Ethics and Regulation

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where relevant. In all cases culture, strategy, remuneration, risk appetite

and governance are likely to feature within the conduct risk framework.

The concept of conduct risk surpasses the previous regulatory idea of

compliance as a ‘tick box’ exercise simply ensuring adherence to the specific

rules and regulations laid down by the regulator. For example just because a

firm has provided the correct regulatory disclosures at point of sale it does not

mean that they have acted in the customer’s best interests, nor that the

customer has received a good outcome. The management of conduct risk

requires a firm to consider their customers interests above their own

interests, managing conflicts of interest as they arise and delivering fair

outcomes.

From a supervisory perspective and as we considered in Module 1, the FCA

will use the three pillar approach to assess the performance and compliance of

UK retail banks, with Pillar 1 focussing on a Firm Systemic Framework to

evaluate the business model and strategy. This framework specifically

assesses if the firm is being managed in a way which results in the fair

treatment of customers and if the firm has adequately reduced the risks which

would impact market integrity. In essence this is designed to measure how

well the firm is managing their ‘conduct risks’ and how effectively they have

identified and mitigated the key drivers of poor conduct behaviour. This

framework allows the FCA to manage the delivery of their own statutory

objectives and where risks are identified within a firm, the firm will be

required to implement a remediation programme. The key question posed

by the FCA at the centre of this assessment which it requires firms to answer

and evidence is “does the firm have the interests of its customers and the

integrity of the market at the heart of how the business is run?”

If the answer to this question is no, or the firm is unable to evidence that it is

concerned with fair customer outcomes and proper market conduct, then the

FCA will consider which of its enforcement powers should be utilised. Even if

there is no specific breach of individual conduct of business regulations, the

Principles for Business (PRIN) will be relevant and allow the FCA considerable

discretion in relation to what it considers to be unacceptable behaviours which

can be punished.

6.4 Drivers of Conduct Risk

As we have discussed the term ‘conduct risk’ covers a wide span of activities

which have the potential to affect both customer outcomes and the statutory

objectives of the FCA, and in particular the areas of consumer protection and

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market integrity. Within the financial services sector there are a number of

challenges to delivering fair and improved customer outcomes. In order to

work towards achieving this goal it is essential that firms, including UK retail

banks, understand the type of risks which are present in their strategy,

business model and the market place itself, together with the factors which

may intensify those risks.

The FCA within their Risk Outlook 2013 & 2014 have set out the factors which

they believe are the underlying drivers of risk. They have divided them into 3

separate categories as follows:

 Inherent Factors: These represent factors which are present in the

market place and other factors which can impact the decision making of

the customer.

 Structures and Business Conduct: This category considers how the

market is functioning as a whole and how this may impact customer

outcomes. It also considers the structures of firms, their behaviours and

how the culture of a firm may influence the customer outcomes.

 Environmental: External developments have the ability to affect a firm’s

strategy, business model and its financial soundness. While a firm may

be unable to influence all environmental changes, it does need to consider

the potential impacts and have an appropriate mitigation strategy to

ensure it remains competitive, financially sound and most importantly

delivers appropriate products and services which provide for good

outcomes.

These key drivers of risk interact with each other in order to produce a set of

market outcomes which are ultimately based upon the competitive position,

sometimes referred to as market dynamics. Competition is one of most

effective ways to achieve innovative products and consumer protection

through the delivery of a range of competitively priced products and services.

Effective competition leads to a well-functioning market. The inherent and

structural factors represent issues which can lead to markets failures in the

form of a poorly functioning market with limited competition and poorly priced

products and services. These factors may be impacted by the environmental

factors which affect the firm and the market place, the outcome of the

environmental impact can be positive or negative.

Each of these categories can be split down further into individual key

components. The following diagram has been taken from the FCA Risk Outlook

2014 and sets out pictorially the FCA’s view of the key drivers of risk within

the financial markets.

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6.4.1 Inherent Factors

These factors are exhibited in the financial markets and also by the

participants of those markets which includes both firms and consumers. The

FCA has split them down into 3 sub categories which they believe are

particularly relevant to the risks which would impact their statutory objectives

and therefore consumer outcomes. This includes the field of behavioural

economics which will be considered in greater detail later in the chapter.

 Information Asymmetries;

 Biases, Rules of Thumb and mental shortcuts; and

 The importance of Financial Capability.

Information Asymmetries

This refers to a situation where one party to a transaction has greater

information, or more relevant information about the transaction than the

other party. This leads to an imbalance of power between the parties and can

impact the decision making potential of the party who does not have access to

full information. This will lead to a market failure in the context of the

economic concept of a freely functioning market. A free market is a

hypothetical scenario where the prices of goods and services are freely set

based upon supply and demand and it is free from any other interventions,

including government intervention. A freely functioning market will exhibit

high levels of competition as firms will compete with each other on the basis

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of the price and quality of their products, leading to innovation and the

development of products and services which truly meet consumer needs.

There are a number of factors which influence how freely a market operates,

information asymmetry is one of those factors.

Availability of relevant information is not always present in the banking sector

to allow the consumer to make an informed choice between products and

providers. Within banking in general the seller will have more superior

information than the purchaser in relation to the majority of products and

services. Transparency of pricing is a significant issue particularly in the

current account and consumer credit markets, where opaque pricing makes it

difficult for consumers to compare costs including fees, charges and interest

across the range of product providers in the market place.

In addition the products sold can be complex in nature and unsophisticated

consumers are left with a lack of understanding of how the product works, as

such this may impact their decision making. The consumer may decide not to

purchase a product which was suitable for their needs and had the potential to

create wealth or mitigate against risk, thereby losing out. Information

asymmetry can also have the opposite effect in that a consumer purchases a

product which does not meet their needs, due to the fact that they do not

have all of the available information in order to make an informed choice, or

do not understand the nature of the product. Examples of this include the

sale of interest rate hedging products which were designed to manage

fluctuations in interest rates and were typically sold to small business

customers alongside a loan, or the sale of payment protection products (PPI)

to retail customers. In the first instance the products were so complex that

the business customers did not understand the nature of what they were

purchasing, which resulted in financial detriment in a large number of cases as

rates moved against the customers and their loan payments increased. With

regard to PPI policies, and in particular single premium policies, consumers

were not informed that the insurance was optional and separate from the sale

of the loan. In addition they were not always aware of the cost of the

insurance in terms of the additional interest payable on the premium. They

definitely were unaware of how profitable the product was for the UK retail

banks selling it. This information imbalance led to UK retail banks seeking to

exploit their position and created an ‘adverse selection’ for the consumer

purchasing the product as the banks’ selectively and aggressively sold a

product which benefited them at the expense of the consumers.

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Competition in the market place may also be affected if the consumer exhibits

inertia due to the lack of relevant information and stays with an existing

provider who is offering inferior products and services.

