New rules and guidance for staff incentives and performance management in consumer credit
In their Business Plan for 2015/16, the FCA had set out their priority with regard to improvements in incentives by firms to ensure markets work well. They had then announced their decision to specifically review incentive schemes in consumer credit firms with a view to assessing how these firms were managing the risk that their reward arrangements could encourage undesirable behaviours leading to poor outcomes for customers.
The FCA have now published a consultation paper (CP 17/20) on 4 July 2017, in which they have shared their concern that “many consumer credit firms are using high risk remuneration and financial incentives practices, have ineffective or inadequate controls and do not appreciate the risks their incentive programmes pose and controls needed to address them”. The paper sets out the findings of FCA’s thematic review on staff incentives and performance management in consumer credit firms. They are proposing new rules in ‘consumer credit sourcebook’ (CONC) within FCA’s Handbook and non-Handbook guidance which all firms engaged in consumer credit activity will be required to consider.
The firms visited by the FCA to review the current practices of staff incentives covered a broad range of sub-sectors including, a) high-cost short-term credit / guarantor lending, b) home collected credit, c) catalogue / internet shopping firms, d)
store / credit card providers, e) credit brokers and f) debt collectors.
The FCA found that a significant number of firms had:
• High risk financial incentives and performance management practices that were likely to encourage high pressure sales or collections;
• Inadequate or ineffective controls around their incentive programmes; and
• A lack of appreciation of the risks that their incentive programmes posed and the controls needed to address these risks.
The FCA have pointed out that risks from incentive schemes arose primarily where staff earned bonus or commission payments based on the volume of sales or collections and where such schemes had certain features, such as the rate of commission varying depending on staff reaching certain targets. An example cited by FCA relates to monitoring arrangements, where in some firms, this was the responsibility of line managers, whose own pay was dependent on the staff they were monitoring.
The FCA are concerned with the findings of this thematic review and therefore have proposed new rules and guidance for firms engaged in consumer credit activity. A new Rule 2.11.4 of CONC is proposed that would require firms engaged in consumer credit activity to, a) put in place adequate arrangements and have policies and procedures to detect and manage any risks associated with their remuneration and performance practices; and b) take into account the nature, scale and complexity of their business when deciding how to carry out the above arrangements
The FCA have provided further guidance in the draft rules giving examples of measures and procedures which firms could adopt, such as monitoring the nature of sales activity, collecting debts and an appropriate suite of management information (MI) to enable the identification of trends in staff behaviour and outcomes.
Money Laundering Regulations 2017 come into force
The Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (MLR 2017) were laid before the Parliament on 22 June and came into force with effect from 26 June 2017. The new regulations have transposed the provisions of the EU’s 4th Money Laundering Directive into UK law by replacing the 2007 Regulations. The Joint Money Laundering Steering Group (JMLSG) have revised their industry guidance in light of the significant changes made under MLR 2017.
The new regulations include a number of changes to the existing framework, especially in the following areas.
Firms in the regulated sector are required to carry out a risk assessment which should be documented and approved by the senior management/ Board. They should be able to provide that risk assessment to the FCA on request. The regulations list a number of factors which must be taken into account as part of the risk assessment including its customers, products, distribution channel and geographic areas in which it operates.
Policies controls and procedures
The regulations expand significantly on the policies, controls and procedures currently required under the MLRs 2007. They include an obligation, where relevant, for firms to communicate their policies, controls and procedures to branches and subsidiaries outside the UK.
Further specific requirements have been included in relation to internal controls such as:
• Appoint an individual at the level of the board of directors or equivalent management body as the officer responsible for compliance with the regulations
• Screen relevant employees and agents prior to their appointment and at regular intervals
• Establish, where appropriate, an independent audit function to evaluate the policies, controls and procedures adopted in accordance with the regulations
• Firms must provide regular training to relevant employees and agents and ensure they are made aware of the law relating to money laundering, terrorist financing and data protection.
