The Dark Side of Staff Incentivisation: Are You Ready for FCA Scrutiny?

In a recent article I shared my thoughts on the FCAs (Financial Conduct Authority) 87-question survey, sent to a diversified sample of regulated advice firms, requesting details of adviser charging models and adviser incentive structures. The survey is the starting pistol for its Thematic Review into the retirement income advice market.

As a consultant, I naturally keep my ear to the terra firma, enabling me to identify issues that are keeping compliance and risk bosses awake at night.?One such rumbling relates to the incentivisation questions in the aforementioned survey… “Why are they asking questions about that?”

It seems this has caught some off guard…but is this line of questioning so unusual? ?After all the Financial Services Authority (FSA) started to talk of concerns about incentive and remuneration structures as far back as 2005, when it started to limber up for the Treating Customers Fairly (TCF) era that was to forerun Consumer Duty.

FCA and regulation of Conduct Risk

The FCA started its tenure in 2013 with a Conduct Risk agenda. Conduct Risk can be explained as the risk to a business arising from the improper, unexpected or inappropriate behaviour of its staff, third-parties, customers or agents. The key word here is behaviour or, putting it more simply, Conduct Risk could also be described as Behavioural Risk.

Another simple tenant is that incentives drive human behaviour. So, as part of its Conduct Risk agenda, the FCA started to think about how firms incentivise their staff, identifying areas where certain incentivisation structures could create risks for customer outcomes.

A raft of action from the regulator followed over the next three to four years, resulting in Thematic Reviews and Finalised Guidance, with additional focus being received by the Consumer Credit sector in 2017, resulting in additional Finalised Guidance and new CONC rules.

The above work was likely to create some enforcement referrals and Lloyds TSB Bank Plc found itself on the wounded stretcher in 2013, hit with a fine that at the time, was the largest the FCA (or its predecessor, the FSA) had issued for a conduct failing.

Totalling just over ￡28 million, the FCA enforcement note commented that the regulator had increased the fine by ten per cent on the basis of a previous fine issued to the Bank in 2003 (in which incentive structures played a crucial part) and because of the numerous warnings to the industry about the importance of managing incentive schemes.

From this 2013 comment we learn the FCA felt (at that point in time) confident it had fired enough warning shots across the bows of the regulated community on the matter of risky incentivisation structures.

In 2023 with a more exacting level of regulation approaching, can we can feel confident this position is likely to have softened? I would suggest not.

Consumer Duty

Consumer Duty brings incentives back into the spotlight and the inclusion of this in a questionnaire (which is overt that it seeks to measure Consumer Duty implementation readiness) should be of interest to all firms with a retail customer base, regardless of sector or product.

Incentives are an area the FCA expects all in-scope firms to have reviewed as part of their preparation for the Duty. It has been clear that it expects firms to ensure that their culture supports and is conducive to their staff acting in good faith.

Further, a firm is unlikely to be 'acting in good faith' if it uses staff incentive, performance management or remuneration structures which are likely to cause detriment to customers. A breach of the new good faith cross-cutting rule is likely to suggest a breach of Principle 12 – the Consumer Principle.

Consumer Duty has enabled the FCA to once again surface this important driver of culture and it is likely that further questions will follow for other firms in other sectors on other questionnaires. Surveys are a very useful tool, allowing the FCA to identify the ‘where’ and ‘who’ for further investigation. ?The regulator has been clear it will become more data led, saying it will use data to ‘stop harm faster.’

What does bad look like?

Examples of poor practice are many and varied across the publications on this topic issued by the FSA and FCA. Casting a net internationally further increases the examples that can be drawn upon, in particular from the United States.

Consider the following scenarios, taken from an aggregation of various real-life examples of bad practice, reported by regulatory bodies. While these are separate cases they could all, in theory, be present within the same firm and intertwined around a culture focused on delivering sales volume rather than good customer outcomes.

Scenario 1:

• A qualified financial adviser, under pressure to reach a sales-goal, recommends a particular product even though she knows it is unlikely to be suitable for the customers’ needs.
• If the adviser does not meet this month’s target, she will be automatically demoted which will carry a pay reduction.
• Despite the earlier sale she is still short of the target, so she sells products to friends and family to artificially inflate the sales figures – the products are to be cancelled later under the contractual ‘cooling off’ period, and after the monthly sales figures are due. This is a regular tactic used by the adviser when the number might come up short.
• The firm does not monitor cancellations of products therefore this regular pattern goes unnoticed.

