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THE SEVEN KEY CHALLENGES OF CONDUCT RISK MANAGEMENT

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Andrew Smart

With the creation of the Financial Conduct Authority (FCA) and the rise of ‘conduct risk management’ up the agendas of board and executive teams across the financial service industry, there are many who are asking the question; what is ‘conduct risk’ and what does it mean for my organisation? writes Andrew Smart, CEO of StratexSystems.

Andrew Smart

Andrew Smart

Conduct risk is the risk that the conduct of a regulated firm will jeopardise the FCA’s ability to achieve its objective, which is ‘to make relevant markets work well so consumers get a fair deal’. This objective is supported by three broad outcomes that the FCA wants to achieve. These include:

  1. consumers get financial services and products that meet their needs, from firms they can trust;
  2. markets and financial systems are sound, stable and resilient, with transparent pricing information; and
  3. firms compete effectively, with the interests of their customers and the integrity of the market at the heart of how they run their business.

For a regulated firm, what does this really mean? I would argue that conduct risk is not simply another type of risk that needs to be ‘ticked off’ by the compliance team. Rather, we see conduct risk as a central part of enterprise risk management but more fundamentally, a core element of the firm’s approach to strategy.

To successfully deliver on the conduct risk agenda, we believe firms must start by asking themselves if they have defined a clear customer value proposition and whether that proposition is embedded into the firm’s business model and strategy.

Based on our experience working with clients across the financial services industry, we have identified seven key challenges of conduct risk management.

1. Managing and embedding Governance
Perhaps one of the biggest failings that has come to light in the financial services industry since the credit crunch has been the failure of governance within many firms. This was evident immediately after the credit crunch when the realisation dawned on the industry that boards and executives had agreed strategies and taken major business decisions without being fully informed or aware of the amount of risk they had committed the firm to taking. Ineffective board oversight, the ability to contest and other governance weaknesses have been identified as major contributory factors in the near total meltdown of the global financial services industry.

2. Definition of the Business Model
With the creation of the FCA, there is an increased focus on the firm’s business model and the importance of creating a business model that was based on ‘fair customer outcomes’. Given recent industry scandals such as the miss selling of PPI, the miss selling on interest default swaps and Libor, it is not surprising that the new regulator is going to be interested in a firm’s business model and the sustainability of that model without relying on unsafe sales practices or ‘fine print’ containing expected charges.

3. Definition and execution of the Strategy
A central tenet of the FCA’s approach to regulation is to ensure that firms put market integrity and the interests of customers at the heart of their business strategy. The Firm Systematic Framework (FSF) reinforces the emphasis, at the heart of which is the Business Model and Strategy Analysis (BMSA).

From a strategy perspective, the challenge that many financial services firms face is a relatively simple one: how do they embed the customer value proposition and consideration of customer outcomes into their business strategy? Additionally, how do they demonstrate to the FCA that they have put ‘the interest of the customer and market integrity at the heart of how the firm is run’?

4. Enabling and embedding Conduct Risk Management
With the creation of the FCA, there will be many executives and risk management professionals that take the view that conduct risk management will require a new set of processes and procedures, more resources etc. I take a different view. I believe that conduct risk management is best delivered as simply a part of the firm’s existing enterprise risk management (ERM) framework and process. This, of course, assumes that an existing ERM framework is in place, effective and embedded and it addresses key aspects of governance and strategy in an integrated way.

5. Process Management, specifically New Product Development, Sales and Post Sales aftercare
With the conduct risk agenda, the FCA is not only challenging regulated firms at the business model and strategy level to embed risk management, particularly the risk to customer outcomes. It is also challenging firms at the operational level, in particular focusing on sales operations, new product development and post sales aftercare.

6. Product level performance and risk management
One of the powers that the FCA has been granted which was not available to the FSA is the power to intervene early in the product development process and to challenge firms to ensure that all products deliver good customer outcomes. Additionally the FCA will be much quicker than the FSA in making public their investigations, or even their intentions to investigate a firm or a specific product.

7. Conduct incident reporting and analysis
With the FCA’s new powers and obvious determination to ensure that market integrity is maintained and customers receive good outcomes, it is going to be increasingly important that firms have in place a risk events process and technology solution which enables any event to be easily captured and managed through to resolution.

