Speech by Marc Teasdale, Director of Wholesale Supervision – Supervision Investment, Wholesale & Specialists Division (SIWS), delivered at The Investment Association, Culture in Investment Management Forum.
Speaker: Marc Teasdale, Director of Wholesale Supervision – Supervision Investment, Wholesale & Specialists Division (SIWS).
Event: The Investment Association, Culture in Investment Management Forum
Delivered: 17 September 2020, 12:40pm
Note: This is the speech as drafted and may differ from the delivered version
- Our regulatory interventions in the asset management sector, such as the Asset Market Management Study remedies, and our continuing work on governance and conflicts of interest, are intended to more closely align the sector with its essential purpose of protecting and growing the capital and income of its customers over the long term. Firms should view the value assessment in particular as an exercise in purpose rather than simply an exercise in regulatory compliance.
- Firms with healthy cultures demonstrate strong governance that supports the daily delivery of their essential purpose. This is particularly true of the asset management sector, where strong governance is needed to appropriately address the conflicts of interest which, if unaddressed, have the potential to cause significant harm to investors.
- A meaningful focus on diversity and inclusion is essential both for strong governance, and to ensure that firms deliver on their purpose for all sections of society.
As you will know, the FCA has a strong focus on the role of healthy firm cultures in producing positive outcomes for consumers and markets, and so it is great to see that culture is such a priority for you too, both through today’s event, and through the broader work that you do on this topic.
The title of my speech today is 'a regulatory perspective: the drivers of culture, and the role of purpose and governance', but before I describe in more detail what I intend to cover, I wanted to start with a brief story. A friend of mine was recently at an event similar to this at a financial services firm (not, I hasten to add, in the asset management sector) where one of the speakers performed a brief experiment. Two statements of corporate purpose were produced, and the attendees were asked to identify which statement belonged to their own firm. Only half the attendees were able to identify their own firm’s statement of corporate purpose, meaning half chose the other statement, which, it transpired, belonged to a well-known high-street retailer. That second, less fortunate group, included the very senior leader who was leading the session for the firm.
Now, is this just a mildly embarrassing story, or does it really matter? This afternoon I hope to convince you that a firm’s purpose is centrally important to its culture, and will explore 3 inter-connecting areas:
- firstly, how the FCA views purpose, particularly in the Asset Management sector, and why a strong and genuinely held purpose is critical to good consumer outcomes
- secondly, how the FCA sees the role of strong governance in supporting that purpose
- finally, why we think an embedded focus on Diversity and Inclusion is essential both for strong governance, and to support meaningful purpose
Culture and the drivers of culture
I’ll start by explaining briefly what the FCA means by culture, and particularly what the 'drivers of culture' in the title of this speech is referring to, as it is an FCA term of art which is not necessarily always intuitive.
When the FCA refers to culture, we mean the typical, habitual behaviours that characterise a particular organisation. A firm’s culture in that sense is little more than the cumulative effect of the ways in which it acts. You will have heard us say before that we don’t have a prescribed view of what a firm’s culture should be, but we do think that understanding a firm’s culture is essential to assessing its likely impact on consumers and markets, and whether that impact is likely to be positive or negative. Consequently, through our work with firms, we have identified 4 factors that we think are particularly important in defining that culture.
The 4 'drivers of culture'
- Leadership including the tone that is set from the very top of the firm, and how effectively that tone cascades through the organisation.
- People policies, and in particular the types of behaviour that are incentivised or disincentivised within the firm, and how this is done. This most obviously includes remuneration, but also extends to a far broader set of considerations including progression, promotion, recruitment, diversity and inclusion, speak-up culture and psychological safety.
- Governance, in the broadest sense of how decisions are made within a firm.
- Purpose, which I will spend a little time describing.
The FCA view of purpose
Over the last couple of years, a lively debate on corporate purpose has developed, both here and in the US, which at times has come close to re-defining the role of the modern corporation.
Questions around the primacy of shareholder interests, and whether they are in tension with, or should even be subordinated to, the interests of a broader set of stakeholders, at their most expansive have become debates about the extent to which companies should explicitly seek to tackle broader societal issues such as climate change.
The FCA sees corporate purpose as a fundamental driver of culture, and so I want to be clear on how the FCA view of purpose fits within this broader debate.
We see a firm’s purpose as being a description of its economic function, and how it makes money. On one level, this is just a description of a firm’s business model. But we also go further, and say that in order to understand how a firm’s purpose drives its culture, you need to understand how a company describes, to itself and others, the essential purpose of the firm, its products and its services, and so its reason for existing, and why the world would be worse off without the value it provides. We are also critically concerned with how far we can see this purpose tangibly driving the decisions made at all levels of the firm.
