Summary

This week, Andrew Bailey, the Chief Executive of the FCA, gave his latest speech addressing the issue of culture.  The speech, which was entitled “The Importance of Diversity” and given at the Personal Investment Management and Financial Advice Association (PIMFA) Wealth of Diversity Conference 2019, reiterates the FCA’s focus on regulated firms doing everything within their power to improve their culture and corresponding governance.  Mr Bailey asserts in his recent speech that fostering a culture of diversity can contribute to changing the behaviour of firms for the better.

Since the financial crisis hit in 2007/8, there has been considerable regulatory focus on culture within financial services.  High profile scandals, including the manipulation of benchmark rates by traders at major banks, served to increase focus on efforts to drive cultural and behavioural change, spurred on by the damning findings of the UK Parliamentary Commission on Banking Standards (PCBS) in 2013 which concluded that “Banking culture has all too often been characterised by an absence of any sense of duty to the customer and a similar absence of any sense of collective responsibility to uphold the reputation of the industry”.  But, over a decade on since the financial crisis, why does the issue of culture still persist and what does the future hold?

Rule-based change

Until recently, the regulatory response had largely been focused on addressing the remuneration structures that were seen to have incentivised the risk-taking and poor behaviour viewed as partly to blame for the financial crisis, and ensuring that senior executives in financial institutions are held properly to account.

In January 2010, the then FSA’s original Remuneration Code came into effect and required the UK's largest banks, building societies and broker dealers to ensure that their remuneration policies, practices and procedures were consistent with, and promoted, effective risk management.  This Code has been through various incarnations and extensions, and now exists in seven Remuneration Codes, with the main rules contained in the FCA Handbook and PRA Rulebook.

In March 2016, the FCA introduced the Senior Managers and Certification Regime (SMCR) for banks, with the intention of identifying the most senior executives in a firm and holding them accountable for any instances of misconduct on their watch.  Last month, the regime was extended to insurers, and at the end of this year the regime will be extended to all FCA solo-regulated firms.  This will include claims management companies following them becoming FCA regulated on 1 April. 

In September 2016, the FCA and PRA introduced rules and guidance requiring banks and insurers to put in place formalised whistleblowing procedures.  These measures were designed to address the PCBS’ finding, in relation to the LIBOR scandal, that “many people turned a blind eye to misbehaviour and failed to report it”.  The rules included a requirement to appoint a non-executive director to be the “Whistleblowers’ champion”.  Although we are not aware of any current plans to do so, like SMCR, this regime could be extended to all financial services firms in the future (it currently serves as guidance).

This year, following extensive public feedback, we can also expect the FCA’s new public directory, including all regulator-approved Senior Managers and firm-approved Certification Function Holders who working in the UK financial services industry, to be formally launched.

Wholesale change

The FCA’s Business Plan for 2018/19 again cited culture and governance as one of its cross-sector priorities.  The extension of the SMCR, the new public register and a review of firms’ remuneration arrangements form part of this.  However, the FCA’s view is that such rule-based changes alone are not going to bring about the wholesale cultural change it feels is still needed across the financial services industry.  The Business Plan states “We will continue to support and engage with firms, sharing our expectations and working to promote effective culture and governance across the industry.”.  Firms are being put more squarely in the hot seat to take ownership and effect change – and the FCA seem to view themselves as facilitators in effecting such cultural transformation.

Last March, the FCA published Discussion Paper 18/2 entitled “Transforming Culture in Financial Services”, containing a series of 28 essays by regulators, industry leaders and academics – and recognising that there is no "quick fix" for cultural change.  The paper was intended to stimulate further debate on transforming culture in financial services, rather than precipitate formal feedback.  The FCA concluded that three key themes emerged from the essays:

1. the need for a system-wide approach to change that considers the influences on every individual within a firm;
2. the importance of organisations providing an psychologically safe environment for employees to speak-up; and
3. that regulation can only go so far in improving culture.

The paper included potential actions for leaders in firms to consider how to effect change in their organisations and questions to stimulate further thought.  Interesting, the possible steps included using behavioural science to guide incentives and cultural change, and we understand that the FCA is using psychologists to assist them with their activities in this area.

Conclusion

Firms need to look carefully at their strategic goals and ensure that they are aligned to promote and reward good culture.  This does not just mean stamping out bad behaviour – although firms’ and regulatory action in this regard will continue to play an important role – but, more fundamentally, recognising and rewarding the value of good behaviour for sustainable success.  The FCA’s Discussion Paper last year proposed various measures that firms could take to tackle this issue.  Only some of these may resonate with your firm – each firm is different and what is a “right culture” for one may be different to another.  However, one thing is clear:  boards and senior managers ignore this issue at their peril.  The enforcement statistics in the FCA’s last Annual Report tell their own story: a 400% increase in investigations in relation to firms’ culture and governance, and this trend continues.  This issue is here to stay top of the regulatory agenda – and therefore top of firms’ agendas too.