Customer due diligence (CDD)
The 2017 regulations take a more prescriptive approach to CDD than that contained in the 2007 regulations. The regulations provide a list of circumstances in which CDD must be applied and a list of factors that must be taken into account in determining when CDD measures need to be applied to existing customers. They also set out information and documents that must be obtained when undertaking CDD on a body corporate, which includes ‘the law to which it is subject and its memorandum of association or other governing documents’.
Enhanced due diligence (EDD)
The 2017 regulations provide a number of circumstances in which EDD measures must be applied, which includes where a transaction or business relationship involves a person established in a ‘high risk third country’. There is also a list of factors that must be taken into account in assessing whether a high risk of money laundering exists and the extent of EDD measures that should be applied.
Politically exposed persons (PEPs)
The definition of a PEP has been expanded and now includes ‘domestic PEPs’. The draft regulations also provide that EDD measures must be applied to a person for at least 12 months after they cease to be a PEP.
Reliance on regulated third parties for CDD
Under the 2017 regulations a person who relies on a third party must enter into a written arrangement with that third party. The third party will be obliged to provide copies of CDD documents immediately on request.
The 2017 regulations requires personal data to be deleted from records after the record retention period prescribed for various transaction and CDD documents, unless the relevant person is required to retain records under an enactment, for the purposes of court proceedings or has the individual’s consent.
[We at Lightfoots have been assisting and will be happy to provide further input and assistance to firms in reviewing their internal policies and controls for compliance with the requirements of MLR 2017, with reference to the final legislative instrument published on 22 June 2017]
Notification requirements in the Money Laundering Regulations for regulated firms
The Money Laundering Regulations 2017 (MLR) came into force on 26 June 2017 and updated the UK’s anti-money laundering (AML) regime. The FCA have now published guidance to firms under Regulation 23 of MLR which requires authorised persons to inform FCA if they are undertaking Money Service Business (MSB) or Trust or Company Service (TCSP) activities.
There are three situations, in which an authorised firm may need to notify the FCA:
• If the firm conducted MSB or TCSP activity before 26 June 2017, it must notify FCA by 26 July 2017,
• If the firm begins to conduct MSB or TCSP activity after 26 June 2017, it must notify FCA within 28 days of doing so.
• If the firm ceases to provide either of these services, it must also notify FCA within 28 days of stopping the activity.
MSB activities include money transmission, currency exchange and cheque cashing.
TCSP activities include:
• Trust and /or company formation agents
• Providing registered offices, business addresses, accommodation or correspondence addresses, or mail forwarding services to businesses (other than those run by sole proprietors)
• Any individual or company providing nominee director services, nominee company secretary services or nominee shareholder services – or other similar services; arranging for another person to act as a director, company secretary, partner or professional trustee; offering professional trustee services (unless they relate to certain low-risk trusts) and providing their services as nominee shareholder (unless they’re acting for a company whose securities are listed on a regulated market)
• Any company providing their services as a company director, company secretary, or partner to another company (unless the other company is a member of the same group)
• Any individual providing their services as a nominee director or nominee company secretary; company director, company secretary or partner to certain high-risk businesses
‘Conduct’ regulation to shape the future of retail banking
Andrew Bailey, CEO of the FCA, said in his keynote address at the BBA on 29 June 2017 that “the changes of the last decade have led to outcomes which are an important focus for the FCA as conduct regulator”.
Mr Bailey described the main pieces of work that the FCA have been doing to improve their ability to respond to the challenges that the banking industry has faced since the financial crisis. He said that “The first piece of work is our strategic review of retail banking business models. It is very much an empirically driven piece of work which picks up where the Competition and Markets Authority (CMA) left off, but is not a full evaluation of the functioning of competition in retail banking markets. It is broader in scope than the CMA’s work, which focused on personal current accounts and SME banking”. Mr Bailey clarified that they were covering both sides of the balance sheet of banks – deposit taking and lending.
