UK: Financial Conduct Authority (FCA)'s Risk Outlook and Business Plan for 2013 published

The FCA's Risk Outlook (FCA RO) has been published today, setting out the regulator's current thinking on conduct in financial markets by analysing the root causes and emergence of conduct risk, and identifying the forward-looking risks that the FCA deems pose the greatest risk to its objectives.  Whilst the document inevitably focuses on consumer detriment arising from the wrong products ending up in the wrong hands, there is welcome recognition that this needs to be balanced against the detriment to society of people not being able to get access to the right products.  The FCA stresses its collective responsibility with industry to co-operate in acting to address these challenges.

The FCA's Business Plan, also published today, confirms that the FCA's strategic priorities are driven by the key forward-looking risks in the FCA RO, as well as the FCA's operational objectives, and the need to address crystallised risks such as LIBOR, PPI and Interest Rate Swaps.  The key priority risks identified in the FCA RO are set out below together with the work planned to address them.  We also summarise the ongoing work the FCA plans to meet its operational objectives, including enforcement and financial crime priorities.   Martin Wheatley commented that "achieving the FCA vision is in all of our interests, not only socially, but also financially".  The FCA's budget - which will be wholly separate from that of the PRA - comes in at £445.7m, just over 80% of the FSA's budget as single regulator for 2012/2013.

The first part of the FCA RO examines drivers of conduct risk, considering inherent risks (such as informational assymetries, biases and heuristics, and inadequate financial capability amongst consumers), structures and behaviours (such as conflicts of interest, culture and incentives, and ineffective competition) and finally environmental factors (such as economics and trends, technological developments, and regulatory and policy changes).  It is important to note that the FCA is actively considering how behavioural economics affect consumer choice and the effectiveness of regulation.  The second part of the FCA RO seeks to identify the implications of, and the risks arising from, those drivers - which are broadly:

• rising pressure on strategic business model adjustment
• failure to balance prudential soundness and profitability with good consumer outcomes
• misalignment of market performance expectations and underlying fundamentals

Key priority risks identified in the FCA RO and work planned to address them

1. Design of products and services that do not respond to real consumer needs or are not in consumers’ long-term interests

• • Product governance: including implementation of 2011 product intervention regime
  • Mortgage arrears and forbearance management: Thematic review of firms’ strategies
  • Product design and oversight - fund fee structure: asset management project
  • Competition Approach: Development of competition expertise, including by carrying out market-level studies to analyse competition issues and input into product risk identification

2. Distribution channels do not promote transparency for consumers on financial products and services

• • Financial Incentives: wider review assessing firm's responses to 2012 guidance, assessing whether more intrusive supervisory work or rule changes are necessary
  • Financial promotions: review across all sectors
  • PRIPs: negotiation of regulation and contribution to development of technical standards
  • Conflicts of Interest: second stage visits to asset management firms to ensure compliance with conflicts of interest rules
  • Fund Fee Structures: focus on asset management (part of product design and oversight project)
  • Custody Banks: Project to assess transparency of secondary services
  • Transition Management: Review of practices across pension funds, local authorities and other main industry participants focusing on fee structures and legal and pre/post transition documentation
  • Retail investment advice: reviewing RDR implementation - macro analysis and further thematic work
  • Wholesale conduct strategy: focus on the culture, systems and controls that govern relationships in wholesale markets and may lead to risks to market integrity (e.g. payment for order flow) or consumer protection (e.g. poor disclosure of dealing commissions and stock-lending fees)
  • LIBOR/Wheatley Review: follow-up to raise standards of governance, systems and controls around rate submissions and create new Controlled Functions

3. Over-reliance on, and inadequate oversight of, payment and product technologies

• • Price comparison firms: Review of compliance and potential consumer protection issues in price comparison firms
  • New/Mobile Banking/Payment Methods: Supervisory work to ensure firms offering new/mobile payment methods providing sufficient information to consumers on services and how to use them
  • Technological Resilience/banking: Implementation of lessons learned exercise from 2012 RBS Group systems failure
  • Market infrastructure: Supervisory and analytical work to assess resilience of market infrastructure and risks associated with trading strategies such as algorithmic or HFT
  • Payment Services Directive: review

