“Risk and Regulations Outlook for 2017”

This paper examines the key trends facing Financial Services Risk and Regulations departments drawing on comment and opinion from leading professionals.

We explore the key themes affecting risk and regulations professionals at Financial Services institutions in the UK and globally – from Geo Political change, to the Capital and Liquidity agenda, to Conduct and Culture, Governance and Technology.

We find that in the backdrop of political, regulatory and technological change, professionals with strategic minds and expert skills will benefit the most (Figure 1). This paper also highlights the most valuable talent in 2017 to be found amongst Contractors with PHD’s and Masters of Quant Finance, Governance professionals with a holistic understanding of interlocking risk problems, Consultants with fungible change expertise and inspirational leaders with global mandates and superior, authentic management styles.



Introduction

For many, it seems, 2016 was a year to forget. Particularly for those of us in the Financial Services industry, the economic and political uncertainty that characterised the year have caused some unexpected complications to the broader risk and regulatory plan.

Financial Services businesses continue to face a range of challenges. Profitability remains tight, largely due to low interest rates and a sustained period of relatively low economic growth. Additionally, as we enter the eighth year of the post financial crisis era, significant uncertainty still surrounds the future form of risk and regulatory structures. Although regulators have been busy transforming the risk landscape with sizeable reforms and regulatory developments, much is still undecided, let alone implemented.

Change still dominates the agenda, with long standing business models, balance sheets, political frameworks and even economies susceptible to unprecedented alteration. Atop this wave of change, of course, is the introduction of new and disruptive technologies that appear to bring both efficient and digital opportunities alongside an inherent increase of cyber and IT risks.

The aim of this paper is thus to outline how 2017 will shape up in regards to the risk and regulations agenda, the impact of various scheduled changes, and projected challenges and opportunities for professionals and businesses.

Methodology

In December 2016 and January 2017, River Partnership surveyed 68 professionals in risk and regulatory leadership roles from our network in Financial Services institutions, management and strategy consultancies, law firms and the regulators (Figure 2).

Our teams threaded a series of questions into their workdays, setting out to gauge where the challenges lie ahead, what fundamental areas need to be addressed and where the future demand for skills and talent may be.

River Partnership consultants conducted interviews with professionals from Board, Executive and Partner level through to MD’s, Directors, VP’s and Senior Managers. Our FS network extends globally and participants included those based in London, Europe, the US and Asia Pacific.

Broadly, our methodology was to ask for expert opinion, thoughts and views on the risk and regulatory landscape. Compiling and synthesising this information, we drew upon analysis of existing research and data generated both from within the River Partnership itself, and the publications and literature cited in the bibliography.

Results are anonymised, aggregated and formed into broad themes and segments to provide a general view, analysis and perspective. We hope you find it interesting and useful.



Brexit

Our last whitepaper entitled “The post Brexit landscape for financial regulations: what can we expect and how do we prepare?” explores this topic in depth. Since the papers publication, the decision has been made by the Prime Minister to trigger Article 50 in March 2017, driving forward the change agenda and eliciting significant pressure on the implementation of contingency plans. Nevertheless, the vast majority of Brexit-related decisions have yet to be made and our experts believe that the following subjects are of most importance in the year ahead:

  • Hard or Soft Brexit?

Important Strategic decisions rest on the firmness of Brexit. Questions relating to the relocation of activities, legal entities, and business models still remain – specifically among non-European Economic Area Headquartered Firms who use London as their base to access the EU. As one risk leader put it, “we have no choice but to consider a scenario where two-way market access no longer exists.” We are therefore seeing an increase in demand for strategic leaders with holistic understanding of macro policy, networks within the European regulators, and legal expertise.

Whether Brexit is hard or soft, it will still impact the way firms need to consider their current risk and regulation policies and how these will be affected (Figure 3 below). The harder the Brexit, the more closely these may need to be looked at. Either way, change is happening and with change adaptability will also have to be demonstrated.

  • Basel Committee on Banking Supervision (BCBS), The European Commissions Capital Requirements Directive (CRD) V and Capital Requirements Regulation (CRR) II
“Finally”, stated a risk MD of a Universal Bank, “BCBS should complete their work on credit risk, market risk, operational risk and capital floors this year.” This will give clarity to the capital agenda and increased demand for change related to the Fundamental Review of the Trading Book (FRTB), Net Stable Funding Ratio and the Total Loss Absorbing Capacity (TLAC) requirements. We expect increasing demand for fungible wholesale risk professionals with experience in FRTB and a continued demand across markets for International Financial Reporting Standard (IFRS) 9 professionals. PHD and Masters Qualified candidates are already in extremely high demand, and we have seen an increase in contractors as these sought-after professionals embrace the gig economy. Already, since August last year River Partnership’s community of contractors (the RiverBench) has increased by 140%!
  • Undertakings for Collective Investment in Transferable Securities (UCITS)

Brexit poses a clear strategic decision for some firms who will need to set UCITS Funds as well as a UCITS management company and a distributor based in the European Union. Professionals with deep buy side, prudential and conduct risk experience will be vital through this process and we therefore expect consulting firms to take up a large portion of this work.

