Getting culture and conduct right - the role of the regulator

Speech by Jonathan Davidson, Director of Supervision – retail and authorisations at the FCA, delivered at the 2nd Annual Culture and Conduct Forum for the Financial Services Industry in London.

Speaker: Jonathan Davidson, Director of Supervision - retail and authorisations
Location: Cavendish Conference Centre, London
Delivered on: 12 July 2016

Note: This is the text of the speech as drafted, which may differ from the delivered version.

Key points

  • Our ambition is for the conduct element of culture: that mindsets and incentives will shift to make doing the right thing for consumers and the markets the objective that is always considered.
  • The role of all leaders is to encourage a culture of personal responsibility and impress upon all staff the value of good culture to the health of the firm and the financial services industry more widely.
  • More firms are forming the view that a strong conduct culture which builds consumer trust in firms and markets and inspires employees is in the economic self-interest of the firms and their shareholders.

Introduction

The topic of my speech today is ‘getting culture and conduct right’, and in particular the FCA’s role within that.

As many of you will have seen, there has been much debate recently on the topic of culture, including specific commentary on the FCA’s engagement with the issue.

So this is a good opportunity to set out our stall.

Let me start by ‘un-muddying’ the waters and stating our position unequivocally: the culture of our regulated firms is and always has been vital in our regulation of their conduct.

Andrew Bailey spoke on the subject earlier in the year in his previous role as CEO of the PRA. Culture and governance is one of the FCA’s seven priorities this year, as set out in the 2016/17 Business Plan. So culture and governance is one of the priorities for our policy work, our thematic projects and for the work that we do in day-to-day authorisation and supervision.

I have taken personal leadership of the culture and governance priority; so I am very pleased to have this opportunity to talk with you today about:

  • why culture is so important to us
  • how do we assess a firm’s culture
  • what we are doing to reinforce appropriate conduct culture

What is culture and why is it important?

Before we can talk about culture, it is worth being clear what we mean by culture.

We define culture as the typical, habitual behaviours and mindsets that characterise a particular organisation. The behaviours are the ‘way things get done around here’; they are the way that we act, speak and make decisions without thinking consciously about it.

And sitting underneath these behaviours or habits are mindsets inside people’s heads; the beliefs or values that people feel are important. We can’t see these mindsets but they are main determinant of behaviour from the trading floor to the Board. The mindsets themselves are influenced by the incentives inherent within each firm.

In the last few years, scandals in the wholesale and retail banking sector alike have inflicted a great deal of damage on the reputation of UK financial services and on the wealth of the nation.

Exemplified by Libor, FX and PPI, revelation after revelation about the behaviours in financial services demonstrated that some in the financial sector had mindsets that divorced themselves from the impact of their actions on their clients and, more widely, the society in which they operated.

Great efforts have been made to draw a clear line under the failings of the past and ensure we don’t see their like again. If firms don’t change the mindsets then they will run a very significant risk that old habits of behaviour will repeat themselves and we will see poor outcomes for consumers, poor outcomes for firms and individuals with continuing fines and redress costs, and poor outcomes for markets and the industry with continued erosion of trust and reputation and business to overseas markets.

We do not believe that there should be a one-size fits all culture that comes off the shelf. As many in this room will know, the regulated community is not homogenous. Each firm is different, of a different scale, with different priorities, a different leadership style and so on.

Imposing one specific model on such a broad range of companies would be a fruitless task. Firms, working within the legal and regulatory framework, have to decide what works best for them.

So we are not going to prescribe the overall culture. Our ambition is for the conduct element of culture: that mindsets and incentives will shift to make doing the right thing for consumers and the markets the objective that is always considered, and that it trumps all other objectives for everyone in financial services.

Changing culture is very difficult and we know it takes time. Why is this? It’s because culture comes from the past. CEOs, boards, programmes, systems and controls come and go regularly. Mindsets are developed and reinforced over years and even decades and are passed down from one generation to the next. Indeed, the types of people who are attracted to and thrive in any one culture are those whose have the mindsets best suited to success. As a result, culture is remarkably resilient in the face of attempts to change it; it takes focus, consistency and time to effect change.

