Are we waiting for the FCA’s first scapegoat?

Lessons Learned from the Sub-Prime Crisis

Prior to The 2008 crisis, banks were required to value their assets based on current market conditions. In 2009, the US Financial Accounting Standards Board relaxed the rules so that banks were no longer required to report mark-to-market valuations. House values had plummeted, but if their true values had been recorded, the banks’ derivatives contracts would have prompted payouts, effectively wiping out all of the biggest banks in the world at the same time. Following the financial blood bath of the era, accounting rules were swiftly changed.

Three new supervisory agencies were established by The European Commission to enforce the new rules and hold banks accountable. Personal bonuses were eliminated, and a host of other measures were enacted to drive a corporate culture of fiscal responsibility. One issue is that smaller financial institutions, already lagging behind their enterprise counterparts, began feeling the heat. By 2011, France, Germany, and the UK imposed levies on big banks to keep them in line and reduce their appetite for risk. Smaller banks temporarily escaped that directive, but it wouldn’t be long until they found themselves in the crosshairs, too.

Sure, there were some changes. But what did we really learn from that time? Apparently not that much.

Since then, there has been a boon in hiring compliance officers, essentially tripling the number of people in the roles of in-house auditing, fraud prevention, and related functions within compliance. And yes, there has been a noticeable shift in power within financial institutions where compliance officers now have more clout and influence. But they’re still not leading the charge.

Things are shifting again one decade later. Executives of large institutions are starting to rethink how much they should be paying for compliance efforts whereas executives of smaller institutions are concerned if they’re paying enough to be prepared for the FCA mandates on the horizon. According to the British regulator, today, as a result of these changes, some financial institutions are starting to exhibit complacency with regard to monitoring for market abuse fraud despite the availability of affordable surveillance systems.

That said, even with the rise of automated solutions, there is still a need for these systems to be informed by those who understand the new legislation enforcing market transparency. As such, compliance advisors will continue to be in demand. Aptly stated by one US bank executive, “There will always be a place for good compliance officers, whilst we may not be able to code we should have the knowledge to tell people what we want the automation to do.”

Small to Medium Financial Institutions Are Particularly Vulnerable

The challenge is that smaller banks must adhere to the same regulations that the large banks uphold, but often operate without the staff necessary to do so properly. Smaller to midsize firms have been especially impacted because they are non-competitive and limited in their ability to recruit the desired talent. In most cases, compliance within smaller firms is a function under operations and not its own department. Typically, budgets are small and compliance expertise is sub-optimal.

Broadly speaking, there is a general lack of understanding of fiscal responsibilities with respect to monitoring for and being prepared to mitigate market abuse and financial crimes. This stems largely from underinvestment in systems and controls, including surveillance systems and training. And a palpable lack of data-informed insights. As such, smaller financial institutions live with a higher level of daily risk. That risk of being unable to effectively monitor for market abuse is likely higher than they would like to have, but they have learned to tolerate it.

However, no bank, regardless of size, is exempt from the legislation enforcing market transparency. Earlier this year, the FCA issued a “Dear CEO” letter outlining the agency’s strategy on how to mitigate the key harms associated with the operations of brokerage firms in wholesale financial markets. The FCA stated, “In our view, brokers in wholesale markets have made less progress than other sectors in embedding a culture of good conduct, and so action to raise standards across the sector has become urgent.” In simple terms, the Dear CEO letter is a clear warning.

Adopting Technology Is Key

Part of the issue is that financial institutions didn’t seem to think at all immediately following the subprime lending crisis. Collectively, their moves were reactive, seemingly following a “hire-as-many-people-as-we-can-to-demonstrate-compliance” strategy. The challenge was, that there was no strategy, only an over-reaction.

Based on a recent survey, compliance salaries are down and banks are cutting deep, particularly at the top. Advances in technology, largely around automation, are driving only a few of these headcount and cost reductions. While the initial reaction may be to fear these advances, most are embracing the consistency, efficiency, and cost savings that automated surveillance systems bring. Not to mention the value of a future-proof compliance platform that can readily adapt to new regulations as they happen.

Now, banks are looking at how they need to change the industry, and bring some coordination to all their inter-departmental compliance efforts which have recently crossed over into the “liability” versus “asset” category. They are also looking at how to better support their staff through IT solutions. Smaller institutions are particularly keen on adopting technology because smart solutions level the playing field with respect to risk.

And Then There’s Brexit

As of October 2019, Brexit is still a mystery to most of us. All financial firms have been advised to make preparations for a no-deal to minimize disruption (and the potential for economic chaos) in the event that agreeable terms are not reached. To this end, the FCA is currently preoccupied with its efforts to guide financial institutions on how to best prepare for the UK’s departure from the EU.

However, just because the FCA is preoccupied, it doesn’t mean that they are prepared to accept complacency with regard to monitoring for market abuse. Don’t be the next scapegoat – invest in the surveillance systems and training that you need now.