A further risk associated with information asymmetry is a lack of confidence in

financial services firms and the market as a whole which can lead to market

instability. This is true where products do not perform as consumers

expected, potentially due to a lack of relevant information about the nature

and likely outcome for the product, or where the product has been mis-sold

by an intermediary due to a lack of understanding and information from the

product provider on the features, benefits and target market for the product.

This can be particularly acute where the product has a long life span, for

example mortgages, investments or pensions, and the consumer does not

discover for many years that there is a problem with their purchase. Often

the consumer has little time left to rectify the situation and can suffer

significant distress and financial loss. At present there is still a low level of

confidence in the financial services sector due to the large number of mis-

selling scandals and inappropriate market behaviours which financial services

firms have engaged in over the past 10 years.

The market sectors as highlighted by the FCA which are most at risk of

information asymmetry include:

 The consumer credit market: Pricing is opaque and comparisons are

difficult across the range of product providers. Consumers may not have

full information about their credit products, for example how much does it

cost if they exceed their overdraft limit, or if their provider refuses a direct

debt, also what default charges are levied and in what circumstances.

 The insurance market: There can be a difference in understanding

between the consumer and the provider (underwriter) in terms of the

cover available and what pre-existing conditions or scenarios are excluded

from the policy. Too often this detail is buried within the terms and

conditions, only becoming apparent to the consumer when they make a

claim. There are also examples of insurers rejecting claims based upon

‘technicalities’ in the terms and conditions unrelated to the consumer’s

claim which would not have been apparent to the consumer at point of

sale. In this case the insurer has an information advantage over the

parameters for payment of claims.

 The investments market: In this case consumers may be mis-informed

about the products or services they are purchasing as with the sale of the

interest rate hedging products; or investment advisers may not have full

information about the products and services they are recommending, in

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particular those products devised by 3rd party product providers, which

can lead to mis-selling. In addition product providers can aggressively

market their investment funds to independent retail advisers using false

or unsubstantiated claims about the benefits of their funds, for example

the benefits of active fund management over passive fund management.

 Trading activities: This is an area which has the potential to damage

market integrity due to information asymmetries which firms and

individuals use to their own advantage. Examples include insider dealing

where an individual who has price sensitive information which is not

publically available, and if it were it would have the potential to alter the

price of a share or investment, uses this information for his own gain.

Perhaps the individual as a result of his employment has seen a press

release relating to a profit warning which is being prepared for a listed

company and is still under press embargo. As a result of this information

he decides to sell his own shares in the company prior to the press release

being made public. As expected the press release results in a sharp fall in

share price of the company, therefore the individual has avoided a loss by

selling his personal holding in the company on the basis of the inside

information. This type of behaviour amounts to market abuse and will

undermine trust and confidence in the markets for the other participants

and for those consumers who indirectly rely on market trading activities to

realise their investment and pension products. The FCA’s market abuse

regime has been updated to include new categories of market abuse

which have been influenced by recent abusive behaviours, for example the

manipulation of LIBOR by a number of major banks. It now precludes

abusive strategies through the manipulation of benchmarks.

In January 2016 five individuals have been brought to trial on insider dealing

charges which are believed to have been undertaken between 2006 and

2010. The insider dealing ring is purported to have earned £7.4M from

trading in stock market listed companies during this period on the basis of

price sensitive information.

The insider dealing ring included a trader and his partner, who used a

middle man to obtain price sensitive inside information from two city

bankers who were often in possession of price sensitive information through

their employment as corporate brokers. One city banker was a broker for

Deutsche Bank, the other a broker for Panmure Gordon.

It was believed to have been a very sophisticated operation with the middle

man (client) alleged to have communicated with the traders using

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untraceable pay-as-you-go mobile phones and code names. It is understood

the traders used their professional dealings on the spread betting market to

conceal the insider dealing trades made on behalf of their client, and they

also engaged in market abuse by investing their own funds in the stocks

which were picked by their client, on the basis of his insider information.

As insider dealing is a criminal offence under the Criminal Justice Act 1993

with a penalty of up to 7 years in jail, the case is being taken through the

Courts and remains on-going.

Biases, rules of thumb and mental shortcuts

This considers the behaviours of consumers and their characteristics which

can lead them to make poor decisions, even if all of the relevant information

is presented to them. This is equally applicable to investment advisers when

recommending products and services to consumers. This can be referred to

as Behavioural Economics. Behavioural economics and the related field of

behavioural finance study the effects which social, physiological and emotional

factors can have on the financial decisions of both consumers and institutions.

Behavioural biases can have an amplified effect on decision making in the

financial services market as the decisions often involve complex products and

services, coupled with the requirement to assess the risk of a product or

service, together with an understanding of how it may perform in the future.

Financial services firms can use this insight into how consumers make

purchases decisions, including how they can present information to consumers

in a way which achieves positive outcomes. They may also take advantage of

these biases for their own gains by leading consumers to purchase their more

profitable products and services or leveraging off consumer inertia by letting

them remain in superseded products which offer little or no benefits to the

consumer but which offer a cheap source of funding for the institution itself.

Firms can also take advantage of biases when designing products and

services, for example by creating products which have visible front end

benefits, the costs or limitations of which are subsumed within the structure of

the product. Alternatively they can use consumer biases to ensure the

product design and associated sales process does not mislead consumers as

to the nature of the product or service.

The FCA has highlighted some of the more common biases which when

combined can lead to a reduction in competition which has the effect of

delivering poorer outcomes for consumers.

 Present Bias: This is a characteristic where the consumer places too

much focus on the current position, only considering the initial or

immediate costs of the product and the short term benefits which it will

deliver. Little consideration is given to the longer term outcomes. The

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longer term benefits are less tangible for the consumer and as such they

have a higher regard for what is happening in the present. This can lead

to firms developing lower quality products as they focus on lower pricing

in line with the consumer’s bias and therefore innovation and competition

is reduced. Present bias can also lead to customer inertia as they may

consider it costly or time consuming to shop around and do not have the

inclination to go through the process of “switching” providers. Essentially

they will put off the decision until ‘tomorrow’ or another day. Present bias

means consumers are more likely to stay with the status quo, even if the

decision means the product or service is no longer the most suitable to

meet their needs. Firms may also take advantage of this by requiring

consumers to opt-out of product changes or pricing decisions, rather than

giving them the option to opt-in.

 Overconfidence: Overconfidence leads consumers to think their

behaviours will be positive and they will be able to adhere to any terms of

conditions of the product or service, thereby not suffering any negative

effects. This reinforces the present bias decisions which consumers take.

For example they may not pay too much attention to overdraft charges on

a current account as they are confident they will not be overdrawn and

incur the charges. Working in conjunction with present bias they may be

happy with short introductory offers on the basis they believe they will

switch products / providers when the introductory offer ends.

Unfortunately too often the consumer will incur penalty charges on the

product, or the status quo of present bias will kick in and they will not

switch providers following the end of an introductory offer, leaving them

with more expensive or less competitive products which do not meet their

needs. Firms can also suffer from overconfidence. Senior management

may believe that their existing controls sufficiently and adequately

mitigate conduct risk, without having the required evidence to

demonstrate this.

