Confucius once said that three things are needed for government – weapons, food and trust. And if you have to give them up, keep trust until the last as “without trust we cannot stand”. The same could be said to apply to financial services.
The innovation of paper money in the seventeenth century by London’s goldsmith bankers ushered in the era of modern banking. That system, depending on receipts and IOUs, was based on a system of trust and confidence.
That was also the start of the long tradition of banking and innovation in the UK. And until relatively recently we have prided ourselves that our markets have been bywords for integrity and fair play. Yet that long and distinguished history has been afflicted by the financial crisis and by wave upon wave of misconduct issues. That system of trust which underpins our financial systems has been eroded.
I would like to talk to you about the intrinsic value of trust to our economy and businesses. Then I’ll talk about what has gone wrong in our markets and outline some of the changes that are in flight to address this. Lastly, I would like to end by discussing whether or not these changes have gone far enough.
What is the value of trust?
Rebuilding trust is a difficult task.
Trust is the foundation on which our markets function. Market confidence depends on people thinking their money is safe, believing firms will do what they say they will and place the interest of their clients ahead of their own. And we have seen the consequences when that trust breaks down. Share prices tumble, markets falter and public belief that the industry is doing the right thing slips further away. It’s simple really - without trust we cannot endure. And, as we know, trust arrives on foot and leaves in a fast car. Rebuilding trust is a difficult task.
Since the 2008 financial crisis, both the industry and regulators have sought to draw a line under the fallout. Collectively and globally, this has included strengthening capital resilience and improving liquidity and creating resolution regimes for failing banks. Financial institutions have become less complex and more streamlined. There has also been massive regulatory, legislative and structural change. However, while we tackled the prudential risk and the financial services industry sought to regain public trust, misconduct continued.
In 2012, we imposed a £59.5m fine – what was then our largest fine – against Barclays for misconduct relating to LIBOR.
Public outrage was palpable.
And the LIBOR fines triggered a wave of reactions that continue today. In many ways it was this, rather than the crisis, that caused patience finally to wear out. So the question for us: as regulators, as the industry, and as investors, is when can a line be drawn? What can be done? And as this week’s fines show, that question remains relevant today. We are not fixed yet.
Let’s talk about these fines. This week we imposed £1.1bn in penalties against five banks, for failing to control business practices in their G10 spot FX trading operations. An investigation into Barclays continues. The banks’ failings meant that, from 2008 to 2013, traders in that business were able to put their banks’ interests ahead of those of their clients, other market participants and the wider UK financial system. The fines were our highest ever – reflecting the fact this involved post-LIBOR misconduct. All of the banks had taken steps post-LIBOR but not enough.
I have answered a lot of questions over the past few days about the retail consumer impact of this behaviour. And my answer has been that the real impact for consumers is not the risk that their holiday money costs more but the corrosive effect these issues have on confidence and trust in our wholesale markets.
But of course other scandals have cost customers dear. From pensions and endowment miss-selling to Interest Rate Hedging products to payment protection insurance (PPI). The industry has paid out billions for its failings. The redress for PPI alone since January 2011 now stands at £16.6bn.
In the US since 2008, fines imposed on its largest banks have exceeded $100bn.
So, trust is not only critical but the cost of getting it wrong is very clear.
So how do we rebuild that trust? Does the regulator have a role in doing so? I’ll come back to these questions.
What went wrong in our markets?
But before we look for answers we have to understand the questions. What went wrong?
The FX fines, and the conduct underpinning them, reinforce once again the need for the right culture. One where people are rewarded for doing the right thing, and call it out when they see others do the wrong thing.
At some point, in some areas of our markets, people ceased to think about their actions. They put aside their social and ethical responsibility in order to get ahead and succeed – and they were rewarded for doing so.
Why did they do that? Is this a case of a few rogues once again tainting the reputation of an industry? Does one bad apple really spoil the whole bunch? Of course, given the right circumstances and over time, one apple can eventually cause the others to ripen then rot. But it is more complex than that.
Philip Zimbardo, a psychologist, examined why good people do bad things in a prison experiment conducted at Stanford University, where normal people (good apples) were put in a prison (bad barrel). Zimbardo found that human behaviour is determined more by situational pressures and group dynamics than an individual’s inherent nature. Indeed, the experiment was terminated early because of how badly formerly good people were acting.
So, how do leaders create the right culture for their firms?
As a regulator, we have said that ‘tone from the top’ is vital in establishing good culture. But it is not enough on its own. This has to be embedded at the level of frontline staff. And that does not happen with fine words. It happens as a result of behaviours and what people see day in, day out. Who get rewarded? What gets rewarded? Who are held up as role models? Can employees who disagree speak out without fear of reprisal? Are there real consequences for people who cross ethical boundaries?
It is only through establishing the right culture at all levels that senior management can convert their good intentions into the right outcomes for consumers and markets and ensure that delivery of these outcomes is sustainable. However, cultural change can take a significant period of time to achieve and, until the culture on the trading floor or the sales room catches up with the aspirations of leaders within the regulated community, firms need to ensure that they have appropriate control systems tailored to the risks presented by parts of their business.
And, as FX demonstrates, comments like “3 musketeers” and “1 team, 1 dream” show that firms must recognise that cultural bonds and loyalties are not necessarily to the firm – they may be at desk level or even across industry groups. So a ‘one size fits all sheep dip’ on ethics will never work. Nor will compliance succeed by simply setting the rules and expecting them to follow. Rules can be avoided, they can also enable people to avoid taking personal responsibility; they can be gamed. The aim has to be a culture where people own doing the right thing at the frontline as part of the way business is done.
