Improving Wholesale Conduct MI

By Jane WalsheJane Walshe
wholesale conduct MI

The Financial Conduct Authority (FCA) has been focused on effective conduct risk management information since 2004 when, as the Financial Service Authority (FSA) it launched the Treating Customers Fairly (TCF) initiative.  The principles applicable to the gathering of effective conduct MI in the retail sphere are equally relevant to wholesale firms. This article explores some of the issues.

The TCF initiative was designed to protect retail customers from tied and multi-tied agents masquerading as independent financial advisors, and encompassed the whole product lifecycle:

1. product design and governance;

2. target markets;

3. product promotion and marketing;

4. sales and advice;

5. after-sales; and

6. complaints handling.

TCF was ignored by investment banks/ investment bank divisions of universal banks, because it was aimed at retail customers. Identifying conduct metrics for wholesale business has been a significant headache for them. This article aims to simplify matters, first by surveying retail metrics, then seeing whether the thinking behind them can be applied to wholesale activities.

In two 2007 papers, the FSA called out as good practice the following heads of TCF MI:

* conduct specific employee opinion survey questions;

* sales by product (especially volumes and commissions);

* product cancellation volumes;

* in general insurance, volumes of refused claims;

* complaints data and Financial Ombudsman Service decisions;

* number of products which were developed, but ultimately not sold; and

* annual product reviews, focused on continuing target market suitability, in light of any unexpected product behaviours (such as higher than marketed investment product volatility).

Positive cultural drivers, such as commission claw-back, salary only compensation, and bonuses tied to sales quality were all articulated that year, as were risks arising from existing compensation arrangements: senior manager targets tied exclusively to profit, income or growth, and employees promoted solely for the amount of business and the level of income generated for the firm (regardless of sales quality indicators such as complaints).

Given the nature of the above, is it reasonable that the wholesale businesses provide their Executive Committees and Boards with operational compliance effectiveness metrics? Common suspects, mistakenly identified as indicators of wholesale conduct risk include; statistics on wall crossing, mandatory training completion, open audit issues, staff attrition, hospitality given and received, whistleblowing investigations, and litigation.

The more willing add simple trade surveillance indicators: frequent booking and cancellation of a trade, irregular logins, and failure to take two weeks mandatory leave.

None of these metrics directly relate to product, or sales quality. Nor do they answer Clive Adamson’s (former FSA Director of Supervision), three questions for non-executive directors (NEDs) to be able to answer:

“How do we actually make money today, what is it we will do in the future to grow the firm and why is this fair?”

Towards a solution

As we learned in the aftermath of the 2008 financial crisis, sophistication is a scale. Local government, northern European pension funds, German Landesbanken , and most recently the Libyan Investment Authority, have all either alleged or successfully proven themselves as being at its lower end.

Investment banking firms/ divisions might consider which of their clients generate the most fees, and/or enter into the highest number of transactions, across structured products and exotic derivatives (on a net flow basis). They might then ask where, on the sophistication scale, these clients fall, and make a judgement on the fairness of offering them complex or illiquid products.

Profit and loss, cut by product and market, can answer Adamson’s money question when cross-referenced with rebates paid. Firms could also generate insight as to the sustainability of reported profits by aggregating exceeded desk trading and position limits, especially when combined with requests for profit and loss suspensions (monitoring this should be a standard control following rogue trading at UBS and Societe Generale).

Firms wanting to impress FCA supervisors would also do well to focus on financial forecasting and target setting. This annual process is a key driver of customer outcomes. If the current process is last year’s numbers plus a percentage, without any evidence of thought given to competitor activity, customer demand, and regulatory and political headwinds, then it may create targets which are impossible to meet safely. There are two simple solutions. Manipulate the numbers, or manipulate the customers. All firms should recall the fates of Tyco, Wordcom, Enron, Bear Stearns and Lehmann Brothers.

To date, retail customers have bought, and then complained en masse about: structured capital at risk products (split caps and precipice bonds), pensions advice, mortgage endowments and payment protection insurance.

Wholesale customers have bought, then sued over: interest rate swaps, collateralised debt obligations and derivatives contracts linked to manipulated global inter-bank offer rates, precious metals fixes and FX rates.

In many cases, regulated firms have paid out more than they took in, taking into account operational litigation, and compensation costs.

Ultimately, the test of effective conduct risk MI is whether it helps boards know that the money their firm makes is money it will keep.

Pension Transfer Update

By The Enforcd TeamThe Enforcd Team

The 2015 accounts for Glasgow based Intelligent Pensions Limited were jubilant:

“Turnover has grown this year by 15.4% and the company generated a profit on ordinary activities before taxation of £285,990, a substantial increase from £159,784 reported for 2014.