 Prominent features and complexity: Many financial services products

are complex not only in relation to the features and benefits but also in

relation to the limitations and the various terms and conditions which

apply to the products. An example of a complex financial product would

be a structured investment or a financial derivative such as a credit

default swap. Many retail customers have purchased structured

investments where the return payable is dependent upon a set of complex

financial derivatives. In some cases the investment may be ‘capital at

risk’ where the customer’s original deposit is at risk depending upon how

the derivative performs in the market. Credit default swaps are often sold

to corporate or business customers who have purchased a debt

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instrument issued by a financial institution. The purpose is to protect

against the default of the issuer of the debt instrument, in return for a

fee. The provider of the CDS is usually an institutional investor who is

speculating on the financial security of debt issuers and the fears of the

debt purchaser that the issuer will default. The products are further

complicated by the fact that the financial capability of debt issuers can

vary over time, the CDS may not cover the full term of the debt

instrument, and they can be traded in the unregulated over the counter

(OTC) market during their lifespan.

 The complexity of the structure of such products, coupled with the

opaqueness of the pricing structures can lead consumers to be

overwhelmed and switch off. When faced with irrelevant or large

amounts of complex information consumers will typically fall back on what

they have learned in the past in order to aid with decision making in the

present. Within behavioural economics the different methods used to

solve the dilemma can include a ‘rule of thumb’, ‘educated guess’,

‘stereotyping’ or ‘shortcuts’. They estimate the likely outcome based upon

similar experiences which have happened in the past and tend to focus on

the most prominent features of the product without considering all of its

attributes. This will have worked in the past for the consumer when

purchasing other types of products and services. Firms can use this to

their advantage by deciding what features will be given prominence with

regard to their products and services and what limitations and/or costs

should be given less prominence. This can lead to poor customer

outcomes such as purchasing products they do not understand or

purchasing products which do not meet their needs.

 Another feature of complex products with opaque pricing structures is that

consumers find it difficult to compare the risks and costs of such products

across different providers and accordingly tend to purchase from their

existing provider which they know, even if they have been unhappy with

service in the past. This means they may not be availing of the best

product or service in the market place.

 Framing: This refers to how information is presented to the consumer as

presentation has the potential to impact the decisions and choices which

the consumer will make. Consumers generally have a limited attention

span and how different product features, benefits and limitations are

‘framed’ will determine what the consumer focuses on. Again firms may

use these consumer behaviours to their advantage by presenting

information in such a way as to steer consumers towards a particular

product from their range, perhaps their flagship or top of the range

product, where in reality a more basic product would fully support the

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consumer’s needs. Framing can disguise features, limitations or costs of a

product.

 Firms for example within their advertising or product literature could focus

on the ease of obtaining credit while making the cost of the credit less

prominent and only including default charges within the terms and

conditions. Firms could also give less prominence during their sales

process to features which they believe are less relevant to the consumer

and ‘frame’ the benefits which they believe the consumer will use. This

can lead to the consumer purchasing costly products which do not offer

value for money, such as a fee paying current account where only a

portion of the benefits will be utilised.

 Price comparison web-sites can amplify these behavioural characteristics

by ensuring consumers’ focus on headline rates. There may be limited

product information for comparison contained on the site, with many sites

referring consumers’ to the product providers own web-site. The link may

take the consumer directly to an ‘apply now’ page and can lead to

consumers purchasing products which turn out to be unsuitable.

Financial Capability

Financial capability is a term which is used to describe the knowledge and

behaviours of consumers which allow them to evaluate financial products and

services in the market place, and make sound financial decisions relating to

those products and services which would best meet their needs. Firms can

support the financial capability of consumers by researching their products

and product literature within their target market, utilising the outputs of

behavioural analysis and adjusting their approach and literature as required,

in order to positively support the consumer’s decision making process.

Financial capability is growing ever more important within the financial

services sector. As public funds have come under pressure the government

has undertaken reforms which negatively impact the welfare provisions that

are available. They have also increased the state pension retirement age,

legislated for auto enrolment in work pension schemes and relaxed the

provisions and investment options available for personal pension schemes.

These initiatives aim to reduce public spending and the provision of State

support, requiring individuals to take more responsibility for their own

financial wellbeing. This combined with high levels of personal debt which is

unlikely to be mitigated by house price increases and a possible rise in

interest rates in the short term, means that a greater level of financial

capability is required if the consumer is to secure their financial future.

Financial planning requires a level of understanding of the financial services

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sector including the products and services on offer, together with an

understanding of the consumer’s needs at various stages during the family

lifecycle and lifecycle of financial planning. Consumers first need to be able to

identify their short term and long term needs and then evaluate the products

and services in the market place to select which of these will best meet those

needs. Where the consumer’s financial capability does not allow them to

evaluate their needs, or the products and services on offer even if the

information is provided in a clear and balanced way, this can lead to an

increased risk of customer detriment.

The Money Advice Service (MAS) has a developed a 10 year Financial

Capability Strategy for the UK the implementation of which is being overseen

by the Financial Capability Board. This aims to improve financial capability

among consumers, providing the means and motivation to enable consumers

to adequately plan for their future. Their statistics show that working age

people in the UK do not plan ahead with 12M not saving enough for

retirement; 27M do not have a buffer of savings to allow them to manage

significant shocks to income (21M do not have a savings buffer of £500); and

only 50% of families have life cover. This initiative however is at inception

stage and as such more must be done in the short term by financial

institutions to aid consumer financial capability.

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The FCA undertook consumer research with regard to the skills and knowledge

needed to manage money well. The Risk Outlook 2014 sets out the results.

FCA Risk Outlook 2014 – Refer P19 Figure 1 Skills

 When shown a sample bank statement, 16% of people failed to identify

the correct available balance (rises to just under 25% of those aged over

55).

 On a positive note 89% of people were able to identify the better deal

from 2 financial products however for those aged over 55, approximately

20% selected the wrong product.

Knowledge

 Gaps in financial knowledge have been identified, particularly in the

under 35 age group. 11% of people believed the current Bank of

England base rate to be over 10%, whereas in actual fact it is 0.5% and

has been since 5th March 2009. This statistic rises to 17% in those under

35.

 13% of those under 35 believed that it was better to start paying into a

pension scheme in their 50’s, this compared to 5% of those over 45.

 The effect of inflation is also not well understood. When asked if inflation

at 5% would erode the purchasing power of a savings account paying

3% interest, 33% of people got the answer wrong. This rose to 44% of

those aged under 35.

This is concerning considering a number of these people will have mortgages

and it is vital they understand the impact that a rise in base rate could have on

their mortgage repayments. The lack of pension knowledge is also likely to

impact the government’s plans in respect of joining work place pension schemes

and ensuring people have sufficient income in retirement.

