On 23 November, the FCA published a report on the compliance function in wholesale banks. In January this year, the FCA sent a questionnaire to 22 wholesale banks asking for information about their compliance function. The firms included large global banks operating across several business lines, medium-sized firms that focus more on specific geographies, and firms with a less significant UK footprint. The range of firms surveyed was broad, as illustrated by responses to the FCA’s question on the number of revenue-generating front-office roles in wholesale banking businesses: figures ranged between two and 3,115.
The FCA report highlights the evolving role of compliance, and where further change is likely to be observed. Its publication is timely, given ESMA’s more recent review into National Competent Authorities’ approaches to reviews of compliance functions. While the FCA makes clear that firms are not expected to take specific action, its findings will likely inform its approach to assessing the effectiveness of the compliance function, and Senior Managers associated with its operation and oversight.
The FCA has included ten questions which the Board and Senior Management may like to consider, covering topics including Board and governance responsibility in relation to the compliance function strategy; support and resources of the compliance function; and the ownership of conduct risks (see Appendix for full list of questions). Together with the supervisory observations set out in the report, these provide a key indication of FCA expectations and will likely be tested through interactions with those carrying out a Senior Management Function, and ongoing supervisory engagement.
Below, we set out some key themes from the questionnaire responses, the FCA’s supervisory observations, and what the implications are for firms.
Summary of key themes from questionnaire responses and FCA supervisory observations
The themes set out are familiar, but it is certainly useful for firms to have them drawn together in one document. Moreover, the report highlights important issues, including how pervasive the technology challenges and opportunities are, while indicating that most compliance functions are at an early stage of tackling them.
- The report found that the compliance function is moving towards a pure, independent second Line of Defence (LoD) risk function with a higher profile within firms. Firms noted that it was common for the Head of Compliance to report to the Chief Executive Officer (CEO); however, a number of firms reported one layer away from the CEO.
- Organisationally, some compliance functions were integrated with Operational Risk. One trend was the separation of financial crime from compliance into its own function, with separate reporting lines into Senior Management.
- Structurally, firms said they are seeking to clarify the shifting boundaries between the first and second LoD to help define the responsibilities of the compliance function with regard, for example, to financial crime. In defining their responsibilities, the FCA observed that compliance functions may benefit from considering how they interact with the other LoDs. It noted that compliance needs to ensure it adequately balances its role as advisor to the front line with its role of providing independent challenge.
- Furthermore, the FCA found that there is now more “checking the checker” activity, where compliance teams examine the effectiveness of the compliance function. The FCA stipulated that conflicts of interest need to be managed.
- The report found that compliance mandates – a key reference point for the function – are in general static, with few compliance heads intending to revisit them in the next three years.
- Mandates setting out what compliance seeks to achieve were in the minority. The following areas were, in general, excluded or under-emphasised in mandates: the provision of challenge, risk ownership, the role of compliance in creating and supporting culture, the sharing of second LoD responsibility with others (for example Risk, Financial Control, Legal), and interaction with the third LoD.
- Overall, the FCA found that there is room to reflect on whether the function could seek to deliver broader objectives and whether it would benefit from a more refined, longer-term strategy beyond the parameters of the annual compliance plan. It said that the absence of strategic goals raises questions about what the planned activity is in service of, other than regulatory adherence. The FCA noted that it did not see reference to longer-term planning initiatives for and by compliance functions, and that the high degree of attention to the annual planning cycle (through the Annual Compliance Plan) may inhibit longer-term planning by compliance functions.
- In terms of challenges, firms ranked regulatory change as the first or second most significant challenge for their compliance function, citing the volume, pace and complexity of new regulation. Challenges around staffing, as well as rapid, complex change coupled with target operating model change in a fast-moving political environment, were also highlighted. Some firms also reported a strong sense of heightened exposure between existing and required staff skills.
