Tackling misconduct risk

Financial Stability Board’s areas of focus and forward agenda

Highlights of the Financial Stability Board's reports ahead of the G20 Leaders' Summit in Hangzhou.

As is now customary, the Financial Stability Board (FSB) published a slew of reports ahead of the G20 Leaders’ Summit in Hangzhou. These documents included a second progress report, published on 1 September, on measures to reduce misconduct risk in financial services. This follows a workplan agreed in May 2015, and a first progress report in November 2015. The latest report describes progress made since the end of 2015.

At one level the FSB’s report is very much a “stocktake” and, because it contains no new standards or expectations, it may slip below firms’ radar. This would be unfortunate as the report is, in our view, important. It evidences how central conduct and culture are to the FSB’s future agenda. The Chairman of the FSB, Mark Carney, highlighted this issue prominently in his recent update to G20 leaders where he stated that “[in] recent years, the incidence of financial sector misconduct has risen to a level that has the potential to create systemic risks by undermining trust in both financial institutions and markets".

We highlight below some of the main areas of focus to date and next steps. At the end of this article you will find a table which sets out the very full agenda that the FSB and IOSCO have set themselves.

Areas of progress

1. Incentives

  • The report makes a strong link between conduct, culture and compensation, noting that banks have made good progress in the area of compensation, including strengthening the links between compensation and conduct.
  • In 2016, the FSB collected further information from “significant” banks and bank holding companies. Somewhat unsurprisingly, it found that jurisdictions have taken different approaches in areas such as the use of variable compensation, deferral and ex post adjustment mechanisms, although there was broad agreement on the importance of compensation tools as one element of the toolkit for reducing misconduct risk.
  • The report noted that it was too early to obtain a meaningful measure of the effectiveness of reformed compensation policies, but the FSB signalled that it wanted to focus on monitoring and reporting – in particular, it said it was “necessary” that financial institutions “develop mechanisms of tracking data to detect trends on misconduct and the use of compensation tools in relation to misconduct”, and that supervisors have access to such data. This is clearly going to be an area of focus in 2017. (A key example of increased reporting – from a regulatory perspective – is the proposed rule on Incentive-based Compensation Arrangements, issued jointly by six U.S. agencies under Section 956 of the U.S. Dodd-Frank Wall Street Reform and Consumer Protection Act. The mission under Dodd-Frank was to force institutions to disclose all incentive-based compensation arrangements to regulators and to prohibit arrangements that could encourage “risky” behaviour or expose companies to financial loss. The question of culture will be central to firms’ ability to comply with the proposed rules, which are likely to become effective from January 2018.)

2. Governance frameworks

  • It is now several years since the FSB last worked on risk appetite frameworks (2013) or risk culture (2014), but it looks like we are seeing some reawakening of the FSB’s interest in governance with the creation of a new “Working Group on Governance Frameworks” (WGGF) in May 2016. This working group has been set up to exchange good practices on the use of governance frameworks to address misconduct risk at firms, and it will look at whether additional guidance or additions to the supervisory toolkit might be necessary. This also accompanies the FSB’s ongoing peer review of the implementation of international G20/OECD corporate governance standards.
  • The WGGF held a two day roundtable in June 2016 (the views of the attendees are summarised on page 8 of the report), and is now going to do a stocktake, to report in March 2017, of current work underway by national and international bodies, as well as industry associations. The FSB has signalled clearly the possibility of a second phase, such as the development of a supervisory toolkit or guidance, to follow. On this, it is worth noting the message delivered by the Chair of WGGF at the roundtable event, that “the industry clearly sees a need to respond to the misconduct problem by developing standards” and that “if the industry does not take action, the official sector will attempt to regulate this”, even though additional regulation “is not the desired outcome”.

3. Improving standards of market practice

  • The IOSCO Board established a Market Conduct Task Force to raise broader awareness about tools and approaches IOSCO members use and present examples of their use in relation to market conduct. The Task Force has completed a stocktake of past IOSCO work on conduct issues in wholesale markets and a survey of IOSCO members on tools and approaches that they currently use to regulate this sector. By end-January 2017, the Task Force will publish a “detailed regulatory toolkit” for wholesale market conduct regulation, by aggregating the tools that market regulators use in practice, providing regulators with examples of approaches adopted by their counterparts in other jurisdictions. One question is whether this will herald some “levelling up” of approaches by those regulators whose toolkit is currently less extensive.
  • In May 2016, the Bank for International Settlements’ FX Working Group released the first phase of its Global Code of Conduct for the Foreign Exchange Market and principles for adherence to the new standards. The complete FX Global Code will be released in May 2017 and will include principles related to electronic trading, trading venues, brokers and prime brokerage.

4. Reforming financial benchmarks

  • The Official Sector Steering Group has been monitoring the implementation of the FSB’s recommendations set out in its July 2014 report, Reforming Major Interest Rate Benchmarks. Two years on (and two progress reports later, from July 2015 and July 2016), the reforms of the interbank offered rates have not yet been completed. Although the FSB’s language is very measured, the report suggests a growing sense of impatience at the pace of progress, particularly in relation to the identification and adoption of new risk-free rates – the FSB emphasised the “importance of this work” and said that it was “paramount that momentum is maintained.”
  • IOSCO has undertaken a number of projects on benchmark reform. Most recently, in February 2016, IOSCO published its second review to assess the implementation of the Principles for Financial Benchmarks by administrators of EURIBOR, LIBOR and TIBOR. It found that all three administrators had been proactively engaged in addressing the issues raised in the first review.


  • Firms should be aware of the extensive work programme that will be taken forward by the FSB and others – it seems that as other areas of reform (such as bank capital requirements and resolution planning) become “business as usual” for the regulatory community, the FSB will focus more on issues such as misconduct risks, as it looks to address “new and emerging vulnerabilities” in the financial system. And the continuing work in this area cuts across a wide range of issues for the industry as a whole – from compensation and governance, through to FICC markets and benchmarks.
  • Moreover, what is very clear is that both market participants and authorities will be expected to satisfy themselves that standards are not only promulgated on paper but are also put into practice. Particularly in relation to compensation, the FSB makes the point of emphasising the need for “a continuous dialogue” with supervised firms, and for supervisors to collect data on the actual use of compensation tools in relation to misconduct.
  • The FSB will publish a third progress report on its workplan in advance of the next G20 Leaders’ meeting in July 2017. But with six items on the FSB’s forward agenda due for publication between now and then, there will be no shortage of data points to enable us to form an interim assessment of the nature and extent of the FSB’s concerns.

Timetable: misconduct risk workplan (see Annex I to report for more detail)


Date to be completed

IOSCO guidance on benchmark administrators to be finalised


IOSCO follow up review of W/M Reuters 4pm London Closing Spot Rate


IOSCO to publish detailed regulatory toolkit for wholesale market conduct

January 2017

FSB to take stock of efforts underway on governance frameworks by international bodies, national authorities, industry associations and firms

March 2017

FX Global Code to be finalised

May 2017

FSB to issue progress report on measures to reduce misconduct risk


FSB to develop supplementary guidance to the FSB Compensation Principles and Standards


FSB to develop recommendations for consistent national reporting and data collection on the use of compensation tools to address misconduct risk


FSB to monitor progress in implementing the workplan on interest rate benchmarks and issue final report


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