Jointly authored by financial crime and compliance specialists Nic Hull and Jason Merritt, our new four-part series explores why firms need to stay focused on compliance. This second piece explores the complex judgements firms need to make about matters way beyond finance to ensure they are truly compliant.
There are many complex factors that buy and sell side firms need to consider before embarking on any compliance programme for control oversight and surveillance. Chief among these are context and conditions: the business operations, asset classes and business lines in the context of the countries or regions where they operate, and the terms and conditions of how they trade and the regulations that therefore apply.
Authors Nic Hull (left) and Jason Merritt (right)
Crucially, firms should not ignore the Financial Conduct Authority (FCA)’s Market Abuse Regulation (MAR) and its “attempted manipulation” criteria. Just because a firm may not have direct membership of a venue, it doesn’t mean that their clients or traders couldn’t ‘attempt’ to spoof the market.
By identifying all the relevant factors, a firm can then define and attribute risk ratings to each behaviour, and/or identify new behaviours which are not explicitly called out in Annex II. Proactive firms will go beyond this and consider the broader picture, including whether a review should also cover other crucial areas such as:
- communications surveillance
- conduct
- culture
- ESG
Taking a broad view is prudent and timely: regulators worldwide are already introducing very different metrics to monitor management conduct and culture. The UK’s Senior Manager & Certification Regime (SM&CR) and Australia’s Banking Executive Accountability Regime (BEAR) are two perfect examples. Both focus on ethics, morals and a transparent approach to remuneration and bonuses. If you can show your investors and clients that your bonus payments are dependent on a system which includes much more than revenue generation alone, then your firm is much more likely to be viewed as ethical not simply to existing and new investors, but also to your current and potential staff, giving you the benefits of enhanced retention and attraction, particularly in terms of appealing to next generation talent.
But there are also differences between buy and sell side – particularly when it comes to ESG.
While the buy side tries to define exactly what is an ‘environmental’ or ‘green’ investment, the sell side is struggling with the societal and governance issues. For example:
- Wind turbines are seen as ‘green’ yet can be highly divisive in the local communities in which they are based; who benefits – and who defines the ‘societal’ good?
- How do you assess firms with diversified portfolios, if these include investments in both renewables sitting alongside assets in gas and coal?
- How far has the conflict in Ukraine affected ethical judgements around investing in defence suppliers and arms manufacturers?
And then we have the ‘aspirational’ aspect, which is often based on partial progress towards some future state. Can a firm be classified as a ‘green’ investment if it’s intending to:
- switch from X% to Y% green energy – and who decides what should those figures be?
- reduce their use of oil and move to Z% plant-based plastics – is only a total change good enough?
- increase the volume of recyclable packing from 30% recyclable to 60% – and can they stop there or must they aim higher?
Once the criteria are determined, the next logical step is to determine how firms monitor for compliance. The sheer scale of data available in trade surveillance systems then incorporating these controls can drive the evolution of their automated solutions.
As things stand, these judgements are opaque, but we expect the FCA’s CP22/20 “Sustainability Disclosure Requirements (SDR) and investment labels” to clarify these issues for all stakeholders and the industry at large.
How can we help?
We work with firms worldwide to help them turn the regulatory requirement to review risks annually into an opportunity to replace poor technology with newer systems, reduce costs and improve efficiency – as well as keeping the regulators on side. If you’d like to discuss any of the issues covered above, or find out more about our wider expertise in financial crime and compliance, please contact us.
Read more in this series
