Wednesday, 4 April 2018

Conflicts of Interest: Connecting Enforcement and Supervision

The FCA announced enforcement action against a commercial broker and a fine of £4 million in late 2017 as a result of failures associated with the broker’s management of conflicts of interest. The details of the case are here.

Conflicts of interest can be anywhere, and firms are well aware of that. However, there is a qualitative difference between the conflict of interest that an individual might have with, say, a supplier, and what the FCA identifies as an ‘inherent conflict of interest’ in the business model or ownership structure. This is the risk that commercial intermediaries must manage.[1] It is not static, and it changes as intermediaries take up other activities where they act as an agent of the insurer.

The FCA has also undertaken a thematic review of commercial insurance intermediaries focusing on this issue. (It published the results in 2014 here.) The FCA evidence included a survey of small and medium enterprises (SMEs).[2] This suggests that many SME customers do not fully understand the intermediary’s role and how it may have changed in recent years. For example, four of five SME customers expect an intermediary to get quotes from two insurers, which is not consistent with how intermediaries operate, in particular for micro SME customers (fewer than nine employees).

There are wider messages from this enforcement action for the practical management of inherent conflicts of interest. To begin with, there should be a regular process to identify conflicts of interest.  This might be challenging but following the sources of revenue would enable a robust identification of conflicts and of the impact of changes in the business model.

While a policy on conflict of interest is a regulatory requirement, it needs to be comprehensive enough to enable staff in the business to actually manage conflicts of interest. This would require specific guidance articulating how to deal with customers, including what information to collect, what checks to undertake, and the production of meaningful management information.

Business arrangements such as ‘preferred facilities’ are not ruled out but must be managed and monitored carefully, taking into account links to brokers’ remuneration, how the firm presents itself to SMEs, the existence of ‘Chinese walls’ and customers’ (probably limited) understanding of the intermediary’s role.

Any quality reviews by the first line should be designed with a view to oversee how inherent conflicts of interest have been identified, managed and mitigated. The process should be risk based, i.e. always applying the same degree of checks to all brokers is unlikely to be appropriate.

Last but not least, as ever, culture is a factor. If statements from senior management do not recognise and support the need to manage inherent conflicts of interests, don’t expect much of the above to be in place.

The FCA will usually say something about how the case was discovered, by either supervisory activity or internal review. I was puzzled that the FCA was rather vague on this occasion. On reflection, I suspect (but cannot be certain) that there may be a dependency with the FCA’s thematic review on conflicts of interest mentioned earlier. If that’s the case, it is useful for firms to understand the potential consequences of being unprepared for a thematic review when invited to participate.

[1] This risk is not exclusive to commercial intermediaries. It exists in other parts of financial services and has also been covered in other FCA enforcement activities.
[2] Businesses with fewer than 250 employees.