How to improve conduct and culture?
Conduct was acknowledged as one of the biggest risks faced by major financial institutions. The 25 largest banks had received combined fines and litigation costs of $260 billion since 2009. This would increase by an additional $65 billion by the end of 2017.
The first dimension of improving conduct and culture was trying to position sustainability ratings as similar in importance to financial ratings. This meant looking closely into product governance as well as strategic and treasury investments. Secondly, institutional clients needed to select conduct risk and culture as selection criteria for their asset management providers. Thirdly, conduct and culture needed to be extended to the retail franchise. If the quality was right, if it was made transparent, and if the product was suitable, then it would improve client outcomes. Finally, conduct and culture had to be part of capital planning, treating conduct and reputational risk as part of the business risk in terms of capital underpinning.
Change needed to be part of the management objectives. This was no longer about quantitative targets but about the ethics code and qualitative objectives, and was now part of the objective-setting, assessment and incentivisation of the team and the management. A financial institution should be run so that it was in everybody’s DNA to ask whether something was right, rather than whether it was legal. If this was done correctly it could translate into more and better business.
Culture and governance of firms was seen as an important long-term focus. Culture shared values and norms within a firm that characterised the organisation and the mind-sets that drove the behaviours of the firm. Remuneration and promoting effective links between the risks run by the firm and individual reward could serve as a mechanism for discouraging excessive risk-taking and short-termism.
At a firm-level, there were three particular aspects where firms could benefit from an increased and continuing focus on culture. The first was an increasingly sustainable business model. The second was more effective risk management. The third was the ability to respond more effectively when things did go wrong.
People had moved past anger and denial, but the current mood still had to change. Middle management needed to be brought along, and those at the bottom needed to be listened to. Sometimes what was right was not clear, and people should be enabled to see the tools available to help with the grey areas, as a lot of what they dealt with was not black and white.
One of the big concerns was that the perception of the public would be that these fines were simply the cost of doing business. A culture of bad conduct put institutions and financial markets at risk. Conduct was not an asset class, and it did not stop at a border, so regulators should be mindful of harmonising rules as much as possible. It should not be a tick-box exercise.
Progress made so far
There had been examples of direct ways to do this, such as the bankers’ oath in the Netherlands, which would lead to conversations within organisations, though it went against the Anglo-Saxon culture. Another was the code of conduct for tax advisors in Demark, making the expected norms and values for tax advisors very clear.
The Dutch supervisor, the Nederlandsche Bank, had since the crisis adopted a framework which analysed the board’s effectiveness, the risk culture and the readiness for cultural change.
The ECB had launched a thematic review on internal governance called RIGA, covering both qualitative aspects of boards’ functioning and risk appetite frameworks of banks. The ECB joint supervisory teams had gone in to look at the agendas into which the information had been flowing, but they had also observed meetings and taken part as observers to grasp the quality of debate. Composition of boards and their members’ suitability was also verified. This had ultimately been a means to test the risk culture within the institution.
In the UK, the Fair and Effective Markets Review had looked into fixed income, credits and currency. Fines had served a purpose in flushing out the issue, but in the UK there had been a move towards the Senior Managers Regime, which continued the focus on individual accountability, to support the rebuilding of public trust. Culture was not something that only applied to client-facing staff, but was for everyone. This went to the point around subcultures: trading desks might feel loyalty to other trading desks rather than to the institution they worked for. Anyone raising an error or mistake needed to be supported through the process rather than being marginalised.
It was crucially important that an environment was created where regulators could share understanding and effectively discuss how better to move forward. There was no single right answer, but firms could learn from one another. The UK had introduced individual accountability for senior managers in banks, and were committed to extending accountability to other sectors. This was an approach that complemented the increased clarity of responsibility on senior managers.
Diversity was also a big help. The Dutch Central Bank had established a special division to look at culture and conduct, introducing psychologists and anthropologists, where they had used to hire economists. The introduction of more colourful people had helped.