These statistics support the view that full and detailed disclosure for products

is a problem for some consumers who may be unable or unwilling to work

through the paperwork and terms & conditions to understand if the product is

suitable for them. Disclosure of risks can be complex and based in legal

jargon which does not allow the consumer to understand the implications.

This is compounded by the behavioural economic characteristics which mean

they may skip over risk disclosures in sales processes and mandatory

scripting. Financial services firms need to consider consumers when drafting

product literature and terms and conditions, ensuring that product disclosures

are shorter, transparent and are delivered in a why which allows consumers to

understand the implications. The FCA proposes to work with the industry in

respect of disclosures to aid consumer understanding and financial capability.

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6.4.2 Structures and Business Conduct

These are factors which are exhibited in the financial markets and also

behaviours and structures which are present within financial services firms,

including their business model, culture, processes and incentives, which have

the potential to pose a risk to consumer outcomes. The FCA has split them

down into 3 sub categories and they continue to seek changes in firm

behaviour through their supervisory approach, thematic reviews,

enforcements and market studies.

 Conflicts of Interest;

 Culture and Incentives; and

 Market Structures.

Conflicts of Interest

Conflicts of interest are common in the financial services sector and in

particular within the wholesale market, however it is when firms fail to

adequately manage their conflicts of interest, or in some cases exploit them to

their own benefit, that it becomes a risk to market integrity and consumer

protection.

Structural conflicts of interest can occur where a firm’s business model

requires it to act in different capacities and/or for multiple clients. Typically a

firm may act on behalf of clients and also trade in the market for its own

account, very often in the same securities and investments as those of its

clients. Firms may also have multiple clients and the servicing of those

clients can lead to conflicts of interest between them. By way of example an

investment bank may act as adviser and underwriter for a firm who is

undertaking an initial public offering (IPO) by underwriting the share issue

and offering them to the public or institutional investors. However it may also

undertake research within the same sector providing investment

recommendations to its clients and the wider market place. There is a conflict

within the investment bank between the firm for whom it issues and places

the shares and the clients to whom it sells or recommends those shares.

While the underwriting division and the research division should remain

separate, the underwriting function will need to be positive about the firm’s

prospects when undertaking a share offering, in contrast the research division

must remain unbiased and compare the firm’s business and trading prospects

to other businesses within the sector and the market as a whole. If the

underwriting client relationship is more valued or more profitable to the

investment bank, which in many cases it will be, then the conflict may

crystallise if the firm (client) puts pressure on the investment bank as a whole

to publish a positive outlook, or the investment bank perceives this to be the

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case. Conflicts of interest within the wholesale sector can also lead to the

principle-agent conflict which we considered in Module 1 when the provider of

products or services may not be acting in the best interests of the consumer,

instead operating for their own agenda. Typically for inherent structural

conflicts of interest the FCA has mandated requirements in the form of rules

and regulation, for example the best execution requirements in the Conduct of

Business Sourcebook (COBS) or the market abuse requirements including

insider dealing and front running within Market Conduct (MAR) Sourcebook.

In the retail sector conflicts of interest can arise when distributers of financial

services products act as agents to both the end consumer who purchases the

product and the financial provider who designs the product. The

implementation of the Retail Distribution Review (RDR) has sought to manage

product bias based upon the level of commission earned (consumers now pay

for advice rather than commission being paid from the product provider),

however conflicts can still exist within these structures. For example product

providers may be seeking high sales volumes and as such will manufacture a

generic product which is not suited to the individual needs of groups of

consumers but targeted at mass market. It may be the case that most

consumers within this mass market group do not possess some or all of the

group characteristics. This may lead to product features which are not

suitable or not utilised by consumers, as is common in the case of fee paying

packaged current accounts, or it can lead to the sale of completely unsuitable

products. The product design may also include exit penalties or tie-ins to

discourage the consumer from switching. The product provider may do this to

recoup costs or increase revenues, if they expect a percentage of customers

will close or switch products due to the product not meeting their needs, not

performing as expected or not offering value for money.

Where multiple distribution channels are employed by the product provider

(direct sales; advised sales; brokers; fund managers; platforms) there is the

potential for the product literature produced by the product provider to be

inadequate when used across different channels and for different types of

customer. The charging structures can also differ across distribution channels

leading to different outcomes for consumers based upon the channel they

choose and depending upon the product and its complexity, certain channels

may not be appropriate for certain product types.

When the product is complex the charging structure may also be complex and

may involve payment to a number of parties in the chain. For products which

have a long life span such as pensions, the disclosures in relation to fees and

charges at point of sale may mislead consumers as to the total cost of the

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purchase. If the consumer makes an inappropriate product choice based upon

these perceived costs, this can lead to consumer detriment in the future, for

example in the form of reduced income or lower investment returns.

Where there are complex distribution chains each party may believe another

party has provided the required regulatory disclosures and in reality these

may not have been provided to the consumer. In addition, distributors may

believe that the product provider has ensured the product offers value for

money, that the risks are clearly articulated in the product literature and the

headline performance figures are realistic. Overlaying these potential

conflicts of interest with the behavioural characteristics displayed by

consumers when they are faced with complex decisions can lead them to

ignore the detail and focus on price and key features rather than quality of the

product of the long term outcome which it may deliver. Decisions may be

based upon previous experience and intuition rather than logic, and reliance

may be placed upon the investment adviser who may also exhibit

‘overconfidence’ characteristics.

There can also be a conflict of interest between an investment adviser and a

consumer with regard to the perception of risk. Whilst an adviser must

establish the ‘risk appetite’ of the consumer, due to their professional

qualifications and industry knowledge advisers are more likely to view the

product they are selling as less complex than the consumer would perceive it.

They may also be less risk adverse, in particular to losses as they will have

experienced the cyclical nature of investments within the financial services

industry and will be aware that investments do fall as well as rise, but are

likely to generate a return over the longer term. In this case the

communications between parties represents a challenge due the fundamental

differences from where both parties begin the conversation and also in

relation to the perception of risk by both parties.

Culture and Incentives

The culture of a firm will influence both its strategic decisions and the

behaviour of its staff. Conduct risks can arise if the culture and incentive

schemes within a firm are not aligned to fair consumer outcomes, for example

if there is a focus on personal reward rather than the appropriateness of a

sale. Incentive schemes have been a focus for the FCA over the past few

years and many firms have reviewed their schemes in order to reduce or

remove conflicts which may exist between the firm and consumer outcomes,

however there continues to be failures and misconduct within the industry and

in particular within the banking sector.

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Culture: The culture of a firm is derived from its values, how it operates its

business and the reputation it wishes to have with its customers and within

the industry. The culture of a business will drive the behaviour of its

employees and ultimately the outcomes which consumers will receive when

dealing with the firm. Since the financial crisis of 2007/8 there has been

recognition that the culture within the financial services industry, and in

particular within the banking sector, needs to change with a greater focus

being placed on the consumers interests. It is acknowledged however that

this represents a significant challenge for many firms and it may take a

number of years before the required cultural changes are fully embedded.

