Scan the Horizon

Banks in the UK have been forced to weather a tropical storm of regulation and process changes in recent years. Handling this deluge requires a fresh approach to compliance issues, as Martin Turner, Group Compliance and Operational Risk Director at Lloyds TSB Group tells Nigel Ash.

In the view of some in the industry, a number of the regulatory and process changes introduced to the UK in recent months have not been fully thought through and the surge is far from over. Handling this often ambiguous, sometimes contradictory and not infrequently overlapping regulation requires a new approach to compliance issues, according to Martin Turner, Group Compliance and Operational Risk Director at Lloyds TSB Group.

‘You feel there is so much coming at you that, potentially, you can find yourself on the back foot and just coping. You really have to get through that and get on the front foot.’ he says. Organisations should have effective scanning mechanisms and be able to find out what is going on and what fresh regulatory initiatives are coming down the pipeline. In addition, he believes: ‘You have probably got to recognise that, while you get sent a lot of consultation papers, you have to be selective in terms of those you actually focus your time on.’ Nor does he think it is adequate to merely always respond to the questions asked in these papers. ‘You have to be prepared to say: “No, you are missing the point. This is the debate you should be having.” It is this approach that stops organisations from merely coping with regulatory change and puts them more on a front foot.’

Regulatory and compliance issues that have hit the UK recently include Basel II, MiFID, SEPA, the Third Money Laundering Directive, the FSA’s ICOB review and the Consumer Credit Act. Yet, counter-intuitively, the mass of new rules and regulations has seen a reduction rather than an expansion in the size of Turner’s team.

‘Because of normal commercial pressures, compliance and operational risk functions have reduced in size, within this organisation and others, so you are dealing with increased complexity with reduced numbers of people. In response, the team has been reconfigured and I would say that we have sought to recruit better quality people.’

Be aware
What makes this possible he explains, is a greater awareness, understanding and accountability within the business lines on regulatory compliance and other operational risk issues.

‘So, you are actually facilitating a model where a lot of the work, decision-making and accountability sits with the business. It is the people in the business lines who should be making those calls. In the old days of regulatory compliance, the caricature was that you had a set of rules and then you had someone from compliance who listed them, took them to the business no choice. I am going to come back in six months and tick back against them.” This was not necessarily a value adding role.

‘In today’s environment, you have a mix of rules and principles-based regulation, so what you need is someone with facilitation skills within the compliance team to go out to the business and say: “Here is some regulation coming down the pipeline, these are the outcomes that are good for customers, good for the business and should meet regulatory objectives. In the context of your business plans and aspirations, what are the options open to you to achieve these outcomes? Let’s discuss and develop the options, let’s look at the risk profile associated with each option and let’s discuss which option to pursue.” This is a totally different process, which requires totally different people. What you are doing is ensuring that the accountability, thinking and decision-making sits with the business.’

Turner says that this process can mean that different business units within Lloyds TSB deal with the same issue in different ways. ‘That is perfectly legitimate. So, clearly, you can allow differences within the group, just as you can allow differences between firms. The key role that we do have at the group centre with any new regulation is to debate where we need a consistent group-wide standard and where it is all right to have these differences. That is a debate you have to have up front with the business, before you decide how to implement against a particular regulation.’

It is Turner’s view that there can be a consistency issue with different regulators, which throws up ambiguities. Such challenges he says, must be addressed with the regulators, either directly through compliance and risk teams or through industry bodies like the British Bankers’ Association (BBA), the Association of British Insurers (ABI), or both.

‘One of the things that stands out for us is that, because of the consumer agenda, the word “fair” is used a lot but there is no common agreed standard between the regulators as to what fair actually is. So, each of the regulators has their own interpretation of the word and that makes things difficult. Then, to compound that, the Financial Ombudsman’s service can say retrospectively, what it thinks is fair, and is not necessarily bound by precedents or legal judgements.’

It’s the principle of the thing
Principles-based regulation carries its challenges. ‘It’s a lovely seductive phrase, everybody will nod sagely. However, in practice, principles-based regulation produces a much more complex and demanding world, for the regulator and for firms, and we have to cope with that. In many ways, it is just adding an additional layer to the regulatory landscape, because a firm like this has to take the principle and has to spend time and money working out what it means for its businesses, laying down standards. This is because, at the end of the day, we are in a volume business and have many thousands of front-line sales staff. You cannot give them a set of principles. For example, you have to ensure that they operate according to a set of defined processes, supported by IT, that are compliant from the point of view of selling regulated products.