  • Solvency II

Now entering it's second year of implementation, the Treasury Committee’s review is likely to happen in March with some anticipating a dilution of some of the more extreme requirements. Nevertheless, the human capital required to ensure that these are met are going to have to be of a much more senior and expert level: Heads of Compliance, Directors, MD’s and Partners.

  • Equivalence under Markets in Financial Instruments Directive II (MiFID II)

After stating the aim of a “clean Brexit”, Prime Minister May left the door open to continued access to the EU based on regulatory equivalence. This may prove to be an astute option for the Government where they can gain the right to financial business in the EU whilst avoiding the politically challenging conditions of membership. In light of this, getting MiFID II right is now even more strategically important, so we expect increasing focus, spend and people resources to endure for several years (expanded on below in ‘Conduct Risk’).

Resilience 

As the BCBS finishes it’s work on measuring risk weighted assets, we will see meaningful change in Prudential Regulation more broadly with credit, market and operational risk programmes bringing about lasting alteration to FS business models. Comments such as “All of us need to strive to improve the integration of regulatory and commercial thinking” and “regulatory thinking and commercial thinking are no longer separate concepts” are central to this year’s direction of travel. “Future business models”, stated a strategy advisory firm leader, “are being designed with risk and compliance at their heart.”

Our research leads us to outline the following as areas of focus leading to derived demand for talent:

  • BCBS

Revised approaches for credit, market, operational risk and capital floors will give more certainty to requirements and is likely to see an increase in human capital for implementation by Q2/Q3. With the CRD IV / CRR II proposal, we will see the implementation of the Net Stable Funding Ratio and TLAC, FRTB and the Binding leverage ratio.

  • FRTB implementation, in particular, is likely to proliferate “a decades worth of work” with the compliance deadline in December 2019 and ongoing challenges expected.
  • Non-Performing Loans

“There are over 1 trillion Euros of impaired assets in the Eurozone. The European Central Bank (ECB) will be monitoring Non-Performing Loans closely and will expect extra rigour in the delivery of solutions.” For these solutions to be met, there will again be a need for experienced and knowledgeable individuals. The European Banking Authority, (EBA) has stated that an asset management company (AMC) should be set up with the government to be able to deal with the impaired assets.

  • IFRS 9
With an implementation date of 1st January 2018, IFRS 9 will be an important priority for many. The output of these models is to inform forecasting and stress testing within the Internal Capital Adequacy Assessment Process (ICAAP) and to better understand the expected increase in impairment provision and the management of higher impairment provisions post transition. “Model development skills continue to be more valuable than model validation skills, with increasing interest in Masters and PHD qualified quantitative candidates, and contractors.” The drive to find these people will mean rising prices, and an increasing reliance on Consulting Firms and contract teams that can more easily tackle the meatier assignments.
  • Cyber Resilience

Cyber Resilience is right at the top of the risk agenda again this year. “If $81m can be stolen from the central bank of an emerging economy, there must be far more scrutiny around IT infrastructure, technological failures, data breaches and cyber-crime.” Expect contractors and consulting firms to be utilised here as well, with technology change leadership becoming harder to find.

Conduct Risk 

Of critical importance to the regulatory agenda is the continuing improvement of Conduct and Culture within the Financial Services industry. Starting with the ‘Tone from the Top’, Conduct risk permeates all facets of the business model and business strategy. Indeed, one leader pointed out that “as Conduct Risk losses amounted to over 70billion Euros in the EBA’s 2016 Stress Tests, the importance of getting this right cannot be overstated.”

  • MiFID II

Furthermore, with the implementation of MiFID II in January 2018, we are now facing a substantial change agenda which will keep Conduct Risk professionals busy for several years. Indeed, a BIG 4 leader commented that “advice on MiFID II implementation will be enormous over the next 24 months, and will continue for another 24 months as we unpick the issues and correct the problems so that it can become BAU.” After hearing the views of leaders within the larger American Banks, this forecast of a “minimum of four years” seems conservative, especially given the current state of preparedness across the industry. One leader exclaimed “only 23% of institutions affected by MiFID II are on track with this programme of change, with a go live date only 12 months away!” Meanwhile, some studies have put this figure as high as 40%!

