Metric issue-03


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CC Metric New Issue no 3

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Metric issue-03

  1. 1. Click here Join Our metric Group CHASE COOPERFSAs Retail Risk Conduct Outlook - new areas forconcern? metric Nick Gibson, Chase Cooper’s Director of Compliance Solutions discusses:Guidance on new Bribery the FSA’s first Retail Conduct Risk Outlook — emerging risks andAct Published potential concernsThe UKs Bribery Act 2010 comes into force on The FSA published its very first Retail Conduct Risk Outlook on 28th February.the 1st of July this year. At the end of lastmonth the Ministry of Justice released a 45- Most of the retail industry is already coming to the end of its decision-making process inpage guidance for commercial organisations terms of new business models to meet the requirements of the Retail Distribution Review,impacted by this new so the article provides some interesting reality checks.act, together with a9-page quick start The outlook is interesting less for its analysis of current issues - including paymentguide. This welcome protection insurance and sales of structured products and deposits to retailguidance seeks to investors - but more for what it tells us about the FSAs likely activities goingclarify many of theareas of concern, forward. This forward-looking element is split between emerging risks (wherenamely the treatment there is already evidence of poor conduct by firms) and potential concerns, whichof joint ventures, is the FSAs own crystal ball gazing based on theircorporate hospitality, assessment of the environment. IN THIS ISSUE OF metricbribery within the ● SEC probe Chinese firmssupply chain, and FSA regulated firms, from retail banks to ● ERM Discussion Draftsactivities of independent financial advisers, should be ● Singapore targets CRAs"associated persons". It also states that, shouldany of the infringements be committed by an methodically reviewing their current and proposed services ● Vickers Report releasedemployee or agent, the existence of adequate and activities in those areas described by the FSA as emerginganti-bribery procedures in that organisation risks to assure themselves that they are operating to an adequate standard, as FSA willwould be considered favourably as defence certainly be looking at them itself. We look at some key issues.against penalties. Key statements were - thatan organisation was not necessarily liable for FSAs Retail Distribution Review (RDR)any bribery within a supplier simply on the Many of the emerging risks described implicitly arise from the imminent implementation ofbasis that it was receiving that suppliersgoods, - also that genuine hospitality and the Retail Distribution Review, and the changes to firms business models that arise from it.promotional expenditure was not necessarily As an aside, it is interesting to note that Barclays has already declared its intention to exitbanned. The guidance laid down six keyprinciples in the creation of adequate the business of advising retail customers on investments through its branch network - theprocedures: proportionality, top level Barclays Financial Planning division - apparently due to low levels of customercommitment, risk assessment, due diligence, activity and increasing regulatory costs.communication and monitoring/review. It alsoclearly stated that procedures were not A clear risk is that firms may be seeking to minimise cost and maximise 3 ISSUEneeded where there was very little risk of recurring income streams ahead of RDR go-live, through a variety ofbribery being committed on behalf of the mechanisms, to cushion themselves against the new regulatoryorganisation. m environment. Examples are: continued on page 2
  2. 2. network, as those charged with control try to manage more people, § Accepting large commissions offered by providers who are seeking learn new products, and cope with a greater volume of sales. All this to maximise market share, resulting in unnecessary product churn from the investors viewpoint; seems self-evident, but network firms need to show that they recognise the risk and take steps to mitigate it. § Increasing the amounts of trail commission charged on current sales; Remuneration Issues § Maximising commission generation ahead of selling the firm or Remuneration issues are always an area of concern, particularly where exiting the market; there are explicit links More than half of unsuitable § Leveraging inconsistency between levels of commission on between remuneration metric equivalent products packaged in different ways, leading to the and the achievement of investment files reviewed by possibility that firms will favour products offering a higher sales targets: the FSA is the FSA failed on the point commission but delivering similar results; concerned that firms of the portfolio not meeting operating such targets the risks the customer was § Using third party investment platforms to facilitate advice and are not devoting enough willing and able to take. administer client portfolios (about half of all new investor money effort to oversee the now is placed through platform services) which only view a limited range of