OSFI Expectations for Risk Management: A Three Lines of Defence Model
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The Office of the Superintendent of Financial Institutions (OSFI) has outlined a comprehensive framework for risk management in financial institutions, known as the Three Lines of Defence model. This model consists of three lines of defence, each playing a critical role in ensuring that regulatory compliance risks are effectively managed.
First Line of Defence: Compliance Function
The first line of defence is the day-to-day control function responsible for managing regulatory compliance risk. This includes:
- Monitoring and testing key controls to ensure they are operating as intended
- Reporting findings and recommendations to Senior Management on a regular basis
Role in Risk Management
The compliance function plays a critical role in identifying and mitigating regulatory compliance risks.
Second Line of Defence: Independent Oversight
The second line of defence is an independent oversight function that provides assurance that the first line of defence is effective in managing regulatory compliance risk. This includes:
- Reviewing and evaluating the design and operation of key controls
- Assessing the effectiveness of the compliance function
Role in Risk Management
Independent oversight plays a critical role in ensuring that the first line of defence is operating effectively.
Third Line of Defence: Internal Audit
The third line of defence is internal audit, which reviews and evaluates the overall risk management framework to ensure that it is operating effectively. This includes:
- Assessing the reliability of RCM assurances provided by the first two lines of defence
Role in Risk Management
Internal audit plays a critical role in ensuring that the overall risk management framework is operating effectively.
Role of Senior Management
Senior Management plays a critical role in overseeing the Risk Management framework. They are responsible for:
- Ensuring that the RCM framework is designed, implemented and maintained in a manner that is tailored to the needs of each business activity
- Ensuring that compliance policies, procedures and practices are adequate and appropriate to control regulatory compliance risk
- Ensuring that all staff understand their responsibilities for complying with such policies, procedures and processes
- Reporting key results of day-to-day compliance controls and independent oversight functions to those who need to know
Documentation and Reporting
OSFI expects all financial institutions to maintain adequate documentation that demonstrates how regulatory compliance risk is managed. This includes:
- Documenting the roles and responsibilities of all individuals involved in RCM
- Producing sufficient documentation to support the flow of information reported to the Chief Compliance Officer (CCO) and Senior Management
Supervisory Assessment
OSFI conducts regular supervisory assessments to ensure that financial institutions are effectively managing their regulatory compliance risk. These assessments focus on the institution’s ability to manage its regulatory compliance risk, regardless of where RCM roles and responsibilities reside within the organization.
Benefits of a Robust Three Lines of Defence Model
By implementing a robust Three Lines of Defence model, financial institutions can demonstrate to OSFI that they have a comprehensive framework in place for managing regulatory compliance risk, thereby enhancing their overall safety and soundness.