The Eighth Challenge
I have outlined seven key challenges that our clients have reported to us in relation to conduct risk management. These challenges are broad in scope and depth.

While these seven challenges are important and must be met, however, there is an eighth challenge that the FCA has laid down for regulated firms. This is a challenge that many have faced in one form or another over the years and have often failed to meet.

That challenge is how to bring together a whole raft of processes, people and data to create a culture that is focused on delivering customer outcomes just as much as it is focused on executing a trade or making a sale.

Shaping the culture of the firm is the real and most significant challenge that every firm regulated by the FCA is going to have to meet. This will require more than a technology solution to solve.

Business

Euro zone business activity shrank in January as lockdowns hit services

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Euro zone business activity shrank in January as lockdowns hit services 1

By Jonathan Cable

LONDON (Reuters) – Economic activity in the euro zone shrank markedly in January as lockdown restrictions to contain the coronavirus pandemic hit the bloc’s dominant service industry hard, a survey showed.

With hospitality and entertainment venues forced to remain closed across much of the continent the survey highlighted a sharp contraction in the services industry but also showed manufacturing remained strong as factories largely remained open.

IHS Markit’s flash composite PMI, seen as a good guide to economic health, fell further below the 50 mark separating growth from contraction to 47.5 in January from December’s 49.1. A Reuters poll had predicted a fall to 47.6.

“A double-dip recession for the euro zone economy is looking increasingly inevitable as tighter COVID-19 restrictions took a further toll on businesses in January,” said Chris Williamson, chief business economist at IHS Markit.

“Some encouragement comes from the downturn being less severe than in the spring of last year, reflecting the ongoing relative resilience of manufacturing, rising demand for exported goods and the lockdown measures having been less stringent on average than last year.”

The bloc’s economy was expected to grow 0.6% this quarter, a Reuters poll showed earlier this week, and will return to its pre-COVID-19 level within two years on hopes the rollout of vaccines will allow a return to some form of normality. [ECILT/EU]

A PMI covering the bloc’s dominant service industry dropped to 45.0 from 46.4, exceeding expectations in a Reuters poll that had predicted a steeper fall to 44.5 and still a long way from historic lows at the start of the pandemic.

With activity still in decline and restrictions likely to be in place for some time yet, services firms were forced to chop their charges. The output price index fell to 46.9 from 48.4, its lowest reading since June.

That will be disappointing for policymakers at the European Central Bank – who on Thursday left policy unchanged – as uncomfortably low inflation has been a thorn in the ECB’s side for years.

Factory activity remained strong and the manufacturing PMI held well above breakeven at 54.7, albeit weaker than December’s 55.2. The Reuters poll had predicted a drop to 54.5.

An index measuring output which feeds into the composite PMI fell to 54.5 from 56.3.

But despite strong demand factories again cut headcount, as they have every month since May 2019. The employment index fell to 48.9 from 49.2.

As immunisation programmes are being ramped up after a slow start in Europe optimism about the coming year remained strong. The composite future output index dipped to 63.6 from December’s near three-year high of 64.5.

“The roll out of vaccines has meanwhile helped sustain a strong degree of confidence about prospects for the year ahead, though the recent rise in virus case numbers has caused some pull-back in optimism,” Williamson said.

(Reporting by Jonathan Cable; Editing by Toby Chopra)

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Volkswagen’s profit halves, but deliveries recovering

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Volkswagen's profit halves, but deliveries recovering 2

BERLIN (Reuters) – Volkswagen reported a nearly 50% drop in its 2020 adjusted operating profit on Friday but said car deliveries had recovered strongly in the fourth quarter, lifting its shares.

The world’s largest carmaker said full-year operating profit, excluding costs related to its diesel emissions scandal, came in at 10 billion euros ($12.2 billion), compared with 19.3 billion in 2019.

Net cash flow at its automotive division was around 6 billion euros and car deliveries picked up towards the end of the year, the German group said in a statement.

“The deliveries to customers of the Volkswagen Group continued to recover strongly in the fourth quarter and even exceeded the deliveries of the third quarter 2020,” it said.

Volkswagen’s shares, which had been down as much as 2%, turned positive and were up 1.5% at 164.32 euros by 1158 GMT.