Scenario 2:

• Another colleague, working as an account assistant at the same firm, is overstretched on his mortgage payments and needs to maximise his income each month.
• He is just short of the bonus accelerator target which will see his monthly commission payment boosted by 25% - however, to get this, staff members must sell eligible credit card products to private banking customers. These products represent the monthly ‘product push’ by management.
• He guides several customers towards the specific credit product, even though he knows it is unlikely to be of benefit to them and their needs. The additional sales help him achieve his target.

Scenario 3:

• The account assistants’ sales figures are reviewed by his line-manager; however, he knows any reduction in the sales volumes of his direct report staff will result in a higher KPI measure for him next quarter, reducing the chances of getting a bonus himself.
• He is selective which sales he scrutinises, and those he does check he only gives a cursory glance. He knows it is best to avoid any sales linked to the monthly ‘product push’. As a Manager his work is not subject to Quality Assurance (QA).

It is natural for any business to want to incentivise its staff to sell, however the risks inherent with the examples above, coupled with a lack of strong internal control, have not been managed. This may result in unethical behaviour by some staff where a culture of ‘nobody is being hurt’ and perhaps more importantly, ‘nobody seems to be looking’ becomes pervasive – a slippery slope then follows.

What next?

For firms with new and existing products and services, there is little time left to comply with the approaching deadline at the end of July, however it’s never too late to take the first step on any journey.

As previously intimated, much has been published on this topic, and this gives firms a useful advantage when seeking to identify existing scheme arrangements which may increase the risk of customer harm. Such examples are:

• 100% variable pay, e.g., commission with no basic salary
• Commission payments which potentially introduce Product Bias into the sales process.
• Incentives linked to the terms of finance e.g., where there is a direct link between the commission earned and terms such as the amount borrowed or interest rate
• Variable salaries that can increase or decrease based on sales made
• Promotions linked to sales targets with significant salary and commission potential available at the next level
• Competitions or promotions
• Schemes that are linked to team performance
• Performance measurement scorecards that are overly focused on sales volume with insufficient attention (or corrective action) given to unsuitable sales, poor results of QA testing or individual/team complaint levels.

The above is not an exhaustive list.

Controls around performance oversight should also be considered. For example, in the Lloyds TSB case noted earlier, the FCA found that managers that were responsible for ensuring good practice of sales staff also had their own performance linked to sales targets – creating a clear conflict of interest that required careful management.

For firms that haven’t done so already it is suggested that a review is prioritised to identify risks arising from any and all current schemes, processes and practices.

Once this is done the firm can assess the risk posed, using factors such as the likelihood of harm occurring and the impact (on customers) as yardsticks. Controls should already be in place to manage any risks, however where they are not, they should be implemented as soon as possible.

Examples of such controls may be:

• Training to ensure staff have the appropriate skills and knowledge around sales processes and practices.
• Clear policies, procedures and supporting guidance, with examples of good and poor practice
• Inclusion of preventative controls to limit which staff can carry out certain tasks and introduce multiple level review and approval for higher-risk sales.
• Embed local level regular monitoring to ensure that staff are following processes and procedures and that any recurring ‘offenders’ are dealt with.
• Identification and management of conflicts of interest which may increase the risk of poor behaviours by sales staff e.g., product bias linked to commission or incentives.

Monitoring is also an important control mechanism, so ensure colleagues in Risk, Compliance and (if present) Internal Audit are on-board with this regulatory hot-potato and that any monitoring undertaken can evidence whether good outcomes are being achieved for customers, taking into consideration the behaviour of incentivised staff.

?How can we help?

The Consumer Duty may be the last opportunity for firms to get their house in order when it comes to the potential behavioural risk caused by incentivisation schemes. Firms should use the wide range of information and examples provided by the FCA through its regulatory work to assess, measure and, if necessary, re-design, schemes or frameworks.

We have extensive experience working with clients to review scheme details, identifying risks and evaluating the design and effectiveness of controls. Our regulatory health check tool can help your firm demonstrate it is taking positive steps to ensure that staff incentivisation schemes do not led to potential or actual customer detriment.

Please reach out to either myself or Sebastien Petsas for a conversation on #conductrisk , #consumerduty or #incentiverisks