Firms should ask themselves the question: ‘should we’ carry out a certain activity as well as ‘could we’ do it.
I would like to thank the Association of Foreign Banks for inviting me to speak to you. I am extremely pleased to be here as we continue our ongoing dialogue with the AFB to set the agenda for foreign banks operating in and out of the UK. Today, and from a position of being almost eight months on since the formal creation of the FCA, I will be re-visiting the basics of what conduct regulation means for firms, how we are supporting evolving business models, the role of senior management, and the increased risks posed by financial crime.
But before I start, I would like to set the scene against which most of you operate. The UK is currently the leading exporter of financial services across the world, with a trade surplus in 2012 of $64bn, more than three times that of the next largest trade surpluses recorded.
The British tradition of welcoming foreign firms has also paid dividends. Today, there are over 1,000 majority foreign-owned financial services firms operating here, employing tens of thousands of people. London’s geographical location between the US and Asian time zones often means that the City can work virtually around the clock, while its unique economic infrastructure has meant that it is consistently named as the number one financial centre in terms of competitiveness by the Global Financial Centres Index survey.
So you may be wondering how the FCA’s approach will help to support the continued growth of this important industry. As you know, we were formally created around eight months ago and I hope you have started to see how different financial services regulation will be going forward. As a conduct regulator, we aim to be more judgement-based, forward-looking, and outcome-focused than our predecessor has been. In essence, what this means in practice is that we are continuing to develop and deepen our understanding of the sectors we regulate and what consumers, both wholesale and retail, are really experiencing. We are looking closely at how firms make their money, and using more data and intelligence to join the dots so we can head-off risks before they crystallise to cause consumer detriment or damage market integrity.
We have also developed a new and more focused supervisory model, which focuses on moving from a reactive approach to a pre-emptive and judgement-based approach; moving from dealing just with symptoms of problems to addressing underlying causes; and moving from an approach that is focused only on ensuring compliance with rules to an approach that encourages firms to do the right thing in respect of their customers and the markets they operate in.
This philosophical change is important because in our experience, when things go significantly wrong in a firm within our remit, it is not because it hasn’t complied with a set of narrow regulatory rules, but because there is a fundamental flaw in the business model, in the culture or its business practices. So in our view, firms should ask themselves the question: ‘should we’ carry out a certain activity as well as ‘could we’ do it. To put it another way, ensuring your firm operates to the highest standards is a cultural question not a control or process challenge.
In our view, this requires much more than a good control environment – what’s really needed is an approach that puts the interests of the customer and right market behaviours first in every aspect of decision making and at all levels of the organisation. This should include how business strategies are developed, how individuals are compensated and how front-line processes are designed and performed.
So before I move on, I want to touch on what underpins all of this. It is clear to us that meeting our requirements is heavily dependent on a firm having a culture that sees the interest of the customer and good market behaviour as paramount. This needs to be led from the top of the firm, grounded in clear business practices or standards that can be easily understood and operate as guide to all levels of management when judgements need to be made about what is acceptable and what is not, and supported by performance management, employee development and reward programmes.
We are often challenged over how we assess firms’ culture. We do this by drawing conclusions on what we observe about a firm – in other words, joining the dots rather than assessing culture directly. This can be through a range of different indicators such as how a firm responds to, and deals with, regulatory issues; what customers are actually experiencing when they buy a product or service from front-line staff; how a firm designs products and the considerations around this; the manner in which decisions are made or escalated; the way in which claims or complaints are handled; the behaviour of that firm in certain markets; and the remuneration structures.
We are also looking at how a firm’s board engages in those issues and satisfies itself that the firm is operating in a manner that would result in positive customer outcomes and market behaviours.
Supporting evolving business models
I would like to turn my attention to our thoughts on the emerging business models of overseas banks operating in the UK. What we have seen is that the branch or subsidiary-based models vary greatly in size and ambitions, often meaning that the likelihood and potential impact of poor conduct differs dramatically when looking at each firm in isolation. We have seen some firms with plans to expand up to 50% per annum, while others continue to innovate and launch newer and more sophisticated products into markets such as retail, wealth and wholesale.
We have taken three steps to help the assessment of this. These include:
- Acknowledging the need to have a robust gateway, we have changed our approach to authorisations. We are looking more closely at how new applicants represent increased competition in the market, whether consumers will be at the heart of all behaviours and decisions in the firm, and whether the firm has the right individuals running it. We do not want to stifle innovation or create excessive regulatory barriers to entry or expansion, but feel some aspects are fundamental to the success of financial services in the UK.
- Along with the Prudential Regulation Authority (PRA), we are considering the role of branches and subsidiaries. However, unlike the PRA, whose legal powers and responsibilities vary depending on the location of the parent and the legal form of its operations in the UK, our remit as a conduct regulator applies regardless of whether you passport in or are based in the UK. Because of this, it is important that non-UK firms are mindful of UK and FCA requirements, particularly of preserving the integrity of the legal entity. We are also striving towards greater clarity of responsibility and accountability in the supervision of international firms as to avoid firms exploiting situations of regulatory arbitrage.
- From a supervision perspective, we are looking more closely at the business models of firms to understand further the key drivers of conduct behaviours. This is based on a range of data, including financial data across peer groups, and allows us to identify and prioritise the firms that pose the greatest risk to our objectives and allocate resources accordingly. This analysis also gives us the ability to understand whether there are common issues affecting a range of firms and determine whether we should conduct specific pieces of thematic work.