Sales at the automaker rose 1.7% in December, at a time when new car registrations in Europe dropped nearly 4%, data from the European Automobile Manufacturers’ Association showed.

Like its rivals, Volkswagen is facing several challenges due to the coronavirus pandemic as well as a global shortage of chips needed for production.

It also sees tough competition in developing electrified and self-driving cars. The merger of Fiat Chrysler and Peugeot-owner PSA to create the world’s fourth-biggest automaker Stellantis adds to the pressure.

Volkswagen said on Thursday it missed EU targets on carbon dioxide (CO2) emissions from its passenger car fleet last year and faces a fine of more than 100 million euros.

The group is expected to release detailed 2020 figures on March 16.

($1 = 0.8215 euros)

(Reporting by Kirsti Knolle; Editing by Maria Sheahan and Mark Potter)

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Global chip shortage hits China’s bitcoin mining sector

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Global chip shortage hits China's bitcoin mining sector 3

By Samuel Shen and Alun John

SHANGHAI/HONG KONG (Reuters) – A global chip shortage is choking the production of machines used to “mine” bitcoin, a sector dominated by China, sending prices of the computer equipment soaring as a surge in the cryptocurrency drives demand.

The scramble is pricing out smaller miners and accelerating an industry consolidation that could see deep-pocketed players, many outside China, profit from the bitcoin bull run.

Bitcoin mining is closely watched by traders and users of the world’s largest cryptocurrency, as the amount of bitcoin they make and sell into the market affects its supply and price.

Trading around $32,000 on Friday, bitcoin is down 20% from the record highs it struck two weeks ago but still up some 700% from its March low of $3,850.

“There are not enough chips to support the production of mining rigs,” said Alex Ao, vice president of Innosilicon, a chip designer and major provider of mining equipment.

Bitcoin miners use increasingly powerful, specially-designed computer equipment, or rigs, to verify bitcoin transactions in a process which produces newly minted bitcoins.

Taiwan Semiconductor Manufacturing Co and Samsung Electronics Co, the main producers of specially designed chips used in mining rigs, would also prioritise supplies to sectors such as consumer electronics, whose chip demand is seen as more stable, Ao said.

The global chip shortage is disrupting production across a global array of products, including automobiles, laptops and mobile phones. [L1N2JP2MY]

Mining’s profitability depends on bitcoin’s price, the cost of the electricity used to power the rig, the rig’s efficiency, and how much computing power is needed to mine a bitcoin.

Demand for rigs has boomed as bitcoin prices soared, said Gordon Chen, co-founder of cryptocurrency asset manager and miner GMR.

“When gold prices jump, you need more shovels. When milk prices rise, you want more cows.”

CONSOLIDATION

Lei Tong, managing director of financial services at Babel Finance, which lends to miners, said that “almost all major miners are scouring the market for rigs, and they are willing to pay high prices for second-hand machines.”

“Purchase volumes from North America have been huge, squeezing supply in China,” he said, adding that many miners are placing orders for products that can only be delivered in August and September.

Most of the products of Bitmain, one of the biggest rig makers in China, are sold out, according the company’s website.

A sales manager at Jiangsu Haifanxin Technology, a rig merchant, said prices on the second-hand market have jumped 50% to 60% over the past year, while prices of new equipment more than doubled. High-end, second-hand mining machines were quoted around $5,000.

“It’s natural if you look at how much bitcoin has risen,” said the manager, who identified himself on by his surname Li.

The cryptocurrency surge is affecting who is able to mine.

The increasing cost of investment is eliminating smaller players, said Raymond Yuan, founder of Atlas Mining, which owns one of China’s biggest mining business.

“Institutional investors benefit from both large scale and proficiency in management whereas retail investors who couldn’t keep up will be weeded out,” said Yuan, whose company has invested over $500 million in cryptocurrency mining and plans to keep investing heavily.

Many of the larger players growing their mining operations are based outside of China, often in North America and the Middle East, said Wayne Zhao, chief operating officer of crypto research company TokenInsight.

“China used to have low electricity costs as one core advantage, but as the bitcoin price rises now, that has gone,” he said.

Zhao said that while previously bitcoin mining in China used to account for as much as 80% of the world’s total, it now accounted for around 50%.

(Reporting by Samuel Shen and Alun John; Editing by Vidya Ranganathan and William Mallard)

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