Leadership and conduct

Speech by Martin Wheatley, Chief Executive, the FCA, at City Week 2014: International Financial Services in the Post-Reform World: Opportunities and Challenges. This is the text of the speech as drafted, which may differ from the delivered version.

martin wheatley speech migration.jpg

Reflections on the year

It’s a pleasure to join everyone for this important event and to have the opportunity to reflect, with Andrew, on what has been a defining year for conduct in financial services – yet another defining year in fact.

So, in April last year we had the introduction of the FCA and PRA. One of the most significant regulatory shake-ups in the City’s history, with more emphasis on moving things forward in key areas like conduct and crisis prevention.

Following on from this, in June, there was the publication of the PCBS report. Another important milestone. And of course in February, Sir Richard Lambert launched his own, industry-backed consultation on standards.

So, a great deal of reflection, activity and further change over the last 12 months – but also, importantly, against an increasingly positive economic context.

Job creation in the industry is up. Volume of business is up. New equity IPOs are up. And of course, the City’s trade surplus is up – to record highs in 2013.

So, the tail winds are here. But the next game, as they say in football, is invariably the most important and for leaders looking ahead to 2014/15, it remains difficult to see much beyond the possibility of another ‘defining year’ for the City and its position in the world.

The significance of London’s fall down the Global Financial Centres Index has been over-played in some quarters. But the report’s immediate concerns – specifically over conduct and issues like market manipulation – do raise multiple questions in the wholesale space for the year to come.

Does London have the credibility today of yesterday? Is it still, as bankers described it 180 years ago, a ‘centre upon which commerce must turn’?

And, if it is losing ground to rival hubs, how do you then restore international trust and confidence in its markets? Who takes responsibility for that change?

The next 12 months will provide some of the answers to these challenges, but they will also pose new, uncomfortable questions.

Most important of all, post-crisis, have we genuinely learnt the lessons of the past? Or is there more to do?

Why, for example, are new allegations of poor conduct - like manipulation of forex markets - still bubbling up after multiple warnings to senior management, frustrating efforts to build confidence?

Equally, why do some 71% of the world’s investment bankers (according to an Economist survey) tell us they need to demonstrate ethical flexibility in order to climb the career ladder?

And, another interesting question for leaders here: why does this figure clash so strongly with findings in the same survey, from the Economist Intelligence Unit, that 91% of executives consider ethical conduct just as important as financial success?

The clear risk here for the City – and the most pressing – is that if anything up to 71% of a profession accept the benefit of working under the umbrella of London’s reputation, without acknowledging their responsibility to protect it, we are clearly storing up problems for the future.

So, for industry leaders today the great imperative of 2014 is to remove this unresolved tension between their people wanting to do the right thing, if you like, and their being correctly incentivised to do it. The clash between career and conscience.

And I want to offer some quick reflections this afternoon on how the FCA is supporting and challenging industry here. Principally by focussing on promoting market integrity, around which much of the FCA’s thinking in the wholesale space is based.

The FCA market focus

So, if we look back to the year gone, a number of key wholesale themes emerged, which are now beginning to flesh out the characteristics of market integrity.

First, the principle of acting as a good agent. So, effectively putting clients’ interests before personal ones: whether we’re talking here about fund managers, corporate finance advisers, agency brokers or any others.

Second, clean pricing. So, firms and markets setting prices that properly reflect underlying supply and demand, liquidity and risk and aren’t subject to any kind of manipulation or other abuse. The LIBOR problem extrapolated, if you like.

Third, management of conflicts of interest in the use of information and all the questions we see here around how firms receive, hold and share information.

Fourth, financial crime, so markets not being used to support money laundering, avoiding sanctions, terrorist financing or any other activity of this nature.

And fifth, quality of market infrastructure – important questions over how innovations, like high frequency trading, and threats such as cyber-crime, affect the resilience of key trading platforms.

So, over the year, the vast majority of FCA activity has linked back to these five core themes and, from there, to the broader market integrity objective.

Some of this work has already concluded. Some is ongoing. Some is moving towards conclusion in the first half of this year, including a couple of the major thematic reviews we launched in the second half of 2013.

The first of these reviews was on the use of dealing commissions: so focusing on how asset managers operate as good agents for clients when spending dealing commissions – examining issues like accountability and transparency – as well as touching on the investment banking business model.

As part of this work, there was significant engagement with firms on both buy and sell side, on the FCA’s proposals to tighten up the definition of ‘research’, improve transparency on charging for bundled services, and desire to explore possibilities over the coming months for deeper, more profound change – if needed. We will be publishing a feedback statement after Easter,

The second review here was on best execution – again ensuring firms are acting as good agents of clients – and we’ll be releasing the full findings of this work in May, including analysis of how well firms act in their clients’ interests and the integrity of the price formation process – all building on messages already sent out to the trading community.

