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Risks arising from incentives and remuneration: what should firms do?

FCA has published draft handbook rules and non-handbook guidance for consumer credit firms on managing the risks posed by incentives and remuneration.

This applies not just to firms engaged in consumer credit activities but also to firms selling goods or providing services financed with credit, for which they are brokers.
Broadly the requirement is for all firms to have procedures to identify the risks posed by their remuneration policies and to effectively manage those risks.

The proposed rule specifically references the risk as being that the firm fails to comply with its obligations under the regulatory system, so this is a 'compliance' problem.

The policies and procedures to detect and manage the risk must be 'adequate' and proportionate to the nature, scale and complexity of the firm's business and the range of financial services and activities it undertakes.

The non-handbook guidance is interesting in addressing both how to risk assess the incentive scheme and a number of the measures required for adequate procedures.

What to look for in risk assessing your scheme?

The FCA has identified the following practices as tending to drive the 'wrong' sort of behaviour:

  • Focussing on the numbers at the expense of the customer outcome or the quality of the sale.  This applies to any direct metric; whether value or volume of sales, product profit or call handling time or number of calls processed.  This type of approach is particularly ill-suited if there may be vulnerable customers in the population.
  • Pay that is fully incentivised (ie variable) with no basic pay.  This puts staff under pressure to achieve minimum sales targets at any cost, particularly if they have missed out on a target or threshold.  Paying a basic salary doesn't entirely mitigate the risk.
  • Targets can create significant risk, where one single sale can determine whether a bonus is paid.  Loading of commission as in a 'retrospective accelerator' (where commission rates are increased retrospectively if a target is reached) is another practice that puts staff under undue pressure.  Similarly, stepped commission arrangements can create pinch points towards the end of bonus periods.

From the perspective of the product, the FCA alerts firms to schemes that are skewed in favour of the more profitable products or that reward high borrowing by the customer.

The regulator found examples of staff being able to control the interest rate being offered and incentivised accordingly.

Such schemes can be at the expense of the customer, encouraging potentially unaffordable levels of indebtedness,  and being unlikely to embed a 'TCF' culture.
In the case of retailers of high value goods, where commission on the sale of the goods is usual, the FCA highlights schemes that only reward sales that are on finance.  In another example of regulatory standards being applied to unregulated activity, the regulator further highlights the risks to the customer created by the approach to commission setting either in relation to the finance, or the goods themselves.

The regulator's review however went wider, spotlighting the risks posed by many types of arrangement, ranging from quarterly targets with salary reviews, to team score boards, or cash prizes for high performers.  

The FCA is bringing to this sector a message that is very familiar to other sectors – that commissions alone are risky and that "balanced score cards" that measure quality of sales and customer outcomes are essential.

Mitigating the Risk

The FCA has provided guidance on how risks such as these could be mitigated, including some good and poor practice points.  The guidance is detailed but key points are:

  • Monitor and measure the quality of the customer facing service, including measures relating to regulatory requirements that can be enforced through withdrawal of some, or all, of the bonus.  A key point here is to get the thresholds and the penalties, right to drive good behaviour; claw back needs to be used if there is a time lag between sales measures and identifying poor outcomes.
  • For monitoring to be effective the sampling needs to be significant, risk-based and timed to identify high risk 'windows' in the incentive scheme, eg. close to deadlines for achieving targets.
  • Where there is a face to face interaction with the customer, this causes particular difficulties that could be overcome with mystery shopping or recording of conversations (with appropriate consents).
  • Management need targeted, insightful management information to know what to look for; for example 'heros or zeros' who have sold very high value retail or finance products, or are close to, or are repeatedly failing to meet targets.
  • The oversight needs to be independent and the decision makers need to be free of any conflict through their role or any bonus scheme they may participate in.

Next Steps

Although many firms will have looked at their staff incentives in preparation for authorisation, this is still a high risk area for this sector.

Of the 25 firms where the FCA carried out a "high-risk" assessment, the overwhelming majority were considered at risk of customer detriment with inadequate control frameworks.  

As a minimum every firm should risk assess its incentives scheme and consider how it could be improved to reduce the highest risks.

For more information contact Emily Benson.

This publication is intended for general guidance and represents our understanding of the relevant law and practice as at July 2017. Specific advice should be sought for specific cases. For more information see our terms & conditions.

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