Conduct and culture – AI for the boardroom

In this feature, Radar examines the growing demand for senior management to assess, analyze, measure and improve the culture within their own enterprise. We go further to identify the drivers for this change, the benefits related to success, and the downside for a failure to get to grips with this discipline.

What is culture?

Culture comes and goes – as intangible and changeable as the ether, it seems hard to grasp. We have heard mention of it to describe the fabric of society, and it is increasingly a part of the corporate environment. But how can it be defined, especially where the senior managers of an organisation are trying to pinpoint what their own culture is and how that manifests itself in the cycle of business life?

A dictionary definition is a good place to start: the values, beliefs, knowledge and understanding shared by a group with a common purpose; company culture is the personality of a company, what it stands for. At a recent risk management conference in London, one commodities firm revealed how it focuses on culture and connects that to its risk management practice. It uses an A-B-C model comprised of the connectivity between attitude, behavior and culture; group culture arises from the repeated behavior of its members; behavior is shaped by underlying attitudes, and both are influenced by the culture of the company. Culture includes observable and unobservable aspects. The unobservable are shared values, beliefs and assumptions.

Industry professionals we spoke to seemed to agree it is a tough attribute to begin to define. One observed, “ongoing confusion around culture and conduct, and firms just not being at all clear. Firms have statements of ethics, statements of culture, but it’s all very blurred at the moment.”

Paul Anderson, partner at Squire Patton Boggs, feels culture is often blamed for a more common malaise, like an outdated business model that is part of an old management regime and unable to adapt. He makes the connection between this and the board, “a lack of cultural leadership means a business will not have a cohesive direction.”

Chris Brennan, partner at White & Case, chimes in, “it is pretty easy to spot very poor culture and the manifestations of that are often very evident. I have worked with one or two clients like this where it has shone through, it was behaviour across the business and was very much a leadership issue at the centre of it.”

Andrew Bailey, chief executive of the UK Financial Conduct Authority, said this about accountability and culture in the recent FCA 2019 Business Plan, “…fundamental change in conduct cannot be delivered solely by rule changes [referring specifically to the new Senior Managers and Certification Regime (SMCR)]. Those who work in financial services must embrace the principles of responsibility and accountability as well as the process.”

Culture is a word that has been a constant in “regulator-speak” in the last few years. A recent Dear CEO letter sent by the FCA to the chiefs of the wholesale brokerage sector talks about the need for firms to operate in an appropriate culture and control environment; it concludes that this sector has made less progress embedding a culture of good conduct [than others], and that it lacks a culture and mindset to estimate the risk of brokers committing market abuse.

Brennan adds, “organisational psychology is the science behind cultural assessment but it only seems really apparent when exemplary or totally rotten. I think back to a fraud at a large fund manager which led to a focus on culture from the then regulator (IMRO), edicts about ‘tone at the top’ and and a furore for a year or two in the 90s before it dissipated. This time it is very different.” He continues in the same vein, “if people understand and want to deliver a company’s values, it just comes down to acting with professionalism and integrity. The basics of proper standards and professionalism have long been understood and adopted by 90 percent of the industry.

Is it just gutfeel?

The practitioners we spoke with had a number of fascinating stories related to external independent analysis of certain situations at various firms. Paul Anderson relates, “at one firm we know, an interim head was sent in to diagnose why performance was weak. He very quickly worked out that the culture was ‘old school’, lots of entertainment at lunch and not much work after 2.30pm. They expected to win business based on this; from the top, the business culture and model were wrong.”

One of the key messages from these anecdotes is that it is more effective to use an independent view to really assess the existing culture – often those within are unable to be objective as they have been there so long, are part of the problem, or are in total denial. Regulators confirm this and state that they can sense “an issue” almost immediately when they interact with certain firms.