4. Shift towards more innovative, complex or risky funding strategies or structures that lack adequate oversight, posing risks to market integrity and consumer protection

• • CRD IV consultation and preparation for implementation

5. Poor understanding of risk and return, combined with search for yield leading consumers to take on more risk than appropriate

• • Scoping work: to develop a detailed strategy to deal with this risk
  • Interest only mortgages: report on findings from initial review due shortly; continued monitoring of product developments (possible intervention)

Other work planned for 2013

The Business Plan also sets out other areas of work which the FCA will be undertaking to meet its statutory objectives as follows:

Consumer Protection

• Mortgage Market Review: online surveys and workshops, enhanced reporting requirements, review of PERG, monitoring readiness for implementation
• Retail Investment Advice: post implementation supervision strategy, assessment of adviser qualifications, thematic work
• Managing Client Assets: increased supervision - more intrusive visits, thematic projects, desk based reviews, action through CMAR/audit information
• Complaints Handling: supervisory focus on effectiveness of complaints handling in major banks to continue and widen to include firms in other sectors
• Listing Rules: finalised proposals for corporate governance within the listing regime, quality of markets and listed funds
• Wealth management: to remain major focus; continuing work on suitability; ongoing thematic and supervisory work
• European policy: ongoing work with HM Treasury on negotiations re
  • Insurance Mediation Directive
  • Mortgage Credit Directive

Enhancing Market Integrity

• Recognised Investment Exchanges: refining supervisory framework; new powers against holding companies within toolkit
• Primary Information Providers: developing processes and resource for exercise of new powers
• Multilateral Trading Facilities: implementing new framework for consistent and proportionate supervision
• Sponsors: increase resource, continued focus on sponsor standards and tightening of requirements
• European Policy:
  • ongoing work with HM Treasury on negotiations re MiFID/MiFIR, Central Securities Depositaries Regulation, Market Abuse Regulation and Criminal Sanctions Directive, Transparency Directive Review, Securities Law Legislation, Close Out Netting Directive
  • AIFMD implementation
  • EMIR implementation of requirements on reporting, risk management, clearing and collateral
  • UCITS V implementation and UCITS VI policy and implementation
  • Financial Market Infrastructures
  • Commodities Market Regulation
  • New authorisation regime for Approved Reporting Mechanisms
  • Credit rating Agencies implementation

Building competitive markets

• Liaison with OFT at operational and strategic levels - shared work plans, coordinated action
• Risk identification, early intervention, barriers to entry
• Market studies in retail and wholesale markets
  • insurance add-on products
  • asset management
• Transparency of fee structures and bank account charges
• Current account switching

Building a new regulator

• Firm Systematic Framework (FSF) - business model and strategy analysis (first FSF module for highest impact wholesale firms in 2013)
• Wholesale conduct supervision - focus on interconnections and greater willingness to intervene
• Issues and product work - "various" thematic projects
• Event-driven work - efficient process and quicker response
• Thematic supervision to focus on identifying and addressing root causes - including incentive structures and corporate culture
• Preparation for consumer credit remit

Enforcement action

• Decisive action to reinforce expectations of wholesale markets
• Removing individuals and firms who fail to meet standards from the industry
• Aggressive pursuit of market abuse through civil and criminal power
• Tough action for TCF failures - sanctions and effective redress
• Ongoing LIBOR work
• Transaction reporting and STRs - building on thematic work
• Financial Crime
  • effectiveness of systems and controls in regulated firms
  • risk-based proportionate supervision:
    • intensive intrusive Systematic Anti-Money Laundering Programme for high impact firms
    • anti-bribery and corruption in H2 2013

Protecting the perimeter

• Making threshold conditions and authorisations a robust gateway: step by step review of authorisations processes
• Approved person: ensure clear definition of accountabilities, increased enforcement action
• Unauthorised businesses: continued action, alerts etc
• Pensions: work with DWP and TPR on automatic enrolment