The recent changes to pension legislation have proved to be very beneficial for the Company with a significant uplift in activity. This has been most noticeable in our pension transfer service which has had an extremely busy year and activity and enquiries continue to be strong. The core pension business has also had a very satisfactory year with new business throughout the UK showing a significant uplift.”

Contrast that with the FCA’s shorter, blunter:

“…with effect from 30th May 2017 the firm shall cease to provide advice in relation to the transfer, or conversion, of safeguarded benefits under a pension scheme to flexible benefits.”

The same fate met an Appointed Representative of Financial Solutions Midhurst Limited:

“… Heather Dunne (FRN 524600) should immediately cease to provide advice in relation to the transfer, or conversion, of safeguarded benefits under a pension scheme to flexible benefits.”

No such article is complete without a reference to the subsidiary of international IFA deVere Group, deVere and Partners (UK) Limited, which was required by the FCA to:

Immediately cease to provide third party companies with TVAS/DBAR reports or other similar report of information designed to assist third parties companies in transferring customers DB pensions to an alternative arrangement.

All three performed transfer value analysis on behalf of other advisers.

The Telegraph credited Intelligent Pensions with performing over 10,000 transfers (which doesn’t seem plausible based on its reported income), whilst Citywire identified that it provided a Direct Benefit to defined contribution pension transfer service to clients of other advice firms unable to offer that service themselves, as well as to its own clients.

All this activity aligned with the FCA’s consultation paper on pension transfer advice. The window for responses closed on the 21st of September 2017, with final rules expected in Q1 2018.  The FCA explained:

“firms without the relevant permission to advise on the transfer or conversion of safeguarded benefits might have clients who are seeking this advice. They can pass the transfer element of advice to an adviser with the appropriate permission but retain a role in advising on the destination of the funds following the transfer, e.g. the specific personal pension scheme and the investments within it. In practice, the assessment of suitability on the transfer cannot be done without consideration of the destination for the transferred funds and vice versa. Therefore in this scenario, although the firms are responsible for different elements of advice given to the client, they will need to liaise to ensure the overall recommendations are suitable and to avoid any disconnect. Both firms must be able to demonstrate the advice they give is suitable for the client.”

Providers of professional indemnity insurance to the IFA sector could do well to carve out this sort of advice from future policies. And firms should know that since they provide the regulator with detailed reports on their income, they should expect scrutiny if that starts looking toppy.

Complaints Handling

By The Enforcd TeamThe Enforcd Team
complaints handling

Complaints handling is (sort of) back in the headlines.

This time the FCA has written to firms with consumer credit permissions, to say that following its review, it had identified:

  • a failure to provide to customers the required information about the Financial Ombudsman Service – this included failing to provide details of the complainant’s right to refer to the ombudsman if they remain dissatisfied;
  • a failure to provide a clear explanation, to the complainant, of the outcome of the complaint and why this outcome had been reached; and
  • a lack of management controls in place to analyse and remedy any root causes of complaints or systemic problems.

The regulator hinted that lenders (who include payday loan providers), were manipulating their FCA reportable complaints handling performance statistics by neither upholding nor rejecting complaints, instead making ex gratia payments that were very similar in amount to their upheld complaints.

The FCA’s previous intervention in the complaint handling space covered packaged bank account complaints. It identified similar concerns:

  • setting out clearly and accurately what the firm has understood the customer’s concerns to be;
  • accurately reflecting the investigation that was actually undertaken (according to the record on the complaint file); and
  • fully addressing every complaint point (or each key theme, where there are multiple complaint points that can be grouped together).

Of course, the gold standard for FCA involvement in complaints handling has to be payment protection insurance, now the subject of a very formal deadline (fronted by a rubber mask based on Arnold Schwarzenegger). For all the FCA’s focus on DISP 1.3.3R (a rule requiring firms to identify the root causes of complaints, see if they impact processes or products not directly complained of, and correct these) PPI was never subject to an industry scheme, whereby all customers were offered redress automatically. This gave a massive boost to the claims management company sector (and the advertising sales departments of most UK tabloids and radio stations).

