Regulation & compliance in 2012Simon MorrisPartner, CMS Cameron McKenna LLP

Looking at …1. What is changing with the FS Bill & FCA?2. Standards for advising & selling 3. Individual responsibility4. The future – Europe & G20

1. A change of tone (but not of substance)

FS Bill – the big pictureLord Sassoon

• We asked too much of the FSA• Process was valued over judgement

• Judgement of expert supervisors is put at the heart of the system

• FCA good news for consumers• Will seek competition-led solutions for better outcomes

Preparation points:• Understand the FCA’s policy and the cultural requirement

• Understand how this will impact your firm

• Understand how the FCA’s consumer agenda will impact your firm

• Consider your competitive position

The view from the Treasury Select Committee

View on the FCA …

• Objectives are unfocussed

• Weak accountability

• Overhang of current FSA culture

Preparation point - This may sharpen the approach

The restructuring is underway2011:

• Announcement that FCA to take over Consumer Credit from OFT

• Start of FSA’s ‘twin peaks’– internal split into PBU (PRA) and CBU (FCA)

2012

• FSB: further sittings at Committee stage. Back to HoC after HoL’s third reading. Expected to receive Royal Assent end of 2012

• Draft legislation on further banking reform due (Autumn)

• FCA approach document to be published

2013

• Draft handbooks for FCA and PRA to be published (early 2013)

• Legal cutover from FSA to PRA, FCA and FPC expected (April). Designate heads: Andrew Bailey (PRA); Martin Wheatley (FCA). FSA wants handover ASAP after 1st March. Depends on FSB

2014

• Expected transfer of consumer credit (incl. 2nd charge lending) from OFT to FCA under FSB

And alreadyFSA effectively divided

Preparation point - what you are seeing is what you will get

Changes in Bill are focused on delivery not substance

• MiFID is pervasive

• But the style can change – AUTH, SUP & ENF

• And G is important

• As is COND, PRIN and APER

Preparation point – the key focus is changes in style

The rulebooksWork starting on the rulebooks – very little change yet

• A change of tune?“Making only the changes required to implement the Bill and support

creation of the new regulatory structure” CP12/24

• PRA & FCA will designate existing FSA rules – but expect divergence• As regulators develop them “in line with their objectives and functions”

• In Guidance

• Plus new COND, PRIN & APER

• Plus new CASS, FEES & COMP

• Substantive changes needed for objectives & functions – GEN & SUP

Preparation point – study and respond to the consultation

Tripartite max – the new realitya) The FPC

We must ... Understand and guard against the big risks

Ensure shareholders’ money is at risk if a bank fails Take away the punchbowl – when this will work

Mervyn Kingb) The PRA

We are seeking to occupy the middle ground between fixed rules and unpredictable discretion

Julian Adamsc) The FCA

I am interested in how to intervene to make things better Martin Wheatley

The FCAThe new philosophy

• Looking at consumer behaviour and what drives decisions

• People make easy mistakes• How can they assess risk?

• How can they compare complicated products?

• Transparency is not enough ... does your business model deliver• Product and approval processes that produce the right product?

• Point of sale processes that produce suitable outcomes?

Martin Wheatley May 2012

Preparation point – look through your customers’ eyes & think TCF

The FCA philosophy in action1. Forward looking – act before goes wrong

• Authorisation, VoP, CiC, thematic supervision

2. Earlier intervention in development & marketing• UCIS

3. Attack underlying causes• Business model drivers

• Governance & senior management engagement

• Flows of MI and systems & controls

4. Securing redress and taking enforcement action• Intensive, interventionist & judgemental

Preparation point – anticipate the challenge

FCA agenda by sector – a measure of continuityRetail banking

• Responsible lending

• Bundled accounts

• Uprisking

• BCOBS

Asset managers• SYSC

• CASS

• Platform transparency

IFAs• Suitability – CIP, DIF &c

• Pressure of RDR

Wholesale• Market integrity

• Systems and controls

• Place in the product chain

Generally • Cost cutting

• Remuneration

• Cross selling

• Outsourcing controls

• Complexity in product design

Preparation point: grasp the agenda

A change in supervisory philosophyThe supervisory stance

• Sector based & firm/product focus• Thematic• Less relationship management• 2/4 year review replaces ARROW• C1 – C4

• Firm Systematic Framework – are customer interests & market integrity central to the firm?

