An FCA speaker at a recent industry conference owned up to the fact that her organisation deliberately did not have a master definition of 'conduct risk.' What does this mean for a bank or other firm that honestly wants to stop its staff from abusing the market?

This time last year, everyone was talking about the heavier burden that the Retail Distribution Review had placed on the compliance and regulatory obligations of retail firms. This had clearly led to an increase in compliance costs; all across the industry we saw profit warnings, consolidation and exits by smaller IFA firms as a consequence. This pattern has continued unabated.

‘Compliance creep’

Nevertheless, ‘compliance creep’ eventually affects all sectors of the financial services industry. For example, in recent months there has been extensive press coverage of the FCA’s criticism of the funds industry, specifically at its failure to impose and manage adequate market abuse controls. This was the result of a recent FCA thematic review across a pretty broad sample group within the sector.

This is a knock-on effect o the FCA’s intention to apply its standards across the wholesale, investment banking and fund management sectors. It was reported that investment management firms were bracing themselves for a redoubling of the regulator's clampdown on insider dealing and market abuse.

As part of its 2015/2016 business plan the FCA has promised to conduct a wholesale market study into competition in investment and corporate banking. We shall see it concentrating on the ways in which poor culture and control continues to threaten the 'integrity' of markets. The regulator is also displaying a keen interest in firms’ systems and controls in relation to financial crime.

Rocketing punishments, rocketing expenditures

In 2013/14 the FCA took action against 28 individuals, imposing over £3.6m in fines and 26 prohibitions, and obtaining five criminal convictions. The regulator held 16 'significant influence function-holders' (assuming that it is gramatically possible to hold a function) to account, imposing penalties and prohibitions.

The ever-increasing compliance burden and the need for vigilance, monitoring and control of market abuse has fuelled demand for compliance staff. This, in turn, has driven salaries upwards in this once unfashionable area of the financial sector. All this has led to an increase in efforts to track and monitor the activities of staff who were previously designated as 'low-risk' and a growth in investment in technology to monitor electronic and voice messaging and communications.

There has also been an increase in the use of monitoring and tracking systems to help people understand and adhere to market-abuse-related regulation. Some firms are alternating the teams that compliance staff supervise in order to ensure that monitoring systems are more difficult to evade. But is this enough to tackle the growing problem of 'conduct risk' (explained in many recent articles in Compliance Matters) and enforcement by the FCA on the grounds of market abuse and insider dealing?

Although it has little to do with private client management, it is worth mentioning that many investment banks are retreating from proprietary trading, particularly in Europe. They are doing so because of further regulatory clampdowns and political and public hostility, together with the rocketing incidence of enforcement action and fines. This is all part of the larger 'de-risking' syndrome that private bankers know about only too well.

Market abuse and a compliance culture

Market abuse is a cultural problem, requiring the human resources and compliance teams to work together. Types of conduct constituting market abuse are set out in section 118 Financial Services and Markets Act 2000 and in the European Union's Market Abuse Directive; yet how effectively are these restraints being communicated to the front office? And what constitutes the limits of ‘acceptability’ for those who are being trained to spot or avoid market abuse? Indeed, how realistic is such a task in these days of high-frequency trading and massive dealing floors with hundreds of traders working across multiple markets and financial instruments?

The Senior Managers' Regime

The big banks in particular will finds themselves worried by the new Senior Managers Regime. The consequences for those on whose watch market abuse or scandals occur will become very dire indeed. Given this threat and the ever-downward pressure on remuneration for senior bankers, not to mention the deferral, clawing-back and taxing of bonuses, is it any wonder that the likes of HSBC are struggling to attract talent at the top end (or seriously considering relocation to other jurisdictions)?

How the FCA assesses compliance culture
 
The FCA assesses culture through factors such as:

• how firms respond to, and deal with, regulatory issues;
• what customers are actually experiencing when they buy a product or service from front-line staff;
• how firms design products and the considerations around this;
• the manner in which decisions are made or escalated;
• the way in which claims or complaints are handled;
• the behaviour of firms in certain markets; and
• the remuneration structures and the ways in which this-or-that firm’s board views those issues and satisfies itself that the firm is operating as the regulator expects.

It therefore makes sense to focus on these key areas when designing assessment and management tools to monitor how well the business and individuals perform and to forestall undesirable results.

An FCA speaker at a recent industry conference owned up to the fact that the FCA deliberately did not have a master definition of conduct risk and that conduct risk profiles would be unique to every firm – making a one-size-fits-all approach impossible. Instead, she said that the FCA had already made it clear that having the right ‘culture’ (i.e. one that puts customers at the heart of the firm’s business) was an important component of conduct risk. The FCA, to date, has offered us no specific definition of the kind of culture it requires.

A cold, hard world

In such a culture, everyone has a responsibility for compliance. A focus on conduct, quality and suitability of advice, know your customer and general customer and market outcomes must drive outputs in terms of behaviours.

The problem requires real-time monitoring of trades, but is this practical or even desirable? Throwing more compliance staff at the issue certainly cannot make it go away. The effective deployment of automated training and competence (T&C) technology and process–based decisions will help free up the already overburdened compliance team to work alongside HR and concentrate on the cultural change required to reduce market abuse.

Furthermore, clear rules or benchmarks that help firms to meet the regulator's expectations will be necessary.