Friday, 14 November 2014

Financial Conduct Authority Enforcement: The Sum and the Parts


In previous posts I have covered the lessons for risk management from a number of enforcement cases from the UK Financial Conduct Authority (FCA) (e.g. here and here). 

An alternative approach is to capture summary data about all fines and assess their evolution over time.  This is what NERA – National Economics Research Associates – have been doing for a number of years.  The latest paper of this series is available here.  (Full disclosure: I worked at NERA several years ago.)

The latest report from NERA evidences the overall increase in FCA (and FSA) enforcement in the last two years.  Total fines to firms have increased from £59 million in 2011-12 to about £420 million in each of the last two full financial years.  The typical fine is also getting larger with the median fine increase from £1.4 million in 2011-12 to £5.6 million in 2013-14.  

There were also some other interesting observations:
  • The overall number of cases against firms does not necessarily predict the total fines.
  • While five out of the 10 top fines against firms relate to LIBOR market manipulation, the others cover “classical” issues such as client assets, unsuitable investments and mis-selling.
  • The total of fines against individuals (as opposed to firms) has diminished from £19.9 million in 2011-12 to £3.9 million in 2013-14.  A similar trend is observed for number of cases pursued against individuals.
There are two points that I would like to consider.

1.    The impact of the FCA revised penalty framework

The increase in FCA fines against firms may be influenced by the reliance on the revised penalty framework.  It is summarised in five steps:
  • Step 1: removal of any financial benefit derived directly from the breach  
  • Step 2: the seriousness of the breach 
  • Step 3: mitigating and aggravating factors
  • Step 4: an increase to the result from the above steps to reflect an adjustment for deterrence 
  • Step 5: settlement discount
This applies to conduct that took place since 6 March 2010.  Given the lead times for enforcement cases, this framework is probably starting to bite in earnest now and fines could stay at the current higher level and even increase further.  It will also be interesting to read in the enforcement notices how economic considerations shape the regulator’s view about the size of any financial benefit derived by the company from the breach.

2.    The decline in enforcement cases against individuals

NERA also wonders if this decline is consistent with the regulatory ambition of using enforcement to provide a “credible deterrent”.  

One possible reason for the decline in enforcement against individuals is the targeted diversion of resources to other investigations such as LIBOR and currency manipulation.  In this case, the decline would be reversed in the not-so-distant future. 

An alternative is to consider whether the change reflects the view that enforcement against firms provides a more efficient “credible deterrent”.  If this were the case, then the decline of enforcement action against individuals would not be reversed.  I have not come across evidence to support this claim but here are two arguments to consider:  
  • A stronger deterrent effect is provided by the overall size of the fines, which tend to be larger for firms, than personal accountability.  
  • Enforcement cases related to individuals tend to reveal individuals’ determination to breach the rules rather than weaknesses in risk management.  There may be a more limited scope for improvement in risk management while providing an effective service to customers.

I would be interested in your thoughts about the likely impact of the FCA revised penalty framework and the decline in enforcement cases against individuals.


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