Risk analysis

July marked the publication of our first annual Risk Outlook. This landmark publication represented the culmination of months of consultation, the distillation of the accumulated knowledge gained through our regulatory engagements across the market, and analytical effort by our Risk Centre.

Risk is central to everything we do at the SRA. Our day-to-day activities are guided by risk, focusing our attention and activities on issues, firms and risks that pose the greatest threat to protecting the public.

Our Risk Framework explained how we would put risk management at the heart of our operations, while our Risk Index categorised the risks to the regulatory objectives we had identified. Both were published in December 2012.

The publication of the Risk Outlook was the final piece in the jigsaw. It is our assessment of the most significant risks we expected to have to manage in the coming year.

How might the Risk Outlook be helpful to law firms?

Firms need to take calculated risks to grow and, even in today’s difficult market, there are opportunities to be taken. We do not want firms to become risk-averse and stagnate, but we do want firms to become risk-aware. The Risk Outlook helps by explaining what we believe are the biggest risks now, and which have the potential to cause us concern. Understanding our concerns – and the actions we will take to manage those risks – will help firms innovate and respond responsibly to changes in the market, and do so in a way that safeguards the public interest.

The outlook is divided into two sections. Part A is our assessment of the characteristics of the legal services market that are driving change. Changes in the market mean levels of risk also change and new risks will emerge. Part B profiles the key current, emerging and potential risks over a 12-month period.

The rapid pace of change in legal services also means risk analysis and management are dynamic processes. We have committed to publishing not only a Risk Outlook annually, but also regular updates and risk assessments throughout the year. The first update to the outlook was published on 7 November.

How have the key risks developed since the Outlook was published?

In the Risk Outlook, we identified the following risks where we already had evidence that they were present and of concern:

• financial difficulty;
• dishonest misuse of client money or assets;
• lack of a diverse and representative profession; and
• failure to co-operate or comply with notification and information requirements.

Since July, it is clear that financial difficulty has been the key risk we have had to manage, and the risk of such difficulty remains high.

This is true for firms of all types and sizes. We asked 2,000 firms from a cross-section of the market to provide us with information about their financial health. Of these, around 5% provided information indicating financial difficulty that could pose an immediate risk.

We have already started to work with these firms and will contact others who provided information that indicated a lower, but still concerning, level of risk. The update includes a more detailed paper that summarises our experiences of working with firms who have been, or who still are, in financial difficulties.

What is equally clear is that financial difficulty can create an environment where client money or assets are more likely to be misused. This link is borne out by recent increases in reports of misuse of client money.

Before the Risk Outlook was published we had already started to see an increase in this risk. Since then we have dealt with even more cases, with July, August and September seeing more than 140 reports made a month. Against the backdrop of increased financial difficulty in firms, these trends give us concern that risks to client money and assets are increasing.

What about the emerging and potential risks identified in the Outlook?

Of the emerging risks we identified, two are of particular relevance three months later.

Given the challenges in the market around the financial stability of firms, and now with the difficulties some firms are experiencing in obtaining professional indemnity insurance, it is more important than ever that firms that either have to, or wish to, exit the market do so in an orderly way. Planning for such an eventuality could avoid the need for SRA action, particularly intervention.

Since July, we have also seen further evidence of the poor standard of service or advice given to vulnerable consumers. Research by the Legal Services Consumer Panel into legal services consumers with learning disabilities highlighted issues around the difficulty of getting specialist advice in a sector undergoing significant changes.

This report adds to the weight of evidence that standards of service and advice do not always live up to the reasonable expectations of vulnerable clients with a legal need. More research on these issues will help us better target our regulation to support the interests of these individuals.

Looking at the potential risks, we have not seen significant evidence of these causing any harm. They are still relevant however and in order to be more proactive in our management, and help firms manage these risks where they are relevant, we are publishing more detailed reviews alongside the update. These look at cloud computing and group contagion.

What next?

We are already looking at the 2014 Risk Outlook and the remaining updates on the 2013 outlook. We will talk to firms, academics and other market participants to get their views on the risks that are going to be most significant through 2014 and into 2015, which will feed into our analysis.

Transparency around our approach to risk is a core principle of the work of the Risk Centre. We are committed to publishing further details of our risk assessment methodologies. In the meantime, our methodology for risk assessing the incoming reports that are made to us is available through the SRA website.

We continue to welcome your involvement in the developments we make. Compliance officers have already influenced our severity survey, and further opportunities will present themselves. The chance to influence our approach to risk is one which I hope regulated entities and individuals will increasingly take.

Andrew Garbutt is director of risk at the SRA