To give a slightly laboured example from a different sector, imagine 2 firms involved in Equity Capital Markets business. Firm A describes its purpose as being to maximise the returns of its shareholders by being the biggest ECM player. Firm B describes its purpose as being to support the sustainable growth of companies that provide jobs, products and services to the wider economy. Both descriptions of purpose can describe the same basic business model (facilitating the provision of equity capital to corporates) but it doesn’t take much imagination to see how each could drive quite different outcomes in terms of the deals that are approved and declined, and even the way in which that business is conducted.
So, when the FCA talks about purpose, it really means that combination of a firm’s business model, and the way in which it thinks about the social or economic contribution it provides. And in this context, we are not necessarily looking for whether a firm can demonstrate a broader social purpose such as fixing climate change or regenerating socially deprived cities or regions. We recognise instead the social value inherent within a business providing financial services and products well, and with a strong sense of the need to demonstrate positive outcomes for the customers it serves and the markets it operates in.
In our experience, where a firm is unable to articulate its purpose in this way, we are more likely to see poor outcomes for consumers and markets. Although we don’t often describe it this way, much of what we do can be seen as regulating to produce an industry or sector more closely aligned to a normative view of that sector’s purpose.
To give an example, operational resilience is a significant priority for the FCA for all firms, but for some firms the resilience of their service is arguably essential to what they offer society. Two sectors that I supervise along with asset managers, and with which you will be familiar, are exchanges and custody banks.
We would say that for firms in these sectors, strong operational resilience is so inherent to the service they provide, that it must form a core part of their purpose. An exchange that isn’t investing appropriately to ensure the market will be there when people expect it to be, or a custodian not doing everything it reasonably can to ensure it is taking proper care of the money and assets entrusted to it, are not meeting the basic reasonable expectation of the purpose those businesses are expected to perform. Our supervision of these firms reflects this view.
Indeed, we would also go further, and say that such firms should not see operational resilience primarily as a regulatory issue, but rather as a business priority, as it goes to the heart of the implicit contract they have with their customers.
In our experience, purposeful firms are therefore more likely to have a culture that produces beneficial outcomes for consumers and markets. It therefore also follows that it is essential that purpose is not just a slogan on a brochure, or above the head-office reception, but can be seen manifestly in the choices that a firm and its employees make day in, day out, at all levels.
So, to come back briefly to my opening story, if half a firm’s employees can’t distinguish between their own corporate purpose and the corporate purpose of a shop they may visit at the weekend, in what sense can that firm be said to have a purpose in a meaningful way at all?
Purpose in the Asset Management Sector
What does this mean for the asset management sector?
The UK’s asset management industry is a genuine and widely acknowledged success story. The industry has developed a concentration of experience and expertise that sees it now manage almost £10trn in assets, and demonstrate clear thought leadership in areas such as ESG and stewardship. One tangible impact of this strength is the contribution the industry makes to UK plc through tax revenues, high quality jobs, and the essential role the buy-side plays in anchoring the broader financial services eco-system that is a true national asset.
But more important still is the critical role the asset management industry plays for society as a whole. The structural shifts that we have seen in pension provision over the last 20 or so years, and the implications that shift has for the ownership of investment risk within society, together with the long-term demographic changes that have attended that shift, mean that the asset management sector plays a more critical role than ever in overseeing the savings and investments of millions of individuals within the UK and beyond. The success of the sector in protecting and growing the capital and income of its customers over the long term will be central to the ability of all of us to provide for our retirement, our long-term health and care needs, and other significant lifestyle events for ourselves and our loved ones.
This view of the purpose of the asset management industry is underpinned in law through the obligation of an Authorised Fund Manager, or AFM to act in the best interests of investors, and was central to our thinking when we undertook the Asset Management Market Study. As you will no doubt be aware, when we looked hard at the asset management sector during the course of the Market Study, we formed the view that this purpose was not being consistently met.
To take one example, we highlighted the practice of funds taking risk-free box profits to the P&L of their investment manager. When we looked at this practice in detail, we took the view that it was hard to see it as anything other than rent extraction – the removal of economic value without any corresponding benefit to investors, and so fundamentally inconsistent with the purpose of the asset management sector. Our consequent intervention more closely aligned the practices of the industry with a normative view of its purpose.
Similarly, the value assessment is the centre-piece of the Market Study remedies, and our profound hope is that the industry will see this as an exercise in Purpose, rather than simply regulatory compliance. The value assessment is a firm’s opportunity to explain clearly to its staff and its customers what value its basic business proposition provides, and then to put real rigour into assessing the extent to which it actually delivers that value. Where there is mismatch, we expect firms to take action to improve the proposition they are offering to their customers. We would also say that purposeful businesses should be doing this anyway.
The role of governance in supporting purpose
The title of my speech today explicitly links purpose and governance, and one of the reasons we have been as vocal as we have about governance in the asset management sector is because we see governance as being critical to the success of firms in delivering long-term returns for investors. In this context, when we refer to governance, we don’t just mean the formal governance at the Board or most senior levels, but rather are also focussed on the broader set of processes, systems, controls and arrangements by which decisions are made and business gets done. Given our view that meaningful purpose should be seen tangibly in the decisions firms make, it is not surprising that we see such a strong link between governance and purpose.
