eight typical elements of a strategy for offsetting conduct risk that the FCA might reasonably expect to see at a wealth management firm.

1. An independent client feedback programme. For example, the FCA might ask for ten suggestions from clients that have actually been turned into reality. Online questionnaires may form part of this process, to ensure that the ‘fix’ to a known problem has worked.

2. ‘Mystery shopping.' This happens when the wealth management firm employs a number of external individuals (e.g. consultants) to pose as clients and then relate the experiences they had when they were trying to do business with it. The FCA is definitely in favour of this approach (which it takes itself when it wants to glean information) and most of the bigger firms already do mystery shopping.

3. Conduct risk dashboard. This is a device to monitor likely outcomes for clients, covering items such as:

• complaints and incidents (for example, looking at the relationships between advisors with high sales volumes and high volumes of complaints or cancellations);
• the tracking of sales (for example, if there are four times as many sales of a new product than expected, the firm unearths the reasons why); and
• an analysis of the ‘quality of the sale’, in terms of the results for clients.

4. Rigorous schemes for managing conflicts. These would certainly include an analysis of gifts and entertainment, but also personal trading.

5. New product development plans. The wealth manager should be able to provide evidence that these new products suit the target market for which they are intended (and will therefore not be miss-sold).

6. Sales incentives. Wealth management firms should by now be avoiding formulaic remuneration schemes based on sales volumes. An example might be if a salesperson passes £500,000 in sales and then gains a bonus on the entire amount. This type of scheme is a red rag - or should I say a 'red flag' - to the FCA and many wealth managers are moving away from these to more discretionary programmes.

7. Provision of ‘lower level’ attestations. Attestations are now being requested by the FCA in many more circumstances than they were in the past. For example, when follow up is to be undertaken by the firm after an FCA review, the FCA will now commonly ask for an attestation that the follow up tasks have been completed. This type of situation used to occur only after warning of enforcement.

8. Monthly client committees. A firm might set up a committee of clients whose purpose is to give those clients a voice that its managers (not the compliance team!) will hear more clearly than otherwise. In this way, the wealth management firm can put its business model, not just its compliance processes, to the test regularly.

A subset of enterprise risk

Conduct risk is a core component of enterprise risk management and, because of this, the average wealth management firm should consider the job of handling it as a central and vital one. This entails the development of appropriate policies and procedures for the firm’s markets and clients. The firm must benchmark and monitor these policies and procedures, while deploying management oversight mechanisms every step of the way.

Nevertheless, there continues to be little evidence that firms are guarding against conduct risk in a radical manner. Yes, Barclays has established its very own ‘Compliance Career Academy’ (in association with Cambridge University’s Judge Business School) after a series of scandals, but too few firms are placing conduct risk at the top of the management agenda and taking responsibility for the issue at board level.

Yet this is the only way that conduct and compliance strategies will ever be embedded 'from the top down' in the manner that the FCA seeks.

* Neil Herbert is the director of the 'training and competence' (T&C) software firm, HRComply. He can be reached on +44 (0)20 3176 7859 or at neil.herbert@hrcomply.co.uk