Firm culture is central to identifying conflicts of interest
The FSA saw a strong correlation between a firm’s culture and its ability to recognise conflicts of interest. At some firms, the management was aware of the possibility of conflicts and trained staff to look for and report them. Formal checks within product development and change management processes forced the firm to consider whether new activities created new conflicts or undermined the mitigation of pre-existing conflicts. Other good practice included firms conducting periodic reviews of operations to look for evidence of new conflicts, using discussions involving operations staff (who understand how processes actually work) and legal and compliance staff (who facilitate discussions and often have a better understanding of how conflicts arise). This ‘bottom-up’ approach to identifying conflicts is in addition to separately considering the inherent conflicts that most asset managers face.
The best control frameworks were designed jointly by business and compliance functions
The regulator found that firms achieved better controls and standards when both business line management and second line teams – such as the legal or the compliance department – designed conflicts management controls. Firms doing so tended to have standards that were relevant to the nature of the conflict, and were operationally effective and accepted by business staff. Many of these standards were also aligned to the regulator's expectations and good market practice.
Monitoring conflicts is more effective when conducted by both business and compliance functions
The FSA found that the most effective monitoring of conflicts of interest involved separate reviews by both business line management and compliance staff. Firms that relied on monitoring performed by the compliance department as the only form of control over conflicts were unable to demonstrate to us how compliance staff credibly challenged investment and trading decisions made by senior investment professionals.
Monitoring conflicts is more effective when boards receive adequate management information
The regulator found that some firms had developed sophisticated monitoring programmes, based on automated management information (MI). Review work didn’t just consist of routinely checking specific procedures; it also looked at whether controls continue to meet their objectives and whether compliance standards used to manage conflicts reflect developments in market practices and new regulations. The regulator found that the highest standards resulted from reviews performed by a governance committee or working group involving independent business staff, rather than by compliance staff in isolation. An example of such an approach working well is the review of broker usage and brokerage commissions.
Conflicts were better managed when UK boards had committees dedicated to conflicts of interest management
The FSA found that only a small number of firms had an effective governance committee to ensure that the firm’s appetite for reputational risk was reflected in the design of new controls and standards. Such governance bodies challenged and approved conflict identification and controls design work undertaken by others, defined the MI they wished to receive and reviewed the implications of materials presented to them. The best example was a committee chaired by an effective, independent non-executive director, which provided a forum for legal and compliance teams and those with day-to-day responsibility for operating the firm’s conflicts practices. The regulator found that such committees could demonstrate a positive influence on the firm’s arrangements for managing conflicts of interest and improve the firm’s culture of serving customers’ best interests.
The regulator saw evidence that firms operating as UK subsidiaries of overseas parents had governance arrangements that did not meet its requirements regarding conflicts management. In some cases, UK boards did not exercise meaningful control and overseas staff who are not Approved Persons were making decisions on core practices. In other firms, there was a blurring of responsibilities between the UK Board and its committees and those of the overseas parent. The result was that the board of the FSA-authorised firm did not take overall responsibility for compliance with the regulator's rules.
© FSA - Financial Services Authority
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