The dominant regulatory theme of our times

The way that financial services firms carry themselves in the market and interact with consumers has never been more important. “Market conduct and market conduct compliance are undoubtedly the dominant regulatory themes of our times,” said Richard Rattue, Managing Director at Compli-Serve, in his opening remarks to a two-hour-long compliance and market conduct seminar, hosted virtually. He noted that firms were under intense pressure to demonstrate the so-called triple bottom line, by making profit without adversely impacting on the environment or society.

From rules- to principles-based compliance

“Environmental, social and governance (ESG) factors influence how financial services providers (FSPs) should be conducting business in today’s marketplace; ESG is a factor you must take into account,” said Rattue, before sharing some thoughts on the history of the compliance function. It became apparent that compliance practices, and the expectation that regulators have of compliance professionals, have radically evolved over the decades. Back in early 1990s, compliance officers existed to ensure that businesses did not break rules without having any significant influence on decision making. Nowadays, compliance officers operate in an outcomes-focused regulatory environment where rules, though still plentiful, are making way for principles-based regulation. 

The current focus on market conduct and market conduct regulation will not surprise those with a two- or three-decade view of financial markets. According to Rattue, today’s regulatory obsession is the inevitable outcome of the countless examples of market conduct gone wrong, as evidenced by the massive bet taken by an individual trader, George Soros, against the UK currency in 1992. Today hailed as a businessman and philanthropist, Soros’ 1992 currency speculation earned him the title ‘the man who broke the Bank of England’. His short sale of around USD10 billion worth of pounds sent that currency into freefall, eventually earning him a gross profit of around USD1 billion. The trade coincided with what was subsequently named the 1992 Black Wednesday crisis. “Soros effectively broke a central bank,” said Rattue, before rattling off a list of market conduct shockers. 

Conduct failings with billion-dollar consequences

Some of the international market conduct failings that have influenced regulators over the years include the ‘dubious accounting practices’ scandal at US-based Enron; various international banks’ complicity in the LIBOR rate-fixing scandal; and the apparent insanity of banks and insurers in the run-up to the 2008-9 Global Financial Crisis (GFC), also referred to as the sub-prime crisis. In South Africa, the financial services community has witnessed countless market conduct related scandals, including the theft of billions from Living Hands; the collapse of Sharemax and other property syndications; Steinhoff; VBS Bank; Tongaat Hulett, and a long list of other disasters. 

“These events serve to highlight the importance of market integrity and trust, which were at stages [in the past] at risk of being completely eroded away,” said Rattue. No surprise then that South Africa’s Financial Sector Conduct Authority (FSCA) and the UK’s Financial Conduct Authority (FCA) are committed to a relentless pursuit of conduct issues. “Regulators have grown increasingly interconnected and are likely to become more so through the increased use of reg-tech, or technology generally,” said Rattue. He pointed out that the embedding of treating customers fairly (TCF) principles in the domestic regulatory environment was, in fact, a worldwide phenomenon. And then he made this important observation: The customer needs a fair deal; if you are not giving the customer a fair deal then you are going to find yourself on the wrong side of the change that is taking place in our industry. 

Market conduct equals TCF?

Rattue identified five key risk areas that compliance professionals would have to keep an eye on as the Conduct of Financial Institutions (COFI) Bill neared finalisation. The first, being the management of conflicts of interest, needs little introduction. “Conflicts create barriers to good market conduct outcomes; businesses must decide what is acceptable and what unacceptable … and be able to motivate such decisions,” he said. Under this risk heading, FSPs and product providers will have to align incentive schemes and remuneration models to the market conduct regulation, and perhaps even consider the impact of their legacy business models and products. It turns out that TCF and market conduct are closely aligned. 

The second risk stems from the product lifecycle. “We need to make sure that conduct risk is part of the new product development cycle; we must evaluate sales incentive programmes; make sure that customer onboarding processes are compliant; and monitor product suitability actively at all stages of the customer relationship, among others,” said Rattue. Compliance ‘success’ includes educating employees on product suitability and making sure to match product with consumer profiles. And, most importantly, FSPs and product providers need to keep evidence of each of the aforementioned processes, including what informed the various product decisions! 

Risk area three relates to market abuse and the importance of market integrity and trust. “We need to be aware of individuals within our organisation who are exhibiting or undertaking behaviour that puts the wider firm at risk, because the conduct of the few affects the main,” said Rattue. Addressing this risk requires putting systems in place to encourage and protect whistle blowers, among other initiatives. Top among these is to have strong anti-bribery and anti-corruption controls within the organisation. Key risks four and five deal with the sales and post-sales approach. 

Fair and equitable approach to sales

“The sales process needs to be fair and equitable; we must sell customers the right product and not force them into something that is inappropriate for them,” said Rattue. There is long list that firms should consider under the ‘sales process’ heading, including whether suitability testing and ongoing outcomes monitoring processes are in place. The main question that should be asked by the product provider is: How did we know this was a product that would work in its target market? As for financial advisers, they must be able to rely on the testament from product providers insofar the product’s suitability for a certain demographic. 

Compliance and risk can play a part in the process by signing off on the incentive schemes designed to accompany new products, for example. Another area where compliance can get involved is with the ongoing training and monitoring of the sales force. Post-sales market conduct centres on the customer’s ability to exist a product without punitive penalties. “Most products that come to market nowadays are more flexible and transparent; in fact, the modern product bears little relation to products of old in terms of the customer’s ability to exit them,” concluded Rattue. He urged compliance teams at firms to build strong controls around claims handling and complaints processes and monitor customer feedback across all channels. In so doing, firms could address around 70% of market conduct risk. 

Writer’s thoughts:
Recent changes to the Policyholder Protection Rules (PPRs) and the pending Conduct of Financial Institutions (COFI) Bill will forever change the relationships between financial and risk advisers and product providers… Are you comfortable that product providers are doing enough during their product design and incentivisation processes to ensure fair outcomes for your clients? Please comment below, interact with us on Twitter at @fanews_online or email us your thoughts [email protected].

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