For leaders today – both in business and regulation – the dominant theme of 21st century financial services is fast turning out to be a complicated question of fairness.
My Lord Mayor, ladies and gentlemen, thank you for that kind introduction – it is a great pleasure and privilege to join everyone tonight.
In creating the FCA as part of the new regulatory architecture, we have created a new voice in finance.
That new voice is about conduct. Not just a conduct toward the man in the street, but also conduct for major players in the system – for banks, investors of all kinds, people who borrow, people needing insurance and conduct in the dealing rooms of the City.
And given this new voice I want to talk, not about the causes of the crisis, or cures:
- not about maturity transformation
- or systemically important financial institutions
- or counter cyclical capital buffers
but about a very simple concept that appeared to get lost in financial services in the last decade.
About fairness.
Public frustration over bank rescues at a huge cost to the taxpayer quickly turned to distrust following payment protection insurance (PPI). Then anger over LIBOR. And finally became a broader issue of justice – the Occupy movement in 2011; interest-rate swaps; multi-billion dollar redress payments; record numbers of complaints; and an associated growth of the claims management business model.
Now I know many people, perhaps some in this room, think it has all gone too far – that we have now entered a compensation society where it is easier to purse an easy pay out via a claims management company rather than accept that you made a mistake in the first place.
But despite that; what I see when we are in the details – and believe me we spend a lot of time in the weeds, is that time and again:
- people were taken advantage of, or misled
- the inevitable information asymmetry between consumers and suppliers was exploited
- or sophisticated trades and products were used to dupe even so-called professional investors
Not all the time. Not in 100% of cases. There will be many cases of mis-buying or buyer remorse – but enough cases for us to need to set up review exercises to get to the bottom of the question ‘was the sale fair?’
So for leaders today – both in business and regulation – the dominant theme of 21st century financial services is fast turning out to be a complicated question of fairness.
And at the centre of this debate about fairness is culture and accountability. How do we get firms to do the right thing, whether the regulator is watching or not? How to get senior management to be accountable for doing the right thing.
I want to argue tonight that we are moving towards a fairer system – that the financial world is in fact responding to the cultural change around it.
But I also want to make the point that there is no room for complacency. Poor conduct is still a daily staple of the news – most recently in the wholesale markets. And until this flow of headlines slows, until the change is real and manifest, it will prove difficult to deliver confidence.
For me, there are two key challenges in moving things forward. Number one: to look ahead more effectively so you prevent crisis. Number two, to respond to the changing world around us with cultural reform of our own.
Let me take both in turn, starting with the importance of looking forward.
Warren Buffett famously remarked that in the business world, ‘the rear view mirror is always clearer than the windshield’ – which explains why ex post analysis of economic crisis lines the bookshelves of stores like Waterstones.
Clearly the same story is true of the official sector. There is no doubt that there has been a deep-rooted problem of retrospection over the years: regulatory community included.
This has taken two forms. First, a broad failure to keep up with the outside environment – in particular technology.
Second, a culture of reacting to specific events rather than anticipating them. In the UK the flagship example is PPI; in the US, mortgages; in Hong Kong the mini-bond crisis, in Korea currency swaps; in Australia structured agricultural products and so on and so forth.
The initial regulatory response is to ban the product and seek redress. What we have now is very different. A regulatory infrastructure specifically mandated to look through the windscreen as much as is possible, which is why we see key issues like interest-only mortgages now being tackled early and authoritatively.
We took a potential problem – that 2.6m people had taken out interest-only mortgages over the last decade or so but that around half did not have a plan that would allow them to repay the capital. We tried to look forward to ask what would happen if we did nothing – for those unable to pay, the options were not good: write-offs are generally not good for banks and evictions generally not good for homeowners.
The action we took – working with the industry to get ahead of the problem; to reach out to the 2.6m homeowners and start putting actions plans in place now, not before it is too late.
Much of the criticism of the regulator in the past – which we are now working to untangle – has been around the frustrations of retrospective action versus early warning, talking to over listening to, and inconsistency over predictability. Forward looking is our new mantra.
Ethics versus obedience – firm shortcomings
Challenge number two for regulators, and for firms, is one of cultural reform.
Culture is notoriously difficult to measure and assess – let alone change.
One of the key areas we have been working on is incentive structures. Not just the million dollar bonuses paid to highly specialised traders – but the much more modest incentives paid to front-of-house staff. And it’s not about the quantum of reward but how they are designed.
In the Big Short, Michael Lewis uses the example of different US hospitals removing more appendixes than others because they get paid more for doing so, to underline a basic point that: ‘if you want to predict how people will behave, you look at their incentives.’
The industry has sat up and listened to our concerns. Many incentive structures have been or are being redesigned. This is a positive step. We will continue to monitor closely but it is certainly moving in the right direction.
