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Speech by Tracey McDermott, Director of Enforcement and Financial Crime, the FCA, at the Thomson Reuters Compliance & Risk Summit, London. This is the text of the speech as drafted, which may differ from the delivered version.

Changing the way in which financial services works and is viewed won’t happen by having an army of compliance staff looking over people’s shoulders – it requires leadership from the very top and all the way down.

It is my pleasure to attend today’s compliance and risk summit and to speak to you for the second consecutive year.

The theme of today’s talk is ‘sustainability’.  Last time I spoke to you the FCA had been in existence for a mere 78 days. I am pleased to say we have sustained – having now been around for a grand total of 15 months.

Today I would like to talk a little about what we have been up to in that time, the demonstrations you will have seen of the difference in our approach and what we hope you have learned from that. I will also then talk a little about the longer term questions, about what is required to ensure the financial services industry is truly sustainable.

What have we been up to?

The creation of the FCA as part of the new regulatory framework last year provided an opportunity for us to reset expectations. Both our expectations, as the regulator of the industry and the expectations of the industry as to how we would approach regulation. And we think we have made significant progress – regulation in 2014 looks and feels quite different to regulation of the past.

Our first 15 months have certainly been busy. To give some flavour:

  • In that period we have authorised around 980 new firms
  • we have completed the registration of some 50,000 consumer credit firms for interim permission (taking the regulated firm population to around 73,000)
  • we have answered over 144,000 calls in our Contact Centres

We have taken on, from 1 April this year, the regulation of consumer credit. This is a sector which provides essential services to most people – including some of the most financially vulnerable in our society. We have started here as we mean to go on, setting clear expectations and being prepared to take action to back that up. So there has already been a significant number of firms changing the way they do business – particularly in the payday sector. 

Taking on a completely new sector, a large proportion of which is very small firms with limited or no experience of regulation, has been challenging for us. It has required us to think differently about how we engage both with the regulated community and with its consumers. It has also provided us with an opportunity to target different parts of the sector with different tools.  So we have used enforcement and supervisory powers to impose requirements on firms, we announced on 25 June that Wonga have agreed to pay compensation of over £2.6m to around 45,000 customers for unfair and misleading debt collection practices; we have introduced new rules through our policy function; we have stated that we will commence a market study into the credit card market to look at how competition operates; we are using our ability to scrutinise firms at the gateway to keep out some of those who will not meet our standards.  We have been pleased with the results so far but recognise that this is going to be a key focus for us in the coming year and beyond. 

We have also started to embed the competition objective into the way we think about both new, and old, problems. I mentioned the market study into credit cards. That takes its place alongside other market studies into general insurance add-on products, cash savings, and, jointly with the OFT/CMA into SME banking. We will also be carrying out a review of how competition operates in various areas of wholesale markets. Market studies provide us with a different way of looking at issues across the markets we regulate and will be one of the principal tools the FCA uses to promote effective competition.

We have also continued to ensure that when things do go wrong firms take steps to put it right. So we have overseen the payment of consumer redress in relation to Interest Rate Hedging Products of over £482m, in relation to payment protection insurance (PPI) of over £4.4bn and have agreed a redress package for up to 7 million consumers potentially mis-sold CPP insurance products.

But, we have also made good on our promise that we would not simply wait until things go wrong. Where we see issues we will intervene early to avoid later problems. And where we can we will work with the industry to find solutions to collective problems – engaging with international partners, particularly in the EU and the US, where those problems, or their solutions, are not confined within our borders.

Our interventions here can be either sector wide or firm specific. So, you may recall, that in May 2013, we worked with lenders to ensure that borrowers with interest-only mortgages were contacted by their lenders to ensure that they were considering repayment options now – not at the point when the mortgage term expires. Our study found that around 260,000 people do not have a strategy to pay back their mortgage.

We also reached an agreement with seven of the UK’s biggest high street banks last June for them to use a same day ‘retry system’ when processing direct debits, standing orders and future dated bill payments. Now, with the retry process in place, if the deposited money is not present when a debit is being taken, the bank will retry the payment in the afternoon before finalising the transaction, saving consumers an estimated £200m in overdraft fees and bank charges.

