FCA Risk Outlook 2013

Financial Conduct AuthorityFCA Risk Outlook 2013

FCA Risk Outlook 2013

Financial Conduct Authority 201325 The North Colonnade Canary Wharf London E14 5HSTelephone: 44 (0)20 7066 1000Website: www.fca.org.ukAll rights reserved

FCA Risk Outlook 2013ForewordContents4Executive summary8Part A. Drivers of conduct risk121.Inherent factors what lies beneath1.1 Information asymmetries1.2 Biases and heuristics1.3 Inadequate financial capability141515162.S tructures and behaviours financial sectorwiring2.1 Conflicts of interest2.2 Culture and incentives2.3 Ineffective competition181919222425333640Part B. The evolving conduct risk landscape434. Forward-looking cross-market risks4.1 Rising pressure on strategicbusiness model adjustment4.2 Failure to balance prudentialsoundness and profitability with goodconsumer outcomes4.3 Misalignment of marketperformance expectations andunderlying fundamentals45Priority risks and links to the Business ConclusionConclusion3AppendicesFinancial Conduct AuthorityPart B5.Part A3. Environmental conditions challenges,change and uncertainty3.1 Economic and market trends3.2 Technological developments3.3 Regulatory and policy changeDrivers of wholesale conduct riskExecutive SummaryForeword

FCA Risk Outlook 2013ForewordMartin Wheatley, Chief Executive Designate4Financial Conduct Authority

FCA Risk Outlook 2013ForewordForeword“This risk outlook provides anopportunity for us at the start ofour journey to take stock of theissues we face as a new conductregulator which we can build onover the coming years”This is the first Risk Outlook to be published by the FCAand so sets expectations for the type of risks the FCAwill focus on.A ‘Risk Outlook’ inevitably will focus on what could gowrong – firms or products failing; misalignment of therisk appetite of individuals with the products they aresold and consumer detriment when lives are affectedthrough failings or misconduct in the financial sector.But there is another side to the risks we are concernedwith: firms not investing in innovating new productsto meet the changing needs of society; withdrawal ofsales forces; and too few new entrants in the industryto allow competition to flourish. So there are two sidesto the risk equation – consumer detriment arising fromthe wrong products ending up in the wrong hands, andthe detriment to society of people not being able to getaccess to the right products.The FCA must recognise that these are both risks andwill need to navigate a careful path between them.This document provides an opportunity for us at thestart of our journey to take stock of the issues weface as a new conduct regulator which we can buildon over the coming years. It sets out our currentthinking on conduct in financial markets by analysingthe root causes and emergence of conduct risk. Wewill complement our approach to retail conduct with astrong focus on wholesale conduct. We recognise thatwholesale conduct in some respects sets the tone forthe conduct of the wider financial industry; the risksin transactions where conflicts of interest are poorlymanaged or counterparts do not act with integrity canundermine overall market integrity, and may eventuallyfeed through to the retail consumer.Our approach to risk will enable us to become moreproactive and intervene earlier, focusing on the sourcesof detriment such as product design, governance andincentives. In this document we set out those forwardFinancial Conduct Authoritylooking risks that we deem pose the greatest risk toour objectives. While the FCA also has prudentialresponsibilities this document focuses solely on theconduct responsibilities for the organisation and howthese link to our regulatory objectives. For the first timewe are publishing our Business Plan alongside the RiskOutlook; in subsequent years we will expect these linksto be even clearer and to develop our approach as wegain experience in the new regulatory environment.From insurance contracts for ships negotiated in thecoffee shop of Mr Edward Lloyd, to goldsmiths actingas safe depositors of money for merchants, the financialservices industry was built on the needs of its customersand functioned in order to meet those needs. In the firstspeech I gave as CEO designate of the FCA, I set out thelifecycle of a typical customer and their interaction withand expectations of the financial services industry. Withthe financial services landscape becoming increasinglycomplex, it is important to keep revisiting this story toremind ourselves of the needs and expectations of thesociety we are here to serve today.The first need for most consumers is for a bank account– somewhere to put money from a first job, or a loan,or maybe even pocket money which they use to save orto buy goods and services. The majority of consumersremain with their first bank for the remainder of theirlifetime, making that first choice all the more important.With our new competition power, we have a role inpromoting choice and ensuring that regulation doesnot act as an unnecessary barrier to new firms enteringthe industry and does not discourage innovation.Our new focus on supply-side issues associated withcompetition problems is a real departure from the FSAregime and will enable us to better intervene in thefactors that affect the functioning of markets and inthe market failures that often lie at the root of poorconduct outcomes in financial markets.5