So the stakes are high and we are and will be paying very close attention to the culture of firms and what boards and management are doing to shape the culture, of which governance is a key factor. So it is a fair question to ask us ‘How do you measure culture?’

How we measure culture

There are a number of survey methods and metrics being used by firms and others in the field to try to understand the mindsets that are the foundations of culture. We are watching developments in this area with interest.

In the meantime, we are making our assessment of culture by looking at the examples of behaviours that we come across in supervision and we are looking closely at what management is doing to shape culture and the direction implied in it. An example of this is where we recently fined and banned three senior executives from performing SIF roles because they encouraged a culture within the firm that prioritised sales and put at risk the fair treatment of consumers.  

The close contact with firms afforded by our supervisory process allows us to gain this insight. It enables us to look at all the interactions we have with a firm and ‘join the dots’, that is, draw conclusions about the appropriateness of its culture.

There are four areas which in our view leaders can use to shape culture. For leaders they are the tools or incentives that they have to manage culture; for us they are ‘indicators’ that gives us a sense of how the culture will, with time and consistency evolve.

I’ll take each one in turn.

The first factor shaping culture is ‘tone from the top’. As Gandhi advised: ‘be the change that you want to see in the world’. We are therefore very interested to understand how leaders are role modelling the professed culture. Is the culture, or the major determinants of culture, an important and regular item for board discussion? What changes are they making to break with the past? How do leaders spend their time?

Perhaps the most obvious of the ‘indicators’, the leadership of a firm sets its direction, role models the change. But it’s not only senior management who are responsible for setting the tone in a firm.

For example, we know employees are more likely to be influenced by the top trader in their division than they are the Board. If they see that colleague as successful despite, or even because of, poor conduct practices; it makes any positive message from the top around good conduct hard to believe. This can undermine any proactive effort a firm is making to improve conduct. Middle management are critically important to the tone from the top and they should not become a ‘permafrost’ layer. This is where the Senior Managers and Certification Regime will show its value.

So the role of all leaders is to encourage a culture of personal responsibility and impress upon all staff the value of good culture to the health of the firm and the FS industry more widely.

The second set of factors are the formal, tangible practices and cues which tell people what they need to do to be successful and ensure that the right people are employed and rise to leadership roles. Clearly, the recruitment, compensation and promotion practices are critical to this.

By rewarding staff for performance achieved in line with firm values, remuneration and incentives can be used as a tool to reinforce and embed a firm’s desired culture. However, a firm’s payment structure can also encourage poor conduct.

A clear example of this was the action we took against a bank in 2013, where our investigation uncovered a ‘culture of mis-selling’ which drove sales staff to hit sales targets to avoid being demoted, rather than to focus on what their customers needed.

The formal statements of what people are responsible and accountable for are also critical. For this reason, the work on implementing the senior managers’ regime and remuneration policy is very important and I will talk more about this.

The third set of factors are the narratives that circulate in a firm that explain what the firm is trying to achieve, how it will be achieved and why it is important. Key narratives that we look at are the tone of strategies, business plans and mission and value statements. Take, for example, targets. How would, say, asking employees to deliver 10% more YOY with 25% less headcount impact on behaviour? If employees feel under pressure to deliver against tough targets, there’s a risk conduct could slip as a result.

The most interesting and most accurate narratives are the ones that are referred to the most, repeated the most and passed on the most because they resonate with the culture of employees. 

Finally, the fourth set of factors that shape the culture of a firm is the capabilities of an organisation. To learn a new mindset and set of behaviours requires learning new capabilities. For example, to have a conversation about the needs of customers requires an ability to relate to a customer and problem solve a solution which is a different competence from the persuasiveness needed to sell a specific product. We welcome the thinking about professionalism taking place in the BSB and many firms. Again, reinforcing industry competence is one of the outcomes that we want to achieve from the Senior Managers Regime.

Each of these aspects is individually important, but the consistency between them is critical to successful culture change, and it’s the conclusion we draw about a firm’s culture by looking at all factors in the round that informs our supervisory approach.

We realise how challenging and complex the topic is for firms and that there is no single right answer across firms. In our supervision of individual firms what we’re looking for is firms recognising issues and taking robust, consistent and persistent steps to effect change. We want to see that firms are moving in the right direction; with indicators supporting the impression that progress is being made.