The complexity and detail associated with MiFID II was emphasised by many experts including a Partner (circa 6ft 4 at a guess) at an established law firm; he stated that when he had MiFID II printed out it amounted to two huge stacks of paper, both equal to his height! A thought-provoking illustration of the density of information and directives that need to be carefully synthesized and brought together into a workable format. No wonder senior Conduct Risk experts are in increasingly high demand with a great deal of reliance required on external advice to supplement relatively small in house teams. “One of the most substantial programmes within financial services in 2017, Conduct Risk change, with MiFID II at the heart, is probably also one of the most lucrative for Consultancies” mused one Partner. Our view is that Investment firms will accelerate their implementation plans significantly this year, with MiFID II change leaders likely to become more and more valuable as time elapses.

  • Remediation

With the Payment Protection Insurance (PPI) mis-selling deadline looming in June 2019, Retail banks will be continuing their remediation. Additionally, the FCA will provide more guidance this year on mortgage payment shortfall remediation.

For investment banks, the trading and clearing of interest rate swaps will continue to be under the microscope and will be expected to learn lessons from FX remediation programmes across the board. Conduct and operational risks will be threaded into ICAAP assessments and supervisory stress tests adding emphasis to whole of business regulatory understanding and leadership. Buy side companies will once again need to be on their toes in 2017 as “with low interest rates continuing, investment Firms will be vulnerable to mis-selling claims as they search for profit.”

  • Financial Crime

The 4th and 5th Money Laundering Directives will likely come into affect on the 26th June this year. This will see changes to the use of prepaid cards, virtual currency exchange and stronger checks on risky third countries. Additionally, we will see ongoing spend on readiness efforts for last year’s monitoring regulations, MAD (Market Abuse Directive) (II) and MAR (Market Abuse Regulation) which overlap with MiFID II, MiFIR and EMIR.

Financial Crime programmes continue to be towards the top of the regulatory agenda.

The detailed requirements on customer due diligence, transaction monitoring, reporting suspicions of money laundering, preventing bribery and corruption, managing fraud risks and preventing market abuse amounts to a huge spend across the industry. Indeed, the global spend on AML compliance will be more than $8billion this year (a compounded annual growth rate of 9%)

  • SMCR

Most firms have made strong progress with the implementation of Senior Managers Certification Regime, or Senior Insurance Managers Certification Regime (SIMCR) in 2016. Under the SMCR and SIMCR initiatives this year, FS and Insurance firms will continue to invest in controls and frameworks that allow certified senior leaders both confidence and comfort. As such, the skill set is merging ever closer to the governance agenda with operational and enterprise wide risk solutions being paramount. Operational resilience and technological security are cornerstones of the requirement, giving rise to higher demand for professionals who have a whole-of-business understanding and experience in structural as well as cultural solutions.

“With the extension of SMCR to Investment Management Firms in 2018,” remarked one leader “we will see an increasing demand for professionals with both practical SMCR experience and deep understanding of the buy side.” As SMCR knowledge becomes more mature across institutions, though, other thematic skills will take precedence and those who can elevate their thinking and experience to multiple areas will see their value rise (Figure 4).

Governance 

Determining that organisational complexity has led to substantial difficulty in firm’s ability to adapt to regulatory change, we hear that the importance of Governance will be elevated in 2017 (Figure 5). As one Governance specialist put it: “Firms unable to identify where misconduct occurs, track the value of capital or of levels of liquidity, will be subject to marked change in the years ahead.”

Seen by many as the overarching agenda, Governance was also described as “emanating from the hub of a spider’s web” – with resolvability, resilience, conduct, technology and geopolitical change as the radial lines sprouting outwards (Figure 6). The key trend here, therefore, will be the need for Senior Managers to deepen their understanding of regulatory requirements, group structures, business models and operating models. “Intelligent Governance will become ever more crucial as businesses seek to simplify organizational complexities and combine risk priorities effectively.”

We see SMCR as a continued area of focus this year alongside Board Effectiveness Reviews, Conduct and Operational Risk Framework implementation, ring-fencing, and IFRS9 compliance. Of course, the increase in demand for Corporate Governance professionals has already occurred in the largest Asset Management Firms. Blackrock’s team has trebled in three years, Vanguard, State Street and Fidelity have followed suit. We see this trend continuing across the industry with prices reaching a premium for those leaders who understand the intricacies of Governance strategy and application and can use effective Governance frameworks to positively impact the bottom line.