Following the LIBOR scandal when a number of major banks manipulated the

interest rates for their own gains, the government set up the Parliamentary

Commission for Banking Standards (PCBS) to consider the professional

standards and culture of the UK banking sector. The PCBS also considered

lessons which could be learnt in respect of corporate governance,

transparency and conflicts of interest. Within its final report – Changing

Banking for Good, it identified that conduct failures have contributed to the

lack of public trust in the banking sector, not only for consumers but also for

shareholders as the sector has failed to deliver value and long term returns.

Even now 7 years after the financial crisis, the majority of banking stocks are

still not paying a dividend. Accordingly the Commission made

recommendations which have been implemented by the government in

respect of reforms to corporate governance models, strengthening governance

at board level and below by ensuring appropriate and robust challenge of poor

practice, and improving corporate culture in banks. The main challenge for

banks is to ensure that their stated values and conduct policies reflect the

standards and culture which is actually being delivered by their firm.

Incentives: The basic purpose of an incentive scheme is to motivate staff

and let them know the type of behaviours and outcomes which their employer

values and more importantly which their employer will reward. As such

incentive schemes are very powerful tools in determining the type of outcome

which the consumer will receive. If the incentives of both senior management

and those below them are not aligned to the long term interests of consumers

they can drive the wrong behaviours which can lead to consumer detriment

and conflicts of interest. The FCA and its predecessor the FSA undertook a

significant amount of work looking at incentives schemes within the financial

services industry and published a set of industry guidance. Also refer to their

thematic review in 2014 – 14/4 Risks to Consumers from Financial Incentives.

As a result there have been significant changes to incentive schemes across

many of the major UK retail banks with sales activity being balanced with

other factors such as customer satisfaction, upheld complaints and product

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cancellations. It is important that firms consider long term outcomes for both

their business and consumers, over shorter term gains, when designing an

incentive scheme. Delaying or drip feeding reward payments will allow for

performance adjustments such as claw back, if it transpires in the future that

fair consumer outcomes were not achieved, or conduct risks crystallise.

Poor incentive schemes will increase a firm’s conduct risks particularly if they

are driven by sales volumes or fee income. For example bonuses being

doubled or tripled where staff cross sell other products and services can lead

to customers being sold products they do not need, or staff mis-selling by not

disclosing all of the eligibility, risks and limitations of products in order to

achieve an additional sale. Other examples of incentive schemes which can

drive poor behaviour include large bonuses for generating the highest level of

sales over a period, bonuses for being first to hit a specific level of sales, or

staff only receiving a bonus once a minimum threshold of products have been

sold. Commission which increases as sales volumes increase or commission

which is weighted towards particular products, and in particular higher risk

products, are also likely to generate inappropriate sales. The regulator

identified schemes where basic pay was dependent upon meeting sales

targets, and could be varied up or down if targets set for a specified period

were not met, as a potential problem. This type of scheme will create fear

and drive inappropriate sales as staff worry about not being able to meet their

monthly financial commitments if their basic salary is reduced. Incentive

schemes which can mitigate conduct risk include features which reward the

fair treatment of customers and penalise mis-selling or poor behaviours.

Examples include deferring bonus payments until outcomes can be assessed;

removal of staff from incentive schemes or reduction of bonuses where poor

sales behaviour or compliance failures have been identified; reducing the level

of commission paid when sales volumes reach a particular level; and claw

back of incentive payments previously made.

When considering culture and incentives firms should not forget about their

training and competency arrangements. These should be aligned to the

culture and values of the firm and focussed on customer outcomes and

suitable advice.

Market Structures

As we considered in Module 1, competition is required to ensure an efficient

and well-functioning market. This will enhance market efficiencies and deliver

innovative and competitively priced products and services which meet

consumer needs. However the existing structure of the financial markets can

lead to ineffective competition which in turn will pose a threat to the FCA

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objectives. From a consumer perspective ineffective competition can result in

a monopoly situation leading to higher prices, lower service levels and less

innovative products and services.

Where firms choose to bundle products and services it can be difficult for

consumers to understand the true costs and whether or not it represents

value for money. If there are a number of intermediaries within the

distribution chain this can lead to increased costs in the form of fees, charges

and commission sharing arrangements between parties.

It can be difficult within the existing structure of the banking sector for new

players to enter the market, there are many barriers to entry including

regulatory requirements, technology requirements and the time required to

build a strong brand. Consumers are less inclined to switch to providers who

are not well recognised or who do not have a proven track record. This is

exaggerated by the inertia behaviour of consumers and their lack of

engagement, together with the complexity of products and services which

make it difficult to compare products across the various providers. This

restricts the consumer’s ability to shop around and can cause an adverse

effect on competition.

Another structural effect is the large back-books which many UK retail banks

have covering savings products, current accounts and mortgages. Due to the

consumer reluctance to switch even where there are price increases or

interest rates on savings accounts are reduced, there is little or no incentive

for these banks to offer more competitive prices and consumers are often left

in uncompetitive superseded accounts. Banks may use the profits from these

back-books to develop their customer acquisition strategies offering better

rates, products and services to new customers. This also restricts competition

as new entrants may find it difficult to compete against these strategies from

a financial perspective. Typically poor service will force a consumer to move

providers but the choice of new provider is more likely to be driven by price

and brand rather than service levels.

Technological developments within the structure of the market place can

impact competition. Within the wholesale market there have been significant

advances in equity trading, with new participants entering and this has led to

more competitive pricing and reduced transaction costs, together with the

provision of new products and services. In the retail markets the growth of

price comparison websites which utilises the consumer’s focus on price to sell

individual products has changed the dynamics within this market place. While

lower prices have benefited the consumer, as price is the main focus products

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sold via these channels may be of poorer quality, with a reduction in features

and benefits to offset the lower cost. Services levels may be lower, for

example no retail outlets and offshore call centres servicing the customer

base. Consumers may not consider these aspects at point of sale and it may

only become apparent at a later stage that they have purchased a product

which does not meet their needs, for example the consumer makes a claim on

an insurance policy only to discover they are not covered for the loss event.

6.4.3 Environmental Factors

Changes in the environment have the potential to impact consumer decisions

and may cause firms to adapt their structure and business model, in some

cases the changes may pose a threat to the financial soundness of firms. The

FCA has identified 3 environmental sub categories as follows:

 Economic and market;

 Technological; and

 Policy and regulation.

Economic and Market Environment

Economic and market developments will influence the types of products on

offer within the market and the pricing and profitability of those products.

The financial crisis and the global recession has put pressure on the income

and profits of financial services firms and in some cases led to the failure of a

number of UK banks. The economic environment in which banks operate has

a significant impact on their success or failure. We will now consider some

of the current economic conditions and their impact on firms and consumers.

