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In the past few years, the FCA has shown its determination to ensure that firms embed a culture where good outcomes for consumers are central, as evidenced by the consumer duty.
Enforcement action also shows that management policies and practices, including pay and benefits, are seen as critical to doing so by the regulator. Nonetheless, we have seen firms fall short of expectations.
Staff need to act in good faith, which means conduct that is honest, fair, open and takes account of the customer’s interest. Company culture should support staff to act in this way, and not reward them for doing otherwise.
Where the FCA has found poor remuneration practices, it has acted. In 2013, Lloyds banking group was fined just over £28mn for serious weaknesses in its controls. The FCA’s report found incentive schemes that created a serious risk of staff being put under pressure to hit targets to get a bonus or avoid being demoted.
Financial advisers’ incentive schemes meant they could increase their salaries by selling products to customers, leading to concerns they were failing to focus on what consumers actually needed or wanted.
The introduction of the consumer duty puts a new emphasis on remuneration, as firms need to think abut how they can align the duty’s consumer outcomes with the incentives created by their remuneration practices. How staff are rewarded can be a key contributor to compliance with the duty, or, if poorly handled, a risk that leads to consumers suffering poor outcomes.
Focusing on good consumer outcomes means avoiding mis-selling, aggressive sales practices, or inappropriate pricing structures. Remuneration is a key lever available to managers to prevent this.
Red flags
We have seen complex incentive schemes where the impacts were not fully understood by the firm. This won’t cut it under the consumer duty. Management needs to ensure that it tests properly how the structure of its incentives might play out in practice.
Testing certain scenarios is a helpful way to pick out weaknesses, and can help inform any changes that need to be made to risk control frameworks. Certain structures will be an immediate red flag to the regulator. For instance, the FCA will be wary of remuneration based on sales numbers. Structures that give a disproportionate reward for marginal sales, where meeting a certain target triggers a large increase in earnings, will be seen as especially suspect. These do not encourage staff to act in the best interests of consumers, but instead to pursue as many sales as possible, whether appropriate or not.
Add-ons for successful cross selling will likely come in for similar scrutiny, as they do not encourage the seller to consider whether additional products are necessary or even desirable for the consumer.
The FCA is also looking out for incentive structures that create inappropriate biases towards certain products. Rewarding the sales of add-on products can create the risk of poor conduct and inappropriate sales.
Deterrents for poor behaviour
Firms need to ensure that their remuneration practices contain sufficient deterrents to penalise poor behaviour. Bonus measurements should go beyond sales numbers, and reflect whether customers have been treated fairly.
Metrics such as customer satisfaction, cancellation rates, complaints and the mix of products sold can all be helpful in determining the quality of sales made. This needs to be calibrated carefully, as a customer being treated fairly and a customer being satisfied are not always the same thing.
Firms can also implement specific measures that mitigate against incentivising poor behaviour. Clawbacks, where bonuses can be withdrawn in certain circumstances, like a customer cancelling a service, can be a powerful disincentive for mis-selling. Firms should monitor clawback levels closely, in particular the reason for cancellation, as this can provide insights on what is going wrong.
Capital decreasing incentives, where bonuses are capped or reduced beyond a certain sales volume, reduces the risk that sales staff will be tempted to rush a number of sales to hit targets before a certain date.
With regulators increasingly focused on ensuring that firms act in the interests of their consumers, misaligned incentive schemes are a clear hazard and firms will be picked up on their failures. The challenge for some firms will be to move from a system that rewards sales volumes, towards something that takes a more holistic view of sales quality.
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