When we sent our portfolio letter to asset management firms in January of this year, we stated that “Overall standards of governance, particularly at the level of the regulated entity, generally fall below our expectations”, and so I will spend a little time explaining what we meant.
The Asset Management Market Study itself diagnosed weak governance as an important root cause of the sector’s failure to consistently deliver good value, especially as the demand side discipline that might otherwise help produce good outcomes, seemed particularly weak in much of this market. The inter-connecting governance remedies produced by the study, specifically the requirement for 2 independent directors on the AFM Board, the value assessment itself, and the new prescribed responsibilities under the Senior Managers and Certification Regime (SMCR), were consequently aimed at ensuring a fuller representation of the interests of investors in firms’ decision-making.
Good governance however does not stop at the Market Study remedies. Much of the work on governance that we do with firms seeks to build further on the work of the Market Study by addressing the connected priorities of regulated entity governance, and the appropriate management of conflicts of interest. The robustness of governance at the regulated entity level is important generally for the FCA, but this is especially the case in the typical asset management group structure. This is because such a structure creates an inherent conflict of interest between the AFM which has an obligation to act in the best interests of investors, and the delegated investment manager from which services are being procured.
We often see insufficient consideration being given to the conflicts being further embedded within the typical group structure through heavily over-lapping AFM and Investment manager Boards, or the appointment of AFM Board members with Group roles and reporting lines that give them a direct interest in the revenue or profitability of the delegated investment manager.
A lot of work has been done in this area, and we have seen real progress being made, but to return to my earlier theme, we see the effective identification and management of conflicts of interest as an expression of purpose for asset managers. At the heart of the asset management sector sits a necessary conflict of interest, the agent/principal conflict, or the 'other people’s money' conflict, and we would argue that a truly purposeful firm will embed an alertness to this conflict in the DNA of its organisation.
This goes further simply than a compliance exercise or putting controls on the side of a firm’s day to day business. So we would ask, how far do your people see managing conflicts as inherent to the job, and so as part of their purpose, or how far do they see it as a compliance issue, or simply a process to be followed?
The importance of diversity and inclusion for both governance and purpose
I have spoken a lot about purpose today, because we see it to be such a strong driver of a firm’s culture. We also think that firms that have the best interests of their investors driving their decision-making are not just more likely to deliver consistently good conduct outcomes, but are also likely to be successful businesses in the longer term.
But before I finish, I wanted to speak about the importance of diversity and inclusion in supporting both strong governance and meaningful purpose.
I’m sure you will have heard the FCA speak before about why we believe that diversity in financial services firms, and an inclusive approach to that diversity, lead to better decision making, and in turn to a reduced risk of harm to consumers and markets. Diversity has many dimensions, and so people with different life experiences (whether because of their race, gender, age, sexual orientation or other characteristics) can bring significantly new thinking, and new approaches to problem-solving and decision-making. This is why we are focussed not just on diversity at the Board level, but throughout an organisation. Truly safe cultures support that diversity with an approach to inclusion that enables employees to bring their whole selves to work, and that creates a safe environment for people to present differing views, challenge accepted norms, and even call out where things may be going wrong. It follows therefore that firms that seek out and welcome diverse and differing views are more likely to successfully identify and manage risks, be less susceptible to group-think, and generally make better decisions.
Although there is still much progress to be made, the focus of organisations such as the Investment Association on diversity and inclusion, and the increasingly meaningful actions we see firms taking, show the sector is trying to move in the right direction.
We have said less to date though as an organisation about the extent to which a whole firm approach to diversity and inclusion is necessary for a meaningful purpose, so in finishing I’ll raise some questions that you might reflect on after today.
If the basic purpose of the asset management industry is to act in the best interest of investors, that must mean all investors, irrespective of their gender, ethnicity or other characteristics. How far has D&I within your firm progressed from a discussion about staff to a discussion about your customers, and how far do you view your purpose in this way?
To give just one example, in retail markets where data science and AI are increasingly used to automate decision-making, research suggests that algorithms can result in discrimination between ethnic groups. As these technologies increasingly spread through all sectors of financial services, including asset management, how far could this also be true of your business? Would you be able to tell if this was the case, and what are you doing to ensure it isn’t? What are the ways in which your firm culture has the potential to result in different outcomes for different groups? What data if any do you hold on different groups with different characteristics, and how is that data used?
In conclusion, from what I have said today I hope to have convinced you of 3 things:
- firstly, that in all sectors, but especially the asset management sector, a meaningful purpose is critical to good customer outcomes
- secondly, that governance, the way a firm runs itself, is fundamental to that purpose
- finally, that a proper focus on D&I is essential to both
I also hope you will agree that the questions I have left you with, whilst being potentially difficult to answer, are increasingly vital.