 Global economy: The economic weaknesses exhibited in other countries

have the potential to influence the UK economy and the financial markets.

For example, concerns about the economic slowdown which is currently

being experienced in China and the Chinese government’s ability to

manage the situation led to sharp falls in stock markets across the US and

Europe in August 2015, the 24th August was termed ‘black Monday’.

These concerns and effects continue into 2016. China is the world’s

second largest economy behind the US and the economic slowdown will

impact the vast number of countries who trade with China. China is

currently a large commodity buyer of metals, including aluminium and

platinum and as such their trades drive the pricing and growth within the

commodity markets. If the economic slowdown reduces commodity

investments this in turn may cause commodity prices to stall. Firms’ who

are active in the commodity markets basing their investment strategies on

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trading within this market, may suffer a reduction in profits and increased

counterparty risk as a result of the effects of the Chinese economy.

 UK economy: Economic growth is predicted to continue over the next

couple of years, mainly driven by domestic demand for products and

services however the level of growth is weaker than previously expected,

in part due to the turmoil of the global economy and global oil prices

continuing to fall in 2016. In particular the volatility in China and the

moderate growth in wages are warning signs going into 2016. Therefore

the rise in interest rates which was predicted during early 2015 is unlikely

to happen in the short term, with Bank of England base rate likely to

remain steady at 0.5% during H1 2016. House prices have shown modest

rises which if it continues may fuel the demand for mortgages as

customers seek to get onto the property ladder at an affordable time,

while existing home owners seek to trade up or release equity from their

properties. A further rise in house prices and the perception that they may

continue to rise, could lead consumers to make poor credit decisions

based upon increases in capital value rather than affordability.

Unemployment has stabilised at around 5.5% (5.1% for Sep-Nov 2015 –

ONS) and reflects the lowest level for approximately 10 years but remains

high among younger age groups, and presents them a significant

challenge in terms of entering the housing market, saving for the future or

growing wealth meaning they are behind the curve of the family lifecycle.

 High levels of household debt: High levels of household debt have the

ability to threaten the stability of the UK economy. As was considered in

Module 1, the rapid growth of debt fuelled by rising house prices was a

significant factor in the financial crisis. There is evidence of deleveraging

since the beginning of the financial crisis as the household debt-to-income

ratio has fallen to around 140-145%, however UK household debt is still

significantly high when compared to other countries, or previous historic

levels in the UK. Should interest rates continue to remain low, house

prices continue to rise and real wage growth increase, it is predicted that

consumer confidence will rise and the level of household debt will increase

again. Low wage growth can also lead to consumers acquiring additional

debt in order to fund essential household purchases which they have been

unable to cover from savings. A high level of household debt leaves

consumers vulnerable to interest rate rises and income shocks such as

redundancy or death of a partner. This can lead to default on loans with

in turn impacts lenders who must work out forbearance strategies and/or

restructure their loan portfolios. A greater number of consumers may

need the assistance of debt management or debt advice companies, and

this is an area of financial services which may see increased growth.

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Accordingly lenders should make consumers aware of the various sources

of free debt advice which is available to ensure these vulnerable

customers are not driven towards firms who would seek to take

advantage of their circumstances in order to further their own gains.

 As consumers place further reliance on debt in order to fund their lifestyle

it is likely they will be repaying debt later into their family lifecycle and

this can impact their ability to save for the future and their retirement.

Consumers may need to continue to work into retirement and beyond to

repay credit and maintain levels of income. At retirement, without proper

financial planning consumers may suffer a significant fall in income and

lifestyle.

 Low interest rate environment: The Bank of England base rate has

remained at 0.5% since 5th March 2009 and looks set to remain at this

level in the short term. A low interest rate environment has positives and

negatives. On the positive side and in conjunction with high levels of

personal debt it has allowed consumers to continue to service their debts,

mitigating the effects of inflation and low or negative real wage growth.

The low interest rate environment has also in part benefited those

consumers who have defaulted on debt by allowing lenders to develop

more cost effective forbearance strategies to allow them to improve and

resolve their financial problems. The position may change if interest rates

start to rise, with consumers experiencing negative outcomes if rate rises

impact their ability to repair their financial position. There is an onus on

lenders to ensure any forbearance strategies offered are tailored for the

consumer’s individual needs and sustainable for the lifetime of the

repayment of the debt.

 On the negative side the sustained low interest rate environment has

impacted the consumer savings market and financial services firms, in

particular pension providers and insurers. This has led firms to seek new

investment opportunities with higher returns and to develop new products

and services, which ultimately may be higher risk and pose a greater

conduct risk to the consumer. From the consumer perspective a low

return on savings has impacted their ability to grow their wealth and may

have affected their investment choices, for example moving away from

standard low risk deposits into higher risk products which may have a

capital at risk element, in order to generate a better return. The low

interest rate environment may also force consumers to retire later than

they had hoped or planned.

 As investors are prepared to take on more risk for greater returns, the

growth of alternative sources of finance and investments such as crowd-

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funding or peer-to-peer lending has been evidenced. This could impact

the business models of mainstream lenders as both consumers and small

businesses turn to these sources for more competitive finance options and

higher savings returns. There is a risk for poor consumer outcomes due

to a lack of understanding of the risks involved with such schemes, for

example risk of default as most are not categorised as deposits and

therefore covered by the deposit protection scheme, mispricing of the

credit facilities or insufficient protection of client money and assets due to

poor segregation or operational controls.

 Potential interest rate rises: Updates from the Bank of England in

January 2016 have confirmed that they will not consider raising base rate

until there is sufficient economic growth including a sustained

improvement in wage growth, and they will only do so gradually to ensure

the economic conditions remain optimum to support the interest rate

increases. But what are some of implications of such interest rate rises?

Because interest rates have been unconventionally low for such a

sustained period of time, there will be a group of financial consumers

(younger consumers and first time mortgage buyers) who have not

experienced any other financial environment and will be budgeting

accordingly. As interest rates start to rise this group of consumers may

need to time to adjust to the new circumstances and may turn to short

term credit.

 An obvious outcome is that consumers who are financially stretched may

be unable to meet the higher repayments costs of their current debt and

will default. From the lender perspective as interest rates increase

forbearance strategies may no longer be sustainable and this may result

in more repossessions, however they should ensure their strategies

continue to treat customers fairly throughout this process.

 Strategies for lenders within the mortgage market will be to lock

consumers into fixed rate mortgages however they should ensure that

their strategies do not over exaggerate the impact of interest rate rises,

potentially putting pressure on consumers to move off low cost variable

deals into higher fixed rate products, ahead of the curve. To ensure they

are operating in the consumer’s best interests it will be key to develop

appropriate fixed rate longer term products and offer these to the

consumer at the appropriate time.

