Conduct Risk – What Is It?

It’s Trendier than Miley Cyrus, says Lee Werrell. But What Exactly Is This New Buzzword All About?

‘Conduct Risk’ is the buzz phrase you’ll hear everywhere in the financial services world today. Jobs abound for "Conduct Risk Managers" or "Head of Conduct Risk". But very few people seem to know what this involves precisely.


Oh certainly, there’s obviously a great deal of information available – including stuff about the reasons for failure and the associated fines that can point you in the right direction –  but if you try to enter a Boolean search (containing the search term in inverted commas) for "Conduct Risk" into the handbook search box, you’ll find that it is not specifically defined in the regulator's handbook. And that nothing can be found between “COND” and “conflicts of interest policy” in the Glossary.


From the various speeches and publications, a number of focus areas become evident. They include:

  • Aligning business models to the fair treatment of customers
  • Complaints handling
  • Product development and governance
  • Product Intervention
  • Remuneration and reward policies
  • Financial Promotion withdrawal and prohibition
  • Conflicts of interest
  • Incentives
  • Wholesale
  • Business Continuity


A Commonsense Definition

Conduct risk isn’t new, and its use doesn’t just stem from the scandals and mis-selling debacles of the last decade.  It’s rooted in the Treating Customers Fairly (TCF) initiatives and the rules in COBS. But it would appear that the definition of the term is excluded on purpose, so as to make it a reflective and subjective term that can be defined by each company.


Then there was the complexity of RDR becoming effective from 31 December 2012 – a landmark development that made significant changes to, and impacted upon, the business models that already existed within the investment advice market. Add to all that the additional work of implementing MiFID II, the new European standard for investor protection, as well as new regulators in London with a more intrusive supervisory stance, and you’ll see that there are bound to be a great deal of elements that firms are unaware of – and which will undoubtedly catch advisors out whenever they are visited, or when "online" or "telephone" assessments are completed.


The changes brought about by the new regulator are;

FSA: Rules/Principles Based – Reactive/Passive


FCA: Judgements & Outcomes Based – Intensive/ intrusive

Judgement/Opinion on adequacy of controls


Judgement about Senior management Decision Making Process

Firms decided best method to achieve outcomes (TCF)


Regulatory Intervenes to ensure firms take action for required outcomes

Focussed on processes and procedures


Focus on Governance, Outcomes & Behaviour

Management responsible for identifying and developing controls for risk


Regulator will proactively identify risks and act to prevent crystallisation

Senior Management to demonstrate adequate systems and controls implementation


Greater emphasis on systems and controls to demonstrate  Governance, Outcomes & Behaviour

Defined actions from risks


Evidence of risk identification, measurement and decision making process


More Guidance

Recently the FCA asked 26 life insurers and advisory firms to provide information about their service or distribution agreements; in total, it received and reviewed 80 agreements. The FCA’s findings included huge potential issues regarding undisclosed conflicts of interest, incentives and an amount of joint ventures that could lead to biased advice and undisclosed costs.


Alongside the review, proposed guidance has been published to help firms further understand how they should act. The guidance explains why the FCA thinks certain payments between providers and advisers may cause conflicts of interest and also gives some helpful examples of good and bad practice. This includes how advisory firms might want to deal with conflicts caused by providers paying for IT development and maintenance, staff training, conferences and seminars, hospitality, research and promotional activities.


Clive Adamson, the FCA’s director of supervision, commenting on the findings, said:

“The changes we made to the retail investment advice sector were designed to mark a step change in the way advice was given. It signalled the end of advice that might be influenced by the commission payments made by product providers to advisory firms, and the start of a new era of trust and transparency between a firm and its customers. The findings of this review reveal that the actions of some firms have the effect of undermining the objectives of the RDR.”

“Most the firms involved in the review have already made changes, which are welcome, but we want all firms in this market to review and, if necessary revise their existing arrangements. We will revisit this area in the future to check that the necessary improvements have been made.”


Full Details can be found here http://www.fca.org.uk/news/life-insurance-and-advisory-firms-undermining-the-objectives-of-the-rdr


So How Do you Prove "Conduct Risk" To A Satisfactory Level?

Firstly, you have to understand where conduct risk falls within your organisation – and, in conjunction with the FCA Risk Outlook 2013, create an idea of where your risks may lie.


The majority of these risks can fall under the Operational Risk umbrella, which a few consultancies can assist you with. You don’t necessarily need expensive software for most modest size of firm, but you need to know how you arrive at the findings, and more importantly what you do about them. If you look in the handbook SYSC, you will see that Operational Risk would seem to apply to insurers (SYSC 13) and it could be easy to overlook SYSC 7. SYSC 7.1.2 R states  "A common platform firm must establish, implement and maintain adequate risk management policies and procedures, including effective procedures for risk assessment, which identify the risks relating to the firm's activities, processes and systems, and where appropriate, set the level of risk tolerated by the firm." This effectively means that all risks apply to every firm; the three types are Credit Risk, Business or Market Risk and Operational Risk.


Operational Risk is widely accepted to be the Basel II definition that states that operational risk is “the risk of loss resulting from inadequate or failed internal processes, people and systems, or from external events.”


Identifying them is only the start, as you then have to agree how best to measure them, which creates a real challenge and considerable work for most firms who do not normally deal in this area. Within the three main areas of conduct risk impact – Inherent, Structures & Behaviours and Environmental – there are a great many areas that can be measured. Within the first two areas, a degree of qualitative and quantitative data already exists, but much of it is overlooked or unreported in most firms.

Conduct Risk Framework

A Conduct Risk Framework will help in identifying the elements and areas impacted. From this adequate and proportionate measurements can be made for reporting. Overlaid with a rationally decided appetite the data can provide an exception report for Senior Management to consider.


The three phases of good management are definition and measurement, management, and then activity. Running any business is typically conducted this way – but the skill of management is actually created and enhanced as a result or product of the activity. Meaning, in effect, that there is no definitive answer on how best to manage.


The key to these phases is providing accurate and usable data to the second phase. Unfortunately many people when defining the Management Information do this the wrong way round.



Conduct Risk is not only here to stay as an extension of the TCF Outcomes – it is also going to ramp up as the FCA get a deeper and fuller understanding of what is missing in the retail distribution world. Focusing on your exposure and level of risk is critical to your firm’s survival, and your best hope of escaping close regulatory scrutiny, supervision – or worse.

This Week’s Most Read

Latest IFA Magazine Podcast Episodes

Keep updated on the most important financial events 

Make sure you are an informed

wealth professional..

Adblock Blocker

We have detected that you are using

adblocking plugin in your browser. 

IFA Magazine