Different roles in culture change
Regulators needed to set an appropriate framework with incentives to get it right. Supervisors needed to effectively apply that framework with strong enforcement consistently across the single market. Businesses needed to assert a better control as to what was happening within firms and develop a sound culture in the area of values and ethics. A lot had been done from a regulatory standpoint in the EU, in the Markets in Financial Instruments Directive (MiFID II) framework. The entire relationship between the company and the investor had been addressed there: a true root-and-branch reform. In a few years, it would be clear whether there was a better regulatory framework to foster a more ethical approach within firms. Businesses needed to take the issue more seriously, which was not easy in a competitive environment.
The Commission wanted to see firmer focus and commitment to conduct supervision from European supervisors across the EU. The dialogue between supervisors and companies was extremely important; there were a lot of good developments coming from the private sector, but more would be needed going forward. A fair game required good rules, a good referee, but also fair play by the players.
Bad conduct was hard to define, but everyone knew it when they saw it. It was also important for regulators to work together to prevent bad apples moving from one jurisdiction or asset class to another. Bad apples could bring down institutions in terms of reputation. It was important to have the right incentives in place. There was not a choice between making money and doing good.
What was lacking on the industry side was a framework which linked risk culture across dimensions. It was not clear that conduct risk could be properly addressed without a proper risk culture framework. Since 2011, the EBA guidelines on internal governance had been available, covering six areas and around 30 principles. They offered an adequate ground for reviewing the internal governance structures of banks, and ensuring that the shortcomings to having a proper risk culture implemented are fully addressed. From the industry side, the question was why they should engage in cultural change. Addressing specific behaviours aligned with the core values and vision was the best starting option. There was a strong incentive to address the cultural issue as a trigger for innovation, and an underlying sound risk culture at the end. This issue should be the main incentive and driver for the industry to engage or take culture seriously.
Everyone wanted to create and foster the conditions for positive ethical and cultural moves. The FCA should be applauded for stepping back from their cultural thematic review at the start of the year, and recognising it was more about engagement with firms. Market participants would appreciate benchmarking results being made visible and transparent.
Sanctions were only part of the solution, but they were an important part. Their imposition was not desirable; however, sanctions were needed which were a real deterrent, which meant they should be high enough to scare financial institutions, and required supervisors who were sufficiently strong and credible. Some supervisors were quite advanced in Europe, and a process whereby ideas on best practice could be exchanged was desirable. Supervisors also had a role in dealing proportionately with things that might go wrong; it was important that enforcement action continued to have a credible deterrent effect.
The industry would welcome a more harmonised approach to assessment of board members and key function holders. Rules varied from country to country. In the UK the senior managers’ certification regime was very stringent, but elsewhere in Europe there was a lack of legislation. Clarity was also needed on the RIGA findings, and whether they would feed into the SREP process; this process was not solely about capital. On suitability, a peer review of fit and proper had been conducted, and the results had been embarrassing. It was difficult to make progress given the differing legislation.
The sector would be helped by increasing diversity on many levels, but it started at the board. People needed to feel engaged and invested in their business.
There had been an interesting report from the G30, saying that banking stood in disrepute. The recent release of the Panama Papers was another episode which cast a shade on the financial industry, though investigations were still underway and there was no evidence so far of any wrongdoing.
The Single Resolution Board (SRB) estimated the cost of misconduct at around €200 billion since 2009, resulting from fines, settlements and redress payments. This was a huge drag on bank profitability. One regulator had said that conduct was one of the biggest risks faced by major financial institutions, which could be seen in the number of fines imposed. According to one study, the 25 largest European and US banks had received combined fines and litigation costs of $260 billion since 2009. It had been estimated that this would increase by an additional $65 billion by the end of 2017.
At the European Banking Authority, there had been a discussion on how to factor conduct risk into stress tests, which were supposed to be finalised over the summer. This was a topic which was increasing coming to the attention of regulators, supervisors, and the banking industry itself. It had to be admitted that, although a great deal of change had already occurred in the industry and on the regulatory side, there was some way to go yet. For regulators, one of the big concerns was a public perception that these fines were simply the cost of doing business; ways were needed to build the public trust.
What could be done to move more consistently across the board?