FCA Risk Outlook 2013“Achieving the FCA vision is in allof our interests, not only sociallybut also financially.”The next time our consumer may encounter financialservices products is when they make payments forgoods or services, perhaps their first car, mobilephone, concert tickets or book their first holiday. Theymay need access to their savings or credit if there is ashortfall; they may need insurance to protect their newassets. Our consumer may be faced with the option ofa general insurance add-on product, which is availablefor just about every product being sold. However as theconsumer is focussed on the primary sale, they do notalways assess the cost or utility of the add-on product.Poor incentive structures that reward high-risk, shortterm strategies are a clear indicator of a culture wherethe customer is not at the centre of how the business isrun. Culture change within firms is essential if we are torestore trust and integrity to the financial sector and theFCA will continue to focus on how firms are managedand structured so that every decision they make is inthe best interests of their customers.The FCA will focus on inherent factors that interactto produce poor choices and outcomes in financialmarkets. We will carry out market studies to identifyfeatures that weaken competition and drive poorconsumer outcomes – the first of these will focus onproblems in the add-on market). Consumers get financial services and products thatmeet their needs from firms they can trust.Going back to our typical customer, after they’ve beenwith their bank a while and built up some savings, theymay want to take out a mortgage to help them buy theirown home. Figures show that since 2002 the averageage of first-time buyers has been fairly stable, at around31 years old. In recent years, an increasing number ofpeople buying their first home have had parental help.Lastly our typical customer will perhaps start lookingto invest or save for their retirement. Part of our roleas the FCA means encouraging a financially inclusivesociety where firms do not focus only on those withsignificant wealth to invest, but also on encouragingsaving amongst those on lower incomes.When our typical customer visits their bank, buildingsociety or IFA in search of investment advice, theyneed to be confident that an advisor will look at theirpersonal circumstances, their goals and aspirationsand how much they’re prepared to risk and then comeup with something that is appropriate for them – notjust see it as an opportunity to earn a little more salescommission.6The FCA’s overall objective is to ensure financial marketsfunction well. For the FCA this means: Markets and financial systems are sound, stableand resilient with transparent pricing information. Firms compete effectively, with the interests of theircustomers and the integrity of markets at the heartof how they run their business.A successful financial services industry is one that canmeet the needs of consumers: the need for a bankaccount in which they can save, credit to help themmake important purchases and insurance to protectthese purchases against loss or damage, to help payfor their home, or to invest for their family’s future. Butit is also one that can meet these needs in a safe andsustainable way. And that is, in effect, the goal of theFCA and the outcome which the objectives set for us byParliament aim to achieve.People need a financial industry they can trust –success for the FCA will be when both consumersand firms rebuild that bond of trust.Financial Conduct Authority

FCA Risk Outlook 2013ForewordForewordThere are some issues that as a conduct regulatorwe may be unable to tackle alone, and maintainingeffective relationships with our stakeholders will bevital in order to achieve the FCA vision. This will includethe Prudential Regulatory Authority and the Bank ofEngland; the regulatory family including the FinancialOmbudsman Service; other European and internationalbodies; financial services firms; consumer organisations;and audit and law firms.We need to be mindful of the effect ourinterventions may have on society as a whole,particularly on groups that may find it harder toaccess the market than others.Achieving the FCA vision is in all of our interests, notonly socially but also financially. There are numerousrecent examples evidencing this point, from theredress bill firms now face following the mis-sellingof payment protection insurance to the contagioneffect of wholesale misconduct such as the attemptedmanipulation of LIBOR. Firms’ behaviour, attitudes andmotivations must be about good conduct; consumers,firms and individuals must take responsibility for theirpart in creating financial markets which work well andoffer a better outcome for consumers.Thus the risks set out in this document should not beof concern only to us, the regulator, but also to theindustry as a whole. And we and the industry havea collective responsibility to co-operate in acting toaddress these challenges.The majority of the consequences of our actions willbe positive, in line with the objectives laid out for us.However in some situations there may be unintendedconsequences, not necessarily within our remit toaddress, which result from the actions we choose totake. When we and industry act to address the risks laidout in this document, we all need to have an awarenessof the wider impact these actions might have – a widersocial conscience if you will.I therefore encourage you to read on and consider therisks we have identified and how you will play your partworking with us to address these over the coming year.Financial Conduct Authority7

FCA Risk Outlook 2013Executive summary8Financial Conduct Authority