What has changed?
We continue to find new ways on delivering on our regulatory mandate.
As I have mentioned a lot has changed since 2008, and it continues to do so. Firms need to strengthen controls but there is also a focus on individual accountability. The new Senior Managers Regime (SMR) requires what should be good business practice – clear lines of responsibility and accountability at the very top.
In the aftermath of the LIBOR misconduct scandal and the recommendations as set out by the Parliamentary Commission on Banking Standards, there has been a focus on strengthening internal firm controls and more individual accountability.
The proposed Certification Regime represents a significant shift of responsibility onto firms to ensure that they employ appropriate staff, and that staff remain fit and proper for their roles on an ongoing basis. Senior managers at firms will be accountable for ensuring that key staff are fit and proper, consistent with the emphasis of the SMR on personal accountability. Firms can make their own decisions about certified staff in the knowledge of their own business, culture and expectations, which should enable firms to embed the culture and values they want in their business.
Looking to the future, the Fair and Effective Markets Review was set up by the Chancellor and the Governor of the Bank of England in June 2014. It is chaired by the BoE’s Deputy Governor for Markets and Banking, with the FCA’s CEO, Martin Wheatley, and HM Treasury’s Director General, Financial Services, as co-chairs.
The Review takes a comprehensive and forward-looking assessment of the way wholesale financial markets operate. Its purpose is to help restore trust in those markets, and to influence the international debate on trading practices. It is consulting on whether answers are cultural, structural or regulatory. The Review launched its main consultation on 27 October and will then make recommendations next summer.
And the regulators have changed too. The FCA has new powers (suspensions, banning financial promotions) and a new approach (for example, early intervention to prevent risk crystallising). But more importantly we continue to find new ways on delivering on our regulatory mandate. Our response to the issues surrounding trading on the foreign exchange market is an integrated response, involving swift enforcement action, forward--looking supervisory work, and continuing policy and thematic work. It is not just about punishing misconduct but about driving up standards across the industry.
We consider this coordinated cross-organisational industry-wide response shows the FCA doing things differently from its predecessor.
And this reflects our overall approach. We look at which tools will achieve the best outcomes. I often hear that Enforcement is the main tool the regulators use, that firms get insufficient credit for the 90% of the time they get it right. I think that perception has to change. We regulate about 70,000 firms and around 150,000 individuals. In comparison, last year we publicised 168 Enforcement outcomes. That is not – by any stretch of the imagination – using Enforcement as our only tool. A lot more than 168 things went wrong in the financial services sector last year.
So how do we do better?
The industry is aware that it needs to change. Trust, fairness and integrity are values that banks are placing at the front and centre of their business models.
Just last month the 142-year-old Co-operative Bank kicked off its advertising campaign in the ‘fight back for trust’. It shows a man having the words ‘Ethics & Values’ tattooed on his back, saying “I belong to an organisation that does things a little differently”.
While Nationwide’s campaign uses the tagline “They say money makes the world go round. We think it’s people”.
Ross McEwan, CEO of RBS, recently said:
“…I have placed trust at the heart of my new strategy for our bank. The reason is obvious but also worth repeating. We aren’t trusted enough by people who rely on us to help them manage their personal and business lives…and whom in turn we rely on business success. And in banking trust is not a ‘nice to have’ – it is a commercial essential.”
Damaged reputations can and, I would argue, must be repaired. But, whatever the method of communication or message, these assurances need to be followed up by action. Public trust is fragile, and these last few years have seen the industry suffer one mishap after another. Promises need to be followed through so trust can be rebuilt.
The regulator cannot, and should not, micromanage culture – that won’t work. But we have seen a lot of culture programmes recently working better than others. So, here are a few observations that firms may wish to bear in mind in the quest for sustainable cultural change:
- The industry needs to align incentives (monetary and otherwise) for all staff to ensure good outcomes.
- ‘One size doesn’t fit all’ – large and complex firms will have micro-cultures and they need to find what works for each of these.
- You must encourage and take seriously frank and open views from all sources.
- According to a Future Workplace survey, 91% of people born between 1977 and 1997 expect to stay in a job less than three years. In that context how do firms retain their talent, build a coherent culture and inspire loyalty in their future leaders?
- Senior managers must lead by example and hold their employees accountable for their actions.
- Culture is what actually happens as supposed to what should happen. Firms need to understand where there is a gap between rhetoric and reality and take steps to narrow it.
Conclusion
To conclude, rebuilding trust will take time.
The regulator has a role to play but ultimately the answer is not more rules and procedures. It lies in people taking responsibility. Responsibility for understanding their business, responsibility for market outcomes and responsibility for their behaviours and for those of others.
Doing the right thing should be part and parcel of the DNA of any role within the financial services industry - within any industry. The expectation that Compliance’s function is to police other parts of the business is an imperfect model. Compliance cannot be omnipresent, and neither can the regulator – no matter how much we would like to be.
And if everything I have said is not enough to convince you, take a look at our FX Final Notices. UBS had several whistleblowing reports – its failure to deal with these cost them very dear.
I believe that with an approach built on collective tenacity and ambition, we can retain and extend the UK’s reputation as a world leader in financial services – and continue to be an example of what being ‘Best of British’ means.