How we are influencing good conduct culture across firms

While engagement with individual firms is very important we have also taken a strategic approach to our work programme on culture with a number of key workstreams. The most significant of these workstreams is the Senior Managers Regime, and I’m sure many of you are well acquainted with it.

I would like to take a minute to reflect on the progress made since the regime came into force in March.

Senior Managers and Certification Regime

I have said that it is vital to establish a culture of accountability for conduct at the heart of a firm’s activities.

The Senior Managers and Certification Regime, or SMCR, represents the formal embodiment of this idea.

At its most basic level, the regime provides clarity around who has responsibility for what and ensures they can do the job. We want senior individuals to feel genuine responsibility, and be held accountable for, the decisions they make and oversee.

On the whole, we’ve been pleased with how firms have approached the regime.

We were especially happy to hear that, for a number of firms, the process of applying the regime helped clarify their own management accountability and governance structures, or highlighted improvements that were or are now being made.

I’d like to highlight three essential ideas underlying the SMR.

First, is that senior managers are clearly accountable for decisions and conduct that falls within their areas of responsibility and that the responsibility for conduct does not fall through the cracks or become shared so widely that no one feels accountable for it.

As we looked at the statements of responsibilities and the responsibility maps we found that in most cases they provided a clear picture. But in some cases, the specifics of senior management responsibilities were not as clear as we would expect, with some overlapping and unclear split responsibilities, leaving confusion over where the dividing line is.

For some responsibilities we found that detail in the statements of responsibilities limited the scope of responsibility to particular activities by focusing on how the relevant senior manager discharged his or her responsibilities, rather than what he or she was actually responsible for. In some cases the detail did not provide a consistent and complete picture of who is responsible for what, for example describing other managers as having elements of the same responsibility when this was not consistently reflected in the other manager’s SoRs. I find myself feeling very uncomfortable with this – especially as the combination of the different elements was simply confused or left gaps or overlaps. More importantly, these sorts of examples reflect a real risk that important prescribed responsibilities don’t get discharged to an acceptable standard.

The second idea is that senior managers are clearly accountable for ensuring that they have taken reasonable steps, for example, through governance and control frameworks, to ensure that the decisions made by individuals in their areas are appropriate. We have not always been confident that responsibilities have been allocated to the most senior and/or most appropriate individual. In some cases, we found that firms were seeking to limit the responsibility of the overall senior manager of an area by allocating some of the responsibility to a subordinate. This is not what we intended. If you delegate leadership and decision making then you are still accountable for oversight of those managers.

The third idea is that all senior managers are clearly accountable for ensuring that individuals working at all levels in their areas of responsibility meet appropriate standards of conduct and competence. In view of the importance of standards to the conduct culture of the industry our supervisors will be paying close attention to how senior managers discharge this responsibility.

We think that these ideas are of general importance and because we demand of ourselves the same professional conduct we expect of the regulated community, we have decided to apply the fundamental principles of the regime to our own senior staff.

Casting forward

We have seen genuine, meaningful engagement with the issue of culture in firms, in many cases, a wholehearted application of the regime.

Indeed, the firms that implement the regime best and get the most out of it are the ones that embrace it, and see it as an opportunity, rather than a box-ticking exercise.

We hope to see more and more firms approaching the issue of culture with this sort of enthusiasm as the regime beds down over time, particularly as we begin to think about how the SMCR will apply to the other regulated firms not covered under the first round of implementation.

We are cognisant of the diversity of firms this will bring under the regime, and proportionality will play a key role as we work to ensure the SMCR works well across all sectors.

But the tenets of the regime – clarity, accountability and transparency – will not change.

And our expectations around conduct, whether the firm is large or small, will remain high.

Conclusion

More and more firms are forming the view that a strong conduct culture which builds consumer trust in firms and markets and inspires employees is in the economic self-interest of the firms and their shareholders.  

We welcome this because culture and behaviour will change permanently for the good if it is chosen and not imposed, if the industry itself takes responsibility for delivering the standards it aspires to and that society is entitled to expect.

It’s important we get this right. We very much look forward to working with the industry to achieve a high performing and a healthy industry.