investment products, thus risking unsuitable advice. suitability of such sales given the clear conflict of interest faced by the sales staff. The FSA acknowledges inconsistencies between firms terms of business and platform services provided, and a lack of clarity around Whilst it is interesting that the FSA describes this as an emergent risk the platform charging model towards the investor. - the conflict between sales levels and related incentives has always It is not remotely surprising that this should be the case, given that the FSA been with us - it can only be that the economic environment makes has effectively unilaterally changed the retail advice business model within achievement of targets more challenging, increasing the risk that the industry. However, in the light of this new reality, actions to maximise sales advisers will act inappropriately to achieve targets. income and shareholder value to ensure survival and prosperity by firms in Customer Risk Profiling the retail financial services sector could have some unforeseen Investment risk profiling for customers is also an emerging area of consequences: a business model that is unacceptable to the FSA is likely to concern, likely to lead to customer detriment. Simply, if the risk cost the owners more than the revenues generated or safeguarded. profile is inaccurate or incomplete, there is a high chance that advice and sales based upon it will be unsuitable. In itself, this is a significant governance risk for firms: how do senior management or proprietors mitigate the risk that all of the initiatives More than half of unsuitable investment files reviewed by the FSA adopted to meet the RDR and carry on in business, as a package, are failed on the point of the portfolio not meeting the risks the not sufficiently focused on ensuring that the clients best interests customer was willing and able to take. This appears to include a continue to be served? Have senior management taken a step back recognition that an unduly conservative portfolio selection fails the and looked at the new business model from soup to nuts? customer by reducing their opportunity for income and capital gain. The FSA is - not unreasonably - expecting a reasonably IFA Networks precise calibration between the consumers expressed risk 2 A further risk generated in part by the RDR is a lack or downgrading appetite and the advice or portfolio constructed for them. of systems and controls within IFA networks. Smaller firms may be seeking to reduce overheads by becoming appointed representatives This is increasingly challenging at a time when customers seek the of an adviser network. At the same time, existing networks are, in unrealistic objective of minimal risk for high returns, leading firms to common with the rest of consider more highly-structured products (which they themselves metricA business model that is the industry, seeing may not understand in depth) in an attempt to satisfy their clients.unacceptable to FSA is falling business levels In response to this key issue, the FSA released guidance in Januarylikely to cost the owners due to the adverse 2011 on assessing suitability, underlining that firms often fail tomore than the revenues economic environment. collect comprehensive information - an example given is the clientsgenerated or safeguarded. Some are adopting a tolerance for loss - or misinterpret the information collected through strategy of increasing vagueness and a lack of clarity in the collection process, resulting in numbers of appointed representatives to sustain income levels, unsuitable outcomes. The main thrust is that firms should ask very together with increasing product sales and moving into more clear questions in order to get precise information that enables them complex investment products. to provide specific advice that they can demonstrate is in the The FSA is concerned that fast expansion at a time of falling business customers best interests. continued on page 3 will put strains on the systems and controls used to manage the
  3. 3. What should firms be doing? New ERM draft standards issuedTaking a step back, and looking across the piste of the proposed new Discussion drafts developed by the Enterprise Risk Managementbusiness model to seek to ensure that: (ERM) Task Force of the Actuarial Standards Board (ASB) are now available for comment. The two documents are titled "Actuarial§ The business model for the new environment, when looked at as a Professional Standards for Risk Evaluation" whole, will continue to serve the best interests of customers; and "Actuarial Professional Standards for Risk Treatment." Both drafts are contained§ The information held about customers is sufficiently clear and within the document, Actuarial Standards of metric precise to enable the provision of suitable advice, neither Practice for Enterprise Risk Management. overshooting nor undershooting the clients risk appetite; The purpose is to share the work done to date and to collect input from interested parties. Comments are§ Risks inherent in new products and in using platform services are requested by June 15th, and are welcome from all interested properly understood and communicated internally; and