From Manchester to Cupertino and back

What can the financial services industry (and its regulators) learn from the management style of the late Steve Jobs?

See our leading article from the November edition of “Compliance Monitor”.

The Decisive Documentation

Are we witnessing a subtle shift in FCA’s mantra that “if it’s not documented, it hasn’t happened”?

Compliance staff industry-wide will be used to advising their firms to document all key decisions. In larger firms, this goes with the flow of normal governance routines, which require decisions to be made after clearly set-out processes have been followed.

Nobody would ever claim that this meant that the decision was always going to be right, but the philosophy has always been that a deliberate and careful (if slow) process of making decisions (often by means of committee) is more likely to come up with the right answer – a better decision. This is because everybody has had time to think about the issues and all interested parties have their say.

The same philosophy holds that where decisions are hurried, where not all stakeholders participate, bad outcomes are likely to result. The lack of documentation is symptomatic of such a hurried process – hence FCA’s desire to see minutes of all meetings, and documentation of decision-making processes when major changes are made.

Whilst the larger firm can achieve this with little change to its operating processes, this is much more challenging to the smaller, more entrepreneurial and owner-managed firm. For such small firms to survive in the big pond, they have to swim faster than the other big fish. Swift decision-making is one of the hallmarks of swimming faster.

Decision making in these environments will be characterised by informality. Key decision makers and stake holders will work in close physical proximity to each other. They will see each other frequently during the course of the working day. They will discuss many issues – and very few of these exchanges will be written down.

Whilst it would be wrong to expect such smaller firms to adopt the processes of their larger competitors, this has not stopped FCA from giving smaller firms a hard time when they lack the full panoply of big-firm governance – in the form of Internal Audit, Remuneration and Audit Committees and detailed board minutes which document the “challenge” to which major decisions – and executive management themselves – have been subject to.

This is not just a governance issue. One of the fundamentals of FCA’s review of suitability at Wealth Management firms has been that FCA has been unable – due to a lack of documentation on file – to satisfy itself that client portfolios are indeed suitable for the client.

FCA does not necessarily allege that investments are unsuitable – just that the documentation available does not immediately show that they are. This may lead the firm to invest in Customer Relationship Management systems, which better record the interactions between the firm and the customer.

However, this may be changing, albeit subtly. We have noticed that on recent ARROW visits FCA seems more willing to listen to arguments about how the firm’s governance process works – given a degree of informality – and more accepting of a premise that states that given the firm’s operating model, big firm functionality (such as Internal Audit) would add little value but would add significant cost.

However, it is not yet time to put out the flags. “Listening” to firm’s arguments as to why their own governance arrangements are adequate is not the same as agreeing with them. In order to convince FCA that its governance arrangements do not pose a risk to FCA, certain boxes need to be ticked. We look at these in more detail below.

Three Lines in the Sand

When FCA evaluate governance arrangements, they look for “three lines of defence”.

The Internal Auditing profession has loosely defined these, as follows:

  • 1st Line: the controls an organisation has in place to manage and deal with the day-to-day business;
  • 2nd line: the functions that provide oversight to the first line of defence. At the highest level, this will include the oversight exercised by the Board. Depending on the complexity of the firm, there may be other oversight committees and support functions;
  • 3rd line of defence: independent assurance of the functioning of the previous two lines.

Firms whose internal arrangements can be seen as meeting the above criteria are well-placed to meet FCA’s requirements – irrespective of their size. Thus on the composition of the Board, FCA’s comments on the role of non-executive directors are well known.

Similarly, the degree of independence exercised by compliance function within the firm can assist greatly in convincing the FCA that the firm as “three lines”.

The more FCA is convinced of their independence, the more likely it is that the firm will pass the “three lines” test.

It is possible – and in some firms, advantageous – to outsource part of the “3rd line”. The practice of outsourcing internal audit to external audit firms is well established.

Fulcrum Compliance can provide a routine monitoring service for firms whose compliance function is also part of the business process.

Governance quality was central to FCA’s assessment of firms in 2011, and will continue to be in 2012.

The New Year is the ideal time for firms to consider their governance and compliance arrangements, and the extent to which they meet FCA’s expectations. Fulcrum Compliance is happy to assist in such a process.

Coming soon…

ESMA, the new European Securities Markets Authority, is starting to flex its muscles.

A Consultation Paper “Guidelines on certain aspects of the MiFID suitability requirements” (one of a number of consultation papers issued by ESMA in the run up to Christmas) pointed to new Europe-wide requirements in the field of suitability, over and above those currently applied by FCA.

These are currently at consultation stage. Fulcrum Compliance will be advising clients on any new requirements as they become clearer.


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