Governance

The latest Dear CEO letter mentioned above makes it clear to the market that the regulator wants to see a strong governance framework that allows culture and values to drive decision-making in the business. Paul Anderson sees the follow-through saying, “our instructions on governance recently show that the boards are increasingly mindful that they need to provide leadership (and that message is persistent in FCA speeches with SMCR really focusing the mind). Now we get maybe the FD or the CCO saying they are concerned about the following issues etc. We are seeing individuals standing up and saying we need to do more in this area, can we use the lawyers or advisers to reform our approach?”

Individual accountability

The rise of new regimes like SMCR in the UK and the Manager-in-Charge Regime in Hong Kong seem to be growing in application globally across the regulatory community. Chris Webber, partner at Squire Patton Boggs, believes that in the UK, SMCR will be the regulatory mechanism to drive home the regulator’s messages around culture “all the way through the firm down to the front line staff, with fitness and propriety assessments – this will be tough for some as some won’t make it. The process of implementing SMCR will probably force some firms to let some people go or to retrain or reallocate them. That is where culture gets real, when people lose their jobs because the firm can’t vouch for them.”

Michael Ruck, partner at TLT, analyses the way that business failings might be linked to culture and the repercussions this might have for individuals in the new environment: “enforcement action against a senior manager for failing to instil the appropriate culture in their organisation will be hard to achieve. It goes to the burden of proof. For a supervisory relationship, the regulator can express concerns and suggest areas it wants a firm to work on or review or change, without meeting any burden of proof or expecting challenge. In the past the regulator finds a specific instance where there has been a breach (eg mis-selling or financial crime) which is pretty binary and can be pointed at as a failing. But when looking at a cultural issue such as discrimination, it may have binary examples but it is harder to prove it permeates throughout the whole organisation.”

Where there is smoke, is there always fire?

The regulated have some misgivings about where this might go. The inference from the regulator rhetoric is that a finding of cultural weakness in one area of the business is unlikely to be an isolated incident and will encourage the regulator to dig deeper to find similar failings in other areas of the business. Sam Tyfield, partner at Vedder Price, puts it this way, “If the FCA has a concern about Small Thing X in a firm’s business, it is going to assume that Small Thing X is symptomatic of Other Things Being Wrong. Small Thing X opens the door to supervision and enforcement to peer into other nooks and crannies.

He continues, ‘‘that is not necessarily a bad thing (firms should be able to withstand scrutiny) but since the FCA is able to insist that every question it asks or demand it makes of a regulated person is “in furtherance of ” the FCA’s statutory authority and the FCA is able to back that up with enforcement tools, this gives the FCA enormous discretion to decide ex post facto whether, in its view, Small Thing X is symptomatic of a wider problem.”

Vaughan Edwards, specialist regulatory adviser and partner at Elixirr, thinks that the first culture action would have to be “a pretty egregious case and not be in any doubt or some sort of ‘should he have, shouldn’t he have’ territory. The most obvious example might be a trading desk that gets up to no good. In the course of the investigation, it becomes apparent that this desk was clearly a conduct and culture outlier and that either there were no metrics that told the CEO that because he or she never invested in those metrics as they never had that control infrastructure despite having that responsibility. Or even worse, there were metrics that clearly told the CEO that they never attended training, they had lots of PA dealing breaches, they were regularly committing racial abuse in their chats and whatever else. If that happens it’s not going to be a pretty picture and I would expect FCA to go after not just the individuals but go after the CEO for a fundamental cultural training failure.”

He notes that the banking sector has really been under the microscope for a while and has got itself into shape after the financial crisis and the multiple scandals that have dogged the industry as they have been fully exposed to the public and governments in the last 10 years. He rings the alarm bell for other sectors, especially with the advent of SMCR across the rest of the market, “the recent cases that have been revealed in the Lloyd’s Insurance market point to some fundamental culture and conduct issues. Diversity is much more in the firing line, this whole idea of conduct out of work and if you take the insurance thing out of the picture there’s all the same references to the drinking culture and the aggression and the bullying and everything else that came out in that one particular court case. We have seen this hit hard in banking and broking. I’m qualifying the idea that they’ve been left until last, I think insurance is very much in the firing line now and there’s a question mark as to whether there’s not dissimilar issues in parts of the asset management industry.”