Meanwhile, the most recent set of quarterly FOS complaints by product category saw 59% of payday loan complaints upheld in the customer’s favour by the FOS between April 2016 and March 2017. These were customer complaints reviewed and rejected by firms. Given this, why aren’t we hearing more about an industry-wide scheme, offering to settle payday loan complaints proactively, by reference to DISP 1.3.3R? The claims management companies are already operating in this space (and taking a much higher share of the smaller amount of redress paid). It may be, that having considered the figures, the FCA decided against it, on the basis that most payday lenders would be rendered insolvent. Still, it’s a bit off. The Ombudsman experience is every bit as bad as payment protection (currently running at a 52% uphold rate), and the FCA has already identified that many customers were not advised of their right to refer a rejected complaint to the FOS.

What are the take-aways?

The FCA is aware that complaints handling statistics are not as reliable as they might be. So the Ombudsman service experience serves to enrich their view (they have a memorandum of understanding and an information gateway in place for this sort of thing). Overall, it’s much harder to hide a problem product. Firms should probably stop bothering.

A Great or Terrible Year to be a Banking IT Manager?

By The Enforcd TeamThe Enforcd Team
Senior Managers Regime Poll 2017

Depending on your point of view, this is either a great, or a terrible year to be a banking IT manager. Three major regulatory burdens are in train: the second payment services directive (PSD2), the general data protection regulation (GDPR), and the second markets in financial instruments directive (MIFID2). It renders the European operations of universal banks completely overstretched, and fighting for the same small pool of contractors and management consultancy support.

GDPR seeks to give EU citizens greater control over data held about them by companies and social networks. This includes the right to request deletion, amendment, and disclosure of all information held on them. On the point of disclosure, the regulations require firms to tell customers how their data will be processed. Data requests will be free, unless excessively complex. Data breaches will need to be reported far more promptly.

This is a far cry from Subject Access Requests under the Consumer Credit Act. For a start, financial services firms will have to figure out how to search for, and present securely, the data that they hold on a customer. They’ll each need to come up with new processes and technologies to enable deletion and amendment. They may have to hire more loan underwriters, because the GDPR enables customers to opt out of automated decision making.

PSD2 promotes data portability (and creates a new vulnerability under GDPR’s data security obligations): payment service providers must give payment initiation service providers (think Apple Pay and Android Pay but integrated with your bank statements and direct payees) access to their customers’ accounts so as to facilitate transactions ordered at the customers’ request. In return, payment initiation service providers must observe a number of data security obligations and take on some liabilities in relation to unauthorised transactions they are responsible for. Facilitating access upon request is the sticky problem, with nascent European financial technology firms worried that bank APIs (back-end data access), will lag behind their customer-facing apps and websites. Currently, many of the services which aggregate multiple accounts across multiple providers rely on holding your access credentials, and scraping the data so accessed.

Finally MIFID2 has mopped up what programming and operational change talent is left by requiring firms to submit data on over the counter derivative transactions (having moved these on to regulated trading venues), and extending the number and type of trading venues in the UK (see for instance organised trading facilities). This will hugely increase the complexity of settlement and regulatory transaction reporting.

One exceptionally geeky concern is that trading venues and their members will need to synchronise their clocks (it helps regulators quickly reconcile trades across venues and between organisations). To understand the magnitude of this requirement, readers should note that some systems within a single bank may observe British Summer Time, whilst others may not. Legacy systems might not be capable of recording a microsecond level of precision. Another concern is when to time-stamp: at the time a trade is sent, or confirmed?

MIFID2 and PSD2 come into force in January 2018 (the FCA is already help firms submit waivers to European regulators). GDPR follows in May 2018. The Information Commissioner’s Office has been at pains to explain that it will not be applying fines at their new maximum come June.

The Brooklands SIPP Scheme

By The Enforcd TeamThe Enforcd Team

Brooklands Trustees Limited languishes on the Financial Services Compensation Scheme (FSCS) complex cases page. It was established in 2006, and operated subsidiaries in the UK, New Zealand, Dubai, Australia and Gibraltar. According to its insolvency practitioners, it acted as trustee to over 6,000 individual pension schemes worldwide. Because it operated self-invested pension plans, it was regulated by the Financial Services Authority, and its successor the Financial Conduct Authority. Its pension schemes were also registered with Her Majesty’s Revenue and Customs, and held funds of £650 million.

In August 2015, the firm recorded a liability of £1.6mn, rendering it insolvent. It transpired that the Financial Ombudsman Scheme had ruled against it in several complaints. Brooklands’ protestations that the complaints were the sole liability of the Independent Financial Advisors (IFAs) who had placed their clients’ assets with Brooklands, had fallen on deaf ears. Clyde & Co, a London firm of solicitors, advised that a judicial review of the Ombudsman’s adjudications would have less than a 50% chance of success.

