As we close the book on 2014, we look back at the Financial Conduct Authority’s progress and select three important stories of 2014.
It was the Best of Times: Enforcement
There were many interesting cases, but 2014 will be probably be remembered as the record-breaking year for the Financial Conduct Authority‘s (FCA) enforcement division. Total fines in connection with benchmarking manipulation and price fixing exceeded £1.2 billion, more than triple the £474 million issued in 2013. Five banks alone paid penalties of over £200 million each in connection with forex price manipulation.
The benchmarking enforcement investigations were also notable for international cooperation between financial regulators. In addition to the FCA penalties, five banks paid over $1.4bn to US regulators and one bank disgorged $138 million to Swiss authorities. Global cooperation between regulators has now become common practice.
Fines Too High?
The high fines have attracted international press attention but many affected financial institutions have been complaining. They have had to set aside hundreds of millions of pounds in reserves to cover the ever-increasing costs of penalties and to meet spiraling legal costs associated with managing a global investigation from multiple financial regulators. The FCA appears to have acquiesced to these concerns and will now conduct a review of the level of its penalties.
It is possible that we will not see a return to these high penalties in future although this will likely be because the most egregious misconduct cases are now behind us. Future cases are likely to focus on enforcement action against senior individuals, which will form part of the FCA’s drive towards changing culture and governance.
Leaving aside the benchmarking cases, the FCA also fined three banks £42 million in total for failing to put in place IT systems that could withstand or minimise the risk of IT failures. The failings also prompted the Prudential Regulation Authority (PRA) to join the FCA and issue its first enforcement penalty, of £14 million against the three banks.
Move Toward Resilience
The case represented an ongoing shift in the FCA’s approach, encouraging banks to move away from “business continuity” (recovering from a disruptive event) to “resilience” (ensuring customer critical activities withstand disruptive events). The IT risk culture was specifically criticised for being too reactive and not sufficiently forward-looking in its identification of risk.
The FCA has been reviewing IT resilience amongst firms and will report its findings in 2015. IT resilience, with its obvious connections to cyber risk, will remain a key priority for financial institutions this year and next.
The case was also notable for being the first enforcement.
It was the Worst of Times: The Davis Review
In March this year, a newspaper, briefed in advance by the FCA, reported that the FCA would conduct an extensive inquiry into 30 million life insurance policies sold over a 30-year period. The story, which included quotes from a senior FCA official, caused billions of pounds to be wiped off the market value of some of Britain’s largest listed insurers. The FCA eventually issued a clarification but not until six hours later. Although the financial markets rallied, the matter caused profound concern amongst the insurance sector and broader financial community, and a review was quickly ordered into the events by senior government officials.
The Davis Review, released in December, investigated the matter and made several criticisms of the FCA and its internal procedures. Primarily, it described the FCA’s strategy of advance briefing in relation the life insurance review as:
…high risk, poorly supervised and inadequately controlled. When it went wrong, the FCA’s reaction was seriously inadequate and fell short of the standards expected of those it regulates.
In response to the findings, the FCA has sanctioned those involved. Four senior FCA members have had their bonuses withdrawn, whilst all members of the executive committee will receive a 25% reduction to their bonus payments. It was also announced that two senior FCA individuals criticised in the Davis Report will leave the FCA in 2015, although the FCA maintains this is not connected to the report’s conclusions but to a general internal restructuring.
It’s a low note for the FCA to end the year on, especially after its enforcement success. The FCA has also been left with £3.15 million in legal costs for the Davis Report.
Although this has been an embarrassing incident for the FCA, the Davis Report does show the FCA is operating transparently and holding itself up to the high standards it expects from its regulated community.
It was the Age of…Culture & Governance
This year the FCA continued to address failings in culture and governance. Most of the significant enforcement cases in 2014 identified failings in culture, and one could argue that thematic reviews into conflicts of interest, bribery and corruption risk and financial incentives were as much an assessment of a firm’s culture as they were about policies and procedures.
The focus on culture and governance has been driven by the findings of the Parliamentary Commission on Banking Standards (PCBS), which was established to inquire into professional standards and culture in the UK banking sector. The PCBS reported in June 2013 that the existing Approved Persons Regime had largely failed to hold individual decision-makers to account, who remained behind an “accountability firewall”. Consequently, senior officials in the banking sector will soon be subject to the controversial Senior Managers Regime.
Senior Insurance Managers Regime
In October, in its Project Verde Report, the Treasury Select Committee asked why the discredited Approved Persons Regime continued to be applied to other financial services institutions, such as insurers. The following month, the FCA (and PRA) issued consultation papers for a new “Senior Insurance Managers Regime”, reflecting Solvency II governance requirements, which will require higher standards of conduct and accountability. Once these changes are implemented, enforcement action against senior individuals is likely to follow.
Greater responsibilities upon senior management are clear attempts to change poor governance and drive cultural change. The FCA has repeatedly spoken of the “tone from the top” – it expects effective governance to implement and lead cultural change programs within firms. Much of this is already occurring and looking toward next year, it’s likely the FCA will look at the “tone from the middle”. It will expect middle management to be implementing and driving cultural change also.
Firms can also expect more pro-active engagement from regulatory supervisors and probing questions such as, “Is this product/outcome right for customers?” not just, “Is it legal?”
This post was written with Jagdev Kenth.