The FCA's Risk Outlook and Business Plan 2014/15 What it means for you
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www.pwc.co.uk/fsrr
The FCA’s Risk
Outlook and Business
Plan 2014/15
What it means for you
Financial Services Risk
and Regulation
April 2014
Summary
The FCA published its annual Risk Outlook and Business Having reviewed both the Risk Outlook and the FCA Business
Plan on 31 March 2014, outlining its approach for 2014/15. Plan in full we recommend that firms:
While many of the headlines have focused on the FCA’s review • review, digest and engage with the documents, considering
of legacy business, it’s certainly not the only risk that the how the core messages are relevant to their business;
industry should be worried about during 2014/15. • pro-actively align their strategy with good consumer
The FCA uses the Risk Outlook to signpost key issues for firms. outcomes, and sustainable good profit;
It is therefore a useful reference for the coming year, in • build a culture, from the top, that delivers this strategy,
helping firms to shape their response to regulatory activity. tackling potential negative reinforcers such as incentive
structures;
The FCA has identified seven areas of focus for the financial
services industry, each of which it wants firms to consider, and • strengthen controls in order to safeguard against financial
then assess against their own business and strategy over the crime;
coming year. • respond to developments in technology, to ensure robust,
resilient systems are well funded and are geared to
consumer outcomes; and
• consider and act upon the root-causes of any failings.
In this briefing we’ll look at the context for the FCA’s approach,
and analyse their main conduct regulatory focus for firms over
the next 12 months.
Areas of concern at a glance
1
The pace of technological change
2
Poor culture and controls
continuing to threaten
3 market integrity
Large back-books leading to firms
acting against their existing
customers’ best interests 4
Retirement income products
5 and distribution delivering
poor consumer outcomes
The growth of consumer
credit leading to
unaffordable debt 6
Excessively complex terms
7
and conditions
Rapid and substantial house
price growth giving rise to
inappropriate customer outcomes
2 | FS risk and regulation briefing | PwC
The FCA’s approach
As with the previous Risk Outlook the FCA considers the Structures and business conduct
underlying drivers of risk, and then overlays environmental When considering structures and business conduct, the FCA
developments and cross-market pressures to identify forward- focuses on conflicts of interest, culture and incentives. The FCA
looking ‘areas of focus’. notes that conflicts of interest can often be deeply embedded in
These are in turn addressed through specific activity in the wholesale markets, and references recent work on the use of
FCA’s Business Plan. dealing commission in the asset management sector.
Culture and incentives are also a key focus of the FCA. Culture
The drivers of risk
drives behaviour, and incentive structures can motivate and
From the FCA’s perspective there are two key risk drivers: reinforce certain behaviours. Market structures are linked to the
inherent risk, and structures and business conduct. FCA’s competition mandate. The interaction of wholesale and
retail markets – and the direct link to an end consumer – make it
Inherent risk possible to distort competition throughout the value chain. The
The inherent factors build on the FCA’s behavioural economics use of technology also influences the competitive landscape.
agenda. Examples cited include information asymmetries,
Related reading:
biases and irrational behaviour, through to the growing
importance of financial capacity. Conduct Soundbites www.pwc.co.uk/conductsoundbites
Both retail and wholesale markets demonstrate these traits.
Environmental conditions
The FCA cites consumer credit as an area where the cost of
credit can be difficult to work out for a consumer, when The FCA identifies three environmental factors which
considering fees, interest and default charges. Equally, the contribute to the key drivers of risk.
information asymmetry demonstrated in insurance markets,
1. Economic and market conditions
or where wholesale market abuse through insider trading
takes place, are equally valid wholesale examples. The FCA’s analysis of the economic and market environment
considers the consequences of the economy, rather than
The FCA has already announced work to consider the impact adding commentary. Key risks to the regulator include the
of consumer bias, including a market study on cash-savings low-interest rate environment, and the high level of household
account teaser rates in retail banking. The FCA also highlights debt. While acknowledging the recent falls in unemployment,
the role of price comparison sites in driving potentially the FCA raises concerns about rising property prices and
irrational decisions by consumers, and the impact of consumers’ responses both now and when interest rates do
complexity in terms and conditions. In wholesale markets, the rise. Additionally the FCA is concerned by investors’
FCA notes the opacity of pricing mechanisms in decentralised willingness to take on more investment risk in a low-interest
markets. The FCA also highlights the need for enhanced rate environment.
consumer financial capability, particularly in light of the
forthcoming pension-access changes. 2. Developments in technology
The FCA believes that technological developments remain a
Related reading: www.pwc.co.uk/behaviouraleconomics
significant environmental factor. While consumers and firms
can benefit from quicker, less costly, simpler and more efficient
interactions, vulnerabilities from weak IT systems, cyber
attack or operational challenges are also magnified.
