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Wholesale Market Conduct Risk Overview

AUTHOR(S): Darren Maher, Joe Beashel
KEY CONTACT(S): Darren Maher, Joe Beashel
PRACTICE AREA GROUP: Financial Institutions
DATE: 26.06.2019

Introduction

A specialised team, the Wholesale Market Conduct Team, has been established by the Central Bank of Ireland (the “Central Bank”) to carry out wholesale market Conduct Risk (“Conduct Risk”) assessments of firms engaging or applying to engage in wholesale market activity.  This team was formed in response to the rapid increase in size and complexity of wholesale financial market activity in Ireland and by branches of Irish firms in other jurisdictions.  It is also part of the Central Bank’s focus on culture and governance.

What is Conduct Risk?

The Central Bank is determined to ensure a culture of good conduct at every level of the financial services industry.  The Central Bank expects firms to have a strong Conduct Risk Framework in place to facilitate a culture that delivers good outcomes both for customers and the markets as a whole.  Therefore, in the past the Central Bank has described Conduct Risk as “the risk the firm poses to its customers from its direct interaction with them”.  Conduct Risk is intentionally not a defined term.  The Central Bank requires firms to be able to articulate what Conduct Risk means to its specific business, rather that requiring firms to adopt a standard definition from a regulator.

Therefore Conduct Risk may affect firms differently, depending on their specific characteristics and conditions.  Key Conduct Risk drivers which encourage behaviour which is not in best interest of the customer and impacts the integrity of the markets have been identified by the Central Bank as:

  • inherent factors: information imbalances between a bank and its customers; Human behaviour and biases;
  • internal structures and culture: processes, management (including culture and incentives) that allow firms to profit from customers’ misunderstandings and from market failures; and
  • external / environmental factors: economic, regulatory and technology trends and changes that impact drivers of a firm and customer decisions.

Central Bank Communication

On 11 March 2019, the Central Bank of Ireland wrote to the CEOs of all regulated financial firms in relation to Wholesale Market Conduct Risk (“March 2019 Letter”).

It is the intention of the Central Bank, by its March 2019 Letter, to communicate to firms its expectations in relation to how these firms “identify, mitigate and manage market Conduct Risk”.

The letter requires firms to:

1. understands, implements and satisfies the Central Bank’s Conduct Risk Expectations;
2. take all necessary steps to ensure that Conduct Risks, to which the firm is exposed are understood, mitigated and managed appropriately; and
3. address any misalignments between the firm’s internal frameworks and practices and the Expectations, and establish the necessary processes to ensure that the firm continues to meet the Expectations on an ongoing basis.

The Central Bank expects firms to demonstrate how ‘’frameworks, policies, procedures and practices formally adopted and utilised by the firm in respect of market Conduct Risk address a number of issues’’ including:

  • market conduct strategy;
  • governance and organisation;
  • risk management;
  • culture and people; and
  • metrics and monitoring

Importantly, the Central Bank requires the firm to present the March 2019 Letter it to its board at the next meeting and this must be recorded in the board minutes.

Themed Reviews and Inspections

Following the March 2019 letter, the Central Bank announced “themed reviews” of selected firms. Some of these selected firms have been called to an interview with the Central Bank, whilst others will be subject to an on-site inspection by the Central Bank.  As part of these themed reviews, firms were:

  • required to complete a survey on Conduct Risk Identification and Assessment;
  • advised to expect further engagement with the Central Bank’s Wholesale Market Conduct Team, depending on the firms’ survey responses; and
  • required to prepare for on-site inspections and additional documentation requests.

Firms were given seven days from the announcement letters’ date to submit inspection documentation relating to Conduct Risk through the Central Bank’s online reporting system.

What Next?

We would expect that firms will already have an identification and assessment process, together with a number of policies and procedures that contribute to its Conduct Risk Framework.  However for some firms the framework may not be documented as a Conduct Risk Framework and it may be unclear to staff, senior management and indeed the Central Bank how each component is part of the wider risk framework. So what can firms do to get to this point?

The Financial Conduct Authority (‘’FCA’’) has similarly engaged in the consideration of Conduct Risk.  The FCA has set out five key questions which it expects firms to ask themselves and be able to answer to the regulator.  Firms would benefit from considering these five key questions when reviewing their existing Conduct Risk Frameworks:

1. what proactive steps does the firm take to identify Conduct Risks inherent in its business? 
2. how does the firm encourage people in front, middle, back office, control and support functions to feel and be responsible for managing the conduct of their business?
3. what support does the firm put in place to enable those who work for it to improve the conduct of their business or function?
4. how does the firm’s board and executive committee gain oversight of the conduct of business within the organisation? And how do people bring it in to their discussions? and
5. has the firm assessed whether there are any other activities it is engaged in that undermine its work to improve conduct?

Additionally, firms may want to consider the following, when carrying out their analysis of their current Conduct Risk Framework to ensure they are addressing the expectations of the Central Bank:

1. definition:  What does Conduct Risk mean for your firm? Do all staff understand what Conduct Risk means for your firm?
2. assessment:  Are the key conduct drivers regularly assess? What controls are in place to monitor and mitigate these risks on an on-going basis?
3. strategy:  Is the strategy of the firm adapted in light of Conduct Risk?
4. risk appetite:  Conduct Risk should be taken into account as part of the Risk Appetite.
5. governance and accountability:  Who is responsible for Conduct Risk and how it is reported to senior management and onto the board? Is front line taking ownership?
6. metrics:  How is Conduct Risk monitored? What time of MI goes to the board?
7. training:  How is the Conduct Risk framework embedded into a firm?

Conclusion

It is clear from the (1) Central Bank’s decision to establish the Wholesale Market Conduct Risk Team, (2) the March 2019 Letter and (3) the launch of the Themed Review and Inspections, that Conduct Risk is a key component of the Central Bank’s prioritisation of culture and governance in Firms.   However Conduct Risk is broader than culture and governance.  Firms should be treating Conduct Risk as seriously as any other risk on its balance sheet and should manage it accordingly through their Conduct Risk Framework and ensure that it is fully embedded within their organisations.

We expect that the Central Bank will communicate the overall outcomes of the Themed Reviews and Inspections in due course and we will keep you updated when they do. In the meantime, should you require assistance with your Conduct Risk Framework, please do not hesitate to contact us.

 

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