We are also seeing a number of new markets emerging, which we are keeping a closer watching brief over. Islamic finance is one of these areas, particularly given the UK’s position as the leading Western provider, with assets of $19bn. While this as a proportion of the total banking sector in the UK is relatively small, we believe there is potential for significant growth going forward, particularly from the six standalone Islamic banks in the UK and from the 15 other conventional banks which offer Islamic financial services through sharia-compliant ‘window’ operations.
Following the Government’s announcement last month that it would be working to launch a sovereign Sukuk and create a new Islamic finance index on the London Stock Exchange for sharia-compliant financial products, the FCA, as the markets regulator, is in discussions with relevant stakeholders to understand the implications of this and how best to take forward the initiatives.
Ensuring hearts and minds of management are based in the UK
It is clear to us that responsibility for setting the tone and culture of the firm sits at the highest levels of any firm.
The second area I would like to touch on is the responsibility and accountability of senior management. As I mentioned earlier, it is clear to us that responsibility for setting the tone and culture of the firm sits at the highest levels of any firm.
We recognise that many firms manage themselves on a global basis – from these, we are looking to a balance between global decision-making structures and legal entity considerations.
We are increasingly looking to understand how leaders and senior managers discharge their responsibilities, focusing their mind through greater use of attestations, and holding them to account for conduct failings. For example, in 2012-13 we took action against 55 individuals, imposed £5m in fines against these individuals and secured 43 prohibitions. This is not to say that these types of investigations are not challenging, not least because industry professionals have a lot to lose if enforcement action is successful.
We are also considering how to operationalise the recommendations of the Parliamentary Commission on Banking Standards (PCBS), which called for the creation of a new Senior Persons and Licencing Regime. The implications of these are profound for deposit-takers and should not be under-estimated. And while it is unclear yet how it will work in practice for banking groups headquartered outside the UK, it is clear that we, as regulators, will be looking even more closely to the role of senior individuals and how they address their regulatory responsibilities.
Ultimately, though, what we want is senior management to demonstrate integrity, role model the right behaviours, challenge where culture is not right, and do the right thing, even when it is hard.
Increased risks of financial crime
Managing anti-money laundering risk should be part and parcel of running a successful business.
The final area I would like to cover today is financial crime, which we know is an issue facing firms across all sectors due to London’s position as the global centre for financial services. I said at our financial crime conference in the summer, and would like to reiterate here today, that managing anti-money laundering (AML) risk should be part and parcel of running a successful business. So while anti-money laundering remains a high priority for the FCA, it is our belief that this should be high on the agenda for AFB members, many of whom deal in countries, products and sometimes with customers that potentially pose high money-laundering risk.
In July, we published our first annual AML report as part of our commitment to greater transparency. Among other things, we set out our view of AML compliance in the industry, which remains a matter of some concern. In particular, we see serious and persistent problems in firms’ dealings with high-risk customers and politically exposed persons. The specific issues we see with these customers include:
- inadequate enhanced due diligence, with some firms failing to collect the right information and others failing to assess it properly
- weaknesses in establishing and corroborating high-risk customers’ sources of wealth and funds, with too much reliance often placed on explanations received from the customer, even when there are credible allegations of criminal activity and
- poor judgements about AML risk, especially when potential profits are high. This can be both a cause and a consequence of due diligence issues
To address this, our financial-crime specialists have been conducting firm-specific and thematic work and I would like to highlight some of the things we’ve published so far:
- In July, we published our review of how financial-crime risk in trade finance is being controlled. Here, we found that most firms in scope were not adequately considering trade-based money laundering risks either in general or in specific transactions. Half had no clear procedures, some failed to identify potentially suspicious transactions and many could not demonstrate that money laundering risk was being considered when transactions were processed. In addition, controls over dual-use goods – goods which can be used for civil and military purposes and can be subject to sanctions – were inadequate at most banks. We have been discussing some of the trickier areas with the AFB, particularly around the assessment of whether goods are appropriately priced or might be dual use, but our belief is that banks can generally do more than most are doing now.
- Last month, we started another piece of thematic work on how 20 small banks are managing the risks posed by high-risk customers, including politically exposed persons (PEPs) and correspondent banks. This is a follow-up to our 2011 AML thematic review and will test whether banks are taking heed of our guidance and we will take a dim view of those who continue to run unacceptable risks without adequate control. We look forward to reporting our findings in the New Year.
Summary
We want all firms to think about their own business models and the way they do business to ensure that the interests of customer and market integrity is genuinely at the heart of how they run their businesses.
So, I hope you found my talk today helpful and you understand further what conduct regulation means for firms. Fundamentally, we want all firms to think about their own business models and the way they do business to ensure that the interests of customer and market integrity is genuinely at the heart of how they run their businesses, and this is supported by a strong culture to deliver this. We also want firms whose parents or head offices are based outside the UK to ensure they comply with our requirements and that senior management understand the role they play.
For our part, we will continue to listen and engage with you and through trade bodies, including AFB, so that we can be in the best possible position to act early, to use our judgement on emerging issues and to keep an eye on the long-term benefits and outcomes for consumers and market.