Technological Developments

Technological advances have changed the way financial services firms and

consumers interact. In particular digital and online channels have allowed

consumers to access information at a time, and in a medium, which best suits

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their needs. Digital innovations and technology developments have also

influenced the payment services industry by allowing faster and more cost

effective payments systems to be introduced. This has improved the

efficiency of this market place and has also reduced the barriers to entry for

new participants, in turn improving the competitive position and the consumer

outcomes. By adopting technological advances on a wider scale firms are able

to gain efficiencies and reduce costs, for example handling a greater volume

of transactions on a more cost effective basis, and this has led to technology

being incorporated within in many business strategies and forward looking

plans. This will improve consumer outcomes as cost savings from distribution

channels and operational processes can be passed onto the consumer.

While the consumer demands are changing and there is a desire to move from

interacting via a typical retail outlet to a faster and more direct method

through technology, for example direct access to products and services via

their mobile phone or tablet, the level of consumer understanding must match

this rapid increase in technological development to ensure they do not make

poor product choices. From a conduct risk perspective financial services firms

must ensure their sales processes are transparent and provide all the relevant

information about their products and services, in a medium which is

appropriate for the distribution channel, in order that the consumer can make

an informed decision. They must have appropriate oversight of these

processes to identify if and when consumers are potentially receiving poor

outcomes, and undertake an assessment of their product range to ensure

those products which pose a high risk to the consumer are not purchased on

an execution only basis.

The speed and ease at which products can be accessed through new

technologies has the potential to increase conduct risks and lead to poor

consumer outcomes. If consumers make hurried decisions and do not spend

time to consider the key features or limitations of the product then a poor

choice can result, such as a product which does not meet their needs, or

proves to be more costly than other provider offerings. This could be a

particular issue in the consumer credit market where loans and short term

credit can be drawn down in minutes through one of many mobile apps on the

market. Consumers may be drawn in by the speed and ease with which they

can obtain credit, placing less focus on the cost and default charges

associated with the credit.

A number of retail banks have started to close branches within their network

as footfall decreases and consumers move to online channels. Some

consumer groups, for example those who do not have access to computers or

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who may be IT illiterate, may suffer financial exclusion as banks seek to

reduce standard services and move towards digital products and services.

This may also lead to over reliance on technology with failures or down time

having a significant impact on the consumer and representing an increase in

the conduct risk profile of the bank. While technology has the potential to

reduce costs and increase profits, it also exposes the firm to disruptions of

service which when faced with the inter-connectedness of the financial

services industry can negatively impact market integrity. Firms need to

consider if their existing IT systems are sufficiently robust and will be able to

cope with an increase in traffic, particularly when maintenance or downtime is

scheduled. Where they purchase new technology in the market place it is

important they have the relevant in-house expertise to both operate and

develop the systems in order to meet the changing needs of consumers and

the regulatory requirements. This can be difficult to achieve if the talent pool

is small and there are a number of competing firms in the sector.

There are a number of other risks associated with technological advances

impacting both financial services firms and consumers. A key risk for firms is

data security and ensuring they protect their customer data from criminals.

Firms may need to put significant investment into the areas of financial crime

and cyber crime, the costs of which may be passed onto the consumer in the

form of higher prices for products and services, indirect charges or lower

levels of service. Another potential consequence of an overreliance on

technology is that it may lead to firms offering more basic products. Where

automated approval technology is utilised, products or specific features

relying on judgement which cannot be modelled into the technology may be

dropped. For example a bank or mortgage provider which only offers an

online automated service may not be able to offer lending into retirement if

the underwriting model is not sophisticated enough and individual assessment

is required. This can impact consumer choice and the competitive market

position.

Policy and Regulatory Environment

The final subsection within the environmental drivers of risk is that of

government policy and regulation. Regulatory changes driven from the UK

and Europe, together with government policy in the form of macro and micro

regulation will have an impact on how firms conduct their business and what

their business models will look like. The volume of regulatory reform required

over a short period of time has caused significant operational and regulatory

risks within financial services firms who have struggled to deliver the

requirements within regulatory timescales.

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There has been an extraordinary amount of regulation and legislation which

firms have been required to implement over the last three years. From a

retail conduct perspective a couple of examples include:

 The Retail Distribution Review (RDR) which required firms to adapt their

business strategies and their technological systems and platforms. The

introduction of this regulation has led to a reduction of services in the

retail investment advice sector, with some banks and independent

financial advisers either withdrawing from the market place or amending

their offering to exclude consumers who have smaller sums to invest.

These types of consumers may now move to execution only services

which can be more cost effective, however if the product is complex and

they lack sufficient financial capability this can lead to poor investment

choices and outcomes.

 The Mortgage Market Review brought technological challenges in respect

of more robust affordability assessments and the production of revised

key features documents, but also increased protections for the consumer

as the majority of mortgage sales now requires the consumer to go

through an advised sales process. The implementation has also caused

structural changes in the market place as some firms have moved to place

more reliance on the intermediary distribution model and may also

outsource the packaging of mortgages including affordability assessments.

The lender remains responsible from a regulatory perspective for ensuring

the consumer meets the lending criteria and affordability requirements.

In the case of outsourced activities the firm must ensure appropriate due

diligence and oversight of the arrangements in place to satisfy itself of

compliance with the regulations.

 The transfer of Consumer Credit Regulation from the OFT to the FCA. This

has affected the structure of the market by bringing unregulated activities

such as pay day loans (high cost short term credit) and crowd funding

(peer-to-peer lending) into the regulatory space. It has resulted in

approximately 70,000 consumer credit firms previously licensed under the

OFT regime, seeking authorisation from the FCA. It represents a more

significant regulatory burden for these firms and as such some have

exited the market meaning consumers in niche areas may find credit more

expensive or more difficult to obtain. Business profitability for some firms

has also suffered as the FCA imposed regulatory caps on the amount of

interest and fees levied by firms which offer high cost short term credit

from January 2015.

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As we have already discussed, the FCA’s regulatory conduct agenda is seeking

to change firm behaviour in order to secure improved consumer outcomes.

The addition of the Financial Policy Committee (FPC) and Prudential

Regulation Authority (PRA) requirements in relation to capital adequacy and

the type of assets which are held on bank balance sheets will have a direct

impact on the bank’s funding position and the type of products and services

which they will offer, in addition to the markets which they will enter. The

current policy agenda seeks to strengthen the financial system and the

financial soundness of individual firms. Policy may seek to reduce lending in

sectors which the FPC / PRA believes pose a threat to the financial stability of

the economy and boost lending in other sectors which benefit the market and

consumers. Where regulatory reforms affect the prospects for growth in

certain markets, firms must consider the social costs and the impact of

financial exclusion before fully withdrawing based upon their risk appetite and

financials.

We considered examples of economic policy within

Module 1

In 2014 the FPC imposed a cap on regulated lenders to ensure that no

more than 15% of any lenders total number of new residential mortgages

should be at, or greater than 4.5 times the borrowers’ income.