- While most firms indicated a need to adapt to future investment in front-office technology by significantly upskilling their compliance staff through hiring and/or training, the survey responses revealed certain challenges in hiring staff as well as gaps in the retention of data on target headcounts. Firms reported consistent growth of compliance functions, with the majority of target headcounts increasing across 2015-2017 (the period of the FCA’s survey). However, responses showed that firms have also been struggling to fill these expanding departments and most operated under headcount for 2015 and 2016. Moreover, not all firms were able to provide information on target and actual FTE and experience: the FCA said it was surprised that a minority of firms were unable to provide particular elements such as target headcount, either for management reasons or because they did not retain the data. In our view, firms should consider the ways in which the data associated with compliance resourcing requirements are compiled and retained in their organisations, as this data will likely inform any longer-term, strategic planning for their compliance functions.
- Firms indicated that advances in technology require compliance functions to engage in system development at an early stage not only to advise and assess risk but also to leverage any opportunity to enhance the delivery of their own “compliance” objectives (e.g. through the design of new controls).
- Investment in surveillance systems and additional personnel were identified by firms as an enabler of better compliance. Several firms saw an opportunity for enhanced data analytics and visualisation, but noted the risks of data quality, data security and cyber crime. Firms believed this risk increased with the use of online storage and cloud solutions. This was followed closely by the challenge of staying abreast with rapid market developments and retaining adequate controls over complex and fast-moving new businesses, products or processes.
- The FCA echoed firms’ views, observing that while technology offers the potential for improved efficiencies, the pitfalls and risks of a technology-based function must be considered, for example, the need for appropriately skilled personnel.
Implications for firms
Although the findings of the exercise have not been expressed as Guidance, the report provides a blueprint for future challenge that compliance functions of wholesale banks can expect from the regulator. Furthermore, there may be read across to other firms, including those operating in retail markets. The Board and Senior Management teams of firms which did not receive the questionnaire may decide to ask their compliance teams to review the questionnaire findings to benchmark themselves against the results of the survey, thereby helping them to prepare for any future FCA questioning in this area.
When assessing the results of the questionnaire, firms should, in particular, note the FCA observations on compliance functions benefitting from a more forward-looking and strategic approach beyond Annual Compliance Plans; recognising the need for compliance to be embedded in Board decision-making processes; taking account of the rise of technological developments; and acknowledging the expanded skill sets needed by compliance staff.
Furthermore, the ten questions set out in the report should be considered by Board and Senior Management, as the issues which have been flagged – as well as the supervisory observations set out in the report – are likely to be discussed in ongoing engagement meetings. In particular, the Board should ensure visibility of the long-term strategy of the compliance function and consider whether sufficient support and resourcing have been allocated to meet these objectives (see question 1 and 2 in Appendix below). It would be prudent for individuals seeking approval under the Senior Managers & Certification Regime to consider these issues as the FCA will be looking for candidates to demonstrate in interviews their appreciation of strategic thinking, and a commitment to embedding good practices.
FCA’s ten questions for Boards and Senior Management to consider
- Do boards and Senior Management committees have sufficient visibility and oversight of the longer-term goals and strategies of compliance functions and their delivery?
- Has the compliance function been given adequate support and resources to conduct sufficient strategic thinking and effective planning in light of the changes to the operating environment?
- Do compliance functions strike the right balance between management and ownership of risk, and assessing the efficacy of the risk management efforts of the first LoD while also balancing their perceived role as adviser and key provider of challenge?
- Has adequate consideration been given to the changing mix of risk ownership and responsibility in the LoD model, and how a compliance function best fits into it?
- Has adequate consideration been given to the possibility of convergence or overlap between the activities and responsibilities of the compliance function and internal audit?
- Is the compliance function adequately aware and taking sufficient ownership of the conduct risks that can arise within it?
- Are compliance functions resourced appropriately, having regard to any changes in the mandate and operating model of compliance and the activities of the firm?
- Is there a medium term (3-5 year) strategy in place to address the growing skills gap for more specialised or senior compliance roles?
- Is the compliance function adequately engaged in the development of technology solutions across the firm?
- Is the compliance function considering whether the development of technology solutions offers it opportunities to enhance the delivery of its mandate?
The FCA notes that this is not an exhaustive list, and when considering the evolving role of the compliance function, Boards and Senior Managers may wish to consider more firm-specific questions based on the themes and survey responses.