Posted: 13th May 2013

This is an abridged version of Paul Scott’s speech given at the BBA Financial incentive briefing 16th April 2013. Paul Scott is the director of Advisory Services at Huntswood.

In its financial incentives paper, the Financial Services Authority (FSA) found that many firms did not properly identify how their incentive schemes might encourage staff to mis-sell. The regulator even went as far as to say that firms had not sufficiently thought about the risks or turned a blind eye. The Financial Conduct Authority (FCA) requires firms to fully consider if their incentive schemes increase the risk of mis-selling and make changes accordingly.

The FCA’s position in relation to incentives and mis-selling is clear: incentivising staff to sell is not in itself a bad thing. Incentive schemes become problematic when they increase the risk of mis-selling. If firms assess their schemes and draw this conclusion, the schemes should be removed. Firms should consider all incentive risks arising in the light of their risk appetite – and the regulator’s – and manage and monitor that risk.

The regulator’s definition of mis-selling is interesting because, in the now FCA handbook – COBs, ICOBS, MCOB – there is no rule requiring a firm to demonstrate understanding by the customer. There are plenty of rules in relation to the suitability of advice, providing clear, fair and not misleading information and explaining the inherent risks, but that is a very different test to demonstrating customer understanding.

Demonstrating customer understanding is a real challenge for firms, particularly given the asymmetry of information between financial services staff and the general public. In our engagements with firms, and the resulting customer contact, we are often reminded how financially unsophisticated customers are.

The answer to the many challenges of financial incentives is to develop an outcomes focused customer contact quality assurance (QA) framework across all product and advice channels. This is necessary because customer risks arise throughout the customer journey or sales lifecycle and result in a firm achieving an outcome for customers which is, or could be, detrimental to them.

From Huntswood’s perspective outcomes testing is about engaging your customers post-sale. This activity is often performed in addition to routine fact find checking as a means of verifying the information recorded in the fact find, to ensure that the customer understands their attitude to risk and the product(s) recommended have resulted in a fair customer outcome. We would expect this to be achieved through a combination of desk based file reviews and actual telephone conversations with customers. Typically, post-sale customer outcome testing sits within the first line of defence, with oversight and assurance provided by the second and third lines of defence.

The primary purpose of post-sale outcomes testing is to gain assurance that regulated sales are being handled fairly and consistently, ensuring the right outcomes for customers. Outcomes testing must consist of sufficient activity to provide reasonable assurance that regulated sales have been handled appropriately and should reflect the risks which are inherent in different types of products and channels. A risk based approach is fundamental to successfully implementing outcomes testing.

As regulated firms, you need to consider whether your incentive schemes increase the risk of mis-selling and review whether the governance and controls aligned to these risks are adequate. Reliance on routine monitoring is not sufficient. There’s only one way to know whether your financial incentive schemes are producing good outcomes for customers: that’s by testing those outcomes effectively.