On a firm specific level, we have taken a range of early intervention actions. The outcomes of these can range from consumer contact; reviewing certain lines of business; taking sales staff off the road and retraining; withdrawing financial promotions all the way up to changes to boards and governance arrangements. Historically this was not an area where enforcement was typically involved.  That has been very different this year – with my teams involved in more than 20 such actions working alongside our supervisors bringing together our different skills and expertise as well as our ability to deploy additional legal tools.

But that is not, of course, the only thing my enforcement teams have been up to. We imposed £425m of penalties on firms in our first year – on 26 firms and 20 individuals.  We also saw five individuals convicted of criminal offences; 26 banned from the industry and cancelled the permissions of 53 firms who did not meet our standards.

What is the impact?

So, a very long list – and even this is only a snapshot of part of what we have been up to.  But the real question is not what we do, but why we do it – and is it working?

We are cautiously (we are regulators, after all) positive.

One of our aims was to put conduct in the board room – to ensure that firms put consumers and the integrity of the markets at the heart of their business.  For too long, managing conduct risks has been seen as a function for compliance and not the responsibility of the business. 

There had been too little attention paid by senior management to the incentives they put in place for their staff, the culture that actually operated within the business and the outcomes that produced for consumers and the markets.  That is changing.  Senior management and Boards are engaged much more actively with the conduct agenda – no doubt helped by the sanctions imposed here and overseas for some historic failings – but also because the investigations into those failings have demonstrated that the way in which the businesses operated was, perhaps, not quite as they imagined, or wanted.

Changing the way in which financial services works and is viewed won’t happen by having an army of compliance staff looking over people’s shoulders – it requires leadership from the very top and all the way down through the business so that people do the right thing because ‘that’s the way we do things around here’ and not just because the rules say they must.

And while I don’t think anyone would pretend we are at the end of the road yet it is clear that significant progress has been made on this. Conduct is well and truly on the board agenda.

We also wanted to ensure that we understood consumers better, that our actions were focussed on things that would truly make a difference to them. We think we have done well on that – and it’s not just me saying that – we were very proud to see Martin Wheatley, our Chief Executive receive the Which? Positive Change award just a few days ago.  A recognition that, as an organisation we have changed the way we think and the way we approach issues.

What lessons should you take?

But, of course, alongside all this positive progress it is very clear that we are not out of the woods yet.  I mentioned the significant amounts of redress being paid by the industry and the significant penalties we have imposed in our first year.  Those are, to some extent, driven by historic conduct but it is also true to say we continue to see disappointing results from our work in many areas – anti-money laundering controls for example.  And it is also true to say that not all the problems we see can be blamed on the issues of the past.  Things are still going wrong and lessons are not always being learned.

A stark example of that was the penalty we imposed recently on Barclays and Daniel Plunkett in relation to the Gold fix.  We fined Barclays £26m for failing to manage conflicts of interest relating to the fix. We also fined and banned Plunkett for his trading in the fix in a way which appeared to be designed to benefit his position in a complex product expiring that day.  This was striking because his actions took place on 28 June 2012. The day after we had published our findings in the LIBOR case relating to Barclays.  There can be no doubt that he, and Barclays, were well aware of the risks of conflicts driving inappropriate behaviour and of the considerable public concern about these issues.  But nevertheless this behaviour happened, and was allowed to happen, by poor systems and controls.

This to me illustrates a problem which I hope will soon be a thing of the past but which I think currently needs more work.  A tendency to think narrowly about regulatory statements and issues and a lack of focus on root causes.  So an enforcement action about LIBOR is not seen as a signal to think about what traders on other desks may be incentivised to do or able to do but as something only institutions that submit Libor need to worry about and then only on the LIBOR related desks.  An enforcement action about mis-selling high risk unregulated collective investment schemes (UCIS) products is not translated into managing risk in other high risk areas.  Our cases provide you with stark examples of where your peers and competitors have got things wrong.  You have the advantage of being able to look at these and try and fix similar issues before things go wrong for you too.