Ethics versus obedience – regulatory shortcomings
Incentive is certainly part of the puzzle but I also want to talk about ethics – doing the right thing. Is it necessary for the regulator, in a very prescriptive way – to set out what is right, what is fair? The traditional mechanism for dealing with a lapse has been to beef up the rules. To close loopholes in the law as and when they appear. To require more disclosure or compliance with specific processes.
The problem with this approach is twofold. First: it is, ‘static’. So it is closing stable doors after horses have bolted.
Second: it encourages the very behaviours it seeks to stamp out. In his excellent book Ethicability – Roger Steare argues for a more sophisticated interpretation of integrity in business – one that is not simply defined by the ethics of obedience – so what is legally right or wrong – but actually looks towards the ethics of care and the ethics of reason.
Steare makes the very good point that: ‘At their worst, rules, laws, regulations and red tape have a tendency to multiply because they remove our responsibility for deciding what’s right’.
His chief criticism? The fact that governments over the years have responded to scandal with rules and regulations, without considering that it was ‘the obedience culture’ that often failed in the first place.
So if we trace back to around 2005-8, the breeding ground for many of the cases we are dealing with today, we find them occurring in a period that – far from witnessing a de-escalation in the rules – actually saw FSA guidance expanding by some 27%.
The important point here is that to move things forward in the current context, the consumer expects regulators, and firms, to look beyond a narrow interpretation of the law to questions of fairness.
And this goes some way towards helping us understand why issues like terms and conditions are such sensitive areas.
Anybody who has an iPhone will have been offered the chance to upgrade the software in the last few weeks. To do that you have to tick a box agreeing ‘to be bound by the following terms’ followed by a lengthy ten-page agreement. Everyone ticks the box. No-one reads the terms and conditions.
It’s as true for financial products as it is for software. No one reads the terms and conditions – except the lawyers. Relying on ‘fine print’ because somebody has ticked the box, but which allows things which are ‘unfair’ is not the way forward. But of course, buried in that ‘fine print’ are lots of terms and exclusions that firms rely on when economic conditions change.
What is ‘fair’ in a contract depends on a whole set of things – marketing materials, representations made at point of sale, what the branding or description implies, as well as the fine print. What do you think the average person understands by ‘absolute return fund’?
So today, we are moving back to the future in a sense – with the regulatory system placing far more emphasis on good judgement and less on narrow compliance with a set of rules. Hopefully to a culture where the ‘ethic of care’ – doing what is right takes precedent over the ‘ethic of obedient’ – doing what is allowed.
21st century response
In a situation where many small employers who took out these products may be struggling to make ends meet – industry deceives itself if it imagines that a total of 32 offers accepted, totalling £2m, is adequate progress.
So what does this new world mean for the financial community – firms and regulators?
First, for firms it means encouraging a more consumer-centric approach to business. Placing far more emphasis on the culture of the firm at every level and at every stage: from chief exec to frontline staff, from product design to sale. Where Chief Executives and senior management are accountable in the way that the Banking Commission envisages.
It also means being open and transparent on the back book of cases we are still handling. Once again, we come back to that word ‘fairness’.
In too many cases, the first injustice is compounded by a second of failing to deal with the problem adequately.
So, in key cases like interest rate swap mis-selling, the initial ‘unfairness’ – the sale of a complex hedging product to consumers who did not need the product; did not understand the downside risks; cannot extricate themselves from the agreement; and cannot refinance – is too often aggravated by the response of the banks that sold the product in the first place.
In a situation where many small employers who took out these products may be struggling to make ends meet – industry deceives itself if it imagines that a total of 32 offers accepted, totalling £2m, is adequate progress. It isn’t. We need to move faster to get redress where it is justified.
A very positive step has been the commitment that some banks have made in the last few days to fast track the payments; in particular to get an initial redress payment out as a first step while the debate on consequential loss continues. I hope that other banks will also look at what can be done to expedite the process.
For the official sector, the challenge of this new world is almost identical. To look forward as well as back. To look beyond what is mandated by law to broader expectations of behaviour. The culture of ethics over compliance.
Conclusion
To end, let me thank my Lord Mayor again and repeat my message at the start – that I do think the financial world is getting its act together.
Last week, complaints data against banks fell by more than a quarter. Many of our biggest institutions are reforming the way they incentivise staff. The voices we hear coming from the top of the business world suggest customers are being moved back to centre stage.
Clearly many important questions remain on the public lips. People want to know whether progress is uniform? Whether we can prevent all financial shocks? Are the efforts of banks and financial services genuine? Are we going to get a fairer deal in the future? Will there be more set-backs? Is the regulatory system genuinely reformed?
To which my answers would be: not yet, no, probably, I think so, yes, and absolutely
The key point here: that we are now firmly in the territory of moving things forward.
The future of the financial world is looking fairer.