In 2015 the FPC was given the power to instruct the PRA to require UK

banks to hold sufficient Tier 1 Capital in order to satisfy a minimum

leverage ratio as specified by the FPC. The means the FPC will specify that

UK banks must maintain a minimum amount of capital, based upon their

assets and certain off-balance sheet items. This will influence the

composition of the bank’s assets and liabilities, their sources of funding and the lending / markets in which they operate.

The primary loss absorbency requirements introduced under the Financial

Services (Banking Reform) Bill 2013 allow the Treasury to instruct the PRA

to require a UK bank to hold minimum levels of debt (the type and length

of the debt instrument can be mandated) which can be ‘absorbed’ by the

bank should they suffer financial difficulties. While this gives added

protections to the bank in the event of potential insolvency and transfers

the risk from the government / FSCS scheme onto creditors, it also influences the shape of the balance sheet and the bank’s funding position.

Policy growth initiatives can influence investor and consumer decisions, for

example the Help to Buy Mortgage Scheme and Help to Buy ISA will

encourage more first time buyers onto the property ladder and the Funding

for Lending Scheme aims to bolster the economy by ensuring there is an

adequate source of credit within the financial system. This scheme is in place

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until January 2018 with incentives targeted toward the small and medium

sized enterprises (SMEs).

In addition the recent government policies in connection with reforms to the

pension market and welfare benefits will influence the way in which

consumers must manage their finances. The extent to which these policy

decisions impact the consumer will depend upon their financial capability and

the degree to which they have prepared for the changes as the ultimate aim is

to move responsibility for financial soundness from the State to the individual.

The pension reforms which allow greater flexibility over personal pension pots

from age 55 may require firms to develop new products and investment

opportunities to deal with consumer demands as they seek to withdraw funds

from their pension in order to access higher returns. While this should

improve competition in the market and encourage consumers to save for

retirement due to the increased flexibility of their savings, it can also lead to

uninformed consumers making short term decisions which will not deliver

good outcomes over the long term. For example, emptying a pension pot to

purchase a Maserati! The changes in welfare and benefit payments may lead

certain consumer groups to require support in terms of managing their

budget, especially if they are moving from having their benefits paid weekly

onto a monthly payment schedule. There is the potential for this consumer

group to utilise high cost short term credit to cover shortfalls due to poor

budgeting. In addition firms need consider their existing product range, in

particular their current account range, to establish if they are meeting the

needs of this consumer group or if they are being financially excluded.

On 1st January 2016 a number of the UK’s major retail banks announced

the launch of a fee free basic bank account. This account offers

customers the same services that are available for other current account

customers, including over the counter services and access to the ATM

network, however there are no charges levied if a direct debt or standing

order is returned unpaid. This will ensure customers are not put into an

unauthorised overdraft position by the addition of fees and charges.

This was driven by an agreement between the government and the

banking industry to develop a transactional account which would assist

the financially excluded. The target market are those customers who do

not already have a bank account, are ineligible for a standard current

account or who cannot use their existing account due to financial

difficultly.

The participating banks are Barclays; Co-operative Bank; HSBC; Lloyds

Banking Group; Nationwide; National Australia Banking Group; NatWest;

Royal Bank of Scotland; Santander; TSB; Ulster Bank.

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6.4.4 FCA Areas of Focus for 2015/6

Within their risk outlook and business plan for 2015-16 the FCA have set out

seven forward looking areas of focus which build upon the drivers of conduct

risk and continue to pose a threat to their statutory objectives of consumer

protection, market integrity and competition.

1. Pace of technological change – needs to be managed more effectively as

there is the potential for the pace of change to exceed the IT investment

made by firms, the capabilities of the consumer and the response of the

FCA to the conduct risks which new technologies deliver. Positives include

faster and easier access to products and services with improved

competition, negatives include consumer over reliance on easily accessible

high cost short term credit, increased security, fraud and IT risks and the

financial exclusion of certain consumer groups.

2. Poor culture, conduct and controls continue to threaten market integrity.

There is further work to be done from the top down, including increasing

staff awareness of conduct risk throughout the organisation. The

implementation of the Senior Managers Regime in March 2016 should

reinforce individual accountability for consumer outcomes.

3. Large back books may cause firms to act against the best interests of

their existing customers, in particular when comparing the products and

service on offer for new customers.

4. Pensions, retirement income products and the associated distribution

channels may deliver poor consumer outcomes.

5. Poor behaviours in the consumer credit sector may lead to unaffordable

loans and defaults. The business plan specifically references younger

consumers who are at risk of over indebtedness at an early stage in their

family lifecycle.

6. Increased focus on a range of issues which have the potential to be

considered unfair, including unfair terms within consumer contracts and

how the disclosures of those terms are communicated to the consumer.

Presently most terms & conditions are considered to be too long and

complex, offering little transparency to the consumer. There is further

work to be done with regard to the disclosure of terms and conditions

over digital and mobile media. Reference is also made to the new

Consumer Rights Act which applies to unfair consumer contract terms

over a number of industry sectors, including financial services – this

broadens the scope when assessing fairness.

7. The importance of robust systems and controls in the prevention of

financial crime.

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Their 2015/16 strategy will aim to improve integrity in the wholesale markets

through consideration of disclosures and conflict of interest positions and in

the retail markets through consideration of inducements / incentive schemes

and conflict of interest positions. In terms of consumer protection the FCA will

consider the ease of availability of consumer credit to particular consumer

groups, the collection of unsecured debts, how the industry has reacted to the

changes in pension legislation, and the distribution models which have been

developed post RDR, in particular those which offer non-advised sales of retail

investment products.

6.5 Importance of Culture in delivering the

Conduct Risk Agenda

The culture within an organisation will influence individual staff behaviours but

what exactly do we mean when we refer to the “risk culture” of an

organisation. Culture can be difficult to define but broadly speaking we are

referring to the knowledge, beliefs and values of individuals which are

developed and shared within an organisation. These beliefs arise from the

interactions and experiences between the staff within the organisation and

also the external environment. They determine what is important to the firm

and what is acceptable or unacceptable behaviour. In essence culture is

learned, we consider the implicit norms around us and adapt our own

behaviour to mirror what we perceive to be the established behaviour of a

defined group, society or an organisation.

As a conduct regulator the FCA has been vocal about the importance of

culture confirming the cultural characteristics of a firm are a key driver of

potentially poor behaviour and as such it is an essential element of conduct

risk. As considered in Module 1 the FCA’s approach to supervision can be

described as intrusive, pro-active and outcomes based. Through their 3 Pillar

approach they will engage with the board and senior executives, providing

robust challenge of the institution’s culture, business model and risk

governance framework. They will assess and challenge the decisions taken by

senior management, ensuring they are consistent with the risk appetite of the

firm and where issues are identified which pose a risk to their statutory

objectives, they will proactively intervene. UK retail banks should be asking

themselves “Does the risk culture within my organisation support appropriate

behaviours and decision making, and is there a strong risk governance

framework to support the culture and organisational values?”