Insurance & Investment Management

After a somewhat piecemeal introduction, this is the year that Solvency II really beds down. Leaders will be juggling trying to get Solvency II right, alongside preparations for Packaged Retail and Insurance-based Investment Products (PRIIPs) and MiFID II.  “The unified strategic approach is vital” said one Regulatory Executive Leader “with both Asset Managers and Insurers likely to focus on revisiting tactical implementation and automating processes so that they can build scalability and client regulatory reporting.” Within compliance and risk departments, we are seeing a concerted move to “smaller, more specialist functions”. Transactional processes are being scrutinised and replaced by technology (workflow management tools, compliance monitoring tools), or outsourced altogether. The pool of specialist leaders with understanding of the complexities ahead is growing narrower and thinner.

  • Solvency II

Last year saw the Bank of England’s Prudential Regulation Authority approve plans for 19 insurers to use their own internal models under Solvency II. For those not in this list, they must use the EU’s standardised model to calculate risk, meaning that the BoE continues to rigorously scrutinise model change applications.

The International Association of Insurance Advisors (IAIS) has released a timeline which narrates the development of the Insurance Capital Standard (ICS) which serves to set a capital standard and framework for the insurance sector. Split into two versions, 1.0 will be adopted mid-2017, with version 2.0 not being adopted until 2019. Version 2.0 is expected to be a part of ComFrame; a comprehensive methodology and set of requirements shifting the international supervisory landscape.  Insurers such as Prudential and Legal & General have raised concerns about the impacts of Solvency II and that it actually results in distorted outcomes for the UK market. They have commented that a fundamental review of SII is needed, as it is a “compromise between 28 countries.” Strategic minds who have a holistic view of Insurance Risk and Regulations policy will become more and more valuable as the evolution of SII plays out this year.

  • Insurance Distribution Directive

This directive puts sales practices in the spotlight, alongside product governance, disclosures and conflicts of interest. Consumer protection will be a priority and senior management will be made more accountable for governance throughout the life of a product.

  • Pensions

There is no doubt that pensions and long term retirement savings are key regulatory priorities for Andrew Bailey’s team. “Due to our aging population” remarked one Pensions Advisory Partner, “pension reform is also important to society. We will see improved outcomes being sought by regulators for older people and additional regulatory scrutiny on products.”  Indeed, Pension Freedoms seem to be a central topic, with an increased risk that consumers will not understand the costs and benefits of the options presented to them therefore meaning more risk for firms to manage in their sales. Our research points to the size of the Pensions advisory market increasing significantly in the wake of regulatory and structural business change.

  • IFRS17

Previously referred to as IFRS 4 Phase II, IFRS 17 is set to be issued in early 2017 with an expected effective date of 2021. It's aim is to replace IFRS 4 on insurance contract accounting. Complex, with parallels to Solvency II in Europe, it is expected to represent a fundamental change in the majority of insurers’ accounting practices and for many this will mean “it will be a major challenge to be fully adaptable”. As a result, technical financial and actuarial skill sets will become more valuable, and we are likely to see several specialist contractors in this space.

  • SMCR

As already mentioned above, SMCR will be extended to Investment Management Firms in 2018 and Governance will be high on the agenda of both Insurers and Asset Managers. The trend here is likely to be increased reliance on Consulting Firms who have the fungibility to apply meaningful technical and strategic advice as well as the horsepower to affect change.

Technology & Change

With the value of FinTech investments set to reach $10.2bn in Europe and $24.4bn in the USA, the importance of keeping up with technology innovation has never been greater.[1] FinTech firms and banks seek to exploit the opportunities presented by the Second Payment Services Directive (PSD2) with peer to peer lending, Distributed Ledger Technologies (including Blockchain), Artificial Intelligence and the use of Big Data leading the disruptive drive to the status quo. “Regulators will be putting FinTech innovations under the microscope, so that they understand the risks and have effective controls in place.”

The implementation of PSD2 will be interesting this year, with both FinTech firms and Retail Banks likely to struggle with the absence of detail in the requirements. By the end of the year, we should have a steer on regulatory policy for “Robo Advice” and are likely to see a continued drive towards the automation of financial advice. This should drive down headcount costs at the mid to junior level within Investment Management functions, although senior policy, regulatory and risk leaders are likely to be in increasing demand.

There will be winners and losers in this field with “change leaders, programme managers and project managers, equipped with digital and strategic operations skills growing in vast numbers, whilst vanilla compliance and ops roles in large and mid sized banks will see a triple threat of automation, outsourcing and offshoring.”