‘What is more, for all those decisions we have taken in terms of achieving the outcomes laid down in the principles-based regulations, we not only have to have the debate; we have to evidence and document the debate and ensure that it is archived for future inspection at any time, either internally or by the regulator. What is considered acceptable against a set of principles, can change over time.

‘You could find yourself in breach of regulations when what you did at the time was perfectly acceptable. So there is a real risk of retrospection as well as the burden of additional activity. That has led to a requirement to up-skill the compliance and risk teams within firms and it also leads to a requirement to up-skill the regulators’.

Accountability
The issues of ambiguity, overlap and lack of consistency across regulators need to be addressed says Turner. Clarity on the accountability of the regulators is also necessary.

‘There is a need for some overarching governance, for proper oversight of activities of various regulators’. Just as importantly, in Turner’s opinion, is an acknowledgement on the part of regulators that, not only do product providers have responsibilities, but consumers do as well.

‘There needs to be an acknowledgement that people do lose money, investments do go down as well as up. You cannot have a regime where everybody is protected and you have a compensation culture if something goes the wrong way. People have an accountability to choose where they invest their money or buy insurance.’

The key issue for Turner is treating customers fairly ‘That’s what you do as a large retail organisation that is dependent on customer loyalty for its future. Although there are responsibilities for a product provider like Lloyds TSB, there are also responsibilities on the part of the consumer. If there is an issue that the consumer does not understand, then you need to educate the consumer and the industry can play a part in that. But it is only one component alongside education, by schools and by government, and straightforward common sense. But, if through government action people think they are always going to be indemnified against their own risk decisions, then that is not encouraging the right balance of responsibilities between the product provider and the consumer.’

Within his compliance and operational risk team, Turner has people scanning the horizon for possible regulatory changes. ‘We have to take a long term and a short term view. We are monitoring regulatory communications, even down to the speeches and press releases, because if you have principles-based regulation then you cannot just read the rule book. You have to take note of every single communication, however formal or informal, in order to understand how people are thinking and interpreting the principles’.

‘Things that we have looked at this year would revolve around future trends in financial crime and future evolution of delivery channels such as Second Life on the internet. If that is how people are going to operate in the future, how will regulation adapt to those new channels?

‘And then, if you look further out in terms of horizon risk, we have a separate public policy unit within the group and it is in discussions with UK and EU government and opposition, trying to understand where government’s mind is, at any one time – how the ideas governments are discussing might later pop up in legislation or regulation’.

A European consensus?
Reading the regulatory runes in Europe is, says Turner, another issue. ‘The aspiration is a level playing field and uniformity across the EU, but you don’t see it in practice.

Thus, the approach to implementation, whether it is Basel or MiFID is different in different European states. That is probably understandable and will probably take many decades to resolve.’

Did Turner’s horizonscanning team anticipate the run on Northern Rock? ‘We didn’t have that particular scenario but we do model for economic and market events irrespective of the trigger. It has brought out the risk profile of different business models’ he says, ‘but since it has happened, now is the time to promote a wider debate on the future shape or regulation, particularly for the retail market. That is broader than the publication of the consultation paper on deposit protection.’

‘The main issue is ensuring that you have an adequately working tripartite arrangement (between the Bank of England, the Financial Services Authority and the Treasury) that is picking up the issues early and ensuring that they are resolved well before they get into the public domain. With Northern Rock the questions are, were there signals there and how were they acted on?’

Lessons need to be learnt. ‘I don’t have an issue with the tripartite arrangement but there needs to be a better understanding of respective accountabilities and how the three act in a co-ordinated way. In this way, problems can be addressed and resolved at an earlier stage.’

Martin Turner

Martin Turner is group compliance and operational risk director for Lloyds TSB, with accountability for the full spectrum of operational risk oversight. This includes regulatory and legal risk and for driving the current programme of activity to enhance the approach to operational risk across the group where Lloyds TSB have been successful in securing AMA status. Prior to joining Lloyds TSB, Turner worked with Barclays holding a number of senior roles in change management, strategy and planning, service delivery and, more recently, risk director for Barclays Group’s IT and operations shared services division.