Measuring the unmeasurable – the regulator leading by example

There is no better place to shine a light in such an opaque area than the banking regulator of the Netherlands, De Nederlandsche Bank (DNB). All roads around cultural metrics and methodology lead to this regulator. In fact it has even written a 334-page book online explaining its approach called “the Supervision of Behaviour and Culture”. The Irish Banking Regulator was so impressed that it asked the DNB to work on a joint cultural analysis of its own key lenders after their recent tracker mortgage scandal.

What has the regulator been doing, for how long and with what impact? The process started about 10 years ago, just after the financial crisis. The regulator had received a lot of signals indicating behavioural problems in the boardrooms. DNB saw the need for an instrument to analyse such cultural issues at board level to help pinpoint future risks. In 2010 it hired psychologists and social scientists as permanent staff and they developed a methodology to identify cultural issues and a model to define culture in the context of supervision and regulation. Up until now, DNB has conducted close to 110 cultural assessments at financial institutions; the specialist team has supported ongoing supervision in many cases.

The DNB then exposed its thinking and process to the firms and banks in order to be transparent and get their views. The general reaction was that it was logical and they wondered how this instrument would work in the toolbox of the regulator, when the instrument was so subjective. The 15-person “culture” team at DNB works within a horizontal supervisory framework looking at issues of governance, behaviour and culture at banks, insurance companies, pension funds and trust companies. As part of DNB’s annual risk assessment, the department – in collaboration with the supervision team – performs an annual offsite assessment. Every firm gets two scores (on behaviour and culture; on governance). This score is a risk driver, not a risk in itself, that might trigger risks like integrity, market risk, credit risk etc. It is an indicative factor in the supervisory agenda – if there are high risk scores or the management cannot explain what is happening, DNB does a deep dive with the supervisors and creates a cultural profile based on its own model, using focus groups to look at specific areas.

Each company has a distinct, broad culture and subcultures and the DNB uses surveys, interviews, document reviews and observations in a focus group which might include the board or a department if deemed high risk to the market. The team presents “a mirror” to show the institution and asks if it is a true reflection. It also presents remediating measures.

The impact of this approach is that culture is now on the agenda for every institution. Most had struggled before as to its meaning and the best way to deal with it (should HR or marketing do it?). Now it permeates the very top of each organisation and is much more part of their daily work. The supervisory focus helps to guide the management board about the dynamics required and emphasizes self-learning and self-regulation to stimulate the culture itself. It is not as prescriptive as other areas of supervision. It is a new way to position the regulator relationship and some at board level have admitted that they think they might be the problem and can only change if they get external coaches or advisers to the board to rectify this.

How has this affected supervision? The assessment gives the supervisors a holistic view where previously they looked at specific risks eg market or interest rate risk. It gives them a potential underlying behavioral root cause of an issue so they are starting to connect the dots and allow earlier intervention. DNB’s aim is not solely to measure and assess the culture and behavior that characterises the firm, but to initiate a constructive dialogue within the board so that it is always reflecting on the outcomes and improving its effectiveness.

The market approach to culture metrics

Talking to the market about the evolving approaches to measuring culture reveals that this is far from standardised and some are much further ahead than others. Most seem to agree that the approach has to be delivered by independent analysis (for firms with more than 100 employees) to be of any worth. The CEO asking his employees how things are going at a company event or during a face-to-face interview is not going to drive many honest results. They agree that surveys are often only of marginal value. Mystery shopping providers are used on occasion, and some firms are clearly better at actually evidencing culture and conduct through metrics. For many, proxy metrics are employed such as the number of personal account dealing breaches, T&E breaches and training attendance, among other things.