The topic would be structured around three core questions. The first was how the conduct and culture could be improved, what levers should be pulled by firms and authorities, which benefits could reasonably be achieved, and what the risks of inaction were. The second was more in perspective, assessing how much progress had already been made. An interesting angle here was also the consistency across firms and jurisdictions, and whether the progress was uniform or there were major differences on the regulatory and industry side in terms of the repair action. What could be done to move more consistently across the board, in terms of both the EU and globally? The third was about the relative roles of the industry, the private sector and the regulators and supervisors. Regulating culture was a difficult issue, as without ownership of the firms themselves it was difficult to make progress. On the other hand, regulators and supervisors needed to perform their tasks with awareness of the incentives they gave to the industry in holding a mirror up to the industry to help it to progress, and on the other side also be alert to punish identified cases of misbehaviour.
How to improve conduct and culture?
Expected benefits of more explicit Conduct and Culture focus
A banker said that the first dimension in terms of conduct and culture, was trying to position sustainability ratings as similar in importance to financial ratings. Everyone was familiar with how position themselves vis-à-vis the investors from a ratings agency perspective. A while ago, his organisation had started to work closely with companies like Sustainalytics, because the issue was about governance dimensions as well as integrating environmental and social dimensions. The first dimension of benefit was achieving better ratings results, and this was key when closely incorporating with the likes of Sustainalytics. They looked very closely notably into product governance, which was a key feature, similar to strategic and treasury investments.
Investors were increasingly using conduct risk and culture as selection criteria
The second dimension, which was closely related to rating, was that institutional investors were increasingly using conduct risk and culture as selection criteria for their asset management providers. The key issue was how they would operate in such an environment; foundations, pension funds, large corporates and insurance companies were going to make this very visible and transparent vis-à-vis their investment committees.
The third dimension was probably the biggest challenge. This was about conduct and culture in terms of the retail franchise. With millions of retail clients, his organisation had had to change their business perception of being a pure product provider. There was a need to invest significantly in terms of not only positioning their product on the shelf, but integrating it into an advisory process and making advice the core product. It was about the risk appetite, life cycle and investment horizon; this was how benefits were measured in retail banking. It was also about net promoter score1. If the quality was right, if it was made transparent, and if the product was suitable, then it would improve client satisfaction.
The fourth and final dimension was about conduct and culture from the perspective of capital planning. With a focus on Europe, the bank had conducted various sessions of Supervisory Review and Evaluation (SREP). This was a very healthy process. They had made clear to the European Central Bank (ECB) in SREP interviews how they interlinked their risk governance, risk appetite framework and risk assessment with their capital planning, funding planning, strategy and vision. They had treated conduct and reputational risk as part of the business risk in terms of capital underpinning, which was directly influencing their capital buffer. This had been quite a clear benefit.
At an individual firm level, there were three particular aspects where firms could benefit from an increased and continuing focus on culture. The first was an increasingly sustainable business model for firms, aligned with the vision of the firm. The second was more effective risk management. The third benefit for firms from an improved culture was the ability to respond more effectively when things did go wrong. Firms would be able to identify those incidents proactively and take the appropriate steps swiftly to deal with them.
This had been done from the top. They had interlinked strategy, vision, capital planning and funding planning sessions with the risk appetite statement. It was key to do this with the board of directors, together with the ECB; however, the much trickier part had been how to implement this in the team. They had tried to make it a clear part of the management objectives. In terms of objective setting, this was not any longer about quantitative targets and objectives, but about the ethics code and qualitative objectives. This was now part of the objective-setting, assessment and incentivisation of the team and the management. Warren Buffet had said, ‘In looking for people to hire, you look for three qualities: integrity, intelligence, and energy. If you don’t have the first, the other two will kill you.’
Creating value for the community was a key issue
The banks were strong believers in running the group with a stakeholder value approach. Creating value for clients could be measured; creating value for shareholders could be measured more stringently, but creating value for the community was a key issue. A financial institution should be run so that it was in everybody’s DNA to ask whether something was right, rather than whether it was legal. If this was done correctly it could be a USP2, translating into more and better business.
Shared values and norms that drove the behaviours of a firm
A regulator said that his organisation had published their plan a few weeks previously, and had identified seven key priorities. One of these had been the culture and governance of firms; this would be an important long term focus.