The firm could not renew its professional indemnity (PI) cover economically, having notified its insurers who explained that the notification may have come too late. Without adequate cover, it could not accept new business.

A note in the insolvency practitioner’s report tells an all too common tale: Brooklands SIPP members were being charged annual management charges, for managing funds which may permanently remain illiquid, or remain so for a period of five to ten years.

The dispute with the PI insurers falls on the affected creditors (some 160 complainants at February 2017). Meanwhile, the firm’s Directors and Officers insurers were notified of the potential claim against them for late notification of the professional indemnity claims.

Looking at the firm’s shareholder register, 80% its shares were owned by BIP Group Distribution Ltd (officers Nigel, Julian and Paul Evans).

One of Brooklands’ directors, Paul Martin Evans, owns 70% of IVCM (Dubai). HPL, the buyer of the SIPP accounts and customer relationships, is paying his firm to provide ongoing administration support. IVCM offers SIPPs in the UK, Gibraltar, New Zealand and Australia. The accounts of UK registered IVCM Distribution Limited are currently overdue.

A look at the Financial Ombudsman Service’s Ombudsman Decisions page showed three complaints. One of these related to Stirling Mortimer. This was an operator of unregulated collective investment schemes, investing in “right to purchase” contracts in overseas property developments in Spain, Cape Verde, Mexico and Morocco. Redemptions are frozen and the enterprise is being investigated by the Serious Fraud Office.

The complainant had been advised by Birmingham-based Aspire Personal Finance, but this firm had become insolvent. IFA Paul Brian Reynolds was banned by the FCA and fined £290k (having earned commissions of £600k). He’d also convinced clients to take out mortgages on their homes, in order to buy geared traded endowment policies. Reynolds forged signatures, and documents to try to throw the FCA. He then moved to Dubai, where International Adviser linked him to Globaleye and Holborn Assets (Globaleye operates in much the same way as deVere Group). In 2016, he was sentenced for defrauding two insurance companies (he’d sold himself and his wife pensions, to generate commission payments of £65,000).

The National, an English language newspaper operating in the United Arab Emirates, covered the state of independent financial advice in a 2014 article:

British expat Pete Manzi, 54, says he ended up losing £11,000 (Dh65,462) on investments when he was hooked by a financial adviser.

“There is no one to go to,” says Mr Manzi. “I went to the administrator of the fund I was put into and they basically ignored me. They said tough luck. The problem in the UAE is that there isn’t a regulatory body and you can actually become a financial adviser without any qualifications. You can walk off the street and say you want to become one. So buyer beware, caveat emptor as my father used to say.”

Mr Manzi became a client of Dubai-based Globaleye after receiving a cold call in 2012 from an adviser offering to manage his £33,000 UK pension for him. Mr Manzi later sold all his holdings at a loss.

He says this is because after requesting to put 75 per cent of his investment into low-risk funds, 15 per cent in medium risk and 10 per cent in high risk, he discovered that all of his money had been transferred to a fund in Hong Kong without his permission – a fund that he was given no information about.

The article also featured deVere Group:

Kuben Naidoo, from South Africa, ended up with “a dud investment” that he claims was sold to him without highlighting important facts. These include the 25 years of management fees he would pay even if he chose to exit the plan early, a plan he says he was unwittingly locked into by a pushy adviser.

“I urge other expats to tread carefully when making long-term offshore investments,” says the married father, who had signed up with Zurich-based deVere.

In the meantime, Mr Naidoo says he is paying 1.5 per cent a quarter in fees on his investment plan, which translates into a 6 per cent annual fee – a rate that in the long run eats deeply into returns. Already he has paid more than $9,000 in fees in five years on an investment that’s valued at about $90,000. If he cancelled his policy today, he would lose about $36,000.

On top of that, the IT executive was told in 2012 that one of the funds he had invested most of the his money in had been frozen after a wave of redemptions.

He had been putting 50 per cent of his monthly contributions, or US$1,000 a month, into deVere’s Strategic Growth Fund, which promised investments into companies that sell baby food and pharmaceuticals, industries he was told would weather any downturn in the economy because people always buy food for their babies and drugs.

A spokesman from deVere said the only information he had on the Strategic Growth Fund was that it is a medium-risk fund, managed outside of deVere, and that it invested a small amount in private equity in 2012.

The Strategic Growth Fund was covered by the South China Morning Post in 2013, which proved that Nigel Green, Chief Executive of deVere Group, controlled the fund’s investment adviser.

British expats taking financial advice from other British expats should remember that UK protections do not apply to them. UK residents should remain wary of small pension SIPP providers and high yielding investments.