Our analysis shows a picture of financial services regulators that are leaner, but more vigorous. Their smart, targeted approach to penalizing poor practice and misconduct will require a similar response from the industry.
Spending increases among the regulators appear to be moderated or reversed this year. Indeed, the FCA cut spending by 17% in the UK while a spending growth at the US Securities and Exchange Commission (SEC) was down to 8%. In Hong Kong, the Securities and Futures Commission (SFC) reduced its spending by more than half from 31% in 2013 to 13% in 2014.
Although it points to a slowdown in spending from 2013 to 2014, there has been a spike in the size of financial penalties, with particularly big increases in the average size of fines from 2013 to 2014: 272% increase at the FCA, 146% increase at the Financial Industry Regulatory Authority (FINRA), 135% increase at the US Commodity Futures Trading Commission (CFTC) and 50% increase at the SFC. Even more striking, from 2009 to 2014, the average financial penalty grew by 1815% at the FCA, 772% at the CFTC and 50% at the SEC.
The averages are clearly impacted by a relatively small number of big penalties (namely Libor and FX rate manipulation), but they are still representative of the trend towards more serious punishments for wrongdoing. New enforcement actions relating to such high-profile scandals will continue to be felt in future years. The industry must be wary, however, of the danger of firms “budgeting” for such massive fines and ultimately passing the costs onto shareholders and consumers. If this happens, the entire point of delivering severe sanctions will be lost.
The increase in average fine values, however, has not in every case equated to an increasing numbers of cases in 2014. Analysis shows that the number of enforcement actions grew only at the SEC (by about 10%); the FCA, CFTC and FINRA all saw a decline in the number of cases filed.
Combined with the rising level of fines, regulators seem to be concentrating on a small number of cases that are pursued aggressively to encourage the rest of the industry to comply. The evidence also suggests that regulators are particularly focused on cases of market integrity and consumer protection, although priorities vary by jurisdiction.
Whether spending growth accelerates again in coming years or not, however, our report also highlights two other trends are central to the regulators’ approach:
Increasing reliance on technology
With more and more trading being done electronically, regulatory attention continues to shift towards solutions that monitor vast numbers of transactions and data. This responsibility will be shared with the industry itself, as technological developments create both opportunities for firms, and greater expectations of them.
Holding individuals accountable
Regulators see this as a powerful deterrent, though their success in this respect is mixed. Actions against individuals accounted for a substantial portion of SEC and CFTC cases, but at the FCA the figure was notably low.
Over the next couple of years, we expect an increase in M&A as companies seek to take advantage of weakness in the sector. In the current climate, it is vital that businesses and owners take advice early to help maximize the number of options available.
It is dangerous to put too much weight on the findings from a single year, particularly given the difference between regulators and geographies. However, enough of a consistent regulatory approach can be discerned for some suggestions as to how the most successful firms will respond:
Invest in compliance and controls
Nine-figure and $1 billion+ fines and settlements remain rare, but they are not the aberration of a single year. Despite the risk of costs being passed to shareholders and a desire to hold individuals to account, prohibitively high fines are now a settled feature of the market. Investments in controls must increasingly reflect this, particularly around market abuse and consumer protection, but also taking into account regulators’ priorities in different regions.
Invest in technology
Investments in technology will continue to play a key role for both regulators and firms. Increasing numbers of suspicious transaction reports suggest firms’ capabilities are increasing, but so too are regulators’ expectations of how firms are monitoring themselves. As technology develops and resources become more limited, regulators cannot expect to keep up with developments in the marketplace. The reliance on the industry to police the market is only likely to grow.
Invest in people
As regulators increasingly focus on actions against individuals, they risk undermining the ability of firms to recruit appropriately skilled staff to fill key positions in the control framework. Compliance, internal audit and other control functions are valued highly, and firms need to continue to nurture internal talent in these areas. They must also ensure that responsibilities imposed by regulators reflect the organizational reality. In that sense, it is the duty of the Board to affect the institutional and cultural changes needed to support these functions in meeting compliance obligations.