Consumer demand for online financial access has in part
driven this development, with examples of high-cost short-
term lenders and platforms such as SIPP operators.
Increasingly online ‘advice’ and guidance delivered in the
retail market is fuelling innovation too.
Technology therefore forms a part of many firms’ growth and
development strategies, including the increased use of data
insights. However, this can create vulnerability in firms’
dependence on underlying systems, and the substantive
operational load this can cause.
PwC | FS risk and regulation briefing | 3Data security, including cyber crime remains a high-profile Cross-market pressure
threat as does the reliance by firms on using technology to
Against the backdrop of the FCA’s risk drivers, the FCA is
reduce costs and increase efficiency.
concerned about three cross-market areas. They are:
3. Policy and regulation
1. pressure on business model sustainability and strategies;
The policy and regulatory landscape is the remaining
2. continued pressure to balance profitability, shareholder
environmental factor for the FCA. The sheer regulatory
returns, cost base and financial soundness with good
burden faced by firms, including a significant number of EU
consumer outcomes; and
initiatives such as EMIR, UCITS V, MiFID II will impact firms.
3. misalignment of expectation with underlying
The FCA also noted the consequences of recent government fundamentals.
policy on sources of funding. The changes to the decumulation
Much of the FCA’s cross-market analysis can be described as a
market and the support industry has received from the
desire for firms to create ‘good’, sustainable profits. The FCA is
Help-to-Buy initiative will both impact firms.
concerned that in seeking to balance profitability and sustain
Related reading business models, negative outcomes which run against
behavioural economic principles could occur.
As examples, the FCA suggests that firms could cause
detrimental consumer outcomes by moving into niche areas to
seek margin, or expanding into inappropriate mass markets,
or wider markets without sufficient resilience in operational
infrastructure. The FCA is concerned that pressure could also
result in firms seeking to extract value through hidden costs,
or prioritising higher margin business to the detriment of
wider consumer access, or using cross-subsidisation of
back-books against new business.
For lenders, the FCA is concerned that overarching funding
pressure remains a challenge which could inappropriately
drive strategy. But while there is a concern about consumer
De-leverage take 2: Making a virtue of necessity EMIR reaches behaviour, the FCA identifies overconfidence in future
beyond the EU The Consumerisation of IT: conditions and risks around the low interest rate environment
as potential risks to firms’ sustainability too.
PwC UK Economic outlook: www.pwc.co.uk/economics
The FCA’s technology concerns are also cross-market
pressures. With increased use of online and mobile platforms,
the FCA identifies potentially inadequate systems, controls or
expertise as a risk, in addition to insufficient spending.
Related reading
IT Resilience: Restoring confidence in Banks’ service delivery
Stepping up vigilance against financial crime
The FCA sees the fight against financial crime as a key element of its determination to uphold market integrity. Firms will
need to develop a more comprehensive, assured and demonstrable approach to financial crime in order to meet the
regulator’s expectations. As well as reviewing and overhauling controls to stay on top of evolving threats; culture and
values are critical - shaping the shared assumptions that drive attitudes to integrity, risk taking and compliance. But what
is especially crucial in relation to financial crime and market abuse is the tone from the top and the extent to which
challenge is encouraged within your organisations - regulators are going to be looking beyond formal controls at any nods
and winks that put profit before probity.
We explore this issue in Conduct Soundbites ‘On alert: Stepping up vigilance against financial crime’
www.pwc.co.uk/conductsoundbites
4 | FS risk and regulation briefing | PwCKey concerns for 2014/15
After applying their risk factors to the market, the FCA has
Our advice
seven areas of focus for 2014. These are:
1. Technological developments potentially • Ensure your organisational culture supports the
outstripping firms’ investment, consumer delivery of good customer outcomes, aligned to
capabilities and regulatory response your strategy.