parties, including non-ASB members. The drafts can be viewed at: m§ That the control environment does not lag behind the business environment, and that the systems and controls for managing the risks inherent in all of the client-facing processes (whether in a Singapore proposal single firm or a distributed network) remain sufficiently robust to to regulate credit mitigate the risk of negative outcomes for clients. m rating agencies The Monetary Authority of Coming up in Issue 4 of metric, metric Singapore (MAS) has released Tony Blunden, Chase Coopers a consultation paper on proposed regulation of credit rating Head of Consulting discusses: agencies (CRAs). The MAS proposes that CRAs be licensed ‘KRIs: Finding the right way’. A under the Capital Markets Services (CMS) licensing regime, considerable number of firms are and "Providing credit rating services" be added as a regulated still finding key risk indicators a activity. Licensees who carry on the business of providing difficult task. During a recent credit rating services will be required to comply with existing Chase Cooper Risk Breakfast requirements that apply to all CMS licensees. The proposal,there was a lively discussion on KRIs and attendees which aims to promote the quality and integrity of rating,were surveyed on their current state of development. strengthen CRA independence and investor protection, andThe article will look at a straightforward methodology enhance protection of information, is based on the IOSCOfor identifying KRIs and their controls. In addition, Code of Conduct Fundamentals for CRAs.the result of the survey will be published. The European Union has already introduced new CRA licensing requirements and the US has extended existing licensing regulations. Hong Kong consulted on new CRA rules in 2010 and these are expected to take effect in June. m SEC probes Chinese firms listing in the USA Following a series of accounting scandals, the US SEC has launched Chase Cooper Strategic 3 a fraud investigation into Chinese companies buying into quoted US Compliance Breakfast companies. The target for this investigation is those firms that have gained US listings by reverse mergers into Briefings are held each month and existing publically quoted, but possibly are free to attend. Breakfast is provided. dormant, US companies. Since the beginning of For more information visit 2007 there have been over 600 such mergers Recent briefings addressed the FSA’s changed Client Money with a quarter of these coming from Greater and Assets regime, and what firms should be doing in the face China. There is concern that companies are of FSA’s more aggressive approach, coupled with the new re- carrying out these mergers with the express purpose of raising quirements for client money oversight, reporting, and diversi- capital on US exchanges and that the overseas companies are often fication of client money deposits. In April we reviewed the already in financial difficulties and that their mergers may have sometimes controversial Bribery Act 2010 following the Treas- been based on inadequate or, at worst, falsified accounting ury’s guidance in March, particularly the new corporate obliga- records. In the past few weeks, the SEC has suspended trading on tions, with a view to taking some of the fear and heat out of two organisations, China Century, a media company, and responses to the new Act earlier in the year. We looked at the Chianjiang Mining and New Energy. In both these cases the US practical steps necessary for a risk-based and proportionate auditors of these companies had resigned saying they were unable approach based on the guidance – whilst still being able to to verify the sources of accounting details. m take clients to Twickenham. m
  4. 4. Regulatory ASYMmetricAL The back page, sometimes critical view from the EditorNEWSThe Financial Stability Board (FSB) has published There has been a lot in the press about the possibilities of banks moving away from the City ofthe detailed national responses to an FSB survey London. This would be as a consequence of the UK Coalition Governments plans to increaseon the implementation of the latest G20 the restrictions on banks in the areas of remuneration, to impose levies on banks balancerecommendations which was conducted in sheets, and, critically, to look at breaking up large banks into separate investment and retailSeptember 2010. The responses formed the banks. This last threat has caused major banks such as Barclays, HSBC and Standard Charteredprogress report on implementation submitted to issue veiled threats that they may consider moving their reporting base to another the G20 Seoul Summit in November 2010.The Hong Kong Monetary Authority has Whilst the mayors of New York and Paris say they would welcome the large British banks,released a further supervisory policy (LM-2) on would governments feel the same. After all, who would then bail them out following anothersound systems and controls for liquidity risk crisis? The recent Vickers Report has also played down the threat – whilst still leaving the doormanagement. These are based on the Liquidity open to regulatory restructuring of banks. It is also a given fact that moving