Conduct Risk Outlook 2012

The FSA’s Conduct Risk Outlook for 2012 was published in March.

It may be recalled that the Regulator used to issue an annual Financial Risk Outlook until 2011 when, in recognition of the ‘twin peaks’ approach, it was replaced by the Prudential Risk Outlook and the Retail Conduct Risk Outlook (CRO). Despite the use of ‘Retail’ in the title, the document will also be relevant to firms that, whilst not having any retail clients, may nevertheless have an involvement with a product that could have retail end users e.g. managers of unregulated collective investment schemes (UCIS) or Host Authorised Corporate Directors (ACD).

The CRO sets out the FSA’s assessment of the most significant retail conduct risks – there are 15 broad risk categories mentioned. The usual suspects are covered such as general insurance and mortgages. In addition the FSA continues to have reservations with UCIS which it classifies as complex products. Whilst it acknowledges that the majority of UCIS are designed for institutional investors it is finding that more of these schemes are being sold to retail investors “for whom this product is unsuitable”.

Firms that are involved in the promotion of UCIS are reminded, yet again, that they should not inappropriately promote,advise or arrange UCIS investments to retail investors. It is a concern to the FSA that firms are making UCIS available to the retail market without conducting sufficient due diligence or establishing appropriate systems and controls to guard against the funds reaching the wrong consumers. The FSA intends to conduct a review of the rules relating to UCIS to improve consumer protection. The FSA mentions that it has taken forward enforcement cases against UCIS providers. Those involved in UCIS should bear in mind the personal, as well as the corporate, aspect in enforcement cases e.g. Banfield/Moss (see Regulatory Roundup 32) where the lack of sufficient understanding of the statutory and regulatory restrictions relating to the promotion of UCIS was a contributing factor and also the penalty imposed on the Compliance Officer of a firm (see Regulatory Roundup 35).

One other area of perceived risk is the growth in Host ACDs. As will be known, an OEIC must have an ACD, the duty of which is to operate the fund, including oversight of the investment manager. Rather than the ACD and the investment manager being part of the same group, there has been a growing trend in outsourcing the ACD role to independent third parties (a Host ACD). In theory it is the ACD that appoints the investment manager, but the commercial reality is that it is the other way around. The concern is that this may present a conflict of interest in that the ACD might feel inhibited from providing the necessary challenge to the potential detriment of investors. There is also comment on the number of small and newly established firms using the Host ACD route; the former lacking the systems and controls found in larger and more established firms and the possibility that the latter may lack the specialist skills and systems needed to safeguard investors. The FSA advises that it has increased its supervisory focus on Host ACD firms.