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Understanding Conduct Risk: What the FCA Expects

Understanding Conduct Risk: What the FCA Expects

Conduct Risk

Conduct Risk Overview: In the ever-evolving landscape of financial services, one constant focus for the Financial Conduct Authority (FCA) is conduct risk. While the term “conduct risk” may not be explicitly defined by the FCA, it holds a pivotal role in the regulatory framework. Firms operating under FCA regulation must grasp the essence of conduct risk, develop their unique definitions, and craft tailored strategies to address it effectively.

Conduct Risk – The Foundation: 5 Conduct Questions

To help firms navigate the labyrinth of conduct risk, the FCA introduced the 5 Conduct Questions program in 2015. These questions serve as a compass for firms to align their practices with regulatory expectations:

1. Proactive Risk Identification: What steps does the firm take to identify conduct risks within its business?

2. Shared Responsibility: How does the firm instill a sense of responsibility for managing conduct across all functions?

3. Support for Improvement: What support mechanisms are in place to enhance the conduct of the firm’s business or functions?

4. Board Oversight: How does the firm’s board and executive committee oversee conduct, and how do employees contribute to this oversight?

5. Holistic Evaluation: Has the firm evaluated any business activities that undermine its efforts to improve conduct?

The FCA’s Wider Objectives

The FCA’s 2019/20 Business Plan highlights its overarching objective of improving the operation of financial markets concerning consumer protection, market integrity, and competition promotion. The 5 Conduct Questions program plays a vital role in advancing cross-sector efforts aimed at fostering a culture of good conduct and robust governance within firms.

Deciphering Conduct Risk

Conduct risk, in broad strokes, encompasses actions by regulated firms or individuals that harm customers, disrupt market stability, or hinder effective competition. These align with the FCA’s three statutory objectives:

1. Consumer Protection: Ensuring an appropriate level of consumer protection.

2. Market Integrity: Safeguarding and enhancing the integrity of the UK financial system.

3. Competition Promotion: Promoting effective competition in the interest of consumers.

However, conduct risk should not be confined to retail clients alone. Firms must apply a consistent definition across all organizational levels, even for overseas entities.

Identifying Key Conduct Risks

Understanding conduct risk begins with recognizing its drivers, which can stem from a firm’s structures and behaviours. Key steps include:

– Identifying specific risks (e.g., insider dealing, conflicts of interest, product design).
– Implementing controls for ongoing risk monitoring.
– Cultivating a culture of awareness and tracking cultural changes.
– Regularly refreshing conduct risk assessments.

Consider conducting a gap analysis to identify additional controls necessary to mitigate risks effectively.

Conduct Risk in Strategy

A clear link between conduct risk and business strategy is essential. Firms must demonstrate how conduct risk considerations shape their strategies and decision-making processes.

Conduct risk – Risk Appetite

Aligning risk appetite with the outcomes of conduct risk assessments and the firm’s strategy is crucial. This linkage should reflect the FCA’s key objectives of achieving positive customer outcomes and maintaining market integrity.

Conduct risk – Governance and Accountability

Effective governance is paramount for risk identification and mitigation. Firms should streamline governance arrangements, avoid redundancy in management layers, and establish oversight mechanisms, possibly through a dedicated Conduct Risk Committee.

Addressing Conflicts of Interest

Scrutinizing business models for potential conflicts of interest is crucial. Key areas to examine include vertically integrated models, product distribution, staff incentives, and PA dealing policies.

Systems and Controls

Robust systems and controls are vital for risk identification. Management Information (MI) must be well-designed to highlight risk areas, and training programs should foster awareness of conduct risk at all organizational levels.

Business Model Impact

A firm’s business model can either mitigate or exacerbate conduct risk. Careful consideration of product and service design, especially in response to market demands, is essential to avoid conduct risks associated with complex or unsuitable products.

Nurturing a Positive Culture

A culture that promotes good behaviour is fundamental. It should involve senior management adhering to policies, discouraging bad behaviour, fostering openness, and addressing issues decisively.

Conduct Risk: Resources for Further Exploration

For a deeper understanding of the FCA’s perspective on conduct risk, you can explore these resources:

Industry Feedback on the 5 Conduct Questions 2018/19 https://www.fca.org.uk/publication/market-studies/5-conduct-questions-industry-feedback-2018-19.pdf
Conduct Risk during LIBOR Transition: Questions and Answers https://www.fca.org.uk/news/statements/conduct-risk-during-libor-transition-questions-and-answers
FCA Conduct Rules https://www.fca.org.uk/firms/senior-managers-and-certification-regime/conduct-rules
Dear CEO Letter: Non-Financial Misconduct in Wholesale General Insurance Firms https://www.fca.org.uk/publication/correspondence/dear-ceo-letter-non-financial-misconduct-wholesale-general-insurance-firms.pdf
Wholesale Conduct Risk – Speech by Megan Butler https://www.fca.org.uk/news/speeches/wholesale-conduct-risk
Conduct Risk Briefing – Speech by Julia Hoggett https://www.fca.org.uk/news/speeches/conduct-risk-briefing
FCA’s Business Plan 2019/20 https://www.fca.org.uk/publication/business-plans/business-plan-2019-20.pdf

How We Can Assist

If you are in the process of establishing or reviewing your firm’s conduct risk framework, we are here to help. Our services encompass gap analysis, implementation of conduct risk frameworks, and the creation of management information packs. Contact us to discuss how we can support your journey toward effective conduct risk management.

Disclaimer: This article serves as a general guide and should not be considered legal or regulatory advice. Always consult with appropriate professionals for specific guidance related to your firm’s conduct risk management.

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