I will now take you through some of the lessons I think you should have learned from our work over the past year – what do we care about – so what should you care about.

We care about consumer outcomes: The world of financial services can often appear baffling to the man on the street and as a mine-field to be navigated.  Too often firms have made things worse by not treating customers fairly.

Misleading advertisements, the mis-selling of low value insurance and poor complaints handling contribute significantly to the general public’s mistrust of financial services. We have brought cases in all these areas recently.  

Just a couple of weeks ago we took action against Yorkshire Building Society (YBS) and Credit Suisse International (CSI) for misleading advertisements in relation to the Cliquet product. This was a product expressly targeted at ‘stepping stone’ investors – risk averse, typically financially unsophisticated. The product gave a guaranteed minimum return and there was also an upper cap on potential returns.  This upper cap was, in reality, theoretical – the modelling showed a close to zero percent chance of it being achieved. Nevertheless the promotions for this product included attention grabbing percentages – giving equal prominence to this theoretical maximum as to the guaranteed minimum. Consumers could not, and should not, realistically have been expected to realise that the maximum was entirely unachievable – and indeed many of them expected to receive it. YBS and CSI are now taking steps to compensate those consumers.

This case was also interesting because we took action not just against YBS – the distributor – but also CSI who had designed the product and the marketing material. Responsibility for ensuring good consumer outcomes does not all lie at the end of the distribution chain.

Indeed you will have seen us focussing on misconduct in the wholesale markets that disadvantages retail consumers. In January this year we fined State Street £22.9m because their transactions management business had developed and executed a deliberate strategy to charge customers substantial, and undisclosed, mark ups on certain transactions, in addition to the agreed management fee or commission. These extra charges were passed on to their customers that included large investment management firms and asset owners holding the pension money and investments of retail customers.

Similarly, in February we fined Forex Capital Markets and FXCM Securities Ltd £4m for allowing the US based FXCM Group to withhold profits that should have been passed on to FXCM UK’s clients from them. FXCM ensured that where trades were done at less than the optimum price that cost was passed to consumers but where it was better they pocketed the difference.

We care about the integrity of our markets – and will take steps to tackle those who undermine it. We are continuing to prosecute insider dealing cases and have number of investigations and prosecutions in the pipeline.

Often threats to the integrity of our markets are threats to overseas markets too – we have effective working relationships with overseas regulators and law enforcement agencies and national boundaries are not barriers to us bringing successful enforcement action. That has been amply demonstrated by our actions in cases such as LIBOR and the JP Morgan London Whale case.

The case of Coscia is also a good example. Michael Coscia was a US-based High Frequency Trader. We fined him $900,000 (nearly £600,000) for deliberate manipulation of commodities markets in the UK. The Commodities Futures Trading Commission (CFTC) also took action against him for similar activity on the US markets. Our actions were coordinated both in terms of investigation and publication of our respective decisions.

We also continue to be focused on ensuring that inside information is properly controlled.  If it was ever acceptable for people to casually chat about inside information it most certainly is not now. The recent Tribunal judgement in the case of Ian Hannam is a good example of this. Many of you will have read press coverage of the Hannam case. The Tribunal’s judgement itself is worth a read; it contains some very useful confirmation of what constitutes inside information and what does and does not constitute acting in the proper course of the exercises of employment, profession or duties. 

We care about the culture of firms – do they reward what they say they value, does the quality of their internal investigations reflect the seriousness with which they say they take an issue; does the firm know who is accountable for what within their firms and do they hold them to account? 

In his book the Big Short, Michael Lewis, famously used the example of some US hospitals performing more appendectomies than others because they were paid more for doing it, to make the basic point that: ‘if you want to predict how people will behave, you look at their incentives.’

We agree - financial incentive schemes are often a good clue to a firm’s culture.  In December last year we fined Lloyds Banking Group over £28m for serious failings in the controls over sales incentive schemes. We concluded that the schemes led to a serious risk that sales were put under pressure to hit targets to get a bonus or avoid being demoted. 

