The new approach to conduct risk

Since the 2008 crisis, conduct risk has been a growing challenge for financial institutions as they seek to comply with evolving regulations. 

Approaches to managing conduct risk have begun to shift, led by the UK’s new approach. We explore how they’re changing, and why behavioural economics is crucial to making better conduct risk decisions. 

A changing definition

Conduct risk is the possibility that a firm’s actions or structures will result in poor outcomes for customers or harm to the market. Historically, it was seen to stem from deliberate actions, like market manipulation or mis-selling. But that understanding has evolved.

Today, regulatory definitions of conduct risk go beyond intentional wrongdoing to include risks created by poorly designed products or ineffective communication. For example, customers might be led to buy a product that isn’t right for them because of the way it’s presented. Or they might stick with a product that no longer meets their needs, because they haven’t been informed otherwise. In each case, the actions of the company have led to poor outcomes for the customer, even if there was no intentional wrongdoing.

Financial institutions have to consider not only how they sell products, but how those products are designed, marketed and used by consumers. The focus of conduct risk regulation is no longer solely on preventing misconduct, but also on making sure products lead to positive outcomes for customers.

The UK’s new approach

The UK has been at the forefront of regulatory innovation in this area, moving from a predominantly rules-based system to one that, while keeping the rules, places greater emphasis on customer outcomes. This shift was captured in the introduction of the Consumer Duty in 2023, a regulation that requires financial institutions to ensure that customer outcomes are aligned with the outcomes of responsible providers.

This approach encourages firms to think from the customer’s perspective, asking how products will affect them and whether the outcomes are genuinely beneficial.

By leveraging growing volumes of data and improved technology, firms can now anticipate consumer behaviour and design interventions that encourage better decision-making. This new way of thinking not only ensures regulatory compliance but also allows companies to create stronger relationships with their customers.

Global influence: Colombia’s adoption of UK best practices

The UK’s outcomes-based model is beginning to inspire similar approaches worldwide, as Frontier’s work with global clients has shown. 

In Colombia, where Frontier collaborated with a leading bank, the Superintendencia Financiera has adopted conduct risk as an important area of focus, aligning its practices with international standards. Conduct risk is seen as an inherent part of financial activity, and firms are encouraged to adopt strategies that manage this risk proactively.

Frontier’s work with one of the country’s major banks helped them to apply this new approach, showing how frameworks from the UK’s Consumer Duty can be applied in different markets. We helped the bank to incorporate behavioural economics into its approach, demonstrating how companies can identify when customers are most likely to make poor financial decisions and design products that nudge them towards better outcomes.

The role of behavioural insights

Managing conduct risk requires a blend of three disciplines: regulation, economics and behavioural science.

Regulatory frameworks provide the foundation for compliance, while economic strategies ensure that products are financially viable. Behavioural economics, on the other hand, helps firms understand how customers actually make decisions. In the UK, this understanding has become crucial, as the Financial Conduct Authority mandates that firms consider key behavioural biases in product design, communications, and customer interactions.

For example, while customers may say they value long-term savings, they often make decisions based on short-term convenience. Financial institutions can use this insight to design products that guide customers towards better choices without overwhelming them with information.

By understanding the behavioural barriers to decision making, firms can create products that are both compliant with regulations and beneficial for consumers.

Towards a customer-centric future

The global trend towards customer-focused regulation is clear. The UK’s approach, along with similar initiatives in Colombia and elsewhere, demonstrates a commitment to creating a financial system that works in the interests of consumers.

In Spain, for instance, changes are underway too, with a planned revision to the Bank of Spain’s Circular 5/2015 aimed at improving the clarity and usefulness of information provided to customers.

By anticipating these regulatory trends and proactively managing conduct risk, financial institutions can not only protect themselves from regulatory penalties but also create a more efficient and competitive marketplace. Firms that invest in better customer outcomes will be better positioned to thrive in a financial landscape that increasingly prioritises transparency and responsibility.