• Emerging issues – firm event driven

• Issues & products – sector analysis

• With focus on conduct risk

We will communicate understandably• Less jargon & regulatory speak

• Consult face-to-face

• Fewer briefer consultations

How will regulatory processes feel?

A change of approach• Viability of business

• Management focus

• The Daily Mail test

Preparation point: grasp the agenda

The FCA agenda – draft product intervention policyTo address potential or actual consumer detrimentLooking at breadth, depth and context

• How many? How much? How vulnerable?

Outside FCA’s view of proper market• Obnoxious features

• Market cannot address – barriers to entry or exit

For example• Single premium PPI

• SCARPs

Preparation point – review and build into your design process

The FCA agenda – competition plansPromoting effective competition in the interests of consumersProduct intervention to tackle competition problems such as

products and services with the following characteristics• One-off high value transactions

• Long term investments where problems only appear many years on

• Asymmetries of information

• Inherent complexities

• Linked-in sales practices such as tying and bundling

• Barriers to switching

• Barriers to entry.

Preparation points• Review your products through a competition filter

• Consider also comparative prices, value for money and clarity of pricing.

The FCA agenda – incentivisation We are concerned that reward culture is contributing to

mis-selling …• we have found that most incentive schemes that we looked at are

likely to drive mis-selling, and this risk is not being properly managed;

• we expect firms to act now to clean up their act in regards to our findings;

• this work will be taken forward by the FCA and we will be taking a closer look at how firms incentivise their staff.

If you do have an incentive scheme, it has to be structured and managed in a way that treats the people it will affect fairly.

Martin Wheatley 5 September 2012

What’s the agenda?We will be making a judgement on what the businesses we

regulate are doing now, and what they plan to do in the future ...

We will look at how firms make their money, • and whether they are ‘good profits’

• how they pay their staff

• whether they are designing, and selling products with customers in mind

In short, whether they are carrying out their business in a way that is treating their customers fairly …

Martin Wheatley 5 September 2012

And the call for action1. First, look at your incentive schemes to see if they

increase the risk of mis-selling, and if so how.

2. Second, review whether your governance and controls are adequate.

3. … Recurring problems need to be investigated, action taken and redress paid to consumers who have lost out.

Martin Wheatley 5 September 2012

What are the exceptionable schemes?

In principle, any incentivisation unless limited & strict governance

Especially ones with• Significant amounts

• Disproportionate rewards

• Inappropriate triggers

• Product bias

• Mix bias

What should a firm look to do?

Remove high risk features• Think through bias generation

• Manager incentives

• Reducing the value of incentive schemes

• Capping maximum payments

Remedies• Act on quality

• Claw back

• Capping

2. Standards of advising & selling

What are the sources?

COBSTCFCampaigns• Replacement business

• CIPs

• ETVs

• Structured retail product governance

And to come• Product intervention

• Competition

Common features – manufacturing

1. The lovable product– Prove it!

2. Carefully crafted– Describe it!

3. With quality distribution– No inducements!

– Oversee it!

4. And monitored throughout the journey– Do it!

Common features – advising

1. Target the customer2. Ascertain the customer needs

– Realistically assess horizon, needs & ATR

3. Measure their present assets v their needs– What is a proper priority?

– Can you adjust the present assets?

– What would it cost them to enhance with your offering?

4. Give the suitable advice– Avoid bias

5. Keeping a very careful record

3. Enforcement & individual responsibility

The future holdsCredible deterrence has been at the centre of our enforcement strategy for a number of years. Simply put, credible deterrence is about taking tough, targeted, effective, public action against firms’ and individuals’ mis-conduct as a way of changing behaviours ...

