Click here for PDF
In March the FCA published its policy statement (PS18/7) and non-Handbook guidance following last year’s consultation on staff incentives, remuneration and performance management (CP17/20). The new rules and non-Handbook guidance mark the culmination of nearly three years work by the FCA in this area, having initially started a Thematic Review in August 2015.
Between them, the rules and both Handbook and non-Handbook guidance set out the FCA’s expectations of the processes firms will have around recognising and mitigating the risks posed by remuneration and incentive structures.
New Rules and Handbook Guidance
New rules are introduced under a new section of CONC, at 2.11. Primarily there are two main requirements:
- That firms establish, implement and maintain adequate policies and procedures designed to detect any risk arising from its approach to remuneration or performance management; and
- That firms put in place adequate measures and procedures to manage the risks arising from its approach to remuneration or performance management.
In practical terms, the FCA’s expectation is that firms will firstly be able to recognise when risk arises, and secondly, take steps to mitigate those risks.
An important point to note about the new rules is that in addition to regulated credit products, they also apply to remuneration/incentives for the sale of unregulated products that are financed by regulated credit, such as motor vehicles. Firms should therefore consider how staff are incentivised for the sale of both credit and non-credit products.
Handbook guidance is provided as to what sorts of practices the FCA believes are good measures to manage risks. This includes:
- monitoring the nature of sales activities;
- collecting management information to identify trends and patterns in behavior that may flag an increased chance of risk;
- having formalised procedures to be followed in the event that individuals act inappropriately; and
- giving senior management (or another suitably senior remuneration committee) oversight of remuneration and performance management.
In addition to the new Handbook guidance provided in CONC, the FCA has published non-Handbook guidance (FG18/2) to help firms identify the risks their practices may pose to customers and to understand what the FCA expects of them. The guidance is provided in four sections:
- Schemes that increase the risk customer harm
- Schemes that may reduce the risk of customer harm
- Management practices and how they may affect the risk of harm
- Managing risks
Examples of incentives schemes that increase the risk of customer harm
An extensive list of scheme types that are likely to increase the risk of customer harm is provided, along with examples of how such schemes pose an increased risk in practice. The schemes covered include:
- Volume, profitability or productivity-based schemes
- 100% variable pay
- Disproportionate reward from marginal sales
- Accelerators or stepped payments
- Incentives linked to the terms of the finance
- Product bias
- Incentives for sale of finance
- Variable salaries based on volume measures
- Competitions or promotions
- Schemes for managers linked to team performance
- Incentives for sales of non-financial products
- Schemes combining several high-risk elements
To illustrate the FCA’s point, take accelerators as an example. Under such a scheme staff only earn commission on sales above a minimum target level, or earn it at a higher rate on all transactions above the target. Through its work the FCA has identified that such schemes could increase the risk of staff inappropriately pressuring customers to take out finance near the end of a bonus period so as to maximize the number of transactions before the start of a new bonus period. This obviously increases the risk of
Examples of incentives schemes that may reduce the risk of customer harm
The FCA also identified a number of scheme types that may reduce the risk of customer harm, which included:
- Incentive schemes based purely on customer service measures
- Reductions in/disqualifications from bonus for failing to meet quality standards
- Deferral or clawback provisions
- Incorporating quality measures into schemes
- Cumulative/Rolling targets
Cumulative targets and including metrics such as customer service measures are obviously already commonplace within the industry, with balanced scorecards being particularly widely used.
Examples of management practices that might increase or reduce the risk of customer harm
The FCA highlighted performance management practices that it believes are important for ensuring appropriate staff behavior, including:
- Focus of performance management
- Volume-based -vs- quality-based targets
- Disciplinary action
- Results affecting other decisions
- Targets for different elements
- Publicising ‘good’ or ‘poor’ performance
Finally, the FCA identifies some of the tools firms can employ to ensure effective governance of the risks arising from incentives, including:
- Understanding risks
- Quality monitoring
- Management information
- Management of conflicts
Firms should be reviewing these new provisions now against their current arrangements, something that we at Locke Lord have assisted a number of firms with. Through our experience we have seen that the biggest challenge is translating these guidelines into tangible, measurable metrics that can be used in practice for both external brokers/dealers as well as internal staff.
Joanne Davis | +44 (0) 20 7861 9010 | email@example.com
Timothy Anson | +44 (0) 20 7861 9075 | firstname.lastname@example.org