This action resulted from thematic work undertaken to look at how incentive schemes for sales staff operated and which has led to radical changes to the incentive arrangements in most of our large retail distributors. It is, however, another example of an area where a bit of lateral thinking might have avoided the issue. 

Remuneration has been a topic of huge interest over the past few years – usually focused on the very large sums paid to some individuals as bonuses.  But the issues about incentives that underpin those discussions – what does your incentive scheme say about your values, what are the unintended consequences of your scheme etc – are just as applicable to someone earning £20,000 as they are to someone earning £20m.  But that read across had not happened.

Where we see repeat offenders we look to determine if the failings result from deep rooted cultural problems. Increasingly, we are looking to understand not just what went wrong but why it went wrong.   And you will have seen our notices explicitly setting out how we have increased penalties to reflect poor regulatory or compliance histories.

We have high expectations of approved persons – being an approved person should be a badge of honour.  People should be able to feel proud to be a member of the financial services industry and should uphold, themselves, the highest standards. They should also expect, and enforce, that standard from their peers and colleagues.

We expect approved persons to act with integrity at all times and where they do not we will take action. Two examples are Anthony Verrier who was prohibited after being found to have given untruthful evidence by the High Court and David Hobbs who was prohibited after lying to us and the Tribunal. 

We also expect approved persons to be part of the solution not the problem; they should act as gatekeepers, seeking to help their clients (and their colleagues) do the right thing – and telling us when they don’t.

The cases we brought this year against Vandana Parikh, a broker, and David Davies, a senior partner and compliance officer, for failing to act with due skill, care and diligence in the period are examples of this. These individuals failed to prevent manipulation of the closing price of certain securities by a client in order to avoid a payment due on a complex structured product.

We expect individuals to cooperate with our investigations openly and honestly. Some firms and individuals who we investigate engage fully with the process, volunteering information and engaging in a genuine debate about the substance of the investigation. Others do not; maintaining implausible and incredible explanations for events only to backtrack at a late stage of the investigation when faced with the weight of evidence. 

We also expect people to take our sanctions seriously. This year we have seen a number of convictions of individuals we had previously prohibited who nonetheless engaged in regulated business.  They all received substantial prison sentences. We have also taken action to bankrupt individuals who have failed to pay the financial penalties we have imposed.

We expect firms to be open with us and do what they say they will - It should be a basic tenant of the relationship between the regulator and those it regulates that there is open dialogue between the two. For the regulatory regime to work it must also be right that the regulator can rely on assurances given to it by the firms that it regulates. Unfortunately, that is not always the case. 

We take that very seriously which is why you will have seen cases, including the cases against JPM and FXCM, where we have increased the penalties because of assurances given that problems were fixed – when they simply were not.  

We expect firms to listen to what we say and take note of our previous actions – whether against them or their competitors. Our publications should serve as a signpost to all the industry of what view we take of particular forms of misconduct.

Given these themes, what are some of the FCA’s future priorities?

There is no one better to effect change in your own organisations than yourselves.

Too often it’s not just the conduct that is familiar, it’s also the root causes. Whether it’s not properly considering the target market for a new product before it is launched, under investment in system and controls, or opaque and ineffective governance structures it is clear that the financial crisis has not yet fully brought about the cultural change in financial services that society is expecting.  

The desire for more accountability from the people in senior positions within large institutions has not diminished; there has been significant legislative change in this area and we will work with the PRA to implement the measures set out in the Financial Services (Banking Reform) Act 2013 to give effect to the recommendations of the Parliamentary Commission on Banking Standards, such as the Senior Managers and Certified Persons Regimes. The new regime will increase accountability of individuals in positions of responsibility and raise standards of governance.  

Remuneration schemes play an important role in setting the sales culture of a firm, influencing how and what staff sell to customers. They can create a culture of mis-selling and may undermine a firm’s positive efforts to treat customers fairly in other areas. While the FCA recognises that firms may want to incentivise staff to sell particular products, firms must ensure that their systems and controls are sufficiently robust and sophisticated to mitigate effectively the risk of any adverse impact the incentives may have on staff behaviour. This should include appropriately focused risk-based monitoring.