Firms are increasingly looking to embed new technology into • Demonstrate to the regulator that your board is
their businesses in an effort to be more efficient and actively engaged with the cultural agenda.
competitive. While the FCA recognises the positive impact
new technology can provide – it also voices concerns around a 3. Large back-books may lead firms to act against
number of risks: their existing customers’ best interests
• Firms invest disproportionately in technologies to support The FCA is concerned that firms may be taking advantage of
new business development, leaving legacy administration inertia with their large and profitable legacy back-books,
systems untouched. This could result in poor service to employing strategies that are not in the best interests of the
existing customers and also create resilience issues. customer. Specific tactics that give the FCA cause for concern are:
• The controls firms employ may become outdated and fail to • Cross selling – including sales of annuities to vesting
keep up with the pace of technological change. This risk is pension customers.
likely to be more acute for businesses that have limited • Exit barriers – using restrictive terms and conditions, high
experience of new technology and so rely on third-party exit charges or misleading disclosures to dissuade
outsource arrangements. customers from switching to better deals.
• New digital distribution platforms present their own risks • Leveraging off profitable back-books to subsidise new
– not least of which is the potential for customers to cheaper products in an effort to maintain market share
‘misbuy’. The FCA highlights risks of firms using poor – which could squeeze out competitors that don’t have a
disclosure, selling complex products to non-advised large book of legacy business.
customers and also breaching the boundary between
advice and non-advised services.
Our advice
• The FCA also notes the risk of firms investing in new
technologies and tools to keep up with their competitors, • Focus on the continued appropriateness of back-
without really considering whether they add value for book products for your customers, as part of your
customers and enhance the services they provide. ongoing product review process.
• Cyber/financial crime is also on the FCA’s list of risks,
concerned that increased use of digital platforms could
expose customers to an increased risk of identity theft, 4. Retirement income products and distribution
fraud, scams and hackers. may deliver poor consumer outcomes
The FCA reiterates its concern that product innovation leads to
Our advice increased complexity and risk of customers buying unsuitable
products. In the life sector, the FCA highlights the potential
• Consider your dependency on technology both
explosion of new products targeted at customers approaching
within your organisation and in your interactions
or in retirement, following the recent Budget announcement.
with customers.
• Assess your relationships with outsourcing The concern is that consumers, hindered by behavioural biases
providers, including vulnerability to cyber-crime. and faced with complex options, may be unable to make effective
decisions that serve their long-term retirement needs.
2. Poor culture and controls continue to threaten Our advice
market integrity
The FCA remains concerned over business models predicated • Be customer centric: build propositions to meet
on cross-selling, with questions remaining over the quality of client needs.
execution services provided. Potential market abuse and firms’ • Review your products and if necessary start from
ability to manage their conflicts of interest remains high on scratch, using technology.
the FCA agenda.
PwC | FS risk and regulation briefing | 55. The growth of consumer credit may lead to
unaffordable debt How will the FCA respond?
The FCA focuses on revolving credit products such as credit From the FCA’s Business Plan, a number of sector-
cards and overdrafts, particularly when used by households specific activities are confirmed:
already highly indebted; a small increase in use could put
many families in financial difficulties. Cross-sector, the FCA will:
Product complexity, including unexpected or hidden charges, in • build on its incentives work to review how firms
expensive short-term sources of credit remain a risk. The FCA mange the performance of their sales staff;
believes these distort a consumer’s ability to compare prices. • in conjunction with other regulators, test the
Financial Services Critical National
The FCA also stresses that they seek risk by using unsuitable
Infrastructure’s resilience to cyber attacks; and
debt management services.
• test the visibility of IT resilience and risks at board
level.
Our advice
• Ensure that you have robust mechanisms in place For banking and lending institutions, the FCA
to properly assess potential and existing customers will:
before lending, and that you fully consider the • review whether victims of unauthorised
impact of future interest rises on those customers. transactions are being treated fairly;
• PwC research indicates that 26% of customers are • review the implementation of the new packaged
already displaying symptoms of potential financial bank account rules;
difficulty and this is likely to get worse.1 • consider the impact of cost-cutting initiatives such
as the withdrawal of paper bank statements;
6. Terms and conditions may be excessively complex • conduct post-implementation testing on the MMR;
With the consumer credit sector continuing to grow rapidly a • review the arrears and forbearance processes of
new range of costly products or products with complex features short-term high cost lenders;
have arisen. As a consequence, complicated terms and • consider hybrid equity release products as a
conditions have become common place, making it more difficult solution to interest-only mortgage maturity; and
for consumers to compare financial products and fully • review governance, risk management and lending
understand what they are buying. Complex features can strategies with recent risk appetite changes.
prevent consumers from effectively managing their use of credit.
For investment and savings firms, the FCA
Our advice will:
• Embrace behavioural economics in your disclosure • continue its market study into retirement products;
and customer contact. • look at the fair treatment of legacy insurance
• Understand your conflicts of interest, and make investment products;
sure back-books are managed in customer’s best • assess the management of conflicts of interest
interests. when wealth managers use in-house funds;
• assess the risks in client take-on procedures in
firms offering contracts for difference; and
7. Substantial and rapid house price growth could • review the due diligence conducted by investment
give rise to conduct issues advisers into products and services sold.