The second piece of work, Mr Bailey added, “is our review of high-cost credit including overdrafts. Last November we issued a Call for Input covering high-cost products, overdrafts, the high-cost credit short-term price cap and report and multiple such borrowing. We are looking at all high-cost products to build a full picture of how these are used, whether they cause harm and, if so, to which consumers. We will then be able to decide if we need to intervene further. We are also reviewing the overdraft market in detail following the CMA’s review which identified problems in the market. We are also reviewing the price cap on short-term high-cost loans which came in force in January 2015”. The FCA propose to publish their findings on this over the summer.
Mr Bailey further stated that “The third piece of work will appear in the near future, and is a thematic review by our supervisors which responds to a recommendation from the Parliamentary Commission on Banking Standards report in 2013 that banks should assess customers understanding of the products and services they deliver”.
EBA Releases 2018 EU wide stress Guidelines for Banks
The European Banking Authority (EBA) is required to initiate and coordinate EU-wide stress tests to assess the resilience of financial institutions to adverse market developments.
Accordingly, the EBA has now published in June 2017 its latest guidance to the EU financial and credit institutions detailing the methodologies for carrying out the required stress test for 2018.
The objective of the EU-wide stress test is to provide supervisors, banks and other market participants with a common analytical framework to consistently compare and assess the resilience of EU banks and the EU banking system to shocks, and to challenge the capital position of EU banks. The exercise is based on a common methodology, internally consistent and relevant scenarios, and a set of templates that capture starting point data and stress test results to allow a rigorous assessment of the banks in the sample.
The EU-wide stress test is primarily focused on the assessment of the impact of risk drivers on the solvency of banks. Banks are required to stress test the following common set of risks:
. Credit risk, including securitisations;
. Market risk, Counterparty Credit Risk (CCR) and Credit Valuation Adjustment (CVA);
. Operational risk, including conduct risk.
The guidance paper describes the common methodology that defines how banks should calculate the stress impact of the common scenarios and, at the same time, sets constraints for their bottom-up calculations. In addition to setting these requirements, it aims to provide banks with adequate guidance and support for performing the EU-wide stress test. This guidance does not cover the quality assurance process or possible supervisory measures that should be put in place following the outcome of the stress test.
In particular, EBA guidance is designed to inform the Supervisory Review and Evaluation Process (SREP) carried out by competent authorities. The disclosure of granular data on a bank-by-bank level is meant to facilitate market discipline and also serves as a common ground on which competent authorities base their assessments.
FCA’s Package of Measures for Asset Managers to deliver better Value for Money to customers
The FCA had published in November 2016 an interim report of their Asset Management Market Study. The report considered how asset managers compete to deliver value for both retail and institutional investors. Our interim report found that evidence suggested that there is weak price competition in a number of areas of the asset management industry.
Their final report published in June 2017 finds evidence of weak price competition in a number of areas of the asset management industry. The FCA found that firms do not typically compete on price, particularly for retail active asset management services. They carried out additional work on the pricing of segregated mandates which are typically sold to larger institutional investors. This showed that prices tend to fall as the size of the mandate increases. The benefits of such lower prices do not seem to be available for equivalently sized retail funds.
FCA have confirmed their interim finding that there is considerable price clustering on the asset management charge for retail funds, and active charges have remained broadly stable over the last ten years. The industry has argued that price clustering and broadly stable prices do not necessarily mean that prices are above their competitive level. However, the FCA have found high levels of profitability, with average profit margins of 36% for the firms sampled. Firms’ own evidence provided to the FCA also suggested they do not typically lower prices to win new business. These factors, in FCA’s opinion, combined to indicate that price competition is not working as effectively for customers as it should and have proposed new measures in their report for implementation by the industry in a consultation paper CP 17/18 which has also been released simultaneously. These include the requirement to improve fund governance, moving investors to better value share classes and ensuring fairer treatment of dealing profits to deliver value for money to customers. Further details can be found by accessing the following link: