Conduct Risk:
what is it and can
you measure it?
Mike Ritchie
Partner
March 2013
Agenda
1. What is Conduct risk and how does it impact
2. First - some context
• Back to basics – I know what it is when I see it
3. How big is the issue (UK experience vs Australia)
• TCF on steroids or something new?
• FCA Core Conduct Risk Assessment
4. If you want to manage it, can you measure it?
•
•
•
•
Setting and managing conduct risk appetite in the new world
What should the conduct risk framework focus on?
Firms have the data, but it gets lost in translation
Real Conduct MI drives better outcomes vs classic “TCF dashboards”
5. Questions
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International”), a Swiss entity. All rights reserved.
KPMG and the KPMG logo are registered trademarks of KPMG International.
2
What is conduct
risk
Compliance: the 16:1 equation
Key themes
 Compliance cost is rising inextricably
Problem Statement
 Effectiveness of current frameworks are inadequate at best
 Conduct risk is arguably the UK’s most material and least understood risk issue
 Current model is not fit for purpose in the new world
Expectations of future conduct risk
governance/frameworks
 Art needs to be turned into science:
-Predictive
-Objective
-Automated
 And be self-funding?
 Cost/efficiency of existing model (‘where is my money spent and on what?’)
Peer group response
 Re-orientating existing MI to conduct risk outcomes
 Re-wiring conduct risk framework and measures into the end to end business model
© 2013 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG
International”), a Swiss entity. All rights reserved.
KPMG and the KPMG logo are registered trademarks of KPMG International.
4
Back to basics – I know what it is when I see it
Conduct Risk characteristics
Cultural fault lines (appetite versus behaviour)
■ Aggregation of many events, most small ticket items,
some not
Recent enforcement action by the FSA appears to
highlight possible fault lines between firms’ desired
culture’ and actual behaviours
■ High probability
■ Distinction between misconduct and detriment with
time lag between them
Firm
Issue
■ Scale of detriment may be contingent on market
movements: should that affect how severely behaviour
is viewed?
Direct
Line/Churchill
Insurance
Complaints handling
£2.8m
■ Waterbed effect: clearing up one issue may just move
the problem if incentives not fixed.
Santander
Misleading literate on
Structured Products and
coverage by FSCS
£1.5m
HSBC
Investment advice and sale £10.5m
of investment products by
NHFA
Combined
Insurance
Unsuitable advice and
complaints handling
■ Impact of the same monetary loss different for different
consumers
■ Potential for multiple risks to accumulate in the bank
© 2013 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG
International”), a Swiss entity. All rights reserved.
KPMG and the KPMG logo are registered trademarks of KPMG International.
Fine
£2.8m
5
How big is the
issue – UK v
Australia
How big is the
issue – UK v
Australia
Recent costs of remediation
US
$25B on residential mortgage lending
US
$445M on unfair, deceptive, abusive acts
and practices
UK
£10B on payment protection insurance
HK
Up to $2B to compensate investors in
Lehman Brothers structured products
TCF* on steroids or something new?
The FCA will focus on 4 key areas:  Financial,  Strategy,  Infrastructure,  Behavioural.
* - Treating Customers
Fairly
Financial
performance
targets
Financial
Markets
Strategy
Product Development
Process
Propositions and
brands
Product Review Process
Clients
Marketing Compliance –
Literature Review
Core business
processes
Unfair Contract Terms
Review
Operational
infrastructure and
technology
Infrastructure
Root Cause Analysis Escalations
&Complaints
Organisational
structure and
governance
Increased visibility and control
Behavioural
MI and KPI
dashboard
© 2013 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG
International”), a Swiss entity. All rights reserved.
KPMG and the KPMG logo are registered trademarks of KPMG International.
People and culture
Findings from GIA &
Compliance Monitoring
Reviews
Existing Controls are not
holistic or joined up
Compliance
advice/support
Measures and
incentives
8
FCA* Core Conduct Risk Assessment will have a fundamental impact throughout
organisations

Whole of market/sector-wide review

Firm/peer group review

Product/thematic interventions

Governance & behavioural
effectiveness
Board
* - Financial Conduct
Authority
Retail
Wealth
Inv
Bank
TCF governance forums and committees
business units
Products
Multiple FCA points
of entry e.g.
Thematic reviews
Incentive
Complaints
Suitability
© 2013 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG
International”), a Swiss entity. All rights reserved.
KPMG and the KPMG logo are registered trademarks of KPMG International.
Structured
products
9
Regulatory developments timeline – UK/EU and Australia
European Market
Infrastructure
Regulation (EMIR) /
Centralised
Clearing for
Derivatives
UK
Retail
Distribution
Review
UK
Recovery and
Resolution
Planning
Australia
Australia
(Implementation of
recommendations – by 2019)
Australia
UK
(pilot commenced in 2012)
Consumer
Credit Regime
UK
Banking
Conduct
Regime
Australia
UK
2009
Australia
2010
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10
How do you
manage it?
Reduced/No profits
‘Too expensive’
Reduced likelihood of
regulatory intervention
and remedial work
Zero LTV
Cost of control means
product is unviable
Long term value and
trust
Setting and managing conduct risk appetite in the new world
Short term high profits
Historic data suggests
increased likelihood of
regulatory intervention,
remediation and
reputational risk
Conduct Risk Appetite
Zero Risk Tolerance
‘Too Risky’
Potential Conduct Risks Areas
Market/environment
Proposition/brands
Clients
Core Business Processes
Operations and Infrastructure
People and culture
© 2013 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG
International”), a Swiss entity. All rights reserved.
KPMG and the KPMG logo are registered trademarks of KPMG International.
12
What should the conduct risk framework focus on?
From a fundamental perspective putting a value on Conduct Risk should be straightforward considering the drivers of risk to the bank and it’s customers:
Design
X
Execution
Should be set very low
Design risks
■ Intrinsically complex
■ Target market difficult
to identify with
precision
■ Potential misalignment
with regulatory
standards or
expectations
■ Represents poor value
for money for
customers
■ Product profitability
Should be set low
Execution risks
■ Poor staff
understanding and/or
weak T&C
X
Environmental
Low probability, high impact
Environmental risks
■ Product performance
■ Macroeconomic factors
■ Process deficiencies or
manual workarounds
■ Regulatory intervention
and focus (at
product/industry level)
■ Suitability of advice not
demonstrable
■ Media or consumer
group focus
■ Adverse impact of
sales targets and
reward and incentive
■ CMC activity
■ Control
weakness/failure
=
Cost
Reputation, Customer Confidence,
Market Share, Financial Penalty, Back
Book Review, Remediation, More
Intrusive Regulation
Investment in conduct risk
mitigation
versus
the cost of repeated public
and regulatory scrutiny
■ Emerging themes from
Conduct Risk Outlook
■ Sales volume volatility
© 2013 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG
International”), a Swiss entity. All rights reserved.
KPMG and the KPMG logo are registered trademarks of KPMG International.
13
Firms have the data, but it gets lost in translation
Markets
•
•
income stream
•
absolute vs forecast
•
Per product type
•
Per sale
•
Per customer type
Proposition and Brands
People and culture
TCF Operational
•
•
•
Product
•
Complexity
•
Type
Distribution
Sales
•
Qual’d advisors
•
Income/adv
•
Non-qual’d
•
Income/prod
•
Banking
Changes in income stream
•
Lending
•
Tied
•
Income/cust
•
Changes in balance mix
•
Protection
•
Open
•
Monitoring
•
Changes per type
•
Savings
•
Retention rates
•
Persistency
•
Client money
•
Wealth
•
•
Training rates
•
NTU’s
Distribution methodology
•
Complex/structure
d
•
Attrition rates
Similarity to current offering
•
Levels
•
•
Agents
•
Advised
•
Outsourced
•
Telephony
•
Online
•
Mix
•
Activity
•
•
•
•
Closed/processed
Add ons
•
Flat
•
Upholds
•
White labels
•
Commission
•
Distribution
•
Bonus
•
Product
•
Mixed
•
Adv
•
Complex
•
Increase/decrease
Changes in balance mix
•
High risk area
•
Changes per type
•
Same
•
Low risk
Client type/profiling
Incentive structure
•
Age profile
•
New structures
•
Redress levels
•
Income profile
•
Product differentiators
•
Speed
•
RCA
•
FOS Benchmarks
•
Distribution
•
Support
•
Sophistication
Blend
•
Degree of
segmentation
•
blending
•
Advisor-supervisor spread
© 2013 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG
International”), a Swiss entity. All rights reserved.
KPMG and the KPMG logo are registered trademarks of KPMG International.
Opened
•
•
•
•
Bundling
Changes in income stream
Changing
Complaints
•
New
•
•
•
•
Correlation sales/complaints
14
Real Conduct MI drives better outcomes vs classic “TCF dashboards”
Assessment methodology can be used to:
• Anticipate emerging risk within the business and operating models
• As a test of ‘operation or experience’ against ‘design or expected outcome’
Financial
Financial
performance
targets
FCA Drivers
Markets
Strategy
Propositions and
brands
Clients
Core business
processes
Operational
infrastructure and
technology
Infrastructure
Organisational
structure and
governance
People and culture
Behavioural
MI and KPI
dashboard
© 2013 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG
International”), a Swiss entity. All rights reserved.
KPMG and the KPMG logo are registered trademarks of KPMG International.
Measures and
incentives
15
Exam questions
What is the organisation's expected loss
tolerance on individual products, books, or
service lines: with respect to conduct?
In terms of scenario planning, what is the
unexpected loss tolerance on the same book?
What would the Board’s initial response be if an
executive suggested to withdraw from this
market?
© 2013 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG
International”), a Swiss entity. All rights reserved.
KPMG and the KPMG logo are registered trademarks of KPMG International.
16
© 2013 KPMG, an Australian partnership and a member firm of the KPMG network of
independent member firms affiliated with KPMG International Cooperative (“KPMG
International”), a Swiss entity. All rights reserved.
KPMG and the KPMG logo are registered trademarks of KPMG International..
The KPMG name, logo and ‘cutting through complexity’ are registered trademarks or
trademarks of KPMG International Cooperative (KPMG International).
Mike Ritchie
Partner in Charge
Financial Risk Management
[email protected]
02 9335 8251