With further housing price rises predicted, risks of weakening
For insurance firms the FCA will:
underwriting standards combined with future increases in
interest rates could lead to forbearance and negative equity • extend the retail claims handling work into
risks, and increased demand for non-mainstream credit. commercial lines;
• look at the impact of wholesale market distribution
Our advice chains on retail customers, including responsibly
and culture;
• Review your underwriting processes, and consider
• embed recommendations for the motor legal
how to build in behavioral triggers into client
expenses and mobile phone insurance reviews;
communication
and
• PwC predict that prices will continue to rise; firms
• review the sales practices in premium finance.
need to build this factor into product design and
approval processes.2
1
PwC ‘Precious Plastics’, November 2013
2
PwC Economics Blog, March 2014
6 | FS risk and regulation briefing | PwCNext steps for your business The Risk Outlook provides a useful tool in shaping your regulatory response for the next 12 months. Over the coming weeks and months you will need to analyse the FCA’s seven focus areas and consider the relevance and impact on your business model and strategy. The FCA expects you to: • have a properly implemented customer centric strategy, which produces good, sustainable profits; • have a board-led culture which supports that strategy and good consumer outcomes; • develop products that operate in the interests of customers, and use behavioural techniques to ensure that those customers also understand them; and • take a prospective view on the products that you sell, stress-testing and ensuring appropriateness for your customers. What you can do to respond? 1. Technology Assess your dependency on technology and review your relationships with third-party suppliers. 2. Culture Demonstrate that your board is actively engaged with the cultural agenda that puts customer outcomes first. 3. Existing customers Make sure your strategies are not acting against your customers’ best interests and make it easy for people to find the best deal. 4. Retirement income products Be customer-centric when developing new products and ensure they always serve the customer’s long-term retirement needs. 5. Consumer credit Reduce product complexity, ensure you have robust controls in place to assess customers before lending and that you consider the impact of any future interest rate rises. 6. T’s & C’s Make it easier for your customers to compare financial products and fully understand what they are buying. 7. House prices Review your underwriting processes to ensure your people are always focussed on the right outcome for your customers. The FCA has shown willingness to tackle the operation of markets through competition powers, and the operation of individual firms through their supervisory and enforcement powers. Coupled with the new senior persons approved regime, the FCA will hold individual senior management personally accountable for failures, including not engaging with and understanding the key tenets of the Risk Outlook and Business Plan.
PwC is conducting further analysis of the Risk Outlook and Business Plan, and will publish further documents shortly. Please speak to your usual contact, or someone below, for more information. Contacts David Kenmir Richard Smith Andrew Clark Financial Services Risk and Regulation Financial Services Risk and Regulation Financial Services Risk and Regulation Partner – Co-head Conduct and Culture Partner – Co-head Conduct and Culture Partner – Forensic Services +44 (0)20 7804 4794 +44 (0)207 213 4705 +44 (0)20 7804 5761 david.kenmir@uk.pwc.com richard.r.smith@uk.pwc.com andrew.p.clark@uk.pwc.com Martin Hislop Craig Gentle Matthew King Financial Services Risk and Regulation Financial Services Risk and Regulation Financial Services Risk and Regulation Partner – Capital Markets Partner – Consumer Credit Partner – Culture +44 (0)20 7804 1126 +44 (0)117 928 1269 +44 (0)20 7212 2801 martin.hislop@uk.pwc.com craig.gentle@uk.pwc.com matthew.king@uk.pwc.com Amanda Rowland Howard Scott David Taylor Financial Services Risk and Regulation Financial Services Risk and Regulation Financial Services Risk and Regulation Partner – Asset Management Partner – Insurance Partner – Retail Banking +44 (0)20 7212 8860 +44 (0)20 7804 9851 +44 (0)20 7804 2892 amanda.rowland@uk.pwc.com howard.d.scott@uk.pwc.com david.j.taylor@uk.pwc.com www.pwc.co.uk/fsrr This publication has been prepared for general guidance on matters of interest only, and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication, and, to the extent permitted by law, PricewaterhouseCoopers LLP, its members, employees and agents do not accept or assume any liability, responsibility or duty of care for any consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it. © 2014 PricewaterhouseCoopers LLP. All rights reserved. In this document, “PwC” refers to the UK member firm, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. 140401-204936-LK-OS
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