We will increasingly focus on how well firms analyse consumer complaints about PPI and proactively contact those who may have been mis-sold but have yet to complain. We will also continue our work to ensure that firms’ ongoing complaint-handling processes generally deliver fair redress and that any poorly handled complaints are reassessed and remediated where necessary.

We will continue to assess anti-money laundering processes and controls in major banks and those staff responsible for them. We will extend this during 2014/15 to some smaller firms that might present high levels of money laundering risk, as well as carrying out focused thematic work. We will also continue to engage internationally to influence a Fourth Money Laundering Directive.

More than £75tn passes through payment systems in the UK every year. That’s around £2.4m a second. The UK’s new Payment Systems Regulator (PSR) was incorporated on 1 April 2014 and we are preparing for its operational launch in April 2015. The PSR will is a subsidiary of the FCA, although it will be a separate legal entity with its own statutory objectives and board. The PSR will have objectives to promote competition and innovation, and to ensure responsiveness to consumer needs.

From April 2015 we will become a concurrent regulator, which means that we will be able to enforce competition law in financial services concurrently with the Competition and Markets Authority (CMA), helping us achieve our objectives to promote competition and make markets work well.

The Chancellor recently announced the FEMR which is to be co-chaired by the FCA, Bank of England and the Treasury. Again this is seeking to address core causes of conduct issues and concerns.

So, there is a lot on the horizon, presenting challenges both for the regulator and the regulated.

And to conclude a few thoughts on the path to sustainability.

Between 2005 and 2008, FSA guidance grew by some 27%. A pattern repeated around the world as industry looked to adopt firm-friendly means of protecting consumers. The model designed to reduce uncertainty and manage risk more effectively ended up achieving the exact opposite. So, we saw the strong bias for rules over ethics fanning the flames of the multiple conduct-induced crises that followed. In other words, growing the rulebook did not prevent problems caused by cultural weaknesses.

The global economy is moving forward by developing better market infrastructures, strengthening prudential frameworks and stream lining business models; these changes however still need to be sustainable to avoid the cyclical booms and busts. Our mutual aim should be maintaining a vibrant financial system for the benefit of both firms and consumers.

Long-term business sustainability depends on an open, transparent and flexible risk-responsive culture. These ideas and thoughts are not new but they are worth reiterating; especially as the industry grows in confidence and profitability.

Perhaps I can illustrate this point by setting out hypothetical Firm A and Firm B’s strategic approach to compliance and risk.

Firm A is keen to do the right thing.  Its compliance function is strong and well-resourced and it audits the business regularly.  Compliance reads and digests all material issued from the FCA and translates that into policies and procedures.  They take no prisoners – they explain to the business that compliance is not optional – if they say it has to be done it has to be done. And they have some success with this but what they don’t do is really force the business to understand and own the problems they face. They spoon-feed the answers and promote a culture where compliance with regulations is required because they are rules not because they are right – and they allow or even encourage gaming of the system.

Firm B’s strategy is almost the opposite – it looks to embed compliance from its Board to its front-line staff. Compliance plays a key role but as a facilitator and a guide – not as the answer. It encourages every employee to become an accountable business conscience for Firm B. Instead of reciting rules Firm B looks at root causes and asks the business to help in identifying where problems might arise.

Firm B’s approach is much harder, and may take longer to achieve results, but if we are to ask what is sustainable then surely it has to be an environment where ultimately many of us in compliance and regulation find ourselves out of a job because doing the right thing has become part of the DNA of the business done.

As a community you know your businesses best, you understand the problems and challenges you face and know where the gaps lie. There is no one better to effect change in your own organisations than yourselves. In fact, the responsibility of ensuring sustainability extends beyond the frontiers a firm’s legal and compliance departments. It falls to each layer of an institution to maintain, protect and invest in its continued growth.

Thank you.