Martin Wheatley July 2012

... enforcement needs to get further up the chain of command – to look increasingly at those in senior management who fail to recognise and manage the risks their firm is running

… we need to have a low tolerance for firms that constantly bump along the bottom.

Tracey McDermott July 2012

Individual approval – judging senior managementAPER 5 – 7 and in due course the PRA/FCA versionsProper control – have you mapped the business & identified the risks?• How did you manage them?

• How did you manage subordinates?

Skilful Management – do you fully grasp it?• What MI do you get?

• What do you do with it?

Business is compliant – how is it monitored?

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Up to 2007/08 …Predominantly directors of small retail firms, for example

• APER 5 – director of retail stockbroker failed to ensure systems and controls for suitability (Weston July 2008)

• APER 6 – director of insurance intermediary failed to monitor Compliance staff (Hales October 2008)

• APER 7 – director failed to ensure quality of advice or complaints reviewed at IFA (Nagaty September 2005)

The common features• Evident wrongdoing

• Resultant detriment

• Clear personal responsibility

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Not forgetting … incompetent compliance officersFailure to ensure firm took reasonable steps to comply

with CASS; delegated responsibility & not supervise - APER 5 & 7 (Thornberry March 2012)

Failed to ensure Compliance contractor performed – APER 7 (Ruff July 2011)

Did not understand business and delegated to others – APER 7 (Royden September 2010)

MLRO failed to assess risks, oversee function or ensure checks made – APER 7 (Chatto May 2010)

What should they have done?

UK / 73064985.1

The new world – senior management competency

Chief executive major IFA (over 300 advisers) breached APER 7Knew from board packs that suitability retail advice only c 60%

• Failure to ensure systems in place for suitable advice

• Failed to implement proper controls over record keeping

• Failed to understand why systems not working

• Aware of problems but failed to take reasonable action

Remedial action cost c £7m.Withdrew approval, fine, 5 year undertaking not apply SIF positionWhat should he have done?

Peter Sprung (Royal Liver) FN Feb 2010

The new world – competency (what is reasonable)

There were serious flaws in governance & risk management Six major issues current on his appointment as CEOOn appointment interviewed, discussed, met & challengedAlso commissioned reviews, appointed new headsFSA argued not wide enough but Tribunal said …

1. Reasonable initial assessment & not prompted to dig deeper2. CEO oversees controls but may rely on delegates3. Only limited authority in large international group4. Investigated every control failure and oversaw remedies5. Thus took reasonable steps despite ongoing serious flaws

John Pottage (UBS) Tribunal April 2012

What are the “defences”?1. Unfair to pick me out2. My conduct was not beyond the range of plausible

judgement3. The FSA never criticised us4. The strategy was agreed by the Board5. I didn’t design the controls6. It was the deteriorating economy that caused it7. I did take some steps to improve things

Every one of these arguments was rejected in Cummins – the focus is on personal responsibility and personal reasonableness

4. There is more (much more) to come

Key

No proposal

Trialogue in process

Adopted but implementation still to come

In force

Insurance• Solvency II: 2014

• IMD II: 2015

• IGS

Banking• CRD IV: 2013-

2019

• RRD: 2014 – 2015

• Banking Union in Eurozone: 2013-2014

• Liikanen Review

• DGS

Funds• AIFMD: 2013

• UCITS IV: 2011

• UCITS V: 2014

Securities, Derivatives and Investments

• MiFID: 2015

• Short selling: 2012

• MAD II: 2015

• REMIT: 2013

• EMIR: 2012/13

• PRIPs: 2014

• CRA

• CSD

Listing and Prospectus• Amending Prospectus

Directive and delegated Regulations: 2012

• Transparency Requirements

Key

No proposal

Trialogue in process

Adopted but implementation still to come

In force