Risking it all
Fear of breaching regulation could drive better behaviour, but a risk-averse culture may damage entrepreneurial spirit.
In the case of both culture and regulation, approaches by the larger banks and financial institutions have translated into the wider market.
The 2009 reviews of UK banks and other financial institutions following the crisis led to changes in corporate governance principles across all sectors through, for example, the adoption of Sir David Walker’s recommendations within the 2010 UK Corporate Governance Code. Similarly, the regulatory move towards personal responsibility through the senior managers and certification regimes, initially developed for banks and deposit takers, will now be extended to the wider financial sector over the next two years.
Encouraging good culture
The Financial Reporting Council (FRC) continues to look at culture, in particular through its Culture Project, and it remains a key focus for the Financial Conduct Authority (FCA). However, the FCA recognises that it cannot impose one ‘good’ culture across firms; there is no ‘one size fits all’. Regulators have instead sought to create a framework in which good rather than poor cultures are encouraged.
Our White Paper, which looks at culture within the financial services sector, suggests that good culture can be a valuable differentiator for financial services firms and opportunities can be found in the way firms apply new or changing regulation. One of the questions of wider interest is whether there is a conflict between ‘good’ culture and making profit, or whether it can in fact drive sustainable profit.
The Investment Association stated in its recent Productivity Action Plan (March 2016) that the role of culture in creating long-term value for companies and their shareholders is being recognised.
Similarly, the FRC’s Culture Project seeks to promote those that will support long-term success. The report on its observations will be followed by an exploration of the findings at the annual FRC conference in September, but as its Chairman Sir Win Bischoff said recently ‘the values, attitudes and behaviours which make up corporate culture are central to the way an organisation achieves its objectives’. However, many people in the industry believe that regulation is stifling innovation and damaging entrepreneurial spirit, and firms should be mindful to avoid a ‘compliance-led’ culture.
As the FCA has begun consulting on the roll out of the accountability regime to the wider financial services sector, it is a good time to consider the lessons that can be learned from how the banks have adapted to the new regime. This includes conduct rules, whistleblowing regulations and senior managers and certification. However, should culture and behavioural change be board or compliance led and how does one achieve such change?
Christine Lagarde, CEO of the IMF, said: ‘Whether something is right or wrong cannot be simply reduced to whether or not it is permissible under law. What is needed is a culture that induces bankers to do the right thing, even if nobody is watching.’
However, there is no consensus on what culture is let alone what ‘good culture’ is needed to adapt to the new regime. At its simplest culture is: ‘the way we do things around here’. A fuller definition might be: ‘a firm’s shared values, attitudes, standards and beliefs and how they are aligned across their goals, strategies, structure and approaches to its people, customers, investors and the greater community’.
There is agreement that good culture needs to address more than the codes, regulations, duties to customers, conduct rules and the administration of justice. It goes beyond compliance. There is a ‘push me, pull you’ relationship between the places only culture can reach and those that lawmakers and regulators dare not tread. Although not uniform, culture needs to engage with social responsibility; doing what is right in a way that aligns with strategic business objectives, practices and reward and with stakeholders.
There is also consensus that values and good culture drivers should come from the top, and then become lived, part of the fundamental assumptions, beliefs and motivations of all in the firm.
The FRC comments that: ‘Codes put forward principles for best practice that make bad behaviour less likely to occur; and public reporting can make it harder to conceal such behaviour. But, by itself, a code does not prevent inappropriate behaviour, strategies or decisions. Only the people, particularly the leaders within a business, can do that.’
Concern over regulation
Regulation alone cannot drive better behaviours and in particular there are concerns that regulation is stifling innovation and damaging entrepreneurial spirit, for many reasons:
Regulations are numerous and introduced piecemeal, and there are tensions between different regulatory approaches across service lines and borders. Even sophisticated businesses find it hard to digest, train and implement the technical aspects, not least among the newly regulated senior manager functions. There can be a lack of clarity and an over-engineering of policies through anxiety over non-compliance; scaremongering may lead to unnecessary complexity. For some fast moving work, the bureaucracy is killing speed of execution and convenience.
Even though the presumption of personal liability has been reversed, fear has driven some firms to overcomplicate the compliance processes, which has led to less than ideal culture. Too much negative reinforcement around liability and punishment can overlook the need to focus on positive change. Senior managers often, at least initially, have felt anxious within the new regimes; the firm’s culture should create a supportive environment. Too much focus on accountability and providing assurances to regulators may put at risk a firm’s wider priorities. Firms should be aligning what is right for their customers, business, people and stakeholders.
Although it is the case that compliance is king, true engagement and change is not led by compliance, but from the top. This is despite the spike in compliance recruitment. Regulation should not be used as an excuse for poor leadership. Into this comes behavioural science to inform leadership; implementation of change programmes to de-risk the board and avoid ‘group think’ and; performance metrics measuring cultural and behavioural compliance.
It is also hoped that the musical chairs that has affected some firms will settle down so that the roles to be played by compliance, HR, GC, CROs, IT, the board, senior managers and others will be clear. There has been a lack of definition of responsibilities which is set to change. The roll out of the accountability regime provides the opportunity to focus on the right approach across the business.
There is concern that regulation is not having the intended impact and that remuneration structures may now be over-engineered. Incentivisation needs to be aligned with the culture of the firm across performance metrics. Remuneration structures and the measurement of contribution by reference to cultural adherence will trickle down across the sector and beyond. We expect to see a cultural dimension to each of the company’s people processes, assessing what they did and how.
Opportunity in challenge
With the roll out of the accountability regime to most regulated firms within the sector by 2018 and further regulatory change, proportionality will be crucial. Excessive regulation can be inhibiting. Until the public and politicians give the sector a much cleaner bill of health, the regulator will have to keep pressing; when trust in the banking sector’s ability to manage itself and maintain high ethical standards declines, as in the financial crisis, regulation will naturally move in to fill the gap that is seen to have been vacated by ethics.
However, entrepreneurs will see opportunities in challenges and should understand that regulatory constraints do not need to be stifling. Some are trying to channel the entrepreneurial spirit of the City to come to the fore, now that Brexit has added to those challenges. There certainly is a history of innovation that is not incompatible with acceptable risk taking.
There are signs of strain, and those businesses already penalised may not have the courage to take risks in innovation for a while. However, it is hoped that the volume of and tensions between regulations will fade in time after a positive response and adjustment of the industry. Culture, when aligned with a firm’s strategy, can help to achieve long-term sustainable success for all stakeholders, including the wider community and environment.
This article was originally published in Governance and Compliance magazine on the 23rd August www.govcompmag.com.
News & Insights
Toolkit for the new Senior Managers and Certification Regime
Vanessa Walters sets out some of the key principles of the regime and how FCA regulated firms can best prepare for it.
Initial Coin Offerings - an unregulated minefield
Jamie Cartwright and Thomas Plowman explore the largely unregulated minefield of Initial Coin Offerings and the potential for litigation.