Individual Accountability and the “C” Word

Introduction

As a financial services regulator for over a decade between 1989 and 2000, a period which included the Barings collapse, the 1998 Russian crisis, BCCI, Orange County and LTCM, the letter ‘C’ was very prominent in my regulatory vocabulary (Client Assets, Conduct of Business and Counterparty Risk featuring particularly strongly). However, I cannot recall one discussion with any of the firms I supervised or within the regulatory bodies I worked for that focused on – or indeed even mentioned – the word ‘Culture’.

Indeed, for most of my subsequent career on the other side of the fence in regulatory and governance roles at major international banks, I don’t recall the concept ever being directly addressed by my successors at the Financial Services Authority (FSA). It was only in the immediate aftermath of the banking crisis in 2010 that the then CEO of the FSA (Hector Sants) made the first major statement on the subject, expressing the view that the regulator had to address the role that culture and ethics had played in the crisis.

In the five years following that speech – a period during which the LIBOR, FX, PPI and interest rate hedging scandals unfolded – there have been regular and more frequent references to culture in financial services. However, regulators arguably struggled with a concept that was acknowledged as being hard to define and measure and was therefore very difficult to supervise and enforce in practice.

The individual accountability regime

In publishing its findings into the Banking Crisis, the Parliamentary Committee on Banking Standards reflected that “One of the most dismal features of the banking industry … was the striking limitation on the sense of personal responsibility and accountability of the leaders within the industry … Ignorance was offered as the main excuse”. As a consequence, one of its core recommendations was the replacement of the existing approved persons regime with a new framework designed to “provide far greater precision about individual responsibilities”.

In March 2016, the new Senior Managers and Certification Regime (‘SMCR’) came into force for PRA and FCA regulated banks, building societies and the larger investment banks. The regime is being rolled out for insurers in late 2018 and is expected to apply to all other (i.e. FCA solo-regulated) firms at some point in 2019. In summary, the regime consists of:

• A list of Senior Management Functions (SMFs) reflecting key positions at executive (e.g. CEO, CRO, CFO etc.) and non-executive (Chairs of Boards and key committees) levels.
• A list of Prescribed Responsibilities (PRs) reflecting key matters such as culture, risk, financial crime, compliance and non-executive oversight that must be allocated to an SMF.
• The creation and ongoing maintenance of Statements of Responsibility (SoRs) for each SMF setting out their prescribed and other key responsibilities.
• A duty of responsibility under which the regulators may take action against an SMF if a regulatory requirement is breached within their area of responsibility and they did not take ‘reasonable steps’ to prevent the breach from occurring (or continuing).

SMCR and culture

Culture is at the heart of the new regime. Specifically, the current regime requires firms to allocate the following two PRs:

• Leading the development of the firm’s culture by the governing body as a whole.
• Overseeing the adoption of the firm’s culture in the day-to-day management of the firm.

The Financial Regulatory Authority (FCA) and Prudential Regulation Authority (PRA) expect that the first PR will be owned by the Chair and the second will be owned by the CEO placing responsibility for culture right at the very top of the organisation.

In addition to culture being ‘hardwired’ into the current regime via these PRs, recent speeches and publications reflect FCA’s acknowledgement that the new regime is its single most important tool in effecting cultural change. SMCR provides the regulators with the effective supervisory and enforcement tool it previously lacked.

In March 2018, the FCA took the unusual step of publishing a Discussion Paper (DP18/2) dedicated to “Transforming Culture in Financial Institutions” consisting of 28 essays by contributors including regulated firms, academics, other national regulators and philosophers. In the Overview section of that paper, the central role of the new regime in effecting cultural change becomes very clear:

“Culture is commonly held as the root cause of the global financial crisis. Ten years on, the SMCR is setting minimum standards for individuals in firms and driving a culture of accountability for misconduct”

Of the various essays in the DP, arguably the most insight into FCA’s thinking can be derived from the contribution by John Sutherland. Whilst listed as an ‘Independent’, he is also one of FCA’s Senior Advisors and his essay should provide a good sense of FCA’s evolving approach to (a) how it assesses firms’ cultures and (b) how it expects SMFs and Boards to oversee their own cultures.

In particular, he adopts the same approach as some other contributors by linking culture to behaviours and goes on to cite the four key drivers of behaviour as being:

• Trustworthiness of senior leaders i.e. do I trust what they say / do they ‘walk the talk’?
• Effective Communication i.e. do the messages from the top permeate through any silos and sub-cultures?
• Decision Making i.e. do decisions made at all levels reflect the firm’s culture?
• Incentives (financial and non-financial) i.e. are rewards aligned to the culture and not overly focused on revenue generation?

This continues the theme that Sutherland developed in a 2017 FCA Insight paper arguing that strong business cultures emerge when leaders start questioning how to influence behaviour.

Summary

The new regime was introduced to address perceived “striking deficiencies” in personal responsibility and accountability.

• UK regulators have progressed from labelling culture as a contributor to the financial crisis to considering it to be the “root cause” of those events.
• The current regime requires direct accountability for the development and adoption of the firm’s culture by the Chair and CEO.
• FCA is becoming more prescriptive about how it expects those individuals to discharge those responsibilities.
• Firms and senior managers should review existing approaches to cultural oversight in light of FCA’s developing thinking around behavioural drivers and the powerful cultural insights available through the use of increasingly sophisticated monitoring tools such as Behavox.

Vaughan Edwards ([email protected]) is a financial services professional with extensive experience in regulation and governance gained at regulatory bodies and major international banks and brokerages. His expertise includes managing relationships with regulatory bodies, managing major regulatory investigations and working closely with executive management and boards. He is currently a Director at Medius Consulting, which is an independent regulatory consultancy operating in the financial services market.