Monica Gogna, partner at Dechert, states, “others are starting to get more sophisticated and behavioral science tools are becoming more favoured. I think it’s really positive that the FCA are looking at this and trying to find more sophisticated ways to measure culture. I think it is really difficult. There is no easy solution here, whether it’s #metoo or diversity or overt or underlying criticism. These are not necessarily things that get washed away with a bright and shiny behavioral analytical tool. But I think that having it hand in hand with a real desire to want to have a good culture, to try to have a really deep and effective integration and implementation program across your firm, plus an accurate way to monitor the culture and the effect on individuals, a combination of that over time I hope would move the needle and increase the chances of a better culture.”

Chris Brennan says that some boards seem to be experimenting more, but do not necessarily know what they want to achieve, perhaps asking McKinsey to analyse and sample and come back every six months to look at culture and cause and effect. Some are taking a more obviously punitive line where “breaches” result in reduced compensation.

Is culture being related to commercial success and can the board expect long-term benefits?

Andrew Bailey leaves those he regulates in no doubt when he says, “we believe that a healthy culture is good for business as well as for consumers and for markets as a whole.” Peter Driscoll, Director of the US Securities and Exchange Commission’s Supervisory unit, OCIE, said at a recent conference in Florida, “without a solid compliance culture, supported by a sincere ‘tone at the top’ by senior management a firm stands to lose the hard earned trust of its clients, investors, customers and other key stakeholders.”

Monica Gogna reminds those with conveniently short memories of the financial crisis, “when you look at the impact that it had on the now-leaders of the industry, many of them are survivors of a huge amount of job-culls that happened when they were moving up the ranks. They saw the real effects of instability, so they’re very conscious and cognoscent of the fact that culture is a really big part of a successful firm. I hope people are looking at these initiatives saying this should allow them to attract the right type of talent, open-minded and diverse, to create an environment in which innovation happens. However, not everybody is equal. When you look at it from that perspective there may be people who need the stick as opposed to the carrot. If that means that regulators have to, as they are, introduce new regimes or introduce tools that monitor this behaviour to make that change, I think that’s a valid thing for them to do.”

Chris Brennan is less optimistic, saying that “scaremongering has been widespread here; it will improve culture but may paralyse people into not risk-taking, not innovating and homogenising. There is now a constant focus on covering backsides, without the freedom to do what they need to do. The banking world is under pressure at a tough time in terms of economics and part of that is this impediment that is restricting innovation. You don’t see the same issue in the fintech sector which is fearless right now.”

He goes on, “the nadir of bad culture came through in the chat rooms which, when revealed, were not only despicable but wholly unprofessional. We have seen a litany of mis-selling scandals, pensions, endowments, precipice bonds, PPI. They exhibit behavioral issues where people prioritise their own financial gain over the needs of their customer and that has to stop.”

Culture is here to stay so what are the key takeaways?

The boardroom is much more aware of its need to analyze culture than ever before. It seems that this is in part dictated by a moral duty and in equal measure being driven by regulatory pressure and the threat of new sanctions (potentially individual liability). There is a collective belief in the need to repair the image of the banker that has been tarnished by a constant stream of negative imagery epitomised by the Wolf of Wall St, Nick Leeson, Gordon Gekko and Bobby Axelrod. Many feel that scandals on the scale of the LIBOR rigging and FX manipulations will pose an existential risk to an industry that is operating on alarmingly thin margins.

There is still a long way to go in terms of actually measuring culture and using that data to the advantage of the firm – it needs to be regular, consistent and objective to be of value and it needs to look at factors that help the organisation to manage its risk, retain morale, employee loyalty and drive commercial advantage.

There is hope. Everyone we interviewed for this article confirmed that there is huge willingness to improve culture and everyone is using best efforts, with the qualifier that some may not be moving at pace or with much direction right now, inhibited by sheer scale, a generational challenge and limited skillsets.

It is also evident that the financial services sector is not the only industry vertical where culture and its measurement should become a priority.