Conflicts of interest in the use of information

Looking further ahead, so to work beginning in the coming financial year, our focus firmly remains on those broad discussions around market integrity and what it means in practice.

And that’s why we’ve announced a number of important wholesale-related reviews this morning in our business plan. The two I want to touch on today relate back to use of information and upcoming work on benchmarks.

On the former, the question here is relatively straightforward: are firms properly protecting and managing information, putting their clients’ interests in front of their own?

Or, as one former trader has described it, does ‘real life get in the way of the best intentions of compliance’? In other words, does information flow too easily across Chinese walls?

The immediate risk here is the complexity of investment banking and its structures. There are, to paraphrase Michael Lewis, lots of ‘hidden gears’, with banks operating in multiple roles, with multiple capacities and in multi-billion pound markets. Annual UK revenue for wholesale banks and investment firms is upwards of £70bn a year.

As a result, there’s always going to be a significant level of confidential, sensitive information flowing in from interactions with clients: potentially creating opportunities to monetise and exploit conflicts of interest. Perhaps passing information on positions held by one client to another or by the firm using the information for the management of its own positions.

This is not necessarily to imply, of course, that these opportunities are being taken. But it is a flag for regulators and reason enough for firms’ senior management to be wary. Managing conflicts of interest around information properly should be part of any firms’ DNA.

So, come the second quarter of this year, the FCA will be launching a review into the effectiveness of controls over flows of information, looking at key issues, including how firms’ ‘business as usual’ activities and broader strategies take account of this risk.

Some priority questions here: do the integrated business models of the wholesale structure create information asymmetries between firms and clients?

And do firms then profit from these asymmetries? Either by using private information to support their own activities, or by withholding information from clients that should be disclosed.

Given the key role that investment banks play in the UK markets, it is important that we determine whether there are practices here which would concern us and, if they do exist, tackle them as quickly as possible.

And it would not be credible for me to discuss the proper use of information without mentioning the movements we saw in Friday’s markets. Media coverage Friday morning focused on a planned piece of work looking at how life insurers treat their legacy customers.
There was a clear reaction from the Market.

Whenever markets move as they did on Friday – scrutiny rightly follows – and this is no different for the FCA. If firms were involved in events like those we saw before the weekend, then we would ask serious questions. It is now incumbent on us to answer the same. That is why I fully support the investigation into Friday’s events announced by our Board. We will share the findings publicly in due course.

This was clearly not the FCA’s finest hour – but it does serve as a timely reminder of the importance to all parties involved in markets of the care and thought that is needed when handling the significant amounts of information we hold as a part of going about our day-to-day business.

Benchmarks: governance of trading activity and conflicts of interest

The second review we’re announcing is control and governance of traders around inputs to benchmarks.

From a purely personal perspective, I find it increasingly hard to believe – given the multiple warnings firms have had from cases like LIBOR – that new allegations of benchmark manipulation are still emerging.

One of the problems we have here is that as the public debate intensifies over issues like financial misconduct; excessive risk taking; bonuses and so on, so too does the risk to London’s reputation from the emergence of new cases that suggest lessons have not been learnt.

The announcement of today’s review on benchmarks is an opportunity for the City to tackle this perception. It is also an opportunity for industry to draw a line under one of the most significant challenges to the integrity of markets we have faced in recent history.

The key issue here is one of prevention. So, over the medium to long run, moving away from a climate of multi-billion dollar enforcement suits to one where potential challenges, including benchmark challenges, are dealt with proactively by firms and regulators alike.

Again, a few key questions here: how do firms apply the lessons from LIBOR? What are the behavioural drivers of conduct risk in benchmarks? Do firms manage their conflicts of interest? Are front office controls sufficiently robust? And, just as important, are firms incentivising risk taking through the use of discretionary compensation?

We expect firms to be clear about the relationships between benchmarks and trading activity. They need appropriate controls in place and these must be underpinned by the right culture – one that puts integrity at the heart of how a firm goes about its business, rather than exploiting a conflict in the pursuit of P&L.

We expect firms to have considered the lessons from LIBOR and applied these to their use of other benchmarks and to be managing the kind of trader behaviour we saw lead to manipulation.

On top of this, we also go back to that critical issue of leadership: do senior executives have enough influence over culture and behaviour? Do they encourage their traders to operate within acceptable standards?


This is a new environment, with more regulatory interest in ethics over rules, more focus on prevention rather than low-value clean up, and more focus on key issues like competition.

As we look forward, to the future of the City and its position as a centre upon which commerce must turn, it is important for leaders to engage positively in this debate.

2014-2015 will be another defining year. But it is an opportunity to create new possibilities for London and, importantly, significant progress towards the rebuilding of confidence that is vital to London’s success.