Within Insurance, the exciting development of driverless cars and the IoT will bring far more complexity to products. Whilst the use of Big Data and telematics in underwriting will be reviewed cautiously by regulators as InsurTech continues to evolve.

River’s view is that the opportunities for business in today’s Fourth Industrial Revolution (4IR) are hugely encouraging (Figure 7). All forward-thinking leaders will be considering or embracing the innovations driven by AI, robotics, the IoT, autonomous vehicles and biotechnologies enabled by billions of people connected with mobile devices. Although economic disenfranchisement of certain parts of the population is largely blamed on globalisation currently, we may see technology becoming more centrally (and justifiably) blamed for such shifts. How companies navigate potential PR issues relating to technological change is therefore of great importance – meaning ‘flash crash’ behaviour of automated trading systems, or ambiguous AI ethical choices will be extremely damaging to advancement in this sector.

Talent trends for 2017

There were some interesting findings to our questions on forthcoming talent trends within Risk and Regulatory functions. Further to the information already discussed, we have summarised our findings below:

  • Consulting Firms should grow, with faster career opportunities than industry:

Given the uncertainty surrounding financial services business planning, it seems that the majority of FS institutions will favour the wait and see approach to permanent hiring within their risk and regulations functions this year (Figure 8). However, with the juggernauts of regulatory change continuing to impact so forcefully, there will be a greater propensity to hire Strategy or Consulting Firm experts to make sense of the required frameworks and create a road map for implementation.

Consultants and Contractors will be in higher demand due to the agility of the resource. Not having to risk redundancy expense and cultural upheaval if business models shift dramatically in the next few years, these temporary, yet experienced, resources will provide a popular solution. As such, we expect jobs to increase within Professional Services, just as the gig economy of experienced contractors will continue to rise.

  • Contractors and Global Searches will threaten hiring plans:

Indeed, the attraction of contracting in this new “gig economy” is among the perceived threats to Risk and Regulations leaders. Gaining advantage over traditional competitors will, as ever, largely be down to the leader’s vision, the amount of interesting work available, clear career advancement and speed of interview process. However, new competition from the emerging FinTech industries will capture some of the finest minds, as will the allure of non-FS technology companies such as Google and Apple (Figure 9).

  • A great leader, stimulating work, and recognition matter

Finally, it is interesting to note that extrinsic drivers do not top the list of policies that are likely to retain top quartile talent (Figure 10). Investing in people leaders within the organisation concurs with a number of more detailed studies on this topic that conclude that affinity with ones immediate leader is the most likely cause of retention and performance. Ensuring that the most talented minds are kept busy with complex and interesting work will help maintain a stable workforce, whilst regular meritocratic promotions will satisfy the status and ego of a high performer. This fear of stagnation is an interesting topic. One might expect the challenges of the next few years of regulatory change to offer substantial opportunities for growth in risk and regulations departments. However, the perilous uncertainty around strategic planning and profitability within FS recently and moving into 2017 has clearly lead the greatest minds in our industry to worry about their career trajectory.



Conclusion 

Delving into the key risks facing our clients in 2017, our research and interviews have uncovered a broad picture of the regulatory and financial issues facing the financial services market. A lot will be centered around the continuing agenda from 2008 – the impact of bank resilience, the increasing focus on culture and the emerging impact of technological change.

The key finding from this report is that the demand for senior, experienced and forward-thinking leaders and lieutenants will increase significantly over the coming year as companies seek wise heads to lead their change programmes without the need to hire vast teams on a permanent basis.

Therefore, elite leaders with the skills required to navigate this change will find themselves more valuable, whilst junior to mid level managers and operational staff may find their opportunities limited. Nevertheless, options may become more attractive for the more agile of these professionals within the Consulting industry, or Contract market.

It is also interesting to note that the fiscal remedies for 2008 that dominate the regulatory agenda, have, in part, been responsible for new underlying economic risks in the global sphere. Unemployment and underemployment risks, intersecting with the trends towards polarisation of society and growing income or wealth disparity, has now manifested into political and trade related risks. Queue the nervous glances towards President Trump in the USA, and the stumbling attempts of Mrs May, Mr Johnson and other key Global and EU leaders in negotiating new trade policies and new political and economic unions.

Within this uncertain climate, whilst risk and regulations work will surely be challenging and stimulating in the years to come, will Financial Services as an industry revive it’s reputation enough to attract, and keep, it’s current and future stars?

To download or view the whitepaper in full, please click here: Risk and Regulations Outlook 2017


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