Culture referred to shared values and norms within a firm that characterised the organisation and the mind-sets that drove the behaviours of the firm.
Key levers which could influence culture included incentives for frontline staff. Remuneration and promoting effective links between the risks run by the firm and individual reward could serve as a mechanism for discouraging excessive risk-taking and short-termism. A positive encouragement of effective risk management and a focus on remuneration as an ex-ante as well as ex-post tool was crucially important. In terms of how to manage staff, it came back to the recruitment and the staff that were brought on in the first place.
At a macro- and industry-level, one key benefit was to rebuild trust
At a macro- and industry-level, one key benefit was to rebuild trust and confidence in the financial services sector and the industry as a whole. Fair outcomes for consumers, clients, and for competition and market integrity would be a mechanism which would then increase trust.
A more effective risk management would be a consequence of an appropriate culture, recognising that there was no one answer for culture, but an appropriate culture within firms. This would lead to proactive identification of risk and firms acting to address risk from a strategic and business model perspective, to deliver good outcomes in their business. An example of effective risk mitigation might be firms increasingly thoughtfully using the intelligence they gathered from whistle-blowers.
Assessing the cultural mood and thinking about the internal mechanisms that could be used for change
A banker commented that there could not be $200 billion of fines and settlements without realising that something was not quite right. People had moved past anger and denial, but this was a marathon rather than a sprint.
Many institutions had taken different approaches to assessing the cultural mood within their organisations, whether getting third parties in to do an audit or having focus groups. Once that had been done, how could the current mood be changed? This was down to a joint and concerted effort across the top management. Middle management needed to be brought along, and those at the bottom needed to be listened to. Reverse mentoring and listening to the reflections of employees were important indicators of what was felt to be going well or not so well. Was sufficient attention paid, in employee engagement studies, to the success factors and inhibitors around good culture?
There had been a culture of a set of people moving around different firms
Many institutions had looked again at their cultural goals, their risk values and at building in greater risk ownership and institutionalising ethical behaviour. It was very important to also think about the internal mechanisms that could be used for change. Tone or character at the top was very important: did all banks have good cultural carriers at the top of the house? One thing that had been clear in the Libor/Euribor scandals was that a number of people had not belonged to the culture of the organisations; there had been a culture of a set of people moving around different firms. Dealing with this was a very big challenge.
In terms of training, sitting in front of a screen and clicking through a web-based training programme did not resonate. Scenario planning3 had received great feedback. It showed that sometimes what was right was not clear, and enabled people to see the tools available to help with the grey areas, as a lot of what they dealt with was not black and white. Her bank had also incorporated an animation series; storytelling appeared to be one of the very positive ways that good cultural outcomes could be encouraged.
Regulatory approaches for improving conduct and culture in financial sector
Regulators vigorously addressed conduct and culture in financial markets by doing two things. The first was to develop clear rules on conduct. The second was to develop robust enforcement tools against those who violated the rules. Regulators were fortunate to have a number of tools at their disposal, but they could and should do more. Governance rules needed to be finalised; tone at the top meant beginning with good, strong governance rules. It was important to talk about things like independence and eliminate conflicts of interest, and this was not just tone at the top; people needed to be trained and developed from the bottom up as well. Conduct was not an asset class, and it did not stop at a border, so regulators should be mindful of harmonising rules as much as possible. It should not be a tick-box exercise.
The EBA had discussed how to factor conduct into stress testing. Different input had been received from supervisors across Europe, because there were different attitudes towards fines, etc. This meant that the impact on capital was very differentiated. The EBA was working on complaints and how to use them as a supervisory tool to apply pressure. How much was this moving forward, and how much was it moving forward in a consistent way? If somebody was making good progress, but the rest of the industry was behind, it was a problem for everybody.
Progress made so far
A politician asked whether there were direct ways to improve culture. There had been some good examples, such as the bankers’ oath in Holland which had been introduced in banks but looked at in a lukewarm way by the rest of Europe. However, it was crucial, because integrity began with a conversation; the banking oath was not an instrument that would change behaviour or stop misconduct immediately, but it would lead to conversations within organisations. Integrity was about grey areas that had to be discussed with each other. The banking oath enabled employees to discuss conduct within the organisation, starting a conversation which would hopefully end with integrity. For this reason, a European-wide bankers’ oath was an attractive idea, though it went against the Anglo-Saxon culture.
Tax advisors’ code of conduct
The second example was a code of conduct for tax advisors in Denmark. The discussion amongst tax advisors was finally changing. Back in 2007, the attitude had been that clients were paying them to end up with a zero tax rate, whereas this was not voiced so readily any more. There had been a visible change in behaviour, and the discussion was now about what was a fair share. This was a discussion that needed to be had. In Denmark, there had been a code of conduct laid down in law, making the expected norms and values for tax advisors very clear. There was not a European equivalent anywhere.
Bank Regulators’ approaches
An official commented that, to start with the regulatory and supervisory approach, the Netherlands was the right country to talk about. The Dutch supervisor, DeNederlandsche Bank, had since the crisis established a very interesting methodology for behaviour and culture. This was basically a framework which analysed the board’s effectiveness, the risk culture and the readiness for cultural change. It then analysed it with different metrics that the ECB was pushing forward.
It was very significant that the ECB, or the Single Supervisory Mechanism (SSM), had one of the first thematic reviews launched last year. This had been the so-called RIGA exercise that had covered the 123 banks directly supervised by the SSM and analysed four dimensions, three of which had been unknown thus far for the industry and even for most supervisors. They had basically related to the board assessment, whether the board individually and as a whole was suitable and whether it had the necessary diversity and skills. It also had to do with the quality of information, and what kind of information flowed within the board, as well as the quality of the decision-making and the discussions.
This had been very novel, as the ECB joint supervisory teams had gone in to look not only at the agendas and related documentation into which the information had been flowing, but they had also observed meetings and taken part as observers. This conveyed the flavour of the new supervisory approach to conduct and culture, because it had ultimately been a means to test the risk culture within the institution. The risk culture was really at the centre of a much more qualitative-focused approach that today underlay not only the regulation but the way that supervisors approached the institutions.
For different firms there were a range of approaches which they could learn from one another
A regulator said that there was no monopoly on what looked good in this context. It was crucially important that an environment was created where regulators could share understanding of what had worked well and what had not, but also where the regulators and industry could effectively discuss how better to move forward. There was no single right answer, but for different firms there were a range of approaches which they could learn from one another and apply to their own businesses, to take forward what they characteristically wanted to improve in terms of their own culture.
In the UK, a regime had recently been introduced of increased accountability for senior managers at banks. They were committed to extending the accountability to other sectors, as well, and eventually all sectors within the financial services world in the UK. Although it also had an effect down the line if things went wrong, clarity of responsibility was crucially important from a forward-looking perspective. Senior managers were clear about the boundaries of their business responsibilities, the boundaries of their accountabilities, and then could take appropriate steps to mitigate whatever risks might arise within their spheres of responsibility. There was a challenge for supervisors in relation to all of this, moving from a world where supervisors focused on supervising firms to one where they looked at both firms and individuals. This was an approach that went very much hand-in-glove with increased clarity of responsibility on senior managers.
The Fair and Effective Markets Review
A banker noted that in the UK in the previous year, the Fair and Effective Markets Review had looked into fixed income, credits and currency. The word fair had been included in terms of the outcomes that policymakers, legislators, regulators and the industry needed. The question of an oath meant that the debate had moved onto the reality around individual accountability. Fines had served a purpose in flushing out the issue, but in the UK there had been a move towards the Senior Managers’ Regime, which continued the focus on individual accountability. Some might say that this was a difficult transition, but it was probably for the good in terms of rebuilding public trust.
It was not simply a compliance exercise or a processing exercise. Culture was not something that only applied to client-facing staff, but rather was for everyone. In the same way, SREP and the definition of operational risk talked about people. Some banks such as BNY Mellon, had been looking at how to ensure that, for lateral moves around the industry, recipient firms had the right data on which to make a decision around the quality and integrity of the people they were receiving. This went to the point around subcultures: how could the loyalty that trading desks might feel for other trading desks rather than the institution they worked for be stemmed? Another important feature going forward was ensuring that the fear factor was taken out of escalation, and making sure that anyone raising an error or mistake was supported through the process rather than being marginalised.
Markets in Financial Instruments Directive (MiFID II) framework
As examples of what had been done, the scope and prohibitions constituting market abuse had been strengthened; the crucial problem of benchmark manipulation had been addressed; an attempt had been made to tackle the issue of poor incentives between financial advisors and customers, such as by tackling financial inducements to recommend certain products and unbundling the costs of financial research. This had been done in the Markets in Financial Instruments Directive (MiFID II) framework. That had been an attempt at addressing issues of conduct from a global perspective. The entire relationship between the company and the investor had been addressed there, and it would hopefully deliver benefits. It was a true root-and-branch reform.
The level of bonuses paid to bankers had been capped, to tackle short-term profit maximisation. This was very important and very new. After the crisis a policy had been launched to try and beef up sanctions across the entire financial system, and also to make sanctions more consistent within the single market, to avoid regulatory arbitrage. Many of these rules, particularly MiFID II, were not yet applied, so it could not be said whether the desired impact would be achieved. However, in a few years it would be clear whether there was a better regulatory framework to foster a more ethical approach within firms.
The need to learn on diversity
A politician added that while there was a lot to learn, diversity was a big help. The Dutch Central Bank had included a special division to look at culture and conduct, and they still had a lot to explain to their colleagues. There was a need to look at the good examples, and learn from those. The Dutch Central Bank had introduced psychologists and anthropologists, where they had used to hire economists. The introduction of more diverse range of backgrounds and perspectives had helped.
Different roles in culture change
Culture change requires various approaches: appropriate incentives, better control, and effective and consistent regulatory frameworks,
An official said that this was a difficult issue, and needed to be approached from three angles. First, regulators needed to set an appropriate framework with incentives to get it right. Secondly, supervisors needed to effectively apply that framework with strong enforcement and in a consistent fashion across the single market. Thirdly, businesses needed to assert a better control as to what was happening within firms and develop a sound culture in the area of values and ethics.
From a regulatory standpoint in the EU, a lot had been done. The reform process following the crisis had been globally very much focused on financial stability. In the EU the system had been reformed to make it more stable, but conduct had also been looked at, as well as the protection of investors. The EU had developed a more balanced agenda post-crisis, looking not only at prudential rules but making sure that investors got a better deal and that problems of market abuse and investor detriment were addressed.
Building culture and accountability involves regulators, supervisors and management
Regulation, of course, was only part of the story. Businesses also needed to take the issue more seriously, which was not easy to do in a very competitive environment. It was easy to make sure that people respected and did not breach the rules, but with grey areas – which were common across the sector – it was more difficult. This was the real heart of the problem, and where it was difficult for businesses.
From the Commission’s standpoint, they wanted to see firmer focus and commitment to conduct supervision from European supervisors across the EU. They also wanted to see banks and other financial firms look at how to build a culture and accountability right up to senior management, in dialogue with supervisors. The dialogue between supervisors and companies was extremely important, and firms needed to assert a better control over their organisation, and over the culture within it, for the good of customers, and to avoid recurrence of past problems. There were a lot of good developments coming from the private sector, but more would be needed going forward.
The change had to start within the industry
A politician noted that change had to start within the business and the industry itself. Supervisors were in a strong position to address the issue of conduct and culture. A lot had been done to address the rules of the game; however, a fair game required good rules, a good referee, but also fair play by the players, and this was more difficult to address.
Culture was not just at the level of the organisation itself, but it had to be taken account that it affected the entire sector. It was not good enough to say one’s organisation was the best example. This did not restore trust; it had to be done industry-wide
Preventing rolling bad apples
An official said that it was hard to define what good conduct was, but everyone knew bad conduct when they saw it. It was also important for regulators to work together to prevent the rolling bad apple problem, where bad apples moved from one jurisdiction to another, or one asset class to another. One way to build public trust was to show that they were being very rigorous in that respect, and that they wanted to make sure that the same bad people did not continue to move from one jurisdiction to another. This was good for institutions as well; there might just be a few bad apples, but they could bring down institutions in terms of reputation.
In terms of legislating for good behaviour, it was important to have the right incentives in place. There was not a choice between making money and doing good; it was possible to do both. However, this paradigm needed to be realigned. When financial markets had been more of a partnership, everyone had been more invested and would not allow their partners to put their money at risk. Today, as financial institutions were public entities, it was the shareholder who was accountable and so people were not as invested in terms of whether they were doing the right thing for the institution. They needed to start to look at culture, not as a compliance-type box, but in terms of how to create incentives to grow businesses and look at culture as a way of doing this, and not as a cost of doing business.
The industry lacked of a framework which linked risk culture with the misconduct
An industry participant noted that his firm started by asking their clients to talk about strategy. Then they would ask whether the client had the right culture to succeed, which was a more difficult question to answer, as they were not always sure that they had in place the right culture throughout the group to address the strategy objectives they proposed to achieve. The question required a two prong answer: on the one hand to address the regulatory and supervisory concerns, and on the other to address their own incentives as an industry to have conduct and culture as a competitive focus and differentiating factor.
What was lacking on the industry side was a framework which linked risk culture across dimensions to do with communication, accountability, challenge, incentives and tone from the top, to the misconduct risk. It was not clear that conduct risk could be properly addressed without a proper risk culture framework set up. This was the first part of an answer, which needed to be underpinned by a full governance analysis. Since 2011, the EBA guidelines on internal governance had been available, covering six areas around 30 principles. These were a good reference to make an internal governance assessment in the institutions, and should underpin this entire approach.
The challenge for the industry was to define appropriate and realistic ambitions
From the industry side, the question was why they should engage in cultural change. From experience with clients, they sometimes engaged in too ambitious a programme. Cultural change could be diverting, because it was too comprehensive a project. Culture was intelligible, and fluid as a concept, because it had to do with implicit norms and behaviours that should be present even without compliance rules. This said, it was important not to have a too legalistic approach.
The proposition was that specific behaviours should be tackled first, rather than going for the big picture, as people were liable to lose themselves. This had happened in many banks. Highlighting specific behaviours aligned with a firm's core values and vision, and addressing behaviours that did not, were important, along with setting up a measurement framework that should be monitored. This was an approach supported by the FCA, which had set out in its 2016/17 business plan its prioritisation of tackling culture and governance issues at firms. Appropriate cultures at firms will be consistent with firms' strategy, business model and product coverage. In this sense there should be a strong incentive on the part of firms to address cultural issues and for the industry to engage with and take culture seriously.
Market participants would appreciate benchmarking results being made visible and transparent.
Consistency and engagement between supervisors and firms were key success factors for positive ethical and cultural moves. A banker said that, across public and private sectors, everyone wanted to create and foster the conditions for positive ethical and cultural moves. On the legislative and supervisory side, this was around having as unambiguous a set of rules as possible, which were proportionate with appropriate levels of enforcement, together with sharing the themes that came out of supervisory visits. The FCA should be applauded for stepping back from their thematic review of two cultural indicators at the start of the year, and recognising it was more about engagement with firms. Hopefully this would lead to some community of practice around what was going on at firms.
A banker added that consistency was also a differentiating factor. Market participants would appreciate benchmarking results being made visible and transparent. Most of the market participants would agree to make it so, not only in terms of income ratio and stress test results from a narrower scope, but including benchmarking results on how market participants handled best practice, operational risk and reputational risk. This would provide feedback that would allow an understanding of who was advanced, and how to do gap analysis.
An official said that sanctions were only part of the solution, but they were an important part. Their imposition was not desirable, due to the impact that they could have on the profitability of financial institutions, and the viability of financial institutions could be brought into question when the threat was to withdraw licences. However, sanctions were needed which were a real deterrent, which required two things. Firstly, they should be high enough to scare financial institutions. Secondly, supervisors were needed who were sufficiently strong and credible to be perceived as able to impose those sanctions. If the system was sufficiently deterrent, then they would not be imposed so often.
There was a case for exchanging good practice between supervisors on the monitoring of conduct within financial institutions. Some supervisors were quite advanced in Europe in this regard, and others were less so. It would be desirable to have a process whereby ideas on best practice could be exchanged, and national competent authorities could converge towards the best practices in Europe, as at present the situation was very diverse.
Harmonising approach to suitability assessment of board members and key function holders
A regulator said that supervision had roles both in a forward-looking context – helping firms to ensure that they were taking appropriate steps to mitigate risk – but also in dealing proportionately with things that might go wrong. In some cases, that would lead to enforcement action, and it was important that enforcement action continued to have a credible deterrent effect. There might be a shift to increasing action against individuals as well as firms, where perhaps in the past there had been very substantial fines on firms without so many actions on individuals, consistent with a focus on an ex-ante basis of increased responsibility and accountability for individuals. This could work through the system to increase individual responsibility at the point where things went wrong.
An industry participant said that one of the things that would be welcomed by the industry would be a much more harmonising approach to suitability assessment of board members and key function holders. National transposed rules were still used, which varied from country to country and created sharp differentiations, even outside of the SSM. For instance, in the UK the Senior Managers’ & Certification Regime was a fairly stringent one, but in other parts of Europe there was a total lack of legislation. It was not yet clear which criteria the ECB would follow on suitability assessment. On suitability, a peer review had been conducted on fit and proper, which had been published the previous year. The results had been embarrassing. It was difficult to make progress when there was different legislation in different member states.
There should not be a decision between doing good and making money
The second point was the need for clarity on the RIGA findings. Would they feed into the SREP process in terms of decisions on the governance pillar, with potential impacts on capital? This was still to be resolved. There had not been much clarity from the ECB about what would be done with the RIGA findings, though it was known that in some cases they had had discussions on the individual institutions, regarding governance. This was the sort of feedback that was going to be used for the SREP process, but it was not yet clear what the limits would be and what impact it would have on the SREP process. This would be important for the industry and the banks to know.
A politician said that the point had been made that there should not be a decision between doing good and making money. The financial sector was very money driven, and attracted people who were money-driven. The sector would be helped by increasing diversity on many levels, but it started at the board, because it was crucial to have different people. When speaking with the financial sector, there was a clear difference between the people who were in charge and those who would be in charge. Hope lay with the generational effect.
An official said that it was still possible to do good and make money. People just needed to feel engaged and invested in their business, and that was part of the core business mission. The big stick worked; having penalties was a big deterrent. However, a better way was to reward people for their good behaviour. A stick and carrot approach was needed.
It was clear that good behaviour could not be legislated, but a framework was needed from the regulatory side that was proportionate, gave the right incentives, was focused on the right things and helped both the industry and supervisors to put pressure on good behaviour. On the regulatory side, there had been a lot of progress, in regulating not only the prudential and financial stability aspects, but also conduct issues.
The key point was that the levers were especially focused on incentives for staff, tone from the top, and governance. A big part of the challenge was making sure that this was cutting through all the components of firms, and how to check that progress was being made and make sure no subcultures were being shielded from improvements.
There was a big issue in terms of it not being only sales staff who had direct contact with customers, but also other staff, and oversight was very important. There had been mentions of two interesting experiments by regulators, to develop new tools. A great deal of the problems emerging in the industry involved a very dominant figure on the board whom nobody felt entitled to challenge, leading to a lack of necessary checks and balances.
They did not see those who misbehaved being individually punished
In terms of driving change, there needed to be punishments in place, both within firms and sanctions providing a credible deterrent. There also needed to be prizes for good behaviour, and make sure that there was more focus on good practice and sharing of information, with the industry itself identifying the best approaches. This could happen in exchanges of information between supervisors on good practice, but also through engagement and dialogue with regulators and industry. Trade associations also had a role, and had developed a substantial work in that respect.
The issue of diversity was also an important one. Having more diversity within staff was an important element which should be nurtured and pursued within organisations. People were needed who thought differently.
Finally, there was a need to acknowledge that part of the lack of trust and confidence from the public was because they did not see those who misbehaved being individually punished. That had created a sense of unfairness, and a balance needed to be struck. Still, the focus on firms alone was not enough; it needed to shift onto individual behaviour. How to do that was one of the challenges ahead for regulatory authorities.
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