headquarters, andSound Principles release by the BIS in regulatory oversight, of a global bank is no easy operation. Ignoring logistical and regulatorySeptember 2008. problems, there are reputational questions - what will existing depositors and investors do?Hector Sants, the FSAs CEO, What will be the reaction from both London or losing financial centres? Therehas sent out an update on could be reputational impact and, this being difficult to quantify, is a risk that noFebruarys plans to transfer bank wishes to supervision of But regulatory inconsistencies are of serious concern to financial institutions. Inbanking and insurance to threebodies - a subsidiary of the the years leading to the last financial crisis, the first 8 years of the 21st century,Bank of England, the Prudential there was a consistency in global financial regulation - although the criticism thatRegulation Authority, and the it did not work could be valid. Basel II was on the way to being adopted in aFinancial Conduct Authority. globally consistent manner - the US was lagging but the view was that theyThis announces the would have come into line. Sarbanes-Oxley was being adopted by most largeachievement of the first global corporations and was seen as a global best practice for many companiesmilestone - the replacement of who were not otherwise bound by this US regulation. And IFRS with its mark-to-the current Supervision and HECTOR SANTS, current Chief market principles was well on the way to being a global standard for allRisk business units with a Executive of the FSA and Chief Executive designate of the PRA accounting disclosures.Prudential Business Unit (PBU)and a Conduct Business Unit (CBU). All this has now changed. Although Basel III has global approval from regulators, there are aThe much awaited report from the Independent significant number that have suggested that its implementation will have regional variations,Banking Commission (the Vickers Report named both in implementation and in the recognition of capital components. The USA has come upafter Sir John Vickers, its chairman) was released with a new set of rules - the Dodd-Frank Act, a massive piece of legislation with new standardsApril 11th. It makes recommendations on how and new supervisory agencies to monitor these standards. This will occupy the attention of USthe retail banking business of UK banks is to be banks for many years to come and the impact on foreign companies quoted on US exchangesisolated from their investment banking arms (the means by which they were drawn into Sarbanes-Oxley compliance requirements) remainsand recommends that the retail banking arms to be seen. The global roll-out of IFRS has been set back by criticisms, amongst whichcarry an extra regulatory Tier 1 capital obligationof 3% taking them to a minimum of 10%. It also are that mark-to-market makes the accounts excessively volatile. In addition to these potential inconsistencies, there are national differences in the regulatory treatment of 4makes recommendations on how bondholdersshould bear responsibility for bank losses. hedge funds - the UK being at odds with the rest of Europe who wish these to be moreHowever the report falls short of proposing tightly regulated - and in the wish to restrict the remuneration and bonus packages of bankerscomplete separation of the investment and - here the UK is considered one of the hawks.retail banking businesses and does not specify Whereas the first decade of this century was marked by a collaboration and consistencyhow the bondholder losses will be between the regulators of the major financial markets, this second decade looks like it isimplemented. The reaction seems to be relief moving towards a free-for-all market with each country aiming to satisfy its nationalfrom the banks and dissatisfaction for thosewho saw this report as a way to significantly requirements and the wishes of its voters. Given the situation, can one blame banks, and bankrestructure the banking industry. shareholders, for considering moving their head offices to those cities that will allow them the greater freedom and the larger profits? Surely it is time for the G20 to come up with someReports from Washington indicate that the USauthorities are divided on the list of US SIFIs agreement on regulatory consolidation - or are we into the era of regulatory arbitrage, and(systemically important financial institutions). increased regulatory risk?The US Fed and the Treasury favour a list limited Early this month the UKs House of Lords Committee on Economic Affairs released a vitriolicto only the major US global banks whilst the criticism of the auditing profession in regards to its failure to play a part in preventing the lastFDIC wish to include large hedge funds, insurers financial crisis. Recommendations included theand asset managers. Institutions in question encouragement of increased competition and that risk metric is published by metrichave launched a major lobbying action to avoid Chase Cooper.being designated as SIFIs claiming it would add committees audit the auditors. Could this be an additional area web: www.chasecooper.comto their costs and lock up capital. of arbitrage? Auditor arbitrage? m email: