Regulating Conduct & Culture in the Financial Industry

The Eurofi High Level Seminar 2016, which took place in Amsterdam from 20-22 April during the Dutch EU Council Presidency, examined new trends and objectives in the financial sector, amongst which the improvement of conduct and culture. The full report of the event was made available this month, [1] containing an account of the discussions held during the roundtable on conduct & culture. [2] The choice of this theme denotes both a new trend in the financial sector and growing regulatory concern with conduct & culture in the financial services industry.

Although amorphous as a concept, culture is very much in the regulator’s sights, responding to the widely held belief that poor conduct was at the root of both the 2008 financial crisis and more recent market scandals. Whilst the initial regulatory priority was to promote a more risk-aware culture to support prudential regulation, the examples of Libor and FX manipulation and collusion behaviors helped build the case for the conduct element of culture to rank high in the regulator’s agenda. The growing focus on conduct and customer protection extends the cultural lens into the murkier areas of ethics and integrity: what does “good” look like?

Conduct and culture, which is still in its infancy in terms of global regulation, has been gaining momentum in the regulators’ agenda. The Dutch and UK regulators have been at the forefront of the more meaningful regulatory efforts laying ground for wide-ranging supervisory action in the field of conduct and culture. De Nederlandsche Bank, the Dutch central bank, has put in place a comprehensive supervisory framework on behaviour and conduct, [3] which will most likely become a reference for the European Central Bank in its supervisory reach. The Financial Conduct Authority (FCA), in turn, has been steadily resorting to a range of supervisory tools and methods to engage with firms individually on issues of conduct and culture, and pushing for enhanced rules on accountability, incentives, fair treatment of consumers and whistleblowing. [4] In parallel, the New York Fed has been holding, since 2014, annual conferences or workshops on culture and behaviour in the financial services industry, the latest of which included a keynote address by IMF Managing Director Lagarde. [5] This shows that conduct and culture is gaining momentum in the global regulatory agenda and sweeping supervisory action is therefore to be expected.

For their part, bank boards have been making serious efforts to set the right tone from the top. But high level intentions do not necessarily impact on the main cultural pillars of accountability, communication and incentives. It is certainly questionable how far tone from the top, if exclusively stemming from board directors or senior management, influences the key decisions and interactions that shape the “moments that matter” within the business. Middle management is critically important to ensure that the tone from the top cascades throughout the different layers of financial institutions—and this concern was one of main drivers for the FCA adopting the new Senior Managers and Certification Regime. [6] By the measures of “are institutions more trusted?” and “are they at less risk of fines?”, the job is still far from done. And the gap between what is said and what is done will apply equally to the financial sector as a whole.

PwC’s analysis shows that culture is more correlated with high performance than strategy, operating model or product coverage. Culture is not only about conformance; it can also be liberating. The more confident boards are that staff will behave as expected, the more licence staff will be given to make decisions and capitalise on opportunities for growth. [7]

Brief window

Financial institutions still have a brief window of opportunity to engage their workforces in cultural change. But, if institutions miss this window, regulators are signalling that they will move to fill the void. The very personal accountability and tough penalties ushered in by the UK’s Senior Managers and Certification Regime offer a taste of what lies ahead if financial institutions do not move quickly enough. And this may only be the beginning.

Leaving regulators to shape culture will not just be bad for the financial sector; it could actually be counterproductive all round. If employees see cultural change as just more compliance, the response can become narrowly legalistic. Culture should be grasped as a driver for aligning behaviours with the bank’s overall risk strategy and appetite.

Driving change

The big challenge is that culture, especially ethics and integrity, are difficult to operationalise and measure. Like an iceberg, much of what is most important lies below the surface, in a profusion of shared assumptions which are communicated and reinforced through a series of subtle signals, many of them undocumented.

Experience suggests that an effective approach is to identify and influence the traits and assumptions which shape behaviours in the moments that matter. Some of these behavioural drivers may need intervention and change, but many others are positive and should be actively reinforced. The risk culture can provide a bridge for addressing ethics and integrity. By measuring and targeting behaviours most in need of attention, financial institutions can demonstrate real differences. What gets measured gets done!

Benefits go beyond simply satisfying regulators. Financial institutions can strengthen reputation, retention and returns. They can also give staff more licence to capitalise on opportunities and embrace innovation, confident that they are doing the right things. Getting the right culture will enable global alignment between conduct and an institution’s values. Cultural change, if appropriately undertaken and tailored according to the dimension, complexity and nature of institutions, can